Big Picture View

Here is a summary of our big picture view of the markets. Note that our short-term views may differ from our big picture view.

In nominal dollar terms, the BULL market in US Treasury Bonds that began in the early 1980s will end by mid-2010. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

The stock market, as represented by the S&P500 Index, commenced a secular BEAR market during the first quarter of 2000, where "secular bear market" is defined as a long-term downward trend in valuations (P/E ratios, etc.) and gold-denominated prices. This secular trend will bottom sometime between 2014 and 2020. (Last update: 22 October 2007)

A secular BEAR market in the Dollar began during the final quarter of 2000 and ended in July of 2008. This secular bear market will be followed by a multi-year period of range trading. (Last update: 09 February 2009)

Gold commenced a secular bull market relative to all fiat currencies, the CRB Index, bonds and most stock market indices during 1999-2001. This secular trend will peak sometime between 2014 and 2020. (Last update: 22 October 2007)

Commodities, as represented by the Continuous Commodity Index (CCI), commenced a secular BULL market in 2001 in nominal dollar terms. The first major upward leg in this bull market ended during the first half of 2008, but a long-term peak won't occur until 2014-2020. In real (gold) terms, commodities commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

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Outlook Summary

Why we almost never write about gold market manipulation

Some gold bulls believe that direct intervention in the gold market by the US Government and/or a cartel of mostly-US banks is the most important, or at least a very important, influence on the gold price. We will now present the main reasons why we disagree, and, therefore, why we devote almost no commentary space to gold market manipulation.

We are not going to argue with the idea that attempts to manipulate the gold market occur on a regular basis, because it wouldn't surprise us if they did occur and if the US Treasury were somehow involved. Our arguments are that if gold market manipulation has occurred then it has been ineffective; that it must always be ineffective given the tools the so-called manipulators have to work with; and that gold market manipulation is trivial compared with the other efforts that are routinely made to influence the financial markets, the economy, and the public's expectations. We will now expand on these arguments.

We've noticed that the commentators who most vociferously advocate the "manipulation-is-a-dominant-influence-on-the-gold-market" theory tend to fixate on very short-term price action, such as intra-day fluctuations. However, we have absolutely no interest in gold's intra-day price movements except to the extent that these movements affect the major price trend. And what we see when we look at the major price trend is that over the past two decades gold has done exactly what it should have done considering the financial/economic conditions that prevailed along the way. To illustrate what we mean we have included, herewith, a chart of the gold/CRB ratio covering the past 20 years. By reviewing gold's performance in terms of a basket of commodities, rather than in terms of the US$, we effectively remove changes in the US dollar's purchasing power from the equation and thus get a glimpse of how gold performed in real terms.

The chart shows that gold drifted lower relative to commodity prices in general during the 1990s and then embarked on a huge bull run in early 2001. Gold, today, is about 240% higher than it was 10 years ago relative to the CRB Index. Moreover, this dramatic out-performance by gold is consistent with the goings-on in the financial world since 2001, as was the preceding decade of relatively poor performance. In particular, gold should do comparatively well during multi-year periods when economic growth is sub-par, confidence is waning and the authorities are pursuing inflationary policies (as was the case during much of 2001-2009), and relatively poorly when economic confidence is high or on the rise (as was the case during the bulk of the 1990s).

The second and third of our arguments are inter-related, so we will deal with them together.

It is said that the government and the financial establishment have a motive to suppress the gold price in that a high and rising gold price signals some sort of financial or economic problem. This is true to a certain extent, although most people outside the "gold community" really don't care what happens to the gold price. Also, a benign explanation for a large rise in the gold price could always be sold to the public as long as interest rates and economic statistics failed to reveal an inflation problem. For example, monetary inflation was responsible for the bulk of the rise in the prices of industrial commodities during 2003-2008, but most people were easily convinced that "Peak Oil" and the real economic progress of the "BRIC" countries were the primary causes.

Which brings us to the point that "they" don't need to suppress the gold price in order to create the illusion that there is no inflation problem because "they" already have control over economic statistics and considerable influence over interest rates and the money supply. In other words, "they" manipulate things that are orders of magnitude more important than the gold market.

Influence over the money supply leads to influence over the stock market because equity prices usually respond far more quickly to money-supply changes than do the prices of goods and services. In fact, despite all the talk of a "Plunge Protection Team" the only way that an over-valued stock market could be 'propped up' beyond the very short-term is via a large increase in the money supply. This is because the financial resources that could potentially be brought to bear in an effort to directly support the stock market will always be tiny relative to the market's overall size, especially since we are talking about a GLOBAL market (the performance of the US stock market is tied to the performances of other major stock markets around the world, and vice versa, so we are talking about tens of trillions of dollars of market capitalisation). That is, the average equity price could only be maintained at an artificially high level by reducing the value of money.

Unfortunately for the manipulators, the gold price could only be suppressed beyond the short-term by clamping down on the money supply. The reason is essentially the same: the markets are way too big relative to the resources that could be mustered for the purpose of direct intervention, especially considering that gold is more closely associated with the multi-trillion-dollar-per-day currency market than with the much smaller commodity markets. This means that -- very short-term considerations aside -- the gold price could not be suppressed at the same time as the stock market was being 'propped up'. Hence our statement that gold market manipulation must always be ineffective given the tools the so-called manipulators have to work with.

In summary, the only gold market manipulation of real importance occurs indirectly -- via the manipulation of economic statistics (CPI, GDP, etc.), interest rates and money supply -- but this means that attempts to suppress the gold price will come into conflict with other strategies. Of particular note, an effective strategy for boosting the stock market could not be implemented in parallel with a concerted effort to suppress the gold market.

The events of 2006-2008 are a great example of what happens to inflation-fueled stock and real-estate markets when monetary policy is carefully tightened in an effort to 'cool off' an inflation-fueled commodity market. And the events of November-2008 through to November-2009 are a great example of what happens to the gold market when the manipulators engineer a huge surge in the money supply in an effort to support the stock market and the banking establishment.

Before we leave this topic we'd like to address two related points, the first being that those who fixate on market manipulation often shoot themselves in the foot by putting forward theories that are just plain silly. Governments and their central banks regularly manipulate critically important information, such as the price of credit, and the effects of these manipulations deserve exposition. Why, then, do the manipulation theorists feel the need to come up with wildly implausible scenarios? An example of what we are referring to is the "tungsten gold bar" story that recently did the rounds. Other examples include the claims that a) the Gold ETF (GLD) is not backed by physical gold*, and b) the Central Bank Liquidity Swaps of September-October 2008 were done to manipulate the US$ upward on the foreign exchange market**.

The final point we'd like to make is that you will never learn anything from your mistakes in the financial markets if you look externally for someone to blame.

    *A good explanation of why these claims are completely false can be read at http://silveraxis.com/todayinsilver/2009/12/22/charlatan-exposed-gld-audit/#more-957.
    **The Central Bank (CB) Liquidity Swaps involved the quick-fire injection of about 500 billion dollars into the currency market. Unless the Fed has found a way to reverse the laws of supply and demand, the price of something cannot be pushed upward by rapidly increasing its supply. In reality, the CB Liquidity Swaps were a reaction to the sudden disappearance of liquidity throughout the world and the resultant sharp rise in the US dollar's exchange value. They were, in effect, an attempt to manipulate the dollar LOWER, not higher.

Natural Gas Update

The Stock Market

It was a little late in starting, but last week's decline in the US stock market was consistent with the Presidential Cycle as illustrated by the chart in the 6th January Interim Update. Recall that the average performance of the US stock market during the 2nd year of the Cycle (2010 is the 2nd year) encompasses a January pullback, an upward bias from early February through to April, a downward trend from April through to early October, and then a rebound into year-end.

If the market adheres to the 2nd-year Cycle average then the current pullback will be complete by the end of this month.

The following chart provides another reason to believe that the current pullback will end within the next week or so. Even though the downturn has just commenced, the chart shows that the NYSE's McClellan Oscillator (MO) is already nearing its lowest levels of the past year. In other words, by this measure the market is already approaching an 'oversold' extreme.

Many journalists have linked last week's sharp downward reversal in the US stock market to Obama's threats to restrict the activities of the big banks, but this explanation doesn't make sense in light of the following chart of the BKX/SPX ratio (the Bank Index relative to the broad stock market). The chart shows that bank stocks have been out-performing the broad market since late December and continued to demonstrate relative strength last week. This, in turn, suggests that market participants collectively believe that nothing more than hot air is emanating from the President's mouth.

So, what did cause the turnaround?

We don't know. Financial journalists like to explain all market moves by pointing to the latest news, but the markets aren't that straightforward. At any given time, prices reflect the decisions of thousands, or perhaps millions, of market participants with their own reasons for buying, selling or holding. Sometimes there will be a specific news-related catalyst for a market move, but more often than not there isn't one.

This week's important US economic events

Gold and the Dollar

Gold

Our view is that gold-stock indices such as the HUI made intermediate-term peaks on 2nd December of last year, which means that we aren't expecting them to make new highs during the first half of this year. However, the situation in the bullion market is different. Our view is that gold bullion made only a short-term peak in early December and stands a good chance of making a new high over the next few months -- in parallel with a decline in the Dollar Index to test last year's low.

The lateral support in the $1070s drawn on the following daily gold futures chart has been mentioned in TSI commentaries as a logical target for a correction low. February gold traded at $1082 on Friday, so this target has essentially been reached. The correction could therefore be complete, but until a correction low is confirmed via a sign of strength the risk of a further decline -- to $1050 or, perhaps, all the way back to major support at $1000 -- will remain.

An example of what would constitute a "sign of strength" is a daily close above the 50-day moving average.

Last week's swoon in the broad US stock market increases the probability that the US Monetary Policy Statement to be issued on 27th January will reiterate the Fed's plan to keep its interest rate target near zero indefinitely. This should lend support to the gold market.

Gold Stocks

Current Market Situation

Over the past 10 years, intermediate-term HUI corrections have resulted in peak-to-trough declines in the 25% to 40% range. The 2nd December high was 516, so a 25%-40% decline would result in a correction low in the 310-387 range. At Friday's intra-day low of 396 the HUI was therefore close to matching the minimum requirement.

As well as achieving a peak-to-trough decline of at least 25%, all the intermediate-term corrections of the past decade have also resulted in the HUI trading below its 200-day moving average and the HUI's RSI moving below 30. The following chart shows that it wouldn't take much additional weakness from here to meet these requirements.

The HUI held up remarkably well on Friday in the face of a decline in the price of gold bullion and substantial weakness in the broad stock market. This sign of strength, combined with the fact that the HUI has almost met the minimum requirements for an intermediate-term correction, could mean that at least a short-term price low is at hand. We have therefore upgraded our short-term outlook from "bearish" to "neutral".

The reason we aren't shifting to a "bullish" stance at this time is that it would take some additional weakness from here to skew the short-term risk/reward decisively in favour of reward. A decline to 380 over the next few days would do it.

When the HUI was peaking in early December of last year, one of the warning signs was the sequence of declining tops in the HUI/gold ratio over the preceding 2.5 months. The following chart shows that the HUI/gold ratio remains in a downward trend.

An end to the HUI/gold's sequence of declining tops would belatedly signal an end to the gold sector's intermediate-term correction. We say "belatedly" because such an event would likely occur well after the ultimate price low. A more timely indication of a correction low would be a positive divergence between the HUI and the HUI/gold ratio, with the HUI making a new correction low while the HUI/gold ratio made a higher low (essentially, the opposite of the negative divergence that occurred in early December). Another potentially timely indication of a correction low would be a decline in the HUI/gold ratio to at least 12% below its 40-day moving average (the blue line on the following chart). Such additional weakness in the HUI/gold ratio would establish the sort of 'oversold' condition that is usually only seen near an important price low.

Note that if the HUI/gold ratio falls to 0.35 this week it will be about 12% below its 40-day moving average.

Suggested buy zones for individual gold/silver stocks

In October-November of 2008 the gold sector's risk/reward was as favourable as it ever gets. The crash in the broad stock market had taken gold-stock valuations down to extremely low levels at a time when gold-mining profit margins were increasing.

Thanks to the downturn of the past several weeks, the sector-wide risk/reward is again turning favourable. However, prices are generally a lot higher now than they were between October of 2008 and March of 2009. Also, there is now a lot more downside risk in the broad stock market and a lot more upside potential in the US$ than was the case during the first quarter of last year. As a result, this is not the right time to be aggressively buying stocks of any description. Rather, it is a time to be selectively and gradually adding exposure to the gold sector, especially if, like us, you built up a lot of cash when prices were higher.

Listed below are a few ideas for new buying.

Note that when determining a suggested buy zone for an individual stock we have taken into account the stock's valuation and its chart. Specifically, at the buy zones mentioned below there is valuation-related upside potential of at least 100% as well as chart-based support. For example, we have suggested the US$2.50-$2.65 range for new buying of Northgate Minerals (NXG). $2.50 is about 50% of our estimate of the stock's full value and, as illustrated below, coincides with lateral support and the 200-day moving average.

Also note that in some cases the buy zones are well below current prices and therefore may not be reached. Individual judgment is always required in that people who already have substantial exposure can afford to be stingier when placing new buy orders than those who have no, or minimal, exposure.

List of candidates for new buying:

ADM.V: C$1.75-$1.90 (current price: C$1.85)
FVI.TO: C$1.70-C$1.90 (current price: C$2.45)
GBG: US$1.55-$1.70 (current price: US$1.77)
GOZ.V: C$0.45-C$0.50 (current price: C$0.51)
GSS: US$2.50s (current price: US$2.88)
NXG: US$2.50-$2.65 (current price: US$2.98)
PEZ.TO: C$1.25-C$1.35 (current price: C$1.44)

Instead of, or in addition to, the above-mentioned juniors, investors could consider the Junior Gold Miners ETF (GDXJ). As explained in the 26th October 2009 Weekly Update, GDXJ is a way for investors to obtain diversified exposure to the junior end of the gold/silver mining universe without going to the trouble of selecting and following individual companies. Go to http://www.vaneck.com/index.cfm?cat=3192&tkr=GDXJ&LN=3-02 for more information about GDXJ.

It would make sense to average into a GDXJ position on weakness, beginning with an initial purchase near the current price of US$24.10.

Finally, the Franco Nevada warrants (TSX: FNV.WT) and the Kinross Gold warrants (K.WT.C) are reasonable speculations near their current prices of C$4.85 and C$3.30, respectively. Of the two, at current prices we prefer the FNV warrants because they offer more leverage.

Currency Market Update

The daily chart displayed below shows that the Dollar Index has substantial resistance at around 78.50. This resistance is defined by former highs and lows, as well as by the 200-day moving average.

If the stock market downturn continues over the coming week then the Dollar Index could spike up to 80, but the bulk of the dollar's initial rally is probably complete. Our view is that the next move of consequence will be a decline to the vicinity of last year's low, after which a larger US$ rally is expected to occur.

Update on Stock Selections

(Note: To review the complete list of current TSI stock selections, logon at http://www.speculative-investor.com/new/market_logon.asp and then click on "Stock Selections" in the menu. When at the Stock Selections page, click on a stock's symbol to bring-up an archive of our comments on the stock in question)

VIX Futures ETN (NYSE: VXX). Recent price: US$31.89

We have been running a 15% trailing stop on our VXX trade, but will now tighten the stop to 10%. In addition, we will exit if VXX trades at $35 within the next two weeks.

    Potential addition to the TSI List: Golden Star Resources (AMEX: GSS). Shares: 257M issued, 265M fully diluted. Recent price: US$2.88

Ghana-based gold producer GSS appears to have finally worked through the issues that have, for years, caused it to continually miss its production and cost forecasts. It is now a 400K-oz/yr producer, and unless something untoward happens should generate substantial cash flow over the next few years.

2010 production is expected to be 400K ounces at a cash cost of US$585/oz. It has a strong balance sheet, with $113M of long-term debt more than offset by $130M of cash and $120M of working capital.

Now that it has successfully ramped up its annual production rate to 400K ounces and has its costs under control, GSS stands a good chance of achieving a higher valuation. Based on the stock market valuations of other gold miners with assets in relatively secure locations and with annual production in the 250K-1000K range, GSS's production should be worth at least $3000/ounce. This gives us a target market cap of US$1200M, which equates to US$4.50 per fully-diluted share.

GSS's chart (see below) looks ugly. The chart suggests that the stock has just completed a head-and-shoulders top and is on its way back to US$2.

The chart points to significant additional downside potential, although the stock price shouldn't drop anywhere near as far as US$2.00 unless the gold market becomes much weaker than we currently expect or a major company-specific problem is encountered.

Taking into consideration the risk of additional corrective activity in the gold sector, GSS's bearish chart and the valuation-related upside, we think GSS's risk/reward would be very attractive in the US$2.50s. The stock will therefore be added to the TSI List IF it trades at US$2.55 within the next 4 weeks.

    Red Hill Energy (TSXV: RH). Shares: 52M issued, 63M fully diluted. Recent price: C$0.35

Last Thursday it was announced that RH, a Mongolia-based exploration-stage coal miner with over 1B tonnes of coal in the Measured-and-Indicated (M&I) category, was merging with Prophecy Resource (TSXV: PCY), an exploration-stage base metal miner with assets in Canada. Under the terms of the merger agreement, RH shareholders will receive 0.92 of a PCY share plus one share of "NewCo" for every existing RH share. "NewCo" is a new company that will initially have $1M of cash and RH's current small investment in lithium assets.

We hadn't heard of PCY prior to the announcement of this deal. Based on what we have since read, its main asset is an exploration-stage nickel project with a 230M-pound resource.

Up until now we had been hoping that RH would be able to do a deal with a major coal producer or consumer to facilitate the development of its massive coal deposits, because such a deal could have created enormous shareholder value. In this respect, Thursday's announcement was a disappointment. The potential to do a deal with a large company still exists, but the fact that RH has agreed to merge with a very small company suggests that nothing is on the horizon.

The new management will probably do a better job of promoting the RH story, which will, of course, be helpful as far as stock market performance is concerned. Also, a company that is not totally focused on Mongolia will have a better chance of attracting investors. Overall, though, we see the PCY merger in a negative light, for two reasons. First, it is evidence that RH's plans for its coal assets have not come together. Second, PCY shareholders will end up with 35% of the combined company but are contributing a lot less than 35% of the asset value.

We will continue to follow RH-PCY for now, pending more information on the direction/plans of the merged company.

Chart Sources

Charts appearing in today's commentary are courtesy of: