-- Weekly Market Update for the Week Commencing 26th March 2018

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.

The BULL market in US Treasury Bonds that began in the early 1980s ended in mid-2016, but there will be many years of topping action in bond prices and bottoming action in bond yields before major new trends get underway. A major decline in government bond prices will unfold during the 2020s. (Last update: 11 September 2017)

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.), gold-denominated prices and inflation-adjusted prices. This secular trend will bottom in 2020 or later. (Last update: 11 September 2017)

A cyclical BEAR market in the US Dollar began in 2016-2017. (Last update: 11 September 2017)

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 in 2020 or later. (Last update: 11 September 2017)

Commodities, as represented by the CRB Index, 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 2020 or later. (Last update: 11 September 2017)

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True Fundamentals Summary [Notes: 1) The date shown next to the current True Fundamentals Model (TFM) signal is when the most recent change occurred. 2) Charts of the Gold and Equity TFMs are included in the "Charts and Indicators" section of the TSI web site]

Last week's posts at the TSI Blog

Another look at gold's true fundamentals

Summary of current thinking/positioning

1) A number of markets are set up for trend reversals or accelerations, with the US$ being the linchpin. If the DX breaks out to the downside from its recent narrow range then rallies should begin or accelerate across the commodity world, with silver bullion and gold-mining stocks leading the way higher. However, if the DX breaks out to the upside from its recent range then the commodity world will have a downward bias for the ensuing two months. Last week there were signs that the DX breakout will be to the downside, but the jury is still out.

2) There is now a good chance that several important stock indices, including the SPX, will revisit their early-February lows before the correction comes to an end.

3) Downward corrections in oil and copper will end by May, with the timing dependent upon what happens in the currency market.

4) Bond yields are in long-term upward trends and will go much higher before year-end, but a counter-trend move is underway. The counter-trend move could end at any time, although we won't be interested in placing a new bet against the bond market (a new bet on higher interest rates) until there is a substantial reduction in the speculative net-short position in 10-year T-Note futures.

5) Holding a cash reserve of 25%-30%.

Thursday's closes will be important

The major financial markets will be shut for the Good Friday holiday on 30th March. Therefore, Thursday 29th March will be the final trading day of the week, the month and the quarter. This means that Thursday's closing prices will be important. From our perspective, the two most important weekly/monthly closes will be for the US$ gold price and the SPX/euro ratio.

Due to last week's price action, the SPX/euro ratio is in an interesting position as we enter the final 4 trading days of March. This is because it is poised at its 24-month MA -- the blue line on the following monthly chart.



As explained in the 19th February Weekly Update:

"...with the exception of the final stage of the drawn-out correction of 2010-2011 the SPX/euro ratio has not ended a month below its 24-month MA since 2009. It traded below this MA during the 2015-2016 correction and again during the week before last, but in each case it managed to avoid a monthly-closing breach of the MA.

The consistency of SPX/euro's long-term upward trend was also present during the 2004-2007 cyclical bull market. SPX/euro tested its 24-month MA many times during this earlier bullish period but didn't end a month below it until November-2007 -- the month after the nominal SPX made its bull-market top.

Further to the above, we would view a monthly close by SPX/euro below its 24-month MA as a sign that the bull market was over. According to our current view, this won't happen during the first quarter but potentially will happen during the second half of the year. In other words, if SPX/euro were to end February or March below its 24-month MA it would suggest that the decline from the January-2018 peak was the start of a major bearish trend as opposed to just a steep short-term correction."

Due to last week's price action, the US$ gold price is also in an interesting position as we enter the final 4 trading days of March.

On a monthly closing basis, gold has support at $1309 and resistance at $1363. At the beginning of last week it was in greater danger of breaching support than breaching resistance, but last week's rally has switched the probabilities.

A 29th March close above $1363 would be an important sign of strength.



Money Matters

The year-over-year rate of growth in the US True Money Supply (TMS) was around 11.5% in October of 2016 (the month before the US Presidential election) and is now only 2.4%, which is near a 20-year low. Refer to the following monthly chart for details. In terms of effects on the financial markets and the economy, up until recently the US monetary inflation slowdown was largely offset by continuing rapid monetary inflation elsewhere, most notably in Europe. However, the tightening of US monetary conditions has started to have noticeable effects and these effects should become more pronounced as the year progresses.



The tightening of monetary conditions eventually will expose the mal-investments of the last several years, which, in turn, will result in a severe recession, but the most obvious effect to date is the increase in interest rates across the entire curve. The upward acceleration in interest rates over the past six months has more than one driver, but it probably wouldn't have happened if money had remained as plentiful as it was two years ago.

It would be a mistake to think that the tightening has been engineered by the Fed. The reality is that the Fed has done very little to date.

The Fed has made several 0.25% increases in its targeted interest rates, but the main effect of these rate hikes is to increase the amount of money the Fed pays to the commercial banks in the form of interest on reserves (IOR). It doesn't matter how you spin it, injecting more money into banks ain't monetary tightening!

The Fed's actual efforts on the monetary loosening/tightening front over the past 5 years are encapsulated by the following weekly chart of Reserve Bank Credit (RBC). This chart shows that there was a rapid rise in RBC during 2013-2014 that ended with the completion of QE in October-2014. For the next three years RBC essentially flat-lined, which is what should be expected given that the Fed was neither quantitatively easing nor quantitatively tightening during this period. In October-2017 the Fed introduced its Quantitative Tightening (QT) program. To date, this program has resulted in only a small reduction in RBC, but the plan is for the pace of the QT to ramp up.

Strangely, the most senior members of the Fed appear to believe that their baby-step rate hikes constitute genuine tightening and that the contraction of the central bank's balance sheet is neither here nor there. The reality is the opposite.



So, the Fed is not responsible for the large decline in the US monetary inflation rate and the resultant tightening of monetary conditions that has occurred to date.

The responsibility for the tightening actually lies with the commercial banks. As illustrated by the next chart, the year-over-year rate of growth in commercial bank credit was slightly above 8% at around the time of the Presidential election in late-2016 and is now about 3%.



We won't be surprised if a steepening yield curve prompts commercial banks to collectively increase their pace of credit creation over the next two quarters, but with the Fed set to quicken the pace of its QT the US monetary inflation rate probably will remain low by the standards of the past two decades. At the same time, the ECB will be taking actions that reduce the monetary inflation rate in the euro-zone. This could lead to stock and bond market volatility during the second half of this year that dwarfs what we've witnessed over the past two months.

The Stock Market

In general, breakouts above resistance or below support are not reliable indicators of the future. However, failed breakouts, meaning breaks through obvious support or resistance that are negated within a short time, tend to be more predictive.

For risk management purposes we usually will assume that a breakout is genuine until/unless proved otherwise, but, with a small number of exceptions that we won't get into right now, we rarely take new positions in response to breakouts. We are far more likely to take new positions in response to evidence of a breakout failure, especially in those cases where we don't have significant existing exposure to a price move in the direction of the reversal and/or the reversal is consistent with our overarching market outlook.

Over the past two weeks we noted that the NASDAQ100 Index (NDX) had broken above obvious resistance defined by its January high and that we would assume, until/unless proved otherwise, that the breakout was sustainable. We also mentioned that a daily close below 6900 would point to a false signal.

A daily close below 6900 happened last Monday. There followed two days of sideways consolidation, at which time we posted our interim report. In this report we wrote:

"The US stock market generated a bearish signal during the first half of this week, in that the NASDAQ100 Index (NDX) and the NASDAQ100 ETF (QQQ) fell far enough to negate the upside breakouts that occurred during the week before last. A daily QQQ chart is displayed below. We therefore have a failed upside breakout on our hands, which increases the risk that the February low will be tested before the correction comes to an end.

In response to this week's evidence that the NDX's recent upside breakout was a 'fakeout' it would be reasonable to purchase a new QID (UltraShort QQQ) position near the current price of US$11.35. Risk could then be limited via a plan to exit the trade if QQQ closed above its recent high. Note that this is not a trade that will be implemented in our own accounts, but that's mainly because we hold some put options that will gain substantial value if QQQ plunges within the next two weeks."

Here is an updated version of the chart mentioned in the above excerpt:



QQQ plunged over the final two days of last week. It ended the week only 1% above its channel bottom, although it is still more than 10% above its 9th February spike low.

The Dow Transportation Average (TRAN) didn't generate a false upside breakout during the rebound from its 9th February spike low; it simply failed to show any real strength. We stated a week ago that it was very much at risk of testing its February low, but that the risk of a test would be greatly reduced by a daily close above 10,800.

A daily close above 10,800 never happened and a test of the February low appears to be on the cards.

Interestingly, the following daily chart shows that TRAN ended last week at the bottom of a 2-year channel. Consequently, there is a lot at stake at the moment.



The weekly chart displayed below shows that the SPX just achieved its lowest weekly close of the year.

On a weekly closing basis, critical support is defined by the 50-week MA (the blue line on the chart). A weekly close below this MA (2554 and rising) would suggest that the overall correction was going to extend all the way to the 200-week MA near 2200. An extension of this magnitude is still a long-shot, although it is less improbable now than it appeared to be a week ago.



Turning to Europe, we see (refer to the daily chart displayed below) that the EURO STOXX 50 Index (STOX5E) made a new 12-month low on Friday 23rd March. However, the breach of short-term support at 3300 was marginal.

We mentioned in earlier commentaries that intermediate-term support near 3100 is a likely target for a multi-month bottom. That's still the case.



Turning to a specific stock that we have an interest in, the following daily chart shows that Tesla (TSLA) just achieved its lowest daily close of the year and ended last week at the edge of the precipice.



Our working assumption is that the SPX will do no worse than test its early-February spike low (2530), but the price weakness on Friday opens up the possibility of substantial follow-through to the downside early this week. If this follow-through happens it should be viewed as an opportunity to take profits on bearish speculations.

Our own account contains QQQ April put options and TSLA April put options. We intend to exit all of these puts if there is a sharp decline (a 'whoosh' to the downside) on Monday 26th March. The TSI Stocks List contains a TSLA April put-option position. This position will be exited on Monday if the stock price drops by at least $20.

Note that due to its chart pattern and its valuation, we would be inclined to take only partial profits on TSLA puts in response to a sharp decline on 26th March if the puts had a few months of remaining time. However, our puts expire in 4 weeks.

This week's significant US economic events [Notes: 1) The most important events (to the markets) are shown in bold. 2) A list of global economic events can be found HERE]

Gold and the Dollar

Gold

The Fundamentals

Our Gold True Fundamentals Model (GTFM) is still in bearish territory, although it turned upward last week. A chart is included below. It turned upward because the Credit Spreads component shifted from gold-bearish to gold-bullish. By the way, this is also why our Equity True Fundamentals Model (ETFM) shifted from neutral to bearish (widening credit spreads are bullish for gold and bearish for the stock market).

As a result of last week's market action a couple of other GTFM components (the 10-year TIPS yield and the relative strength of the banking sector) are close to switching from bearish to bullish. If they do then the GTFM will move into bullish territory. However, it isn't there yet.



The Price Action

Below is the chart comparison of the US$ gold price and the Dollar Index (DX) that we've shown a few times over the past two months. Both remain within their multi-month horizontal ranges.

The gold price rebounded strongly from the bottom of its range over the final three days of last week and closed above lateral resistance in the low-$1340s, which hints that a rally to new multi-year highs has begun. However, this possibility was not validated by the gold-mining sector, so we could be dealing with nothing more significant than the type of multi-day surge in the gold price that occurred in mid-February.



When we say that the potentially-bullish implications of last week's gold-price strength were not validated by the gold-mining sector we have in mind the following chart of the HUI/gold ratio. The HUI/gold ratio is still languishing near a 2-year low.

The HUI/gold ratio usually won't lead the gold price at an important bottom, but it invariably moves sharply higher during the first few weeks of an intermediate-term rally. Last week's absence of strength in this ratio is therefore a caution sign.

As an aside, when the gold price eventually breaks out to a new 12-month high it will, to some extent, be time to throw caution to the wind and aggressively buy the mining stocks/ETFs.



In euro terms, last week's gold rally does not look significant. A daily close above 1110 euros will be the first solid evidence that an intermediate-term reversal from down to up has occurred.



Silver

Long-term investors interested in the 'monetary' metals at this time should be buying silver, not gold. The main reason is that the silver/gold ratio is near a 20-year low. Refer to the following weekly chart for details. Another reason to favour silver at this time is that inflation expectations are likely to ramp up over the coming two years and silver usually performs better than gold during periods when concerns about inflation are on the rise.



However, for short-term traders this is not an ideal time to buy silver.

One reason is that until the gold price breaks out to a new 12-month high it's likely that the silver price will be limited by the channel drawn on the following daily chart. This implies upside potential to $17.50-$18.00 and downside potential to $14.50-$15.00, that is, about $1 of reward potential versus about $1.50 of risk.



Another reason is that although the COT situation now looks more bullish than at any time over the past 10 years if we consider only the net positioning of speculators, if we also consider Open Interest (OI -- the green bars in the bottom section of the following chart) we find that the sentiment backdrop is less clear-cut. Important price bottoms in the silver market have tended to coincide with relatively low levels of OI, but OI surged last week and is not far from the all-time high reached in April of last year.

The low level of the total speculative net-long position in silver futures combined with the high level of OI suggests substantial disagreement among silver speculators.



In our opinion, short-term traders should buy silver if one of the following happens:

1. The gold price closes above resistance in the low-$1360s, especially is it's a weekly close.

2. The silver price drops to around $15.00.

3. The silver price breaks above its channel top and then pulls back to test the breakout.

Gold Stocks

Although the gold-mining indices didn't respond with any vigor to last week's surge in the US$ gold price, the HUI gained enough ground to make the February-March move below the December-2017 low look false. That is, there was enough strength last week to generate a bullish signal in the form of a failed downside breakout. The HUI must now stay above 174 on a daily closing basis to sustain this bullish signal.



We continue to expect that there will be a big catch-up move in the gold-mining sector after the gold price breaks decisively to a new 12-month high.

The Currency Market

The Trump regime is ramping-up its international-trade-related attacks on the US economy (yes, the US economy). Not deliberately, of course, but due to a very poor understanding of economics in general and trade in particular.

Implementing tariffs and other policies that restrict the importation of goods is like imposing economic sanctions on yourself. These policies adversely affect the external producers of the goods that are subject to the protectionist measures, but they adversely affect the domestic consumers to the same extent. That's even if there is no retaliation by other governments. However, China's government has made it clear that there will be retaliation, and in a battle of political wills between the US and China the Chinese side has one big advantage: Xi Jinping doesn't have to worry about re-election.

Donald Trump's decision to sign an executive memorandum last Thursday imposing tariffs on up to $60 billion of Chinese imports and an initial retaliation by China's government on Friday was blamed in the financial press for the plunge in the stock market during the final two days of the week. There were many factors involved in the plunge, including the NDX's failed upside breakout and the increasing risk that governments will use the recent Facebook issues to start intervening more aggressively in the businesses of the some of the world's most successful companies. However, fear that a trade war has begun and will escalate to the detriment of the global economy almost certainly played a part.

The protectionist missteps didn't have a significant effect on the currency market, though. Apart from the Yen, which was very strong in response to the unwinding of carry trades and other speculative positions, the currency market was uneventful over the final two days of the week.

The euro remains within the narrow horizontal range that has confined its movements since mid-January. This range could be a topping pattern or a mid-trend consolidation.



Updates on Stock Selections

Notes: 1) 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. 2) The Small Stock Watch List is located at http://www.speculative-investor.com/new/smallstockwatch.html

Company news/developments for the week ending Friday 23rd March 2018:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, FY = Financial Year, IRR = Internal Rate of Return, ISR = In-Situ Recovery, MD&A = Management Discussion and Analysis, M&I = Measured and Indicated, NAV = Net Asset Value, NPV(X%) = Net Present Value using a discount rate of X%, NSR = Net Smelter Return, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Blackham Resources (BLK.AX) announced a positive change in the mine plan for its Golden Age Underground gold mine. Golden Age is a relatively small part of the company's Matilda-Wiluna operation in Western Australia.

Mining studies have extended the Golden Age Underground mine plan from Jun-18 to Dec-18. This involves about 5K ounces of additional production. Also, there's a good chance that an underground drilling program will further extend the life of this mine.

Although the Golden Age mine is relatively small, its production has an outsized effect on the company's overall profitability due to the mine's high grade and associated low costs. The mine life extension is therefore a significant plus.

BLK is a classic example of why it is important for a junior mining company to start production with a strong balance sheet. This company has recently begun to achieve the sort of production performance it was supposed to have achieved 12 months earlier. If the balance sheet had been strong at this time last year then the production problems it encountered could have been solved without a massive reduction in the per-share value.

  *Energold Drilling (EGD.V) announced that it was recently awarded more than $10M in new "green drilling" contracts in the US. No further details were provided.

EGD is trading at a substantial discount to its working capital and is a good way to obtain exposure to future commodity-price strength.

List of candidates for new buying

From within the ranks of TSI stock selections the best candidates for new buying at this time, listed in alphabetical order, are:

1) ALK.AX (last Friday's closing price: A$0.31)

2) AAU (last Friday's closing price: US$0.84)

3) AOI.TO (last Friday's closing price: C$1.24)

4) EGD.V (last Friday's closing price: C$0.43)

5) PG.TO (last Friday's closing price: C$3.26)

The above list is limited to five stocks. It will sometimes contain less than five, but it will never contain more than five regardless of how many stocks are attractively priced for new buying.

The potential addition of Aura Minerals (TSX: ORA)

We first wrote that ORA.TO would be added to the TSI List if it traded at C$2.05. We then revised our plan by writing, in the 14th March Interim Update, that we were putting this potential selection on hold pending an update from the company regarding the US$40M sale of its Serrote da Laje copper-gold project.

It was announced last Thursday that the Serrote sale has been completed and that ORA has received the US$40M payment -- US$30M of cash plus an unsecured US$10M note. We therefore reinstate our plan to add ORA to the List at C$2.05.

ORA has 43M shares outstanding, 120K-ounces/year of current gold production and an organic growth path to a production rate of around 170K-ounces/year within two years. For more information refer to our initial write-up in the 27th December 2017 Interim Update.



Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.goldchartsrus.com/
http://research.stlouisfed.org/