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

Natural Gas Update

The AMEX Natural Gas Index (XNG) broke above resistance to a new 52-week high on Friday. This creates a short-term chart-based target of 625-650.

The recent price action has added to one of the most extraordinary divergences we have ever seen between a commodity and the stocks of companies that produce the commodity. The divergence is illustrated by the following chart comparison of the XNG and the natural gas price. Note that since November of 2008 the XNG has gained 80% while the natgas price has fallen 35%.

There are some good reasons why natural gas equities have generally performed a lot better than the commodity over the past 18 months, the most important of which are:

1. Most natgas producers also produce oil, and the oil price has trended upward

2. The stock market's post-crash rebound has been strong enough to lift almost all equities

3. New drilling technology makes it possible for natgas producers to be profitable at a lower commodity price

4. Most natgas producers hedge part of their production

But even taking these reasons into account, the extent of the divergence is impressive and unusual.

As previously advised, we think it makes sense to scale out of natural gas stocks into strength with the aim of being down to a minimum position by the end of May.

Grains - biding our time

The Stock Market

The US stock market ended last week at a new 52-week high, so there is no evidence, yet, that a peak is in place. However, it would be an understatement to say that the market is 'overbought' and at risk of experiencing a sharp decline. The Dow Industrials Index has now risen for 8 weeks in a row and on 10 of the past 11 weeks, while the S&P500 Index has risen on 9 of the past 11 weeks. Furthermore, over the past 11 weeks none of the senior US stock indices have experienced a draw-down of more than 2%.

As discussed in recent commentaries, the new 52-week highs made by the US stock market over the past several weeks have not been confirmed by some other important markets. Those of a bearish bent should be focused on the markets that are now rolling over after making lower highs, examples being Brazil, Hong Kong and China. These markets led to the upside during 2008-2009 and now appear to be leading to the downside.

The following chart shows that the Shanghai Stock Exchange Composite Index (SSEC) broke below trend-line support last week. More important lateral support lies at around 2900.

This week's important US economic events

Gold and the Dollar

Gold

The June gold futures contract ended last week about $10 below short-term resistance in the low-$1160s. Breaking above this resistance would probably be followed in fairly quick time by a test of the December-2009 peak at around $1220.

It could be significant that the Fed is due to issue its next monetary policy statement this Wednesday. Considering the large amount of speculation going on in the financial markets at this time, the gold price could promptly move up to the $1200s if Bernanke and his gaggle of money manipulators are silly enough to again state their intention to hold the overnight interest rate near zero for an extended period.

The following chart shows that the euro-denominated gold price (gold/euro) continues to rise in 'stair-step' fashion and ended last week at a new all-time high. As previously noted, the benefit of the doubt should be given to the short-term bullish case as long as pullbacks in gold/euro end at, or above, the 50-day moving average. In other words, it would take a solid break below the 50-day moving average to signal an end to the upward trend.

Also, acceleration in gold/euro's rate of advance could be viewed as a warning of an impending trend reversal on both a short and intermediate term basis. For example, if gold/euro were to move more than 15% above its 50-day moving average we would interpret it as a sign that the market was within a few weeks of an intermediate-term peak.

There is no point expressing gold's long-term upside potential in US$ terms -- or, for that matter, in terms of any other fiat currency -- because who knows what a dollar will buy in a few years time. For example, a rise in the gold price to $5000/ounce over the next 5 years wouldn't constitute a good return if the price of a loaf of bread rose to $100 over the same period.  In our opinion, the most logical way to view gold's long-term potential is in terms of the Dow Industrials Index. This is because: a) the Dow will adjust to changes in the purchasing power of the US$, b) the history of the gold/Dow ratio is long enough to indicate a likely range for an extreme high, and c) the gold/Dow ratio trends inversely to overall stock market valuation over the long-term.

The following chart shows that the gold price would have to increase by a factor of 10 from here, relative to the Dow, to match its 1980 high. A similar increase would be required to take gold/Dow back to its 1932 high.

Gold Stocks

Current Market Situation

The HUI's 'choppy' price action continues. The most important levels of nearby support and resistance now lie at 420 and 470.

We are hoping that the HUI strengthens sufficiently over the next few weeks to make a new multi-month high during May, because such an outcome would be the best fit with our short-term expectations for other markets and because a May high would give us information as to what to expect from the gold sector over the ensuing six months (a May high would be consistent with a decline to an ultimate correction low during October-November). However, we are not betting on any particular short-term outcome.

The importance of stock promotion

The managers of some public companies ignore the performance of their company's stock on the basis that if the business does well then the stock price will take care of itself. This is actually the best approach for the managers of large and profitable companies, because such companies will already be well known within the investment community and will not have to sell equity in order to remain in business. A company such as Newmont Mining, for instance, would gain nothing from stock promotion, so its managers should focus all their attention on improving the underlying business. However, stock promotion will be a critical activity for the senior management of any company that has to regularly issue shares to pay its expenses, which is the case for almost all exploration/development-stage mining companies. For such companies, the ability of the management to effectively promote the stock can have a large bearing on fundamental value. The reason, in a nutshell, is that the higher the stock price the lesser the number of shares that will have to be issued to finance the business and the greater the per-share value will become over time.

Effective stock promotion won't turn a bad story into a good one, but at any point in time there will always be many small companies with good stories vying for the attentions of analysts and investors. Therefore, one of the most important roles of the CEO of a small company reliant on equity financing is to ensure that his company's story gets out to the potential buyers of the shares and to the people who influence the buying of others. We are mystified as to why so many managers of junior resource companies fail to understand this.

Currency Market Update

After Thursday's market action we began to wonder how many times the currency market could react to the same old news about the Greek government's debt problem. The market pushed the euro back to its March low on Thursday in response to 'news' that Greece's debt/deficit problem was worse than the government had been letting on, which really shouldn't have been news at all. Then, on Friday, the market pushed the euro upward in response to 'news' that the government of Greece was officially requesting the loan package that had previously been cobbled together.

Europe's monetary union has a problem that cannot be solved by propping up members that are now, for all intents and purposes, bankrupt. The most sensible course of action would be for the government of Greece to default on its debt, scale back its involvement in the country's economy and cut taxes. This course of action would pave the way for a sustainable recovery in Greece's economy and would not impose additional costs on the taxpayers of other countries, but it does not appear to be under consideration. The least sensible course of action would be for the government of Greece to increase taxes and replace its existing debt with new debt provided by other governments. This is currently the chosen course of action and is being promoted as a bailout for the Greek economy and Greek taxpayers, even though it all but eliminates the possibility of a sustainable economic recovery and only benefits the institutions that were silly enough to buy Greek government bonds. It is clear that the "no bondholder left behind" policy remains dominant.

We continue to believe that the euro will move much lower relative to the US$ over the next 12 months. This view was initially predicated on the likelihood of the US$ being boosted by another wave of de-leveraging once the global stock market rebound petered out, but of almost equal importance now is the growing realisation that Europe's monetary union will not remain intact. The debt-related problems of US state governments and the US federal government are just as severe a those being faced in Europe, but an important difference is that the US federal government has UNLIMITED access to new money. This unlimited access to new money will eventually destroy the US$, but over the next year or two it will give the US government the ability to maintain the illusion of solvency.

Having said that, price action and sentiment still point to a short-term euro rebound.

Update 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)

Andina Minerals (TSXV: ADM). Shares: 105M issued, 118M fully diluted. Recent price: C$1.09

Over the next few weeks we plan to remove some gold/silver stocks from the TSI List in order to free up space for new stocks with better risk/reward ratios. The candidates for removal will be those stocks/companies that have performed the worst over the past year or that have relatively high valuations.

ADM has been one of our worst performers over the past year, but we have no intention of removing it from the List. In fact, at current prices we think ADM is one of the most obvious candidates for new buying for PATIENT and risk-tolerant speculators. This is because it controls a large in-ground gold resource in a politically secure country (Chile), and because it has a strong balance sheet (about $40M of cash and no debt). The risk is that its deposit will prove to be uneconomic at today's metal prices, but at the current stock price a lot of risk is already factored in. We say that because ADM's M&I gold resource (at a 0.5 g/t cut-off)* is presently being valued by the stock market at only $17/ounce (or $11/ounce if we deduct the value of the company's cash).

Patience will be required, though, because over the next several months the company will be re-engineering the project to account for the inability to achieve an adequate gold recovery using the earlier mine plan. This means that there probably won't be any significant new developments for quite a while. To be more specific, apart from issuing some non-market-moving drilling results within the next couple of months, the company will probably be quiet on the news front until the Preliminary Economic Assessment (PEA) is ready for publication early next year.

It was news that the previous mine plan would not be viable that caused the stock price to plunge at the end of February. As we noted at the time:

"...after a stock plunges in response to bad company-specific news (or news that is generally perceived to be bad), the initial reaction low is normally not the ultimate low. There are no 'hard and fast' rules, but more often than not the initial low will be followed by a rebound and then a decline to a new low. It is likely that ADM's initial low was put in place on Friday or will be put in place early this week, after which there will be a rebound and then a decline that tests or breaches the initial low."

When we wrote the above the stock had just plunged to the mid-$1.30s and we guessed that the ultimate low would be in the low-$1.20s, but it turned out that the initial news-related decline took the price down to around $1.15. As illustrated by the following chart, the stock then accomplished the obligatory rebound from the initial low and has since dropped to a new low for the move. Prior to Friday's sidestep the stock had fallen for seven days in succession.

ADM is probably now at, or very close to, its ultimate news-related low, although stocks such as this can make big moves in response to relatively small changes in buying/selling pressure and can therefore overshoot by wide margins to both the upside and the downside.

    *Using a 0.5 g/t cut-off the M&I gold resource is around 7M ounces. Using a 0.3 g/t cut-off the M&I resource increases to 9.8M ounces.

    Orsu Metals (TSX: OSU). Shares: 158M issued, 214M fully diluted. Recent price: C$0.25

OSU's cash shortage has been solved via an equity financing that raised $28M. This financing has reduced the stock's risk because the company should now be fully funded for at least the next two years, but it has also reduced the upside potential because it resulted in an increase of more than 200% in the total number of outstanding shares.

It is also worth noting that Kyrgyzstan, the location of OSU's most important asset, is politically unstable at this time (refer to http://www.reuters.com/article/idAFLDE63M14S20100423?rpc=44 for more info).

Even with the massive stock dilution and the resultant reduction in value per share, OSU still has considerable upside potential. However, there are many other junior gold/silver stocks with just as much upside potential and with assets in politically secure regions. We have therefore decided to remove OSU from the TSI List and record a huge loss of around 96%.

    New Gold (AMEX: NGD, TSX: NGD). Shares: 387M issued, 471M fully diluted. Recent price: US$5.70

We have suggested buying NGD at many different prices over the years. For example, our original entry was at US$1.11 way back in 2003 (via Metallica Resources) and we most recently highlighted the stock as a trading buy in the US$4.20s last month in anticipation of a move up to around US$6.

NGD hasn't quite made it to the aforementioned short-term target of $6, but it is not far away and the following chart shows that it is nearing its channel top. More importantly, NGD is now expensive compared to many other gold stocks. For example, NGD's 2010 production is currently being valued by the stock market at $6500/ounce, versus only $2300/ounce for the production of Northgate Minerals (NXG).

We have therefore decided to remove NGD from the TSI List. Based on our original entry price, the profit on this long-term speculation was 414%.

If we return NGD to the List in the future it will most likely be as a short-term trading position.

On a related matter, it is important to understand that our assessment of a stock's valuation is dynamic, the reason being that the fundamentals are continually changing. It is therefore possible for a stock to be fully valued at $5/share at one point in time and to subsequently be under-valued at $10/share (due to positive changes in the fundamentals). By the same token, it is possible for a stock to be under-valued at $10/share at one point in time and to subsequently be fully valued at $5/share.

In NGD's case, back in April of 2008 we explained why we thought the stock was worth $9/share. Since that time the gold price has gained about 20%, but the stock now appears to be over-valued -- at least relative to other gold stocks -- at $5.70/share. There have been some positive developments in the mean time, but there has also been a large increase in the share count and the write-down to almost zero of an asset (the Amapari gold mine) that was once thought to be very valuable.

    US Natgas Fund (NYSE: UNG). Recent price: US$7.58

UNG needs to close above resistance at $7.70 to provide additional evidence that a bottom is in place.

When we added the short-term UNG trading position to the TSI List in early April we said that the initial 'stop' would be a daily close below $6.79. We will leave this initial stop in place until UNG closes above $7.70, at which point we will switch to a 5% trailing stop based on daily closing prices.

Chart Sources

Charts appearing in today's commentary are courtesy of: