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 ended in 2012. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2018-2020. (Last update: 20 January 2014)

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

Important Note: No Interim Update this week

We will be taking a break this week, so there will be no Interim Update. The next commentary will be the Weekly Update scheduled for Sunday 1st June, although we will issue an email alert during the intervening period if the market action is sufficiently dramatic or unexpected. 

Monetary inflation in Japan

The Fed's QE directly boosts the money supply, but, as far as we can tell, the Bank of Japan's (BOJ's) QE only boosts the reserves of financial institutions. Consequently, whereas the Fed can create whatever amount of monetary inflation it desires, the BOJ relies on financial institutions expanding credit in response to reserve injections. This means that the BOJ's QE only boosts the country's money supply to the extent that Japanese financial institutions respond to reserve injections by monetising assets and expanding their loan books. Due to the general unwillingness or inability of financial institutions to take such actions, Japan's monetary inflation rate has remained relatively low despite the QE programs implemented by the BOJ over the past 15 years.

The QE program introduced by the BOJ early last year is by far the biggest to date and has had a greater effect than its predecessors on Japan's money supply. However, Japan still has the lowest monetary inflation rate in the developed world. For example, the 3.5% year-over-year rate of increase in Yen supply compares to year-over-year rates of supply increase of around 8% for the US$ and the C$, 11.7% for the A$ and 5.6% for the euro. Furthermore, the strong seasonality of changes in Yen supply has not been affected by the massive QE program introduced last year, and the latest figures suggest that Japan's monetary inflation rate, having risen from its long-term average of 2% to slightly more than 4% at the end of last year in an initial reaction to the latest round of QE, is now on the decline.

The seasonality mentioned in the preceding paragraph is evident on the following chart of the 3-month rate of change in Japan's M2 money supply. The pattern that repeats almost every year involves a January peak, a pullback into a March low, a rise to another (usually higher) peak in May, and then a decline to the low for the year in September or October. The most consistent aspects of this pattern are the May high and the September-October low.



Due to the latest QE program, the May-2013 seasonal peak was the second-highest of the past 10 years and the September-2013 bottom was higher than any of the September-October bottoms of the preceding 10 years. However, signs have emerged that the upward shift in the pattern was temporary, in that the annualised 3-month rate-of-change in Japan's M2 just achieved its lowest April reading since 2008 and its lowest March reading since 2004.

What's a Japanese central banker to do?

The Stock Market

The US

The S&P500 Index closed above 1900 for the first time ever last Friday. At the same time, the number of individual NYSE-traded common stocks that made 52-week highs was only 81. To put this number into perspective, when the SPX makes a new 52-week high it is normal for the quantity of individual new 52-week highs among NYSE-traded common stocks to be at least 300. In a healthy market it would be more than 400. Last Friday's tally of 81 was actually in the bottom quintile of the 2-year range.

Some of the sectors that had been relatively weak since early-March have recently rebounded. For example, the following chart shows that the NASDAQ100 Index (NDX), after holding important support at 3400 in April, was strong last week in both nominal terms (the top half of the chart) and relative terms (the bottom half of the chart). This rebound is not surprising and doesn't change the overall picture. It doesn't change the overall picture because we now have another marginal new high in the SPX that was not confirmed by numerous other indexes and indicators, including the NDX and the NDX/SPX ratio. Note, however, that the overall picture would be altered by a weekly NDX close at a new high for the year. Such an event, which is certainly not expected, would open up the possibility of a 2-3 month upside blow-off.



In last week's Interim Update we mentioned that the Volatility Index (VIX) had dropped to near its low of the past few years. It fell a little more last Friday and is now at its lowest level in many years.

The current situation is about as good as it gets for establishing bearish positions. This is not just because of the extended price action, the over-bullish sentiment, the high average valuation and the numerous bearish divergences/non-confirmations, but also because the NDX's rebound to slightly below its March high means that managing risk is relatively straightforward. Bearish positions could be established with the plan to make a quick exit if the NDX closes at a new high for the year.

In previous commentaries we said that we didn't intend to make any formal recommendations with regard to bearish equity positions, although for information purposes we said in the 12th May Weekly Update that we had added a small SSO (ProShares UltraS&P500 ETF) put-option position to our own account. We also said that we might double our exposure to these puts in response to some additional near-term stock market strength, but that the overall position size would remain small. Again for information purposes only, we advise that we haven't added to our SSO put-option position but late last week we purchased some VIX August-2014 $15 call options with the aim of profiting from a short-term volatility spike.

We still have no intention of making any formal equity-bearish trading recommendations, and, as previously noted, will only be taking a small bearish position for our own account. We do, however, expect to achieve a sizeable gain from weakness in the broad US stock market due to the loose inverse relationship between the broad stock market and gold-related investments.

Russia

The Russian stock market is the only broad stock market that we are interested in being 'long' at this time, with the Market Vectors Russia ETF (RSX) being our preferred vehicle. A couple of weeks ago we suggested taking an initial position in RSX with the aim of averaging into a full position on weakness over six months.

The following daily chart shows that RSX has moved sharply higher since breaking above lateral resistance at $24. It is now extended to the upside on a short-term basis and will soon hit resistance defined by its 200-day MA, which means that now is not the time to be buying. A new buying opportunity could, however, be created by a pullback to former resistance (now support) at around $24.

This week's important US economic events

Gold and the Dollar

Gold

Gold and India

It's a good bet that later this year India's newly elected government will remove, or substantially relax, the gold import restrictions that were brought in last year by the previous government in a misguided effort to 'fix' what policymakers saw as a current-account-deficit problem. In fact, a step was taken in that direction last week when the Reserve Bank of India allowed seven private jewellery exporters -- companies that had been barred from importing gold since July 2013 -- to resume imports. We hope that these import restrictions are soon eliminated because doing so would benefit many people in India by reducing the premium they pay when buying gold, but either way it won't make much difference to the price at which gold trades in major financial centres such as New York and London. The fact is that although India has traditionally been a large and steady importer of gold, changes in Indian gold demand have never had a significant effect on gold's price trend.

The reason that changes in Indian gold demand have never been important drivers of gold's price trend is similar to the reason that changes in annual gold production don't have much effect on the gold price. It's because the amount of the change is invariably small compared to the global demand for gold. Note that at any given time the global demand for gold equals the global supply of gold, which is probably now around 170,000 tonnes. As explained in numerous TSI commentaries over the years, significant changes in the desire to hold the aboveground gold supply are primarily influenced by the ebbing and flowing of confidence in the world's most important currencies (at this time, the US$ and the euro).

The annual amount of gold imported by India has oscillated between 700 tonnes and 1000 tonnes since 1997. It was around 1,000 tonnes last year in response to an import surge during the first half of the year followed by greatly reduced imports during the second half as the government's import-restricting rules took effect. Despite the on-going restrictions, India is expected to import around 1,000 tonnes of gold again this year, with illegal imports (smuggling) mostly counteracting the large decline in legal imports.

Removing the import restrictions would give a hefty boost to legal imports and substantially reduce the amount of gold smuggling, with the net effect probably being small and almost certainly being no more than 20%. A 20% change either way amounts to a 200-tonne difference over the course of a year, which is a veritable drop in the gold-market ocean.

If India were to suddenly quadruple its annual gold imports or suddenly switch from being a 1,000-tonne/year importer to a 2,000-tonne/year exporter it could have a meaningful effect on the global gold price, but that's not the type of change we are going to get. The type of change in Indian gold imports that has a realistic chance of happening in response to changes in the Indian government's import restrictions won't affect gold's price trend.

Manipulation-centric commentary gets sillier by the week

All the financial markets, including the gold market, are manipulated -- sometimes to the upside, sometimes to the downside. This has always been the case and always will be the case. Get used to it. The biggest manipulators and the only manipulators that permanently damage the integrity of the market are governments and central banks. Calling for governments and their agents to become more involved in the markets in order to put a stop to manipulation is therefore completely wrongheaded.

The latest manipulation story being promoted by ZeroHedge can be found HERE. Because the ZeroHedge writer wants to propagate the idea that the gold market is always manipulated downward he has cherry-picked an example from mid-2012 that supposedly supports his agenda, despite the fact that the period under investigation covered 9 years beginning in 2004. When looking at the complete picture a plausible argument could be made that the bulk of the gold-market manipulation was to the upside. Also, as pointed out by Dan Norcini, you only need to take a slightly wider-angle view of the 2012 market action to see that the manipulation evidence now being trumpeted as a "smoking gun" had no effect beyond a single-day blip.

As far as we can tell, over the intermediate-term timeframes that interest us neither upward nor downward manipulation of the gold price has been effective.

The Fundamentals

One of the most important gold-market fundamentals over the past several years has been the profitability of and the general confidence in the US banking industry, as indicated by the BKX/SPX ratio. A rising BKX/SPX ratio indicates rising confidence in the major US banks, which is bearish for gold, and a falling BKX/SPX ratio indicates falling confidence in the major US banks, which is bullish for gold.

The BKX/SPX ratio peaked in July of last year at around the time that gold was bottoming. It then made a slightly lower peak in March of this year before reversing course and breaking out to the downside in April.

The performance of the BKX/SPX ratio is one reason why it is very unlikely that gold will drop below, or even seriously challenge, its June-2013 price bottom.



Current Market Situation

The US$ gold price continues to move sideways within a very narrow range. There's a high probability that the next $100+ move will be to the upside, but although it's not the most likely scenario there is a realistic chance that gold will quickly drop to the $1250s before commencing a substantial rally.

Silver

The silver market's price action has recently been almost as uneventful as that of the gold market, the US stock market and the Dollar Index. However, it will be difficult for the boredom to continue for more than two more weeks because the silver price has worked its way into a corner. A breakout in one direction or the other will have to soon occur. We are obviously anticipating a break to the upside.



Platinum

The top section of the following daily chart shows the US$ platinum price. The price action reflected by this chart suggests to us that the platinum market has completed its short-term correction and is on its way up to test intermediate-term resistance at $1550. Once through $1550 the target would be $1750.

Platinum resistance at $1550 is equivalent to gold resistance at $1425.

The bottom section of the same chart shows the platinum/gold ratio. In the 17th February 2014 Weekly Update, we wrote:

"The platinum/gold ratio has broken out to the downside, suggesting that platinum peaked relative to gold early this year. We won't be surprised if the early-2014 peak in the platinum/gold ratio is tested later this year in similar fashion to this ratio's August-2012 test of its late-2011 bottom, but our guess at this early stage is that an important trend reversal is in the works."

The recent strength in platinum relative to gold is setting the stage for the early-2014 peak in the ratio to be tested as part of what we think is a major topping pattern. Since gold is more of a counter-cyclical speculation than platinum, the most likely period for the platinum/gold ratio to test its 2014 peak is the period between now and when the S&P500 Index falls far enough to make it clear that an intermediate-term stock-market decline is underway.



Gold Stocks

The HUI has closed at 216-217 on each of the past six trading days and at 216-222 on each of the past 13 trading days. This lack of volatility is unusual, but is consistent with the recent lack of volatility throughout the financial world.

The following chart illustrates the loose inverse relationship of the past few years between the gold-mining sector (represented by the HUI) and the broad stock market (represented by the SPX). Although the SPX has continued to trend upward, it lost upside momentum at the end of last year. Our view is that the end of last year was when the HUI made a major low.

Everything is taking longer than expected, but all the markets still appear to be on the right (from our perspective) track. The right track involves a HUI rally to around 300 within the next two months, with or without a preceding spike down to support at 210.



The Currency Market

The Dollar Index has rebounded and the euro has pulled back over the past two weeks. These moves have now gone as far as they should go IF (as we believe) they are corrections to continuing trends (up for the euro, down for the Dollar Index).

The following chart shows that the euro ended last week near its 200-day MA. Furthermore, the RSI at the bottom of the chart shows that the decline of the past two weeks has resulted in the euro becoming 'oversold' on a short-term basis. This means that a reversal should soon happen IF the recent decline was corrective.

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 ended Friday 23rd May 2014:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, IRR = Internal Rate of Return, 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%, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Endeavour Mining (EDV.TO) received 2.5M shares of Legend Gold (LGN.V) as part payment for an early-stage non-core project in Mali. EDV now has 7.3M LGN shares and will have almost 10M when the final payment is made. EDV's investment in LGN is currently not financially significant, although it could eventually be significant if LGN's exploration is successful.

Final thoughts (for now) on the proposed Rio Alto (RIO.TO/RIOM) - Sulliden Gold (SUE.TO) combination

We reiterate that our concerns about the wisdom of this merger -- from the perspective of RIO shareholders -- has almost nothing to do with the quality/potential of the asset being acquired by RIO and everything to do with the price being paid. Considering the way that assets are currently being priced throughout the gold sector, SUE was an expensive stock prior to RIO's takeover bid, whereas RIO was very under-valued. Consequently, we don't believe that this deal would have made sense for RIO shareholders even if there were no premium involved (RIO's offer was pitched at a 43% premium to the market).

In simple terms, RIO, a company with more than 200K-220K ounces/year of current low-cost gold production, is trading almost half of itself for an asset that could, if all goes well (that is, if no major obstacles are encountered) and with the expenditure of another $150M, add 90K ounces/year of production in 2 years' time. Another way to look at the situation is that the chance (not the guarantee) of increasing production by less than 50% is costing RIO a doubling of its share count combined with a $150M reduction in its working capital.

Our assessment of the deal is based largely on the September-2012 FS for the Shahuindo project. If an updated FS were to indicate a much higher rate of production and better economics for Shahuindo, then our current assessment of the deal is definitely too pessimistic and could be completely wrong. However, we suspect that if it were possible to demonstrate much better economics for Shahuindo then the promotion-savvy senior management of SUE would have already done so.

Fortunately, the market views the deal far more favourably than we do. That's why RIO is only down by 8% from its pre-announcement level, which is a normal decline by the stock of the acquiring company.

As mentioned in our initial reaction to the deal in last week's Interim Update, in our own account we are maintaining a larger-than-average position in RIO for now. Our plan, at this stage, is that the RIO position will be exited when the gold-mining sector next becomes extended to the upside on a short-term (1-3 month) basis.

Review of price action for individual stocks

In general, the stocks of gold-mining companies that need a much higher gold price to either be profitable (in the case of producers) or have an economically-viable development-stage project (in the case of explorers) have recently been very weak. GSS, CFO.V, RMS.AX and SBB.TO are examples from the TSI List. However, the stocks of companies that have economically-viable businesses at the current gold price have generally held up well and appear to be completing, or in a few cases to have already completed, routine corrections. Here are charts showing examples from the TSI Stocks List:

List of candidates for new buying

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

1) EDV.TO (last Friday's closing price: C$0.78).

2) EVN.AX (last Friday's closing price: A$0.81).

3) PLG.TO (last Friday's closing price: C$1.36).

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://bigcharts.marketwatch.com/