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 2013. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 23 January 2012)

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

T-Bond Update

The following weekly chart shows that the US T-Bond made a new 2-year low last week before recovering to end the week with a small gain. This could perhaps be construed as a minor positive, but the trading range was too narrow for the upward reversal to be significant. At this stage, therefore, the T-Bond remains sufficiently 'oversold' to create a short-term and an intermediate-term price low, but the price action is yet to indicate that a low is in place.



The next weekly chart shows the yield difference between the 10-year T-Note and the 10-year TIPS, a quantity that we refer to as the "Expected CPI". The Expected CPI is a measure of the bond market's inflation expectations.


                                    Chart Source: http://www.fullermoney.com/

As mentioned in previous commentaries, the most remarkable aspect of this year's decline in the T-Bond price (rise in the T-Bond yield) is that it has been accompanied by a decline in inflation expectations. This is unusual to the point of being unprecedented, given that the expected level of "price inflation" is by far the most important driver of long-term interest rates.

Normally, a multi-month decline in inflation expectations would go with falling long-term interest rates, but this year's decline in inflation expectations has gone with a substantial rise in long-term interest rates. The explanation that long-term interest rates have risen in anticipation of stronger real growth is a non-starter because real growth leads to a rise in the purchasing power of the currency and should be accompanied by lower, not higher, yields on default-free government bonds.

The most reasonable explanation of this year's unusual relationship between the T-Bond and inflation expectations is that the Fed's machinations had pushed bond yields so far below where they would otherwise be that the anticipation of reduced Fed intervention caused yields to rise despite a decline in the expected level of price inflation.

A reduction in the level of the Fed's bond market intervention will probably become a reality before the end of this year, but a major bear market in the T-Bond will certainly require a large rise in inflation expectations. The reason is that in the absence of higher inflation expectations, a 4%+ T-Bond yield (the current yield is 3.8%) will look very attractive to many large investors after it becomes apparent that the stock market has peaked. 

The Stock Market

The misunderstood relationship between the stock market and long-term interest rates

Last week we used the chart displayed below to help make the point that the US stock market entered a secular decline in 2000 and that the decline is probably not complete. Our argument was that long-term equity trends are determined by valuations rather than nominal prices, and that the US stock market's overall valuation commenced a major decline in 2000 (as evidenced by the blue line on the chart). This week we are using the same chart to make the point that there is NOT a consistent historical relationship between equity valuations and long-term interest rates (the red line on the chart).

The conventional wisdom holds that, over the long haul, rising equity valuations go with declining long-term interest rates and falling equity valuations go with rising long-term interest rates. The popular "Fed Model" is predicated on this line of thinking. But as is often the case, the conventional wisdom is wrong.

The widespread belief that equity valuations and long-term interest rates are inversely correlated arose because, as shown by the following chart, they were inversely correlated from 1966 through to 2000. Consequently, if you were analysing the relationship during the 1990s and you didn't look at what happened prior to the mid-1960s, you would naturally come to the conclusion that such a correlation existed. In addition, the idea that rising long-term interest rates will generally go with declining equity valuations and that falling long-term interest rates will generally go with rising equity valuations seems reasonable at a superficial level. However, the inverse correlation has not existed since 2000 and did not exist prior to 1966.


                             Chart Source: http://www.irrationalexuberance.com/index.htm

To demonstrate the absence of a consistent correlation between equity valuations and long-term interest rates, we cite these facts:

First, here's what happened during the last three long-term equity bull markets:

a) The 1921-1929 equity bull market began at a HIGH long-term interest rate and occurred in parallel with a DOWNWARD-trending long-term interest rate (meaning: NEGATIVE correlation between equity valuations and long-term interest rates).

b) The 1942-1966 equity bull market began at a LOW long-term interest rate and occurred in parallel with an UPWARD-trending long-term interest rate (meaning: POSITIVE correlation between equity valuations and long-term interest rates).

c) The 1982-2000 equity bull market began at a HIGH long-term interest rate and occurred in parallel with a DOWNWARD-trending long-term interest rate (meaning: NEGATIVE correlation between equity valuations and long-term interest rates).

And here's what happened during the last three long-term equity bear markets:

a) The 1929-1942 equity bear market began at a MODERATE long-term interest rate and occurred in parallel with a DOWNWARD-trending long-term interest rate (meaning: POSITIVE correlation between equity valuations and long-term interest rates).

b) The 1966-1982 equity bear market began at a MODERATE long-term interest rate and occurred in parallel with an UPWARD-trending long-term interest rate (meaning: NEGATIVE correlation between equity valuations and long-term interest rates).

c) The 2000-20?? equity bear market began at a MODERATE long-term interest rate and up until now has occurred in parallel with a DOWNWARD-trending long-term interest rate (meaning: POSITIVE correlation between equity valuations and long-term interest rates).

To summarise the above: Over the past 90 years, major US stock-market trends were inversely correlated with long-term interest rates about half the time. That is, there was no consistent correlation.

The bottom line is that the major trend in the long-term interest rate does NOT determine the major trend in the stock market. Regardless of the interest-rate backdrop, long-term equity bull markets begin when equity valuations are very low and end when equity valuations are very high, and long-term equity bear markets begin when equity valuations are very high and end when equity valuations are very low.

Current Market Situation

Going by the NASDAQ100 Index (NDX), all that happened this month is a minor hesitation within a continuing short-term upward trend. As illustrated by the following daily chart, the NDX is still close to its high for the year and didn't even reach its 50-day MA during this month's pullback.



Going by the Dow Industrials Index, a correction of at least short-term significance is in progress. As illustrated by the following daily chart, the Dow has clearly breeched its 50-day MA.



Due to its relative weakness, the Dow will probably be the first of the senior US stock indices to generate a bear-market warning signal by breaking decisively below its June low (14,500). Looking from a different angle, as long as the Dow (the weakest senior index) manages to hold above its June low it will be premature to conclude that a bear market has begun.

There is currently no evidence that anything more than a short-term top is in place, although our guess is that a major topping process is underway. Gold's rebound lends some credence to this guess.

This week's important US economic events

Gold and the Dollar

Gold

Meaningful price trends in the gold market are not driven by Chinese housewives or US retail coin collectors or Indian wedding-season buyers. They are driven by large speculators and investors trading in anticipation of, or in reaction to, macro-economic, monetary and financial-market developments. The general assessment of the issues that drive the investment/speculative demand for gold will not always be correct, but it is what it is. For example, the main driver of the gold-price decline during the first half of this year was the increasing popularity of the view that a) central-bank monetary stimulus had set the economy on a self-sustaining growth path without causing an inflation problem, and b) a new secular bull market in equities had begun. We are confident that this assessment is wrong, but right or wrong it clearly had a material adverse effect on the total demand for gold.

A major shift is probably now happening, with equities in a topping pattern and gold in a bottoming pattern. But just as it took more than 12 months for the belief in the return of economic/monetary stability to gain the upper hand, it will take time for the majority of market participants to embrace a different reality. Therefore, it is unrealistic to expect that the gold rebound of the past two months will continue to build upward momentum over the months immediately ahead. It's far more likely that there will be a short-term top within the next three weeks followed by at least 1-2 months of 'backing and filling'. The 'backing and filling' could encompass a test of the June low during October or November.

With regard to a likely level for the next short-term price peak in the gold market, we've had the $1400-$1530 range in mind for a while. That the bottom of this range has already been reached (last Friday's high was $1399.90) improves the chances of getting to near the top of the range during the first half of September, but the main point we want to make right now is that it isn't realistic to expect gold to do any better than rise to the low-$1500s within the next three months. So, we suggest that you ignore the far more bullish short-term targets that will undoubtedly get bandied about if the gold price breaks decisively into the $1400s in the near future.



Silver

The following weekly chart contains a moving average envelope that under normal circumstances limits silver's upside and downside. Once a meaningful silver rebound was signaled, the top of this MA envelope became a high-probability short-term target. This target was slightly exceeded last week.

With silver now slightly above the top of its MA envelope and short-term 'overbought' by some measures, the best of this particular rally is probably behind us. There is a possibility that resistance at $26 will be tested before the next sizeable price decline gets underway, but $26 for silver should be viewed similarly to $1530 for gold; that is, it should be interpreted as a level that defines the MAXIMUM short-term upside potential.



Gold Stocks

On the negative side of the ledger, there was a minor bearish divergence between the bullion market and the HUI over the past six trading days, with the bullion making new multi-month highs and the HUI consolidating below its 15th August high. On the positive side of the ledger, the 1968-1970 model points to strength in the gold sector over the coming three weeks.

As is usually the case, we do not have a strong opinion on what the markets will do over the next few weeks. What we do know is that we would view significant additional strength between now and mid-September as a short-term selling opportunity.



Currency Market Update

The currency market has been uneventful over the past three weeks, with the Dollar Index consolidating just below its 200-day MA. This consolidation improves the odds of a spike to a new 6-month low within the next couple of weeks.



As evidenced by the COT data and Market Vane's sentiment survey, speculators, as a group, have remained positive about the US dollar's prospects throughout the Dollar Index's decline from its June high. This is probably why the Dollar Index hasn't yet reversed upward. It simply hasn't become 'oversold' in a meaningful way, despite having trended downward for two months. A genuine 'oversold' condition is not necessarily required for a tradable rally to commence, but it would certainly help.

Fed-related confusion has no doubt contributed to the reluctance of speculators to switch from the US$-bullish camp to the US$-bearish camp. Neither the currency market nor the Fed itself can figure out when and by how much the monetary accommodation will be "tapered". Nobody knows what's going to happen on the monetary front, because the Fed's actions are -- by the central bank's own admission -- data dependent, and nobody knows what the economic numbers are going to be during the few weeks leading up to the next FOMC meeting.

It's ridiculous and sad that much of what happens in the financial markets these days revolves around traders trying to guess what central bankers are going to do and central bankers trying to guess how traders will react to the actions and words of central bankers. Long gone are the days when interest rates provided accurate signals about the economy-wide propensities to save and consume.

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

Company news/developments for the week ended Friday 23rd August 2013:

[Note: 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]

  *Carpathian Gold (CPN.TO): It was clear from the quarterly financial reports issued by CPN during the week before last that additional financing would soon be needed. We didn't have to wait long for details of the additional financing, because a CPN press release after the close of trading last Monday announced a "bought deal" to raise $16M by issuing 114M new shares at the low price of C$0.14/share.

$16M is probably enough to see the company through the next two months, but CPN is not out of the woods. Depending on the time it takes for the newly-constructed RDM gold mine (Brazil) to get to the point where it is adding cash to the company's balance sheet, it's possible that more money will have to be raised in the not-too-distant future. However, with this $16M equity financing in place it should be possible for CPN to obtain additional funds by expanding its debt rather than its equity, thus avoiding further dilution to the stakes of current shareholders.

The equity financing announced last week is due to close on 5th September.

  *Clifton Star (CFO.V) reported the final set of results from the 2013 drilling program at its Duparquet gold project (Quebec). The results should enable in-pit resources to be upgraded and could enable the overall resource to be increased. The most significant results came from drill holes BD13-23 (2.46 g/t Au over 18.5 m), BD13-27 (1.14 g/t Au over 72.0 m) and BD13-34 (2.27 g/t over 15m), the reason being that these holes have potentially expanded the west pit shell.

CFO also advised that it is waiting for the results of Pilot Plant tests carried out to evaluate and compare the POX (Pressure Oxidization) flow sheet as used in the Duparquet project's PEA and the potential to produce saleable gold concentrates as an alternative process. These test results will be important in assessing the economic viability of the project.

As we noted last week, CFO is a reasonable speculation at C$0.30 or lower. As also noted last week, the main short-term risk is that the company only has a few million dollars in the bank and will have to seek additional financing within the next 6 months.

  *Pretium Resources (PVG) is topping up its treasury by issuing 1.5M "flow-through" shares at C$10.10 per share. This financing is not significant.

  *Sabina Gold and Silver (SBB.TO) announced results from on-going drilling at the Back River project's George Property. As usual for Back River there were several eye-catching gold intercepts within the results, including 24.96 g/t Au over 11.25m in drill hole 13GRL152. However, we don't know how these latest results will affect the overall project resource.

The next resource update is scheduled for Q1-2014. Prior to that we get the next look at the project economics via the PFS scheduled for mid-October.

Candidates for new buying

The relatively low-risk/high-quality junior gold stocks that we've suggested for new buying over the past several weeks have rallied far enough and fast enough that even though they remain very under-valued based on what we expect to happen over the coming year, they are no longer in short-term 'buy zones'. Significant additional price gains are certainly possible over the coming three weeks, but better buying opportunities will probably arise during October-November.

For those prepared to take a lot of risk in exchange for substantial short-term reward potential, Jaguar Mining (TSX: JAG, US OTC: JAGGF) could be of interest. JAG is in a very precarious financial position, but it could quickly double or more in price from its current ultra-depressed level of $0.28 due to receding fear of bankruptcy if gold rises to around $1500/oz.

Short-term price targets and candidates for partial selling

Refer to the 19th August Weekly Update for chart-based short-term price targets for the TSI stocks that have rebounded strongly over the past few weeks. Some stocks have tested initial resistance levels, but the potential exists for higher levels to be tested by mid-September.

Our only additional comments at this time are:

1) Ramelius Resources (RMS.AX) was strong last week and is now testing initial resistance at A$0.20. This stock's next significant resistance level -- and a realistic short-term objective if the sector-wide rally continues for 2-3 more weeks -- is A$0.30.

RMS is extremely under-valued at A$0.20 and will still be extremely under-valued if gets to A$0.30 in the near future, but if, like us, you were a buyer near the recent low of A$0.10 then you could reasonably decide to take some profits on these low-priced purchases into the current strength.



2) As well as a long-term position in EDV.TO, the TSI Stocks List contains a short-term EDV position that was added two months ago in anticipation of a rebound to around C$1.00. For TSI record purposes, this short-term position will be exited if the stock trades at C$0.97. It ended last week at C$0.89.

Fading Barrick

The strategic decision-makers at Barrick Gold (ABX) have demonstrated an amazing ability to buy high and sell low. In fact, you could have made a fortune over the past 13 years by simply doing the opposite of what ABX's top strategists were doing. As evidence, we point out that they: a) decided to make a substantial investment in oil production in mid-2008, with the oil price near a long-term peak; b) decided to make a substantial investment in copper production in early 2011, with the copper price near a long-term peak; and c) maintained a huge gold short position (they called it a "hedge position") during the first ten years of gold's bull market and then spent several billion dollars to unwind this position. Continuing the pattern, they have just sold 450K ounces/year of gold production in the world's best country for mining (Australia) to Gold Fields Ltd. (GFI) for the incredibly low price of $300M.

ABX's loss is GFI's gain. GFI was a reasonable long-term speculation prior to last week's ABX deal and now looks very good, especially since the market's initial reaction to the deal was to dump GFI shares.

With this purchase of assets from ABX, GFI's annual gold production will increase from 1.85M to 2.3M ounces and its average production cost should fall. Furthermore, its per-ounce valuation and its political risk profile will improve. With regard to the latter, the ABX deal will result in GFI's production being geographically spread as follows: 42% from Australia, 34% from Ghana, 13% from Peru and 11% from South Africa. This means that only 11% of the company's production will come from a high-risk country.

GFI and Kinross Gold (KGC) now have similar valuations. GFI has the advantage of lower political risk, but KGC has a stronger balance sheet (GFI will have net debt of $1.95B after the ABX deal is completed, whereas KGC has approximately zero net debt) and a lower average production cost. GFI has greater leverage to changes in the gold price, which could be an advantage or a disadvantage depending on gold's price trend.

It would be reasonable to begin averaging into GFI shares, but for TSI record purposes we are going to obtain exposure to the stock via long-dated call options. Specifically, we have added the January-2015 US$7.00 GFI call option to the TSI List at Friday's closing price of US$0.84.

Chart Sources

Charts appearing in today's commentary are courtesy of:

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