-- Weekly Market Update for the Week Commencing 27th June 2016

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 early-2015, but there will be many years of topping action in bond prices and bottoming action in bond yields before major new trends get underway. (Last update: 29 June 2015)

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 2018 and 2020. (Last update: 29 June 2015)

A secular BEAR market in the US 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 2018 and 2020. (Last update: 29 June 2015)

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 2018-2020. (Last update: 29 June 2015)

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Outlook Summary

4. Long-term views are determined almost completely by fundamentals and intermediate-term views are determined by a combination of fundamentals, sentiment and technicals.

Last week's posts at the TSI Blog

Central bankers believe that they can provide free lunches

The evidence be damned!

Summary of current thinking/positioning

1) Concerned about short-term downside risk in gold, silver and the associated mining stocks, but comfortable maintaining substantial 'core' exposure in anticipation of large additional gains over the next two years.

2) Maintaining relatively small exposure to non-gold commodity-related stocks and positioned for short-term weakness via XME put options, but getting more bullish about intermediate-term prospects. Looking for a near-term opportunity to exit the XME puts.

3) Thinking that the US stock market has commenced a significant decline and betting (via QID call options) on additional short-term weakness, although less aggressively now than a week ago due to having sold some QID calls on Friday 24th June.

4) Thinking that industrial commodities (oil, copper, platinum, etc.) and the main commodity currencies (A$, C$) made long-term bottoms during Q1-2016, but that the bottoms could be tested during the second half of this year as part of a basing process.

5) Thinking that the days around the 23rd-24th June "Brexit" event will turn out to be a pivot point for the currency, gold and bond markets (a top for gold, the Yen and the 'safe haven' government bonds).

6) Anticipating a tradable decline in the T-Bond.

7) Maintaining an unusually-large cash reserve of around 50% in recognition of the downside risk in almost all equities.

Apres Brexit le deluge*

Here is the opening of an article posted at The Telegraph last Thursday:

"Voters in France, Italy and the Netherlands are demanding their own votes on European Union membership and the euro, as the continent faces a "contagion" of referendums.

EU leaders fear a string of copycat polls could tear the organisation apart, as leaders come under pressure to emulate David Cameron and hold votes."

This is what the EU leadership has been most afraid of -- that giving British citizens the chance to vote on EU membership would 'get the ball rolling'. With Britain now having opted to leave the EU the pressure to hold similar polls in other European countries will be even greater.

We can't quantify the odds, but there appears to be a non-trivial risk of Europe's economic and monetary unions unravelling within the next two years. In other words, rather than being a culmination, "Brexit" could be the start of a trend. A positive trend, we would add.

    *A modification of the French expression attributed to Marquise de Pompadour.

Flooding the system with liquidity

In the email sent to subscribers last Friday we mentioned that central banks were bound to flood the financial system with 'liquidity' in response to the "Brexit" result. We said that this would add to the long-term damage that the idiots have already done, but would support prices in the short-term. This prompts the questions: why would the financial system suddenly need additional 'liquidity' and how would the central banks go about providing it?

The answer to the first question is that with one possible exception (discussed below), the financial system would NOT need additional 'liquidity'. Prices would simply adjust and the world would go on. However, central bankers wrongly believe that it is their job to stabilise the financial markets and also wrongly believe that stabilisation can be achieved by pumping additional money into the banks and other financial institutions. Two wrongs do not make a right.

Price signals are only useful if they reflect reality and when central bankers intervene in markets they prevent this from happening, so the entire concept behind the intervention is wrong. However, central bankers do not trust and do not understand markets, so they do what they can in a counter-productive effort to make the situation better. They don't know what they are doing but they feel they have to be seen to be doing something, so they do the only thing they know how to do: create new money via some form of asset monetisation. This often has the effect of boosting some prices, especially the prices of stocks and bonds.

The one possible exception is that due to the way today's global monetary system works, a sudden increase in risk aversion can lead to a short-lived surge in the demand for US dollars. This can create a temporary shortage of dollars OUTSIDE the US that, if not for intervention, could lead to a large, rapid and disruptive increase in the US dollar's exchange rate. To prevent this from happening the Fed engages in currency swaps with other central banks. For example, the Fed provides US dollars to the ECB, the BOE and the BOJ in exchange for euros, Pounds and Yen, respectively. These swaps are subsequently reversed after the short-term US$ demand surge has abated.

At this stage we don't know exactly what, if anything, the central banks did in response to Friday's developments. It's highly probable that the Fed did some currency swaps with the BOE and the ECB, but it's possible that no other liquidity-providing measures were undertaken.

We should know more of the details by the end of this week.

Time to take another stab at a bearish T-Bond speculation

Last week we gave four reasons to believe that an important top for long-dated US government bonds was not far away and that the coming decline could be worth trading. We also wrote: "The risk is that even if our view is correct in terms of time, the combination of the Brexit vote and stock-market weakness could bring about a trend-ending blow-off to the upside in 'safe haven' investments."

Friday's price action in T-Bond futures (see chart below) qualifies as a blow-off, although whether it was the trend-ending kind is not yet known. In particular, if the stock market follows through to the downside over the coming 1-2 weeks there could be a surge to another new high in the T-Bond price.



Due to the realistic possibility of some additional panic over the days ahead a bearish T-Bond speculation is still risky, but now that we've had at least part of the trend-ending blow-off in safe-haven investments the risk involved in such a speculation is lesser and the potential reward is greater. We have therefore added the TBT September-2016 $35 call option to the TSI List at Friday's closing price of US$1.11.

Here is a chart of TBT. For this trade to work well we don't need a major decline in the T-Bond, all we need is a 5%-8% decline within the coming 2.5 months.



Commodities

Uranium price to double by 2018?

"Uranium prices set to double by 2018" is the title of an article that appeared at Mineweb early last week. The gist of the article is that while a large increase in uranium demand is 'baked into the cake' due to the number of nuclear power plants under construction and in the planning stages in Asia, negative sentiment has prevented this coming demand surge from being reflected in the uranium price.

The problem with the argument put forward in the above-linked article is that the uranium price is determined by producers and consumers of the commodity that are well aware of the supply/demand fundamentals. To put it another way, this is not a market that is currently dominated by poorly-informed members of the general public.

We won't be surprised if the uranium price doubles over the next two years. After all, the oil price managed to double in the space of only four months after bottoming in February of this year. However, the reason won't be the discovery that a lot of reactors are being built in China, because this information is already well known by the dominant participants in the market.

At major commodity-price bottoms it takes only a small upward shift in demand relative to supply to reverse the price trend. In the uranium market the shift could happen at any time, especially given that most of the world's uranium production is unprofitable at the current spot price, but we long ago gave up on trying to 'nail down' the timing.

As evidenced by the fact that the uranium price made a new 5-year low within the past two weeks (refer to the following weekly chart for details), what we do know is that the shift hasn't happened yet.



In the stock market, traders periodically anticipate a turnaround in the uranium price. There is, for example, evidence in the following chart of the Global X Uranium ETF that traders of uranium-mining equities made their latest attempt to anticipate a uranium-price turnaround over the past five months. They were undoubtedly emboldened by the rallies in oil and other commodities, but, as illustrated above, the uranium price has not yet begun to validate the optimism of the stock traders.



URA's current chart pattern suggests that a long-term base is forming (the price pattern over the past 12 months is a potential head-and-shoulders bottom). In other words, URA's chart pattern looks constructive. Traders of uranium-mining equities have not shown themselves to be adept at predicting the inevitable/eventual turnaround in the uranium price in the past, but perhaps this time they will be correct.

We'll wait and see before adding to our uranium exposure.

Natural Gas (NG) has signaled a multi-year trend reversal

NG's seasonal pattern contains a high in mid-June followed by a low in early-September. The seasonal pattern has not been a reliable predictor over the past few years, but there are signs that it is being followed this year. Of particular relevance, there was a sharp rise into the time-window when a seasonal high was due.

On a longer-term basis, the fact that NG was able to achieve a weekly close above resistance at US$2.50 is bullish. It warns that a multi-year reversal from down to up probably occurred during the first quarter of this year. If so, the seasonal low due in August-September should be comfortably above the March low.



The Stock Market

The US

Current Market Situation

We concluded last week's discussion of the US stock market as follows:

"The bottom line is that while the US stock market moved in the right direction (from our perspective) last week, it hasn't yet signaled that something more than a routine pullback is underway. What needs to happen is a daily TRAN close below 7500, a daily NDX close below 4300 and a daily SPX close below 2040."

Thanks to Friday's drama, the SPX has just closed below support at 2040. This means that it has just achieved its lowest daily (and weekly) close since March. The next support of consequence lies at 1950.



Also, the NDX has just closed below support at 4300. The next support of consequence is defined by the January-February lows in the 3900-4000 range.



It should be noted that last Friday's breaches of SPX and NDX support were marginal and happened as part of an emotional reaction to news that is not fundamentally bearish for the US stock market. However, Friday's breach of TRAN support was decisive.



TRAN has been the leading US stock index over the past 18 months, so its clear-cut downside breakout is potentially significant. At the same time, our favourite measures of market breadth are more bullish now than they were just prior to the starts of substantial declines last August and December. Also, the fact that Friday's downside breakouts happened in response to news that was not in any way bearish makes their sustainability more questionable than would otherwise be the case.

There could be some follow-through to the downside over the next couple of days, but there could also be an immediate rebound. If there is an immediate rebound it's likely that it would be followed by a decline to below last week's low.

Whether or not the market rebounds or continues to decline over the next few days, we expect that a short-term bottom will be in place within two weeks. What happens thereafter will largely depend on the level at which the short-term bottom is formed.

Update on short-term bearish speculations

At the end of last week the TSI List contained a QID (leveraged NDX bear fund) July-2016 $35 call option at a small (by option standards) loss and a QID October-2016 $40 call option at a small profit. In the email we sent to subscribers following last Friday's Brexit news we wrote that the actions we took in response to the news would depend on the magnitudes of the price moves in the US markets, but that we were planning to exit the July QID call options and retain the October QID calls. This was for both our own account and the TSI List.

Due to the closeness of the expiry date we have removed the QID July call option using the middle of Friday's closing bid-offer spread (US$0.60) for record purposes and -- as mentioned in the email -- have retained the October calls. Also, if there is significant additional downside in the US stock market within the coming two weeks we will probably exit the October calls with the aim of re-positioning following a rally.

Europe and the UK

In response to the Brexit news, European equities in euro terms generally fell much further than UK equities in Pound terms. However, that's only because the Pound was much weaker than the euro. When we measure performance in terms of the same currency, that is, when we compare apples with apples, it's interesting to discover that European equities plunged by almost the same percentage amount as UK equities last Friday.

Specifically, the following charts show that UK equities in US$ terms (EWU) and euro-zone equities in US$ terms (EZU) both plunged by about 12% on Friday. The magnitude of the market reaction is indicative of the magnitude of the surprise at the result of Britain's referendum.

The next chart shows that in terms of a common currency (the US$), UK equities were much weaker than European equities from mid-2012 (around the time that the village idiot who runs the ECB promised to do whatever it takes to maintain Europe's monetary union) through to April of 2014. Over the past two years the relative performance has stabilised and has possibly begun to shift in the UK's favour.

This chart confirms that the relative performance trend was not affected by last week's dramatic news.



Lastly, it's worth pointing out that the Europe 600 Banks Index (FX7) plunged 14% last Friday to a new 3-year low. It is now within 7% of the lows reached during the darkest days of the 2011-2012 euro-zone debt crisis, which could be viewed as a plus because it means that there is now only 7% between the current level and a major support level.

Unfortunately, abject failure only encourages central bankers to do more of the same.



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 US$ gold price has achieved a weekly close above last year's high and in doing so has provided more evidence that a bull market is underway.



It's the same story with regard to the euro-denominated gold price.



With regard to the gold price in terms of the British Pound, there was an incredible 19% swing from Thursday's low to Friday's high and an equally-incredible 15% gain from Thursday's close to Friday's close. In Pound terms, gold is at its highest price in more than three years.



With gold not yet short-term 'overbought' in momentum terms and having just broken above important resistance, there could be significant additional gains prior to a meaningful top. $1400/oz is now a realistic near-term possibility. However, on the other side of the ledger we have the following:

1) Gold's true fundamentals are bullish, but not demonstrably so. Furthermore, they didn't become appreciably more bullish as a result of last week's Brexit news. That is, Friday's price gain was almost totally sentiment-driven.

2) Although the US$ gold price broke decisively above important lateral support at $1308 on Friday, it finished the session well below its high of the day and also below its 4.5-month channel top (refer to the first of the above gold charts).

3) The total speculative net-long position in COMEX gold futures was at an all-time high last Tuesday with the gold price at $1270 and will almost certainly now be well into new-high territory. This creates downside risk.

4) The fact that there was a roughly 120K-contract increase in the total speculative net-long position in COMEX gold futures from early-March through to last Tuesday in parallel with almost no increase in price indicates that it was taking a progressively greater amount of buying on the part of speculators in the futures market to prevent the price from falling. This means that the underlying demand for physical gold does not currently support a gold price above $1250.

5) On Friday silver was unable to close above, or even to trade above, its 2015 peak of $18.50. This is currently a minor bearish non-confirmation of gold's breakout, but it could be important.

6) Relative to commodities, last Friday's moon-shot in the gold price looks more like a counter-trend bounce than an extension of the longer-term upward trend. Here is a chart of the gold/GNX ratio.



Due to risk/reward considerations, our intermediate-term gold outlook has shifted from bullish to neutral.

Gold Stocks

Considering everything else that was happening, Friday 24th June was a strangely non-committal day for the gold-mining indices. After rocketing upward to a new high for the year near the start of trading on Friday, the HUI dropped back and failed to close above its highs of the past two months. At the same time, the downward reversal from the intra-day high didn't look significant as the bulk of the initial gain was retained.



The one potentially bearish development was the fact that on Friday we had a new closing high for the year in the gold price accompanied by a lower high in the HUI/gold ratio. It's the first time this year that there has been a bearish non-confirmation between the bullion market and the HUI/gold ratio.

A near-term surge in the HUI to 250-260 remains a realistic possibility, albeit not one we are inclined to bet on.

The Currency Market

The Pound

This is extraordinary. In reaction to a development that should benefit the UK economy over the years ahead, the British Pound collapsed on Friday from a 6-month high to a 30-year low against the US$.



We exited a short-term and small-scale Pound trade last Thursday (a decent win in percentage terms, but trivial in monetary terms). We are interested in re-establishing some 'long' exposure to the Pound, but this time on a larger scale, with a much longer holding period in mind and via a currency deposit rather than options. Our tentative plan is to scale into the position over the next few months.

The Dollar Index

The Dollar Index needs to close above its late-May high to confirm that an intermediate-term bottom was put in place in early-May. It traded above this level during last Friday's mini-panic, but didn't manage to close above it.

The Dollar Index did manage to close above the top of 7-month downward-sloping channel on Friday (see chart below), but, as is the case with the US stock indices, the sustainability of the breakout is called into question by the fact that it happened as part of an emotional reaction to news.

A second weekly close above 95 would suggest that the channel breakout was genuine.



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 24th June 2016:

  *Ivanhoe Mines (IVN) reported the results from the first six holes of its 2016 drilling campaign at the Kakula discovery at the company's Kamoa copper project, Democratic Republic of the Congo.

Kamoa already has the world's biggest undeveloped high-grade copper deposit, so adding pounds to the resource tally isn't the primary objective. Instead, the primary objective of the drilling program is to confirm and expand a thick, flat-lying, bottom-loaded zone of very high-grade copper mineralisation at the southern part of the Kakula Discovery, because doing so could have a significant positive impact on the overall project's economics.

It's a case of so far so good, in that the results to date confirm the high grades and shallow, flat-lying geometry of the Kakula mineralised zone indicated by previous drilling. For example, the latest batch of results included the following exceptional intercepts (at a 2.5% copper cut-off): 11.82 metres (true width) of 4.06% copper, 8.86 metres (true width) of 6.56% copper, 6.42 metres (true width) of 5.70% copper and 10.23 metres (true width) of 6.18% copper.

We suggest accumulating IVN on weakness over the coming few months for exposure to copper, zinc and PGMs. The country risk is high, but this risk is counteracted by a very low valuation.

  *Premier Gold (PG.TO) reported excellent results from two more step-out holes drilled at its exploration-stage McCoy-Cove gold project in Nevada. The best intercept was 124m averaging 3.54-g/t gold. This follows the 51m intercept averaging 7-g/t gold that was reported about three weeks earlier.

There are 9 more holes to be completed in this year's program, after which a resource estimate will be calculated.

  *Resolute Mining (RSG.AX) reported that it has fully repaid its US$50M senior secured cash advance facility and redeemed its A$15M of convertible notes. RSG now has no debt apart from a subsidiary-level working capital overdraft facility. The company is therefore well positioned to invest in the projects that are expected to provide its production growth over the next few years.

One of RSG's current in-house growth projects is the Ravenswood Extension Project (REP) in Queensland, the first stage of which is expected to result in production of 71K ounces over the coming 16 months for a capital investment of only A$5M. A Feasibility Study for this project is almost complete.

Another is the Bibiani gold project in Ghana. The results of this project's FS were reported last week and show that for US$72M Bibiani could be developed into a 100K-oz/year underground mine with a 6-year life and an AISC of US$858/oz. The economics of this project would currently be marginal, but by expanding the resource and adding at least 2 years to the mine life it could become economically attractive at US$1250/oz or higher.

RSG is performing very well on the ground and in the stock market. Its market cap has quintupled over the past 6 months, but its intermediate-term risk/reward is still skewed decisively towards reward.

Chart Sources

Charts appearing in today's commentary are courtesy of:

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