-- Weekly Market Update for the Week Commencing 27th August 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

Sentiment pitfalls, the gold edition

Summary of current thinking/positioning

1) Despite breaking out to the upside only eleven trading days ago, the Dollar Index may have already reached a short-term peak.

2) Gold-market sentiment remains extreme (relative to the past 15 years) and the first evidence of an upward reversal has emerged. Also, the fundamental backdrop has begun to shift in gold's favour.

3) It is still not clear that the capitulation in the gold-mining sector has run its course, but the odds have shifted in favour of at least a 2-3 week rebound.

4) There are numerous divergences within the US stock market, but the senior stock indices have not yet shown significant signs of weakness. This means that new highs could be achieved before a tradable decline gets underway. However, with monetary conditions tightening, the short-term downside risk is high.

5) After being relatively strong for the bulk of the past 12 months the oil market looks set to be relatively weak for the next few months.

6) The T-Bond price should have an upward bias (meaning: the T-Bond yield should have a downward bias) for at least another 1-2 months. In fact, with the speculative short position in 10-year T-Note futures making another new all-time high last week you would have to be desirous of losing money to bet against the T-Bond at this time.

7) We are holding a cash reserve of 30-35%.

Will the Fed buckle under Trump's pressure?

The answer to the above question is no, Trump's berating of the Fed for continuing to hike its targeted interest rates will not lead to looser monetary policy. If anything, Trump is making it more difficult for the Fed to slow or stop its rate-hiking because if it now does so it will appear to be yielding to political pressure and will lose credibility. Don't get us wrong, the Fed will buckle; it just won't be due to the haranguing of Trump.

Until the past couple of months we thought that the Fed would continue merrily along the rate-hiking path until something broke, with a large decline in the stock market being the most likely catalyst for a monetary-policy directional change. However, recent comments by senior Fed representatives have indicated that there is another, perhaps even more likely, potential catalyst for a shift in the Fed's stance. We are referring to fear of the US yield curve inverting.

At least a few influential members of the committee that sets the Fed's interest rate targets have got it into their heads that an inversion of the yield curve CAUSES a recession, and therefore that a recession can be avoided by preventing short-term interest rates from becoming higher than long-term interest rates. Consequently, the closer the 10-year T-Note yield gets to the 2-year T-Note yield the more likely it will be that the Fed puts its rate-hiking program on hold.

As illustrated below, the 10yr-2yr yield spread ended last week at a new cyclical low of only 0.19%. This means that if the 2-year yield doesn't move it won't take much of a bond rally to bring about an inversion of the curve. Given the huge speculative short position in 10-year T-Note futures, an inversion could happen as soon as next month.



If the Fed soon starts taking actions designed to prevent a yield curve inversion, the most important ramification could be a dramatic rise in long-term yields next year due to surging inflation expectations. In other words, if the Fed tries to stop the yield curve from inverting it may end up getting what it wants -- good and hard.

Oil Update

Two weeks ago we cited three reasons to focus on oil's short-term downside potential. One was that oil's high price relative to other industrial commodities opened up the possibility of a catch-up move to the downside. The second was that the "NonReportable" traders of oil futures (the proverbial dumb money) had recently experienced a surge of bullish enthusiasm, exactly as happened near important price tops in 2011, 2012 and 2014. The third was that the Dollar Index had just broken out to the upside.

We wrote that it could make sense for speculators to take a bearish oil position, although a better entry point would be established by a near-term rebound to $70-$71.

We also wrote:

"We caution that it is always risky to bet against oil by purchasing a leveraged bear fund or shorting the futures. The reason is that this is a market that can always rocket higher in reaction to 'out of the blue' news such as a 'blow-up' in the Middle East. A protective stop may not help in such a situation.

We will be making the bet in our own account by purchasing USO January-2019 put options, and we possibly will add a USO January-2019 put option to the TSI List if the oil price rebounds to around $70 in the near future."

The oil price subsequently dropped to its 200-day MA, where it found support. It then rebounded and last Friday touched resistance in the form of its 50-day MA. This is a reasonable place to establish the bet against oil via the above-mentioned put options.



There are two main threats to a bearish oil speculation at this time. The first is that the physical supply-demand situation remains supportive. However and as noted two weeks ago, a correction to the mid-$50s could occur in parallel with bullish fundamentals and in any case there is no guarantee that the fundamental backdrop will remain supportive. Also, for industrial commodities it is normal for the fundamentals to lag the price at important turning points. The second threat is that the Dollar Index may have already peaked on a short-term basis.

Despite these threats we have gone ahead and added a USO (US Oil Fund) January-2019 $13.00 put option to the TSI List at US$0.39 (the option ended Friday's session at ($0.38-$0.40). A daily USO chart is displayed below. Note that for those with exposure to O&G stocks this USO put-option position could be viewed as a hedge (short-term insurance) as well as a speculation.

By the way, although we think that the oil price is headed for a decline to the mid-$50s or lower, we won't be surprised if the decline doesn't begin in earnest until October. That's why we have selected options with about 5 months to expiry. If the anticipated decline is going to happen it should do so within this time frame.



The Stock Market

The SPX broke out to a new all-time high last week, although on the following chart you may need a magnifying glass to see it. Importantly, the breakout was confirmed by the NYSE Advance-Decline Line, which is shown in the lower section of the chart.



The bottom section of the next chart shows the TSI Put/Call Indicator (TPCI). The TPCI is calculated by dividing the 10-day MA of the OEX put/call ratio into the 10-day MA of the equity put/call ratio and reflects the sentiment of the public (the dumb money) relative to the sentiment of professional hedgers (the smart money). The lower the TPCI, the more optimistic the dumb money relative to the smart money.

A sell signal is generated when the TPCI moves below 0.30 (the bottom red line) and a buy signal is generated when the TPCI moves above 0.80 (the top red line). The buy signals have a higher success rate than the sell signals, but TPCI sell signals tend to be meaningful when they occur in parallel with 'overbought' market conditions. If a TPCI sell signal happened in the near future it would, we think, be an important bearish warning sign.

We are mentioning this now because the TPCI is not far from its sell level.



Despite the obvious risks and the potential for a rare put/call sell signal, it is best not to get enthusiastic about the US stock market's short-term downside potential until the SPX breaks below the bottom of the channel drawn on the chart displayed above and/or the NDX breaks below the bottom of the channel drawn on the chart displayed below.



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

Sentiment Update

To the limited extent that sentiment works as a market-timing tool it does so because the 'dumb money' always ends up on the wrong side of the fence, that is, the 'dumb money' is invariably very bullish near important price tops and very bearish near important price bottoms. Therefore, it stands to reason that before you can correctly assess the sentiment situation in a market you must first determine who is the proverbial dumb money.

In the gold market the large speculators, a.k.a. the "NonCommercials", are not the dumb money. The large specs are usually either trend followers or macro traders. Consequently, when the fundamental backdrop is gold-bearish the large specs generally will reduce their long-side bets and increase their short-side bets as the price declines. In doing so they will magnify the downward trend and naturally end up with a maximum collective bearish position near the ultimate price low. After the price reverses upward this will prompt some contrarians to exclaim "the large specs were wrong again!", ignoring the fact that they were right almost all of the way down.

The significance of the positioning of large speculators is that after they pile onto one side of the market there will be a lot of fuel to power a rally in the opposite direction after the price trend reverses. In particular, if the true fundamentals shift from bearish to bullish while the large specs are positioned for additional price weakness then a rally lasting at least 3 months likely will follow.

In the gold futures market and most other markets, the small traders, or the "NonReportables" in the CFTC's nomenclature, constitute the dumbest money. Collectively, these traders generally will not only follow the price trend, but also be more vulnerable than the large specs to being influenced by fake or irrelevant fundamentals.

Therefore, a prerequisite for the sentiment situation to be decisively bullish is that small traders are more pessimistic than usual. In the COT reports, this pessimism would manifest itself as the "NonReportables" being more short or less long than usual.

The following two charts show the net positions of the "NonReportables" (the small traders) and the "NonCommercials" (the large speculators) in Comex gold futures. They reveal that during the past two weeks the "NonReportables" had close to their smallest net-long exposure in 2.5 years and the "NonCommercials" were net-short for the first time in at least 9 years. This means that the overall COT situation was/is decisively bullish, although the group of traders that constitute the dumbest money is not as pessimistic about gold's price prospects now as it was in 2015.

Fundamentals Update

At the end of last week our Gold True Fundamentals Model (GTFM) was still bearish, but, as illustrated below, it bounced sharply last week from a 3-year low. This was due to two of the seven inputs (the real interest-rate and the general commodity-price trend) switching from bearish to bullish.

It wouldn't take much to shift the Model to bullish. An extension of the T-Bond rebound would help, as would a significant pullback in the US stock market.



The Monthly Price Action

It takes at least five points to properly define a price channel -- at least 3 points on one side and at least 2 points on the other side. It has taken a while, but as a result of this year's downward reversal from the mid-$1350s there is now a well-defined channel on the monthly US$ gold price chart (see below).

There should be plenty of evidence of a long-term reversal to the upside before the channel top is breached, but closing a month above the top of the downward-sloping channel that dates back to the September-2011 all-time high would provide belated confirmation of such a reversal.

After a new long-term upward trend gets underway, corrections during intermediate-term rallies will be limited in most cases by the 8-month MA (the black line on the following chart).



The Short Term Price Action

The first real evidence that a short-term bottom is in place for the US$ gold price emerged on Friday 24th August via daily closes above initial lateral resistance at $1210 and the 20-day MA.



Gold will encounter a lot of technical resistance as it attempts to extend its rebound. For example, it overcame initial short-term resistance on Friday, but there is additional short-term resistance a little higher (near $1220) and then intermediate-term resistance at $1240.

Due to the constructive sentiment situation, the nearby technical resistance should cause nothing more than a pause for breath on the way to higher prices as long as the fundamental backdrop continues to shift in gold's favour. In this regard gold's prospects will be helped by an extension of the T-Bond rebound, which looks likely. With stable inflation expectations, a rise in the T-Bond price translates into lower real interest rates.

The bottom line is that gold stands a good chance of building on its recent upward reversal. As always we'll take the evidence as it comes, but at this time the most reasonable assumption is that we are dealing with a rebound that could last anywhere from a few weeks to three months.

Further to the discussion earlier in today's report, one thing that could transform a 1-3 month gold rebound into something far more bullish would be an attempt by the Fed to steepen the yield curve.

Gold Stocks

The gold-mining sector, as represented on the following chart by the Gold Miners ETF (GDX), hit some sort of low on Thursday 16th August. There was then an unimpressive 4-day up-move followed by a plunge last Thursday (23rd August) that retraced the bulk of the up-move and took GDX back to the vicinity of its 16th August low. At this point the most bullish price action would have entailed a spike to well below the 16th August low followed by a reversal, while the most bearish price action would have been a weak 2-day bounce that retraced only part of the 23rd August decline. The aforementioned bearish development would have encouraged us to re-establish an insurance position in the form of GDX put options during the first half of this week.

As it turned out, the gold sector's price action was somewhere between the bullish and bearish patterns described above. It didn't set up the potential for a definitive reversal by plunging below the 16th August low, but nor did it rebound weakly. Instead, it rebounded strongly enough on Friday to hint that a successful test of the 16th August low has occurred.



A lot of pundits will proclaim that a multi-month or longer-term bottom is now in place. That could be the case, but there's no evidence to support such an assessment. In fact, GDX could move as high as $21.00 (about 10% above Friday's close) over the next 2-3 weeks without generating clear-cut evidence that the short-term decline is over.

It's worth noting that on 16th August GDX's daily RSI(14) hit its second-lowest level in 10 years. This prompted us to write that regardless of whether or not the short-term price decline was over, the decline's momentum extreme was in place. It's also worth noting that GDX's lowest daily RSI in 10 years occurred in July of 2015. The July-2015 RSI extreme was followed by a multi-week price rebound to the 50-day MA and then a fast decline that resulted in a test of the price low. Something similar could be in store this time around.

Another plausible short-term outcome is that a multi-month rally has begun.

We expect that the fundamental backdrop, as indicated by the GTFM, will determine whether there is a 2-3 week rebound to the 50-day MA or a much larger/longer rise. If the GTFM turns bullish within the coming week or two then we probably are dealing with a 2-3 month (or longer) rally, but if the GTFM stays bearish then we probably are dealing with nothing more than a 2-3 week bounce to resistance.

Of course, there is still the risk that a plunge to new lows will precede either of the above-described up-moves, but bullish traders could mitigate this risk by placing a stop slightly below the 16th August low.

The Currency Market

The global US$ short position

According to the BIS, there is $3.7 trillion of US$-denominated corporate debt across the "emerging markets". Also, total US$-denominated debt issued by non-US non-financial corporations is $11.5 trillion. This is sometimes referred to as the global US$ short position. The equivalent euro-denominated debt amounts to 3.1 trillion, or less than one-third the US$-denominated amount.

As we've explained a few times in the past, the so-called "global US$ short position" always exists and therefore is never the driver of currency-market trends. To put it another way, regardless of whether the Dollar Index is immersed in a bull market or a bear market there will be a huge global US$ short position.

It's just that when the US$ is strong the global US$ short position is generally perceived to be a problem, because under these circumstances the debt becomes more difficult to repay and widespread default becomes more likely.

Fear of default by non-US issuers of US$-denominated debt can prompt a wave of speculative US$ buying, as occurred a couple of weeks ago in response to the brewing economic crisis in Turkey. While this adds to the short-term upward pressure on the US dollar's value relative to other currencies, US$ strength will always be more of a cause than an effect of financial stress outside the US. The underlying cause of US$ (Dollar Index) strength is the combination of out-performance by the US stock market and a widening real interest-rate differential in favour of the US.

Current Market Situation

Knee-jerk reactions to news are disguising the trend.

A little more than two weeks ago the Dollar Index (DX) broke above important resistance at 95.5 on a daily-closing basis and 95.1 on a weekly closing basis. This was partly a reaction to news of the worsening economic situation in Turkey and the risk that it would create major problems for several European banks. Then, during the first half of last week the DX retreated to below its daily breakout point (95.5) and threatened to break below 95 in reaction to the news that Michael Cohen, President Trump's former lawyer, had pleaded guilty to bank fraud, tax fraud and campaign finance violations. The concern was/is that Cohen will provide evidence that leads to Trump's indictment or impeachment. On Thursday there was a rebound possibly in anticipation of a 'hawkish' speech by Fed Chairman Powell that was fully retraced on Friday, ostensibly in response to Powell turning out to be more 'dovish' than expected. At the end of the week the DX had dropped by enough to suggest that a short-term top (a top that holds for 1-3 months) was in place, but had held its weekly breakout by the slimmest of margins.

It will be interesting to see if the DX can end the month of August above 95.1. Even if we are now dealing with a short-term DX correction, a monthly close above 95.1 would be a longer-term bullish signal for the US$.



The fundamentals are decisively in the DX's favour and as long as they remain so we shouldn't expect something more than a short-term downward correction. At the same time speculators are betting aggressively on additional US$ strength, especially against the Swiss Franc (SF), the Australian Dollar and the British Pound. This implies that the correction could retrace more than half the gains made by the US$ from its Q1-2018 low to its recent high.

We continue to be optimistic about the SF's short-term prospects. As mentioned in last week's Interim Update, it looks like the SF is close to completing a multi-month base.

The SF can be traded on the stock market via FXF, a chart of which is displayed below. In the TSI List there is exposure to FXF in the form of a September-2018 $96 call option.

There is still enough time for an upside breakout in the SF to give a substantial boost to the price of our September call option, but there is also a high risk that even if we are right about the SF's basing pattern the upside breakout will happen too late to be of benefit to this option. Consequently, if we were now taking a new position we would choose an option with a December-2018 expiry date.



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 August 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]

  *Sabina Gold and Silver (SBB.TO) reminded the market about the good chance for resource expansion at its development-stage Back River gold project in Canada's far north. It did this by reporting an exceptional intercept of 39.5m grading 11.6-g/t from a hole drilled well outside the existing resource. This counts as a new discovery and a potentially-important one at that.

In addition to more drilling results from Back River, SBB could have market-moving news within the next three months relating to its silver royalty linked to the Hackett River zinc-silver project owned by Glencore. We are referring to the fact that if Glencore hasn't announced a production decision by October-2018 then SBB will have the right to buy the project for what Glencore has spent on it over the past few years.

SBB is a takeover candidate, with Agnico Eagle (AEM) being the most likely acquirer.

  *Tinka Resources (TK.V) published its financial statements for the June quarter. The statements showed that the company had about C$17M of working capital at 30th June.

TK's current working capital should be enough to fund the exploration of its 100%-owned Ayawilca zinc project in Peru for the next 12 months.

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) AAU (last Friday's closing price: US$0.60)

2) CNL.TO (last Friday's closing price: C$3.53)

3) PG.TO (last Friday's closing price: C$2.08)

4) PRQ.TO (last Friday's closing price: C$1.06)

5) SBB.TO (last Friday's closing price: C$1.41)

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.

Chart Sources

Charts appearing in today's commentary are courtesy of:

https://stockcharts.com/
http://www.goldchartsrus.com/