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

Natural Gas and the Grains

Although they weren't added to the TSI List and are therefore not being formally tracked at TSI, over the past two months we noted that natural gas and the grains (via JJG) were suitable for long-side trades. It's time to check on how these commodities are faring.

Our last comment on natural gas (NG) was in the 8th September Weekly Update, at which time we wrote:

"If the NG market is going to continue following its seasonal pattern, then a seasonal low should be in place by the end of this week. Therefore, anyone interested in trading the seasonal pattern by averaging into a natgas position during August-September weakness should place an initial sell stop just below whatever low is in place at the end of this week."

$3.81 was the price when the above comment was published and $3.72 ended up being the price that NG needed to remain above to avoid invalidating the seasonal pattern on which the trading idea was based.

NG managed to rally to $4.18 in early October before reversing course. It closed below $3.72 on Monday 20th October, thus deviating by enough from the seasonal pattern to invalidate our trading idea. We continue to be bullish on NG's intermediate-term and long-term prospects, but this commodity's short-term prospects have been muddied by the recent price action.

Our last comment on the Grains Total Return ETN (JJG) was in the 22nd September Weekly Update, when JJG was trading at $33.79. This was our conclusion:

"As a result of the continuing sell-off in and the current extreme relative cheapness of the grains, a good opportunity to buy JJG for an intermediate-term trade is now at hand. At this time we don't intend to add JJG to the TSI List, but we will probably soon start averaging into a position in our own account."

JJG bottomed at $32.58 about one week later and then reversed course. At the end of last week it was up by around 10% from its low.

We continue to be bullish on JJG's intermediate-term prospects, but would hold off on new buying for now. The reason is that the September low of around $32.50 will probably be tested prior to the start of a substantial rally. Given that three of the most important JJG lows of the past six years have occurred during December-January, we suspect that the next buying opportunity will emerge about two months from now.

Note that a multi-week pullback followed by a break above the 80-day MA (the blue line on the following chart) would confirm a trend reversal in JJG.

The T-Bond is to the stock market as gold is to the industrial metals

The three charts presented below tell an interesting story. The theme of the story is: preliminary evidence of a long-term trend change has emerged.

The first chart is the least interesting and least informative of the three, but is worthy of inclusion nonetheless. It shows that the iShares 20+ Year Treasury Bond ETF (TLT) rallied strongly since the beginning of this year and spiked to an all-time high (in dividend-adjusted terms) on Wednesday 15th October.

At its recent high TLT was very 'overbought'. Sufficiently 'overbought', in fact, to have put in place a multi-month price top (as we noted in the 15th October Interim Update). However, for the reasons outlined below we do not believe that the time is ripe for a bearish speculation in the US Treasury market.



The first reason we have no interest in betting against the Treasury market is sentiment. Despite this year's strong upward trend in the prices of long-dated US Treasury securities, the 'dumb money' remains stubbornly bearish on these securities.

The second reason is relative valuation, in that even though the 10-year T-Note does not yield enough to provide a real return, its return looks attractive compared to the returns and the risks associated with credit-market alternatives. In particular, how could anyone in their right mind be bearish on US$-denominated 10-year bonds issued by the US government yielding 2.2% when the euro-denominated 10-year bonds issued by the governments of Germany, France and Spain are yielding 0.9%, 1.3% and 2.2%, respectively, and the Yen-denominated 10-year bonds issued by the government of Japan are yielding 0.5%?

The third reason is also relative valuation, but in this case relative to the US stock market. Although TLT is extended to the upside in nominal dollar terms, the following chart of the TLT/SPY ratio suggests that relative to the stock market it has just begun to turn higher from near a 10-year low. Given that TLT is near the top of its long-term channel in dollar terms and offers a paltry yield, this chart says more about the stock market's unattractiveness than the bond market's attractiveness.

Also worth highlighting is that the TLT/SPY ratio's 50-day MA has just crossed from below to above its 200-day MA, which is exactly what it did near the beginning of the 2007-2009 equity bear market. This chart can therefore be taken as preliminary evidence that the US stock market has just commenced a multi-year decline.



Our final chart compares the TLT/SPY ratio with the gold/GYX ratio (gold relative to the Industrial Metals Index). Considering the superficial differences in these ratios, the closeness with which they have tracked each other over the past 10 years is remarkable.

The strong positive correlation between TLT/SPY and gold/GYX is not a fluke. It can be explained by the fact that during periods of declining economic confidence and/or market liquidity, the investment demand for T-Bonds rises relative to the investment demand for equities and, at the same time, the desire to own gold for safety/store-of-value purposes increases relative to the consumption demand for industrial metals. The opposite happens during periods of rising economic confidence and/or market liquidity. That's why this discussion is titled: "The T-Bond is to the stock market as gold is to industrial metals".

Interestingly, but not surprisingly considering the long-term relationship, the recent small upturn in the TLT/SPY ratio has been accompanied by a small upturn in the gold/GYX ratio. This, again, is what happened near the beginning of the 2007-2009 equity bear market.



The upshot is that while it is far too soon to make any definitive statements, some indicators that should be reversing course near the beginning of an equity bear market appear to be doing so.

The Stock Market

Current situation for the US stock market

We think that the short-term US stock market situation can be described as follows:

1. The INITIAL decline from the S&P500's 18th September peak ended at 1820 on 15th October at an 'oversold' extreme. That an initial bottom was in place was signaled the following day by a collapse in the number of individual NYSE and NASDAQ stocks making new 52-week lows, as mentioned at the time in a TSI blog post.

2. The rebound from the 15th October bottom was likely to retrace 50%-100% of the initial decline, suggesting a rebound target of anywhere from 1920 to the low-2000s.

3. As at the end of last week the rebound was still in progress.

4. The rebound could end at any time, especially given that last Friday's high was within 2 points of the 50-day MA. However, we guess that it will continue into early-November with an intervening multi-day pullback this week.

5. The rebound will likely be followed by a sharp decline to test the 15th October low, but a major decline is unlikely over the months immediately ahead.



There is evidence that a 1-2 year cyclical bear market has begun. If so, there probably won't be a major decline over the next few months. Instead, the market is likely to gradually roll over via a series of lower highs and lower lows. The reason is that after a bullish trend has remained in place for more than three years it takes a lot of time for a critical mass of market participants to come to the realisation that the long-term trend has changed. For example, this general realisation, or point of recognition, didn't occur until 9-11 months after the major stock-market peaks of January-1973 and October-2007.

At this time there is still a realistic possibility that the S&P500 is experiencing nothing more than a short-term bull-market correction (its first since 2012) and that some other stock indices, such as the Russell2000 (RUT), are experiencing intermediate-term bull-market corrections. However, even if this is the case there is a good chance that the 15th October low will be tested prior to the resumption of the long-term upward trend.

Casey Research's stock market crash alert

Casey Research issued a stock market crash alert early last week. We think that the probability of a crash happening within the next few months is very low, but we were intrigued by one of the bearish speculations suggested in Casey's crash alert. We are referring to the suggestion to buy put options on the Regional Banking ETF (KRE).

This suggestion interests us for two reasons. First, on a relative-strength basis the regional banking sector of the stock market has moved in the same direction as credit spreads over the past 12 months, which suggests that it is acutely vulnerable to evidence of economic weakness. Second, the chart shows a potential top in the making and a rebound to resistance. Furthermore, the rebound to resistance occurred in both nominal terms, with KRE moving up to near its 50-day MA, and relative terms, with the KRE/BKX ratio moving up to its channel top. Refer to the following chart for details.



It could be appropriate for option traders to average into KRE put options (either January-2015 $35 puts or March-2015 $33 puts) over the next two weeks.

SSO (Ultra S&P500 Fund) Put Options

With regard to the exposure to SSO put options in our own account, we have decided to focus on the January-2015 $100 puts for now because the January-2016 puts are too expensive and illiquid. We purchased an initial position in these put options last Wednesday and plan to add to the position into market (S&P500) strength over the next two weeks.

For longer-term exposure to the market's downside potential our current plan, which is subject to change based on price action, is to average into unleveraged actively-managed bear funds (BEARX and HDGE) over several months.

This week's significant US economic events (The most important events are shown in bold)

Gold and the Dollar

Gold

Gold broke above lateral resistance in the low-$1240s during the first half of last week, but the fact that the breakout wasn't confirmed by silver and the gold-mining indices indicated that it probably wouldn't be sustained. It wasn't.

It seems that the market cares more about resistance defined by the 50-day MA than resistance defined by the June low, as the US$ gold price reversed downward as soon as it reached this moving average.



The US$ gold price is in a position where it could gain 5% without significantly altering the longer-term chart pattern. However, a gain of only a few percent in the euro- and Yen-denominated gold prices would result in potentially important upside breakouts. In the case of the euro-denominated gold price, it would result in the completion of a major basing pattern. In the case of the Yen-denominated gold price, it would result in an upside breakout from a 12-month consolidation pattern. The relevant charts are displayed below.

Gold Stocks

Current Market Situation

The HUI has now fallen for 8 weeks in a row, with the last 3 weekly declines being small. The major low that occurred 14 years ago (November-2000) was put in place via the HUI declining on 9 out of the prior 10 weeks, with the last 4 weekly declines being small. The following weekly charts show the HUI's current situation and what happened during 2000-2002.

A literal comparison with the final decline to the 2000 bottom suggests that there will be an upward reversal, signaling the start of a strong intermediate-term rally, during the first week of November (next week). However, a literal comparison might not be valid.

The main point we want to make in today's report is that the gold-mining sector is now so depressed that a trend reversal will be easy to identify soon after it happens (probably within one week of the event, definitely within two weeks of the event). For example, a daily close by the HUI above its 20-day MA (the blue line on the following chart), which is something that should happen within a few days of the bottom, would now be an early warning that an important trend change had occurred.



Individual gold stocks will bottom at different times, and regardless of what we think is going to happen on a sector-wide basis we are always on the lookout for short-term buying and selling opportunities in the stocks we own/follow. However, those who trade gold-stock ETFs should probably wait for a daily close above the 20-day MA before establishing or adding to long positions.

The current bout of tax-loss selling will end this week, removing one source of pressure on the gold-mining sector in general and the junior gold stocks in particular. There will be another bout of tax-loss selling in December, but the effect it has will be determined by what happens to prices during the intervening period.

Kinross Gold (KGC) versus Gold Fields Ltd. (GFI)

We've previously written that KGC and GFI offered the best value among the senior gold producers, with GFI being the better intermediate-term speculation, despite having the slightly higher valuation and the weaker balance sheet, by virtue of its much lower country risk. (Note: The bulk of KGC's value is associated with mining assets located in Russia and Mauritania (West Africa), whereas almost half of GFI's production comes from Australia with the remainder spread across Latin America, Ghana and South Africa.) However, KGC's underperformance has been so dramatic over the course of this year, and especially over the past four months, that the additional risk associated with the locations of its assets appears to have been more than fully discounted.

The following chart compares the year-to-date performances of the two stocks. It shows that GFI is up by about 20% since the start of the year and is at roughly the same price now as it was 4 months ago, whereas KGC is down by about 36% since the start of the year with all of the loss coming over the past 4 months. As a result of these relative performances, the stock market is now valuing KGC's gold production by about 35% less than GFI's gold production.



KGC has a production-cost advantage of almost 10% over GFI, but both companies have low-enough production costs to be modestly profitable and cash-flow positive at the current gold price.

So, despite having lower production costs and a stronger balance sheet, by one important measure KGC is now being valued at 35% less than GFI, which, itself, appears to offer good value in absolute terms and relative to other senior gold producers. As noted above, it's therefore possible that the stock market has gone too far in its attempts to account for the comparatively high-risk locations of KGC's assets.

The Currency Market

The following chart shows the close relationship between the VGK/SPY ratio (European equities relative to US equities) and the euro. The VGK/SPY ratio closed at a marginal new low for the year last Friday, which suggests that we could still be one more new low in the euro and one more new high in the Dollar Index away from multi-month extremes. If there is going to be a trend-ending move to a marginal new low in the euro and new high in the Dollar Index, the next two weeks is the most likely time for it to happen.

The near-term potential for new euro and Dollar Index extremes would be eliminated by a daily close below 128.5 in the euro and/or a daily close below 85 in the Dollar Index.

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 24th October 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]

  *Almaden Minerals (AAU) announced that it will be spinning out its royalty and early-stage exploration assets into a new company ("spinco"), with AAU retaining the Tuligtic gold-silver project in Mexico. The shares of Spinco will be distributed to existing AAU shareholders at the rate of 0.6 for 1. Therefore, a holder of 1000 shares of AAU pre-spinout will have 1000 shares of AAU plus 600 shares of Spinco post-spinout.

Spinco will initially hold a 2% Net Smelter Return ("NSR") royalty on the Tuligtic project in Mexico, a 1.5% NSR on the Caballo Blanco gold deposit in Mexico (a development project currently operated by Goldgroup Mining), a 2% NSR on the Elk gold deposit in Canada (an advanced exploration project currently operated by Gold Mountain Mining Corp., a portfolio of 21 additional NSR royalties on exploration projects in Mexico, Canada and the United States, a 100% interest in the El Cobre copper-gold porphyry exploration project in Mexico and the Willow copper-gold porphyry exploration project in Nevada, a portfolio of 20 other exploration projects, and sufficient working capital to satisfy stock exchange requirements.

This is a smart move by AAU's management, for three reasons. First, it forces the market to value the assets that are going into Spinco (as far as we can tell, these assets are currently not being assigned any value as part of AAU). Second, it will enable AAU to focus exclusively on its flagship project. Third, it will pave the way for an eventual purchase of AAU by a mid-tier gold or silver mining company.

  *Pilot Gold (PLG.TO) reported that it has discovered another gold-copper porphyry deposit, called the Columbaz Target, at its TV Tower project in Turkey. The discovery hole returned 0.60 g/t Au and 0.11% Cu over 357.7m.

PLG has now discovered five separate deposits at TV Tower: a deep and relatively high-grade gold-silver-copper zone at the KCD Target, a near-surface zone of silver-only mineralization that partially overlies the high-grade gold-silver-copper zone at the KCD Target, and three gold-rich porphyry deposits. The project clearly has district-scale potential.

  *Pretium Resources (PVG) published the remaining assay results from infill surface drilling in the Valley of the Kings deposit at the Brucejack gold project. The purpose of the drilling was to a) confirm the grade and continuity of Indicated and Inferred gold mineralization in an area defined by the 2013 resource estimate block model, and b) confirm the continuity of gold mineralization below the area defined by the 2013 resource estimate. The program achieved its goals.

One of PVG's next steps along the development path is an underground infill drilling program to support the Brucejack Project mine plan. This program will begin early next year.

  *True Gold Mining (TGM.V) reported the results of a PEA that considered the addition of the heap-leachable portion of the North Kao deposit to the current mine plan for the development-stage Karma gold project in Burkina Faso. According to this PEA, at a $1250/oz gold price the NPV(5%) of the Karma project could be increased by around $60M via additional capital expenditure of only $18M. The PEA therefore suggests that the North Kao deposit can add substantial value to TGM.

The PEA published last week assumed that North Kao would be mined following completion of the current mine plan. TGM had to make this assumption for regulatory reasons, but this is almost certainly not the way it will end up happening. It's far more likely that North Kao will be mined as part of, rather than at the end of, the current schedule, but before TGM can officially assess the economics of proceeding in this way it must first convert North Kao's Inferred Resources to the M&I category via an infill drilling program.

    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$1.17).

2) EDV.TO (last Friday's closing price: C$0.59).

3) EVN.AX (last Friday's closing price: A$0.64).

4) PVG (last Friday's closing price: US$5.18).

5) TGD (last Friday's closing price: US$1.26).

Note that 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:

http://stockcharts.com/index.html