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   -- Weekly Market Update for the Week Commencing 28th January 2013

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

Market
Short-Term
(1-3 month)
Intermediate-Term
(6-12 month)
Long-Term
(2-5 Year)
Gold Bullish
(17-Oct-12)
Bullish
(26-Mar-12)
Bullish

US$ (Dollar Index) Neutral
(24-Dec-12)
Neutral
(09-Jan-12)
Neutral
(19-Sep-07)

Bonds (US T-Bond) Neutral
(12-Nov-12)
Neutral
(18-Jan-12)
Bearish
Stock Market (DJW) Bearish
(30-Jul-12)
Bearish
(28-Nov-11)
Bearish

Gold Stocks (HUI) Bullish
(24-Dec-12)
Bullish
(23-Jun-10)
Bullish

Oil Neutral
(30-Jul-12)
Neutral
(31-Jan-11)
Bullish

Industrial Metals (GYX) Neutral
(30-Jul-12)
Neutral
(29-Aug-11)
Neutral
(11-Jan-10)


Notes:

1. In those cases where we have been able to identify the commentary in which the most recent outlook change occurred we've put the date of the commentary below the current outlook.


2. "Neutral", in the above table, means that we either don't have a firm opinion or that we think risk and reward are roughly in balance with respect to the timeframe in question.

3. Long-term views are determined almost completely by fundamentals, intermediate-term views by fundamentals, sentiment and technicals, and short-term views by sentiment and technicals.

Gold stocks versus the broad stock market - the wide-angle view

With the aim of putting the recent price action into perspective, we present, herewith, a weekly chart showing how gold mining stocks (represented by the BGMI) have performed over the long term relative to the US stock market (represented by the SPX). The chart covers the last two secular gold-stock bull markets and the intervening secular gold-stock bear market.



There were two major 'corrections' in the BGMI/SPX ratio during the course of the bull market of the 1960s-1970s. The current correction, having gone further than we thought it would, now looks similar to the first of the preceding bull market's major corrections (the one that began in early-1968 and ended in late-1972).

The BGMI/SPX ratio's first major correction of the preceding secular gold-stock bull market ended just prior to the start of a 2-year cyclical decline in the S&P500. Considering the way the gold mining sector and the broad US stock market have traded in relation to each other over the bulk of the past 18 months, it's not unreasonable to expect that the current major correction in the BGMI/SPX ratio will also end near the start of a cyclical decline in general US equities.

At the end of last week there was obviously no sign that a general equity bear market had begun. It could begin in the near future, but we recognise the possibility that the current equity bull market could continue for longer than we expect. It has already continued for longer than we expected.

Expectations regarding what a market is going to do in the future should be based in part on the historical record. When we look at the long-term record we see that cyclical equity bull markets that occur within secular equity bear markets last anywhere from 1 year to 6 years. The average is 2-3 years. For example, there were three cyclical bull markets during the secular equity bear market that extended from the mid-1960s through to the early-1980s. The first (1966-1968) and second (1970-1973) of these cyclical bulls lasted 2-3 years, but the third (1974-1980) was an outlier with a duration of 6 years. The current cyclical bull market will be four years old in March. This means that it is already much older than average for a cyclical bull within a secular bear, but still more than two years younger than the maximum age for a bull market of its type.

What if the current equity bull market really 'pushed the envelope' and continued for another 1-2 years? Under that unlikely scenario, would the start of the gold sector's next major advance be pushed into the future by an additional 1-2 years?

Not likely. Given the US stock market's moderately high valuation, two things would have to happen for the equity bull market to have any chance of continuing for another 1-2 years. First, there would have to be a lot of monetary inflation. Second, there would have to be enough economic weakness and/or fear of financial crisis to prevent the monetary inflation from creating effects that collapse the T-Bond market. In other words, the set of circumstances that would make it possible for the equity bull market to continue for another 1-2 years would also be bullish for gold. In fact, the economic/monetary backdrop required to perpetuate the equity bull market well beyond the short-term would be far more bullish for gold than for general equities.

In summary, it presently looks like the start of the next major advance in the gold-mining sector will roughly coincide with the end of the cyclical bull market in general equities, but in any case the conditions that would make a lengthy extension of the equity bull market possible would be bullish for the gold sector. 

The Stock Market

The S&P500 Index made another marginal new multi-year high on Friday 25th January. It has now closed higher for 8 days in succession, but the cumulative gain over the course of this sequence of up-days is only 2.2%. This must be one of the smallest cumulative gains for an 8-day winning streak ever recorded by the S&P500, although for speculators not participating in the rally it probably feels like the market is running away to the upside.

Thanks to the September-January collapse in AAPL shares, the NASDAQ100 Index (NDX) has fared much worse than the SPX over the past few months. Normally we would consider this to be a very significant bearish divergence, but in this case we are uncertain of the significance of the divergence because it is almost totally due to a single stock.

Putting aside any explanations for why the NDX's price chart (see below) looks the way it looks, one interpretation of the chart that comes to mind is that this index is still immersed in an intermediate-term correction that began last September. If this interpretation is valid then the NDX's current short-term upward trend will end well below the September-2012 high and be followed by a decline to below the November-2012 low. Important support at around 2400 could come into play within the next two months.



One of the props supporting the on-going stock market rally is the belief that a sustainable recovery is in progress in the European banking industry. This belief was seemingly given some validation last week by news that European banks had collectively repaid more of their LTRO (Long-Term Refinancing Operation) borrowings than expected.

European banks remain highly leveraged. On average their balance sheets are a) far more leveraged than those of their US counterparts and b) not in materially better shape today than they were in 2008-2009, making these banks far more vulnerable to a future reversal of the 'positive' price trends in the financial markets. Leverage is good as long as prices are moving in the right direction. It's only after prices start heading in the opposite direction that leverage becomes a problem.

This week's important US economic events

Date Description
Monday Jan 28 Pending Homes Sales Index
Durable Goods Orders
Dallas Fed Mfg Survey
Tuesday Jan 29 Case-Shiller Home Price Index
Consumer Confidence
Wednesday Jan 30 FOMC Announcement
Q4 GDP
Thursday Jan 31

Personal Income and Spending
Employment Cost Index
Chicago PMI

Friday Feb 01 Monthly Employment Report
ISM Index
Motor Vehicle Sales
Consumer Sentiment
Construction Spending

Gold and the Dollar

Gold

Wood versus Metal

One of the surest ways to generate losses in the financial markets is to do in the present what you wish you had done over the preceding 12 months. The future is always uncertain, but an investor who tends to get bullish after a period of substantial outperformance and bearish after a period of substantial underperformance is probably not going to do well over the long-term.

Take the lumber/gold ratio (the performance of the lumber market relative to the performance of the gold market) as an example. While there was no way of knowing, in advance, exactly where and when an intermediate-term turning point would occur, the fact is that by August of 2011 lumber had become very 'oversold' relative to gold. This is evidenced by the unusually low level of the RSI shown at the bottom of the following weekly chart. It wasn't obvious in August of 2011 that the ratio was about to bottom and embark on a strong rally lasting more than 12 months, but it was obvious in August of 2011 that it was a bad time to be turning bearish or becoming more bearish on lumber relative to gold.

After reaching an 'oversold' extreme in August of 2011, the lumber/gold ratio reached an 'overbought' extreme late last year. In fact, the weekly RSI suggests that lumber/gold became more 'overbought' late last year than it had been at any time over the preceding seven years. We don't know that last year's peak in the lumber/gold ratio will turn out to be the major variety. We guess that it will, be we obviously have no way of knowing for sure. What we do know is that this is a really bad time to be turning bullish, or getting more bullish, on lumber relative to gold.



Current Market Situation

Below is a daily chart of gold in euro terms (gold/euro). When gold/euro was peaking in September of last year we thought that it would experience a routine short-term correction to no lower than its 200-day moving average before resuming its advance, but the correction has clearly gone longer and deeper than originally expected. The correction has even managed to break gold/euro below the upward-sloping trend-line that dates back to September-October of 2011.



The trend-line break is confirmation of the obvious: that the correction has gone deeper than expected. However, it doesn't tell us anything about the future. As far as we can tell, there was only one similar trend-line break in gold/euro over the past 10 years. It happened in late-2004, just prior to the start of an 18-month rally.

After rebounding for a short while gold is again becoming very 'oversold' in both euro and US$ terms. A short-term bottom is likely by early February.

Gold Stocks

With economic confidence on the rise and general risk aversion on the decline it is not surprising that the gold market has been unable to sustain a rally and has just moved back to near the bottom of its 5-month range in both US$ and euro terms. What is surprising is the extent of the recent weakness in the gold mining sector. Gold mining stocks are riskier than gold bullion and should therefore hold up better than gold when the financial world is becoming less risk averse.

The gold sector is in the midst of a short period when nothing matters except the price action. The sector's inability to rally caused frustrated shareholders to sell, which made the price action look worse, which prompted more selling, etc. When the HUI eventually broke below support at 420 last week the selling quickly intensified. We are now witnessing a capitulation.



A re-test of the HUI's May-2012 low became an even-money bet after the November low was breached in early December. A re-test of the May-2012 low is now a high-probability outcome, but it won't necessarily happen right away. One possibility is that the capitulation will continue, resulting in the May-2012 low being tested this week or the week after. If this happens then the low that gets put in place over the next two weeks will probably turn out to be the low for the year. A plausible alternative is that the HUI reverses upward without first experiencing significant additional weakness. If this happens then there will probably be a 4-6 week rebound followed by a decline to test the May-2012 low.

Currency Market Update

The primary fundamental basis for speculative Yen selling was shattered when the BOJ announced early last week that although it would embrace the government's 2% "inflation" target, it would do nothing different in an effort to attain the target and didn't expect the target to be reached within the next two years. However, the Yen continued its rapid decline after briefly trying to rebound.

When currency speculators get the 'bit between their teeth' and one fundamental story in support of the desired price action doesn't pan out, they tend to find another story to replace it. The potential for the BOJ's plans to change after new board members are appointed in April is a story that can now be used to support a bearish Yen view, as is the widening Japanese trade deficit. These stories seem plausible as long as you ignore the fact that the Yen is being aggressively sold against currencies that are already being inflated like crazy (no need for any new board members at the Fed in order to get a pro-inflation consensus) and are associated with much larger trade deficits.

As an aside, if Japan's government wants to eliminate the country's trade deficit then the quickest and least-damaging way for it to do so would be restart most of the nuclear power plants that were shut down in 2011 in an ill-considered knee-jerk reaction to the Fukushima disaster. To make up for the power generation capacity lost when the nuclear power plants were shut down, Japan has drastically increased the amount of liquid natural gas (LNG) that it imports. We calculate that the increase in LNG imports since Fukushima accounts for about 35% of last year's record 6.9 trillion Yen (US$78B) Japanese trade deficit, and that the total monetary value of Japan's LNG imports during 2012 was about 90% of the country's trade deficit for the year.

One interesting aspect of the currency market's situation is that sentiment is now almost diametrically opposite to what it was last July. Speculators were extremely pessimistic about the euro's prospects just 6 months ago, but they are now optimistic. Speculators are now extremely pessimistic about the Yen's prospects, but 6 months ago they were optimistic. As it almost always does, the market's sentiment has simply followed the price. The average speculator gets increasingly optimistic as the price rises and increasingly pessimistic as the price falls, causing him to reach extremes of optimism and pessimism at inopportune times.

It is worth pointing out, however, that while Yen sentiment is at a pessimistic extreme, euro sentiment hasn't yet reached an optimistic extreme. This doesn't preclude the possibility that the euro is near an intermediate-term peak, it just means that euro sentiment is not yet flashing a warning signal.

Another interesting aspect of the currency market's situation is that recent US$ weakness against the euro has largely been offset by US$ strength against most other currencies. With the US$ falling against the euro and rising against almost all other currencies, the Dollar Index, which is dominated by the USD/EUR exchange rate, has traded sideways. This sideways trading in the Dollar Index will probably soon give way to a quick 3-point move, but we currently don't have an opinion on the most likely direction of this move. If the Dollar Index drops below support at 79 it will indicate that a 3-point move to the downside is underway.



Below are daily charts showing the performances of the Canadian Dollar and the British Pound over the past 4 years. Both of these currencies traded at 5-month lows late last week, but on a longer-term basis they remain within wide consolidation ranges. The C$ has strong support at around 97 and the Pound has strong support in the low-1.50s. These support levels probably define the maximum short-term downside potential.

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 25th January 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]

  *Dragon Mining (DRA.AX) provided an update on exploration work at its Kuusamo project in Finland. Kuusamo is expected to be the main contributor to DRA's production growth over the next few years.

Last week's press release reported a few decent intercepts from recent drilling at Kuusamo. The press release also noted that the drilling hasn't expanded the defined resource, although the confidence level of the resource has increased due to the upgrading of Inferred resources to the M&I category. The total Kuusamo resource amounts to 460K ounces of gold, 320K ounces of which are now classified as M&I.

The overall progress of Kuusamo's development is slower than we'd like, but we can afford to be patient with DRA as long as its existing mines generate at least enough cash to cover all costs. An update on the performance of DRA's existing mines is due within the next two weeks.

  *Endeavour Mining (EDV.TO, EDR.AX) reported its production results for 2012 and its guidance for 2013. Total production from its three operating gold mines (Youga in Burkina Faso, Nzema in Ghana and Tabakoto in Mali) came in at 311K ounces in 2012, which was slightly better than forecast. The company didn't advise the cost of production other than to say that it was within the guidance range. This probably means that the average cash cost was around $680/oz.

2013 guidance is for production of 310K-345K ounces of gold at a cash cost of $790-$830/oz. The annual production rate should then increase by about 100K ounces in 2014 due to a new mine (the Agbaou mine in Cote d'Ivoire) coming into operation.

The 2013 and 2014 guidance from EDV is consistent with what we've been assuming when valuing the stock. Our valuation is based on a gold price of $1600/oz and remains at around C$4.00/share.

EDV also reported the results of a PEA for the Hounde project in Burkina Faso. The Hounde project was part of Avion Gold, the company that EDV acquired last October.

The PEA suggests the potential for Hounde to be developed into a 160K-oz/year gold mine by 2016, taking EDV's total annual production to 550K-600K. The economics look good: Post-tax NPV(5%) and IRR of $584M and 34% at a gold price of $1650/oz. The total initial start-up capital is estimated to be $345M, an amount that could be funded by EDV's cash reserve, existing credit facility and cash flow from its operating mines.

Work has commenced on the Hounde project's FS.

The EDV story continues to evolve in a positive way. The company is meeting its targets on the production front and taking prudent steps to grow its business over the next few years.

The stock rallied last week on the back of the positive news releases and would have rallied a lot more if not for the pronounced sector-wide weakness. If the sector-wide sell-off continues then EDV could again become available in the low-C$2.00 area. If so, anyone without a full position should view it as a buying opportunity.



  *Golden Predator (GPD.TO) issued two press releases last week, neither of which was important.

The first press release was issued at the behest of Canadian regulators to "clarify and retract certain technical disclosure". In a nutshell, GPD provided information via interviews and presentations that wasn't covered in the regulatory reports submitted by the company. This, apparently, is a no-no. It seems that aside from information vetted and signed-off by government representatives, the public is supposed to be kept in the dark regarding the plans of listed corporations. For the public's own good, of course.

The only part of GPD's first press release that had any significance to us was the following sentence:

"The Company has engaged EBA Engineering Consultants Ltd. to prepare a preliminary feasibility study on the Project, which is currently expected to be available in the second quarter of 2013."

To our eyes this looks like a delay, but whether it is or not depends on the meaning of "early". GPD had previously said that the PFS would be available in early-2013, which we took to mean in Q1. Maybe in the north of Canada where the winters are long and oppressive, early can mean any time before the middle.

The second press release announced that high-grade gold had been discovered in rock samples taken from one of GPD's many properties in the Yukon. Nobody cares about rock samples.

Last week's most important GPD-related development was the late-week pullback in the stock price in sympathy with the HUI's breakdown. GPD's price had moved up from C$0.33 to C$0.39 during the first two days of last week in reaction to the very positive news announced after the close of trading on Friday 18th January, but a large sector-wide decline has since created another good opportunity to buy at around C$0.35. At this price we think that buyers of the stock are getting the royalty assets at around 50% of fair value and the Yukon assets for free.

  *Jaguar Mining (JAG) announced after the close of trading last Friday that it had drawn down the first $5M of the $30M credit facility provided by Renvest. This was expected.

JAG shares were volatile last week. The stock gained 32% (from US$0.75 to US$0.99) last Monday on heavy volume and then dropped back in sympathy with the sharp sector-wide decline during Wednesday-Friday, but still managed to end the week with a net gain of about 15%. We don't know the reason for the sudden interest in JAG.

  *Pretium Resources (PVG) announced that it was raising $20M by issuing 1.57M new flow-through shares at an average price of $12.74/share. This small financing tops-up PVG's treasury and guarantees that the company will not run short of funds this year.

In the short-term PVG is probably what stockbrokers call a "sector perform", meaning that it will probably trade in line with the overall sector as represented by indices such as the HUI and the XAU. This is because the next piece of important company-specific news isn't due until the second quarter of this year. We are referring to the FS for the Brucejack high-grade project. If the FS is very positive (we think it will be) it should give the stock price a hefty boost and could prompt a large mining company to make a takeover bid.

  *Ramelius Resources (RMS.AX) reported disappointing results for the final quarter of last year. Last quarter's production quantity of 20K ounces was roughly according to forecast, but costs were much higher than we (and the market) were expecting. Of particular importance, the cash cost of quarterly production at the newly commissioned Mt Magnet mine -- the mine from which almost all of RMS's production will be sourced during the 2013 calendar year -- was $1199/oz. Although this is $4/oz lower than the preceding quarter's result, we thought that the production ramp-up at Mt Magnet would lead to a much larger cost reduction. Specifically, we were anticipating a decline in the per-ounce cost to around $1000/oz during Q4-2012, with further improvement to come during the first half of 2013.

RMS was expected to be cash-flow positive during the December quarter, but due to the surprisingly high cost of production at Mt Magnet the company burned through another $5M of its cash. However, it still has $50M of cash along with no debt, so its balance sheet remains healthy.

The company's guidance is for 20K ounces of production in each of the next two quarters, with 16.5K ounces of the March quarter's production and all of the June quarter's production sourced from Mt Magnet. Sustained quarterly production of this magnitude would justify a 100% higher stock price IF the per-ounce cash cost were reduced to less than $1,000.

With upside potential of at least 100% at the current gold price and downside risk limited to around 15% by the combination of the low valuation, the low political risk and the strong balance sheet, we are going to give RMS another quarter to prove itself.

  *UEX Corp. (UEX.TO) announced that it had optioned its non-core Black Lake uranium project in northern Saskatchewan to Uracan Resources (URC.V). To earn a 60% interest, URC will have to spend $10M exploring the project over the next 10 years.

This is a smart move by UEX as it now has no-risk exposure to exploration success at Black Lake.

  *Volta Resources (VTR.TO) reported a big increase in the resource for its Gaoua copper/gold project in Burkina Faso. The project is now estimated to contain a total of 3.4M ounces of gold and 2.1B pounds of copper, almost all in the Inferred category. This constitutes an increase of about 180% over the previous estimate.

The magnitude of the resource increase in very impressive, but the resource grade is very low. This type of mineral deposit could become valuable in the distant future, but it is not going to garner much interest anytime soon.

As we've previously stated, VTR should focus all of its limited financial resources on progressing the FS for the Kiaka project. That's where the opportunity to create shareholder value lies.

Potential Agnico Eagle (AEM) call option opportunity

One of the few trades that worked well for us in 2012 was a long position in AEM January-2014 call options. A new opportunity to buy AEM calls could arise this week.

Due to the indiscriminate sell-off in all things gold-mining-related, AEM's stock price dropped sharply over the final three days of last week. It's certainly possible that AEM has just reached a short-term bottom near its 200-day moving average, but our suggestion is to buy AEM Jan-2014 $50 call options if the capitulation continues and the stock drops to around $43 during the course of this week. With the stock at around $43 the aforementioned call options would probably trade at around $3.30, but $3.50 or lower would be a reasonable price to pay.

AEM is a relatively expensive gold stock, but it is in the process of winning back its 'market darling' status and stands a good chance of rebounding strongly in the early part of the gold sector's next rally. This is regardless of whether the next rally is a counter-trend rebound or the first leg of a new major upward trend.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html



 
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