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   -- Weekly Market Update for the Week Commencing 28th June 2010

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 mid-2010. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

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
(0-3 month)
Intermediate-Term
(3-12 month)
Long-Term
(1-5 Year)
Gold
Bullish
(21-Jun-10)
Bullish
(12-May-08)
Bullish

US$ (Dollar Index)
Neutral
(07-Jun-10)
Bullish
(02-Nov-09)
Neutral
(19-Sep-07)

Bonds (US T-Bond)
Neutral
(17-May-10)
Bearish
(14-Dec-09)
Bearish
Stock Market (S&P500)
Bearish
(16-Jun-10)
Bearish
(11-May-09)
Bearish

Gold Stocks (HUI)
Neutral
(07-Jun-10)
Bullish
(23-Jun-10)
Bullish

OilNeutral
(28-Oct-09)
Bearish
(01-Mar-10)
Bullish

Industrial Metals (GYX)
Bearish
(21-Sep-09)
Bearish
(25-May-09)
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 giving an approximately equal weighting to fundamental and technical factors, and short-term views almost completely by technicals.

The bad-policy spiral

According to a recent article by Ambrose Evans-Pritchard, "Federal Reserve chairman Ben Bernanke is waging an epochal battle behind the scenes for control of US monetary policy, struggling to overcome resistance from regional Fed hawks for further possible stimulus to prevent a deflationary spiral." The article goes on to explain that with the economy rolling over the Fed should be prepared to quickly inject a massive amount of new money, and that pig-headed resistance to more monetary inflation by a few Fed governors poses a serious threat. However, nowhere in the article is there a logical explanation of how counterfeiting more money would benefit the economy. This could be because such an explanation doesn't exist.

Despite being a well-respected commentator on economics and the financial markets, Evans-Pritchard's understanding of economics leaves a lot to be desired (to put it mildly). He perceives falling prices as the major threat facing the US economy and is therefore an advocate of doing whatever it takes to arrest widespread price declines, but fails to realise that falling prices are just a symptom and that the 'solutions' recommended by him and his beloved Bernanke will increase the severity of the disease.

If you increase the money supply by enough then you can surely get most prices to rise, but only at the cost of general impoverishment. This is because monetary inflation distorts the price signals upon which the economy relies, thus leading to the wastage of resources and the destruction of wealth.

When it comes to understanding the world of economics, one of the problems is that the link between cause (the policy) and effect is sometimes so long and indirect that it will only be evident to the people who had a good understanding of economic theory to begin with. This is certainly the case with monetary inflation, which sometimes gives a short-term boost to markets and economies while it weakens the economy's foundations. The difficulty of 'seeing' the link between cause and effect is why so many people are able to claim, with straight faces, that more monetary and/or fiscal stimulus is needed to address an economic downturn that was caused by earlier rounds of monetary and/or fiscal stimulus.

It can take years for the problems caused by monetary inflation to ripple through the economy, but the adverse effects of some other "stimulus" measures have shorter lead times. For example, when the government directly pays people to buy things they otherwise wouldn't have bought, there will tend to be a short-lived boost followed by a plunge. Something along these lines has occurred in the US residential property market over the past year. With house prices having been propped up by government incentives and with considerable demand having been sucked from the future, the US housing market is now in a weaker position than it was 12 months ago. So, it must be time for more stimulus, right?

It should always be kept in mind that "stimulus" of any kind is a zero-sum game AT BEST. This is because the government doesn't generate any wealth of its own; it just redistributes existing wealth. In reality, "stimulus" is always a negative-sum game because the process of redistribution always results in the less efficient use of resources.

In conclusion, the world of economic policy-making tends to operate as follows: bad policies beget problems, which beget more bad policy responses, which beget even bigger problems, and so on. The major threat facing us is therefore not a deflationary spiral, as asserted by Evans-Pritchard et al; it's a bad-policy spiral.

Interesting quote or fact of the week

In the following quote from Chapter 24 of "The Ethics of Liberty", Murray Rothbard argues that it is immoral to invest in government bonds.

"Many libertarians assert that the government is morally bound to pay its debts, and that therefore default or repudiation must be avoided. The problem here is that these libertarians are analogizing from the perfectly proper thesis that private persons or institutions should keep their contracts and pay their debts. But government has no money of its own, and payment of its debt means that the taxpayers are further coerced into paying bondholders. Such coercion can never be licit from the libertarian point of view. For not only does increased taxation mean increased coercion and aggression against private property, but the seemingly innocent bondholder appears in a very different light when we consider that the purchase of a government bond is simply making an investment in the future loot from the robbery of taxation. As an eager investor in future robbery, then, the bondholder appears in a very different moral light from what is usually assumed."

The Stock Market

At this stage it looks like last Monday's 'pop' in response to the largely irrelevant news about more Yuan flexibility created the top for the stock market's counter-trend rebound. However, there's a good chance that last week's peak (1120s for the S&P500) will be tested before the next downward leg begins in earnest.


There are three reasons to expect a return to the vicinity of last week's high, or at least a significant 1-2 week recovery, prior to the start of a decline to new lows for the year. They are:

1. Last week's sharp pullback in the US stock market was not confirmed by the Hong Kong stock market, in that the Hang Seng Index experienced only a minor consolidation.

2. Last week's sharp pullback in the US stock market was not confirmed by the currency market, in that the Dollar Index still appears to be in 'correction mode' with more downside likely before it resumes its intermediate-term bullish trend.

3. Last week's sharp pullback in the US stock market was not confirmed by the commodity market. Of particular note, the gold/CRB ratio (see chart below) continued to consolidate. It's likely that gold/CRB will move to a new high at around the time that the stock market's next downward leg commences.


This week's important US economic events

Date Description
Monday Jun 28
Personal Income and Spending
Tuesday Jun 29
Case-Shiller Home Price Index
Consumer Confidence
Wednesday Jun 30 Chicago PMI
Thursday Jul 01 ISM Manufacturing Index
Construction Spending
Pending Home Sales Index
Friday Jul 02 Monthly Employment Report
Factory Orders

Gold and the Dollar

Gold

August gold made a round trip from $1260 to $1230 last week. This should be construed as bullish because support at $1220-$1230 survived a test. As previously advised, a failure of gold's recent upside breakout would be indicated by a daily close below $1220.

US$ gold has near-term upside potential to $1300-$1350.


In euro terms, gold has consolidated since reaching the top of its moving-average envelope at the beginning of June (refer to the following chart for details). The fact that it hasn't broken sharply lower means that although it became sufficiently 'overbought' in early June to create an important top, such a top has not yet been signaled.

Note that gold/euro's 50-day moving average is rising rapidly and will soon be high enough to be used as a timely indicator of a trend change. 


Gold Stocks

Breakout now or later?

In last week's Interim Update we said that the HUI had traced out what technical analysts often refer to as a "cup and handle" on both the daily chart covering the past 9 months and the weekly chart covering the past 3.5 years. We also said that if the HUI held above 460 during the coming days and then rose to the 490s there would be a "cup and handle" pattern evident on an hourly chart covering the past 2 months. Due to Friday's rebound to the 490s, we now have a "cup and handle" pattern on the hourly chart displayed below.

Under normal circumstances we wouldn't bother looking at an hourly chart of anything, but current circumstances aren't normal.


The HUI's 10-year performance record suggests that there won't be a sustained move to a new high for the year until at least September. Furthermore, a downward trend to an October low continues to fit most neatly with our longer-term outlook for the gold sector and our views on other markets. However, the market doesn't always follow our script and the recent price action suggests that there is a good chance of an upside breakout in the near future.

As stated in the Interim Update, an upside breakout in the HUI would be signaled by consecutive daily closes above 505. Going the other way, a daily close below 470 would now be a clear sign that the trend had reversed downward.

Gold Stock Value Comparison

Below are updated versions of the gold-stock value comparison tables previously included in the 1st March 2010 Weekly Update. The tables show the per-ounce values currently being assigned by the stock market to the in-ground resources and production of the TSI gold/silver stock selections and a few other gold/silver stocks (the stocks that are NOT current members of the TSI List have asterisks next to their names). The first table contains companies that are now in production or should be in production within the next 12 months, while the second table contains companies that are more than one year away from having any production. Naturally, the companies in the second table do not have per-ounce production values.

The "Recent Price" shown in the third column of each table is the closing price on Thursday 24th June 2010.

Producers and Soon-To-Be Producers

Company Name Symbol Recent Price (local $) Ent. Value (US$M) 2010 Prod. (Koz) Total Resource (Moz) EV $ per oz prod. EV $ per oz res.
Catalpa Resource CAH.AX 1.66 272 130 1.7 2094 160
Crew Gold* CRU.TO 0.25 579 220 4.9 2631 118
Dominion Mining DOM.AX 2.98 242 120 1.4 2016 173
Etruscan Resources* EET.TO 0.40 227 72 2.3 3153 99
First Majestic Silver FR.TO 4.26 405 100 3.6 4047 111
Fortuna Silver FVI.TO 2.09 162 28 1.1 5799 145
Great Basin Gold GBG 1.79 716 200 16.0 3580 45
Gold-Ore Resources GOZ.TO 0.52 40 40 1.0 999 42
Gammon Gold* GRS 5.62 687 220 5.3 3122 130
Golden Star Resources* GSS 4.41 1117 400 6.7 2792 167
Minefinders Corp. MFN 8.91 664 180 6.2 3687 108
New Gold* NGD 6.25 2500 350 16.9 7143 148
Northgate Minerals NXG 3.02 876 310 5.6 2825 158
Orvana Minerals ORV.TO 1.33 169 120 2.2 1409 79
Resolute Mining RSG.AX 1.10 676 400 8.8 1690 77
Silver Standard* SSRI 18.10 1331 100 57.9 13310 23
US Silver* USA.V 0.21 54 43 0.6 1253 98

Explorers and Developers (no near-term production)

Company Name Symbol Recent Price (local $) Ent. Value (US$M) 2010 Prod. (Koz) Total Resource (Moz) EV $ per oz prod. EV $ per oz res.
Andina Minerals ADM.V 1.17 80 0 7.2   11
Clifton Star CFO.V 4.06 202 0 1.0   202
Chesapeake Gold CKG.V 7.70 286 0 18.5   15
Gryphon Gold GGN.TO 0.14 12 0 1.0   12
Golden Queen Mining GQM.TO 1.47 130 0 2.8   46
Keegan Resources KGN.TO 5.64 199 0 2.8   73
Rio Novo Gold* RN.TO 1.35 80 0 0.8   102
Orsu Metals* OSU.TO 0.18 -1 0 1.9   0
Pediment Gold PEZ.TO 1.31 50 0 2.5   20
Sabina Silver SBB.TO 2.54 255 0 5.2   49

Table Notes:

1. Enterprise Value (EV) = market capitalisation plus total debt (including hedge-related liabilities) minus cash
2. Silver production and resources have been converted to gold-equivalent values at a ratio of 70:1
3. Total Resource = M&I Resource plus half of Inferred Resource
4. CAH figures assume full 100K prodn. from Edna May project
5. CKG figures assume that silver would be treated as a byproduct
6. CFO figures account for Osisko's 50% stake in the company's projects
7. GGN figures assume completion of the JV with Sage Gold, meaning that GGN ends up with 50% of the Borealis project
8. GRS figures assume no production from El Cubo
9. NGD figures assume all cash used to finance New Afton mine
10. NXG figures assume all cash used to finance Y-D mine
11. ORV figures assume a) US$20M of debt needed to complete El Valle, and b) prod. of 100K from El Valle and 20K from Bolivia
12. RSG figures include US$100M liability associated with hedge book
13. CRU and EET are included in the table because Endeavour Financial (EDV.TO), a TSI stock, owns 43% of CRU and 55% of EET


When deciding which gold/silver stocks to buy, the information tabulated above is just a starting point in that no gold stock should ever be bought or sold simply because the value being assigned to its ounces is relatively low or relatively high. This is because there are always other important considerations, such as:

a) Growth potential

b) Production cost or expected production cost

c) Deposit size and expected mine life

d) Deposit location

e) For exploration-stage companies, the estimated cost of building a mine and the estimated time to get into production

f) Management

For example, CFO and KGN are relatively expensive based on their current resources, but these companies have a lot of growth potential. On the other hand, ADM and GGN look extremely cheap, but there are good reasons for their current 'cheapness'.

Of the stocks that we follow, SBB has experienced the largest increase in valuation over the past few months. However, in value terms it is still one of the best opportunities we know of because the exceptional drilling results recently achieved by the company are not yet reflected in our per-ounce value calculations (and won't be reflected until an updated resource estimate is done).

Our Australia-listed gold-stock selections (CAH, DOM and RSG) offer very good value near their current prices, as does Orvana (TSX: ORV). ORV will deserve to sell at a discount until its El Valle project achieves commercial production (expected by year-end), but the current price offers speculators the potential for a 100% gain within 12 months assuming no change in the gold price.

Of the gold/silver producers that are presently not members of the TSI List, GRS, GSS and SSRI offer reasonable value. GRS was close to being fully priced a few months ago, but it has recently been hammered to a 52-week low in response to the closure of its El Cubo mine and is now beginning to look interesting. SSRI looks very expensive based on its current production level, but the relatively low per-ounce value being assigned by the stock market to its massive in-ground resource makes it attractive.

The two exploration-stage stocks in the above table that are not presently members of the TSI List have some speculative merit near their current prices. OSU is interesting because it is now selling at cash value, meaning that the market is assigning no value to the company's 1.9M-ounce gold resource. RN is discussed in the "Updates on Stock Selections" section of today's report.

Currency Market Update

In the 31st May Weekly Update we wrote:

"Intermediate-term turning points in the Baltic Dry Index (BDI), an index of international shipping rates, often roughly coincide with intermediate-term turning points in the Dollar Index, with BDI highs coinciding with US$ lows and BDI lows coinciding with US$ highs. The BDI's most recent high of significance was in Q4-2009, which makes sense because the Dollar Index was bottoming at that time. However, the BDI is yet to really confirm the currency market's trend change because it has just moved back to near last year's peak.

It's a good bet that the BDI will move a lot lower over the next 6 months and thus bring itself into line with the currency market."

The BDI has since plunged from 4100 to 2500 and is therefore now more in line with the currency market, although if our intermediate-term currency market outlook is close to the mark then the BDI will probably move much lower before this year is out.


By the way, it makes no sense to use any form of "technical analysis" with quantities such as the BDI that are not directly traded in the financial markets. This is because to the limited extent that technical analysis works at all it does so due to the psychology of market participants; in particular, due to the ways that market participants react to price changes and the attainment of certain price levels.

Below is an updated version of a chart we've shown in the past. The chart's message is simply that being 'long' the Canadian Dollar is effectively the same as being 'long' the US stock market.


We've thought that the 50-day moving average was a likely target for the euro's rebound. It's a falling target, and over the past 4 weeks has fallen from just above 1.30 to just below 1.26 (basis the September futures contract).

As illustrated on the following daily chart, the euro's 50-day moving average now roughly coincides with lateral resistance at 1.26.


In our opinion, the euro has probable upside to 1.26 and possible upside to 1.30 over the next few weeks. Beyond the next few weeks, our outlook for the euro remains bearish. The catalyst for the next substantial euro decline will probably be the resumption of the euro-zone's government debt crisis or breaks to new lows for the year by the world's major stock markets.

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)

Rio Novo Gold (TSX: RN). Shares: 91M issued, 113M fully diluted. Recent price: C$1.47

RN is a new entry into the world of junior gold stocks, having listed on the TSX less than four months ago. It is not a current member of the TSI Stocks List and we aren't going to add it at this time, but it is worth keeping an eye on for the reasons outlined below. Also, we think the RN warrants (TSX: RN.WT) are interesting speculations with high risk and high potential reward, but they are very illiquid and therefore difficult to trade in size. The warrants have an exercise price of C$2.25 and an expiry date of March-2015.

Here is a summary of the RN story:

1. IPO'd in March-2010 at C$1.60/share, raising more than US$40M in the process. Current cash and working capital are $39M and $37M, resp.

2. Two projects in Brazil (Almas and Guaranta) with NI-43-101 gold resources, one of which (Almas) was formerly in production and could potentially be put back into production inside two years.

3. RN's chairman is Sean Roosen, the CEO of Osisko. The CEO (David Beatty) and the president (Julio Carvalho) of RN are very experienced and highly regarded.

4. RN's majority shareholder is billionaire Brazilian businessman Paulo de Brito (de Brito controls 57% of the shares).

5. The company plans to drill 40,000m in 2010 across its two projects, paving the way for increased resource estimates late this year or early next year. The drilling program should generate good news flow over the coming months.

    New TSI stock selection: Silver Standard Resources (NASDAQ: SSRI). Shares: 79M issued, 84M fully diluted. Recent price: US$18.60

SSRI is a liquid stock that offers considerable leverage to both gold and silver. We are going to add it to the TSI Stocks List as a trading position, with the initial stop being a daily close below US$17.50.

At only 5.9% below Friday's closing price, our selected stop is 'tight'. We have opted for such a tight initial stop because the gold sector is either close to a short-term peak, in which case we will want to be out of this trading position following the first sign of weakness, or about to make a big move upward, in which case the gold-stock indices and SSRI should hold above last week's intra-day lows.


    Copper Fox (TSXV: CUU). Shares: 285M issued, 373M fully diluted. Recent price: C$0.32

Exploration-stage copper miner CUU peaked during the first half of April and has since been consolidating. It ended last week in an interesting position, in that any additional strength from here would constitute a breakout on the chart (see below) and project a rise to a new high for the year.


The Feasibility Study (FS) for CUU's Schaft Creek copper/gold project is due to be complete by year-end, and a positive result could propel CUU to C$1.00 in early 2011. This is our assessment of the intermediate-term upside potential. However, there probably won't be much in the way of company-specific news over the next few months and there is a lot of remaining downside risk in the copper price.

In our opinion, CUU would be a good candidate for new buying at C$0.22 or lower. For those with substantial exposure to the stock it would make sense to scale back to a comfortable 'core' position within the C$0.35-C$0.50 range.

    Crowflight Minerals (TSX: CML). Shares: 583M issued, 717M fully diluted. Recent price: C$0.14

CML continues to have difficulty ramping its Bucko nickel mine up to the targeted production rate. In May it produced 372K pounds of nickel, which is less than half of what it should be producing.

On the corporate front the CML story is both interesting and confusing. Pala Investments had at one time expressed interest in buying the Bucko mine, but Pala recently sold its CML stake to a Chinese company called King Place Enterprises. King Place was already a large investor in CML, and with the Pala stake now owns about 42% of the company. Also, there is still a C$0.22/share takeover bid for CML on the table from Jinchuan, another Chinese company. This takeover bid, however, is subject to the strange condition that Jinchuan obtain 100 per cent of the off-take from the Bucko Lake mine. It's a strange condition because CML has a contract to provide its off-take to Xstrata.

At this stage, CML is a pure speculation on either a much higher nickel price or a reasonable takeover bid from Jinchuan or King Place. The former is unlikely this year, but the latter has a decent chance of happening.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.futuresource.com/



 
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