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

Currency devaluation: The most destructive policy of all

"Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the existing distribution of wealth*. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become 'profiteers', who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and it does it in a manner which not one man in a million is able to diagnose."

The above quotation is perfect. It does such a good job of succinctly describing why currency devaluation is a destructive policy, both economically and socially, that it could have been written by Mises. Strangely, therefore, it was written by Keynes**.

It seems that Keynes understood the problems wrought by policies designed to debauch (devalue) the currency, but such understanding is nowhere to be seen among his modern-day followers. Instead, the modicum of sense contained in the writings of Keynes has been discarded by the Keynesians of today in favour of a total focus on "aggregate demand". If you wrongly believe the economy to be an amorphous blob driven by changes in "aggregate demand", then you are looking at the economy through a lens that creates such a distorted view of the world that what you perceive is the opposite of reality. When looking through such a lens, currency-devaluation policy can appear to be justifiable.

One of the most common 'justifications' for currency devaluation is that it makes local exporters more competitive. The problem, as explained in previous TSI commentaries, is that it can only benefit exporters at the EXPENSE of consumers and importers. There can be no net benefit to the economy. Moreover, the beneficiaries only benefit temporarily. The reason is that a sustained reduction in a currency's value on the foreign exchange market requires relatively high monetary inflation, which leads to rises in domestic prices that not only counteract any benefit to exporters from the exchange-rate decline, but also distort relative prices in a way that makes the overall economy less efficient.

Related to the "we need to devalue our currency to make our exports more competitive" idiocy is the handwringing that happens in reaction to trade deficits. According to neo-Keynesian orthodoxy, every dollar that flows out of the US due to a trade deficit is a dollar less of spending within the domestic economy, which, in turn, leads to a weaker domestic economy and higher unemployment. In reality, however, every dollar that flows out due to a trade deficit eventually returns as some form of investment. That's why the $500B+ annual US trade deficit has not reduced the US money supply. As Joseph Salerno (a good economist) explains in a 17th July article, trade-deficit dollars get invested by foreigners in US stocks, bonds, real estate such as buildings and golf courses, and financial intermediaries like banks and mutual funds, with many of the dollars ultimately being lent to or invested in US businesses. These businesses then spend the dollars on paying wages and buying real capital goods like raw materials, plants and equipment, and software. The point is that the flow of spending in the US economy is not diminished by a negative trade balance, but merely re-routed. There will be a redirection of labor and capital out of export industries into industries producing consumer and capital goods for domestic use, with no net loss of jobs. A net loss of jobs will, however, come about due to policies put in place to 'fix' a perceived trade-deficit problem.

Another common 'justification' for currency devaluation is that it lowers real wages and thus gets around the problem that the nominal price of labour tends to be 'sticky'. The idea is that nominal wage rates are excessively slow to fall in response to reduced demand for workers, and that currency devaluation helps by surreptitiously reducing the real price of labour. The first point to note here is that the 'stickiness' of wages was never a problem in the US prior to the 1930s, when the Hoover and Roosevelt Administrations took steps to prevent wages from falling in response to a severe economic downturn. A second and related point is that government payments to the unemployed can reduce the incentive for able-bodied people to accept lower wages to re-enter the workforce. In other words, if nominal wages are problematically 'sticky' it is because of government intervention, not the free market. Third, the knowledge that modern money relentlessly loses purchasing power over time would tend to make nominal wages 'stickier' than they would otherwise be. In other words, the policy designed to address the perceived problem of 'sticky' wages actually contributes to the problem. In any case, these points are not critically relevant. Regardless of whether wages really are 'sticky' and regardless of the cause of the supposed problem, 'sticky' wages could never logically justify a policy that must ultimately weaken the economy.

The primary problem with currency devaluation is that it leads to non-uniform changes in prices throughout the economy. In effect, the implementers of devaluation policy send false price signals into the economy, which leads to more investing mistakes than would otherwise happen. As a result of the greater number of investing mistakes, there ends up being less wealth. Furthermore, the smaller pool of wealth will be redistributed by the devaluation policy, often in a way that is so obviously unfair that it provokes calls for new interventions and punitive taxes. It therefore puts the economy on the proverbial "slippery slope".

In summary, Keynes wasn't right about much, but early in his career he was absolutely right about currency devaluation. It is a process that engages all the hidden forces of economic law on the side of destruction, and it does it in a manner that not one man in a million will be able to diagnose.

    *The undeserved wealth distribution caused by currency devaluation policy is the root cause of today's fixation on "inequality". Unfortunately, none of the most popular writers on this topic understand the cause of the perceived problem.

    **The quotation is from Chapter 6 of Keynes' 1919 book titled "The Economic Consequences of the Peace".

China Update

If you have been reading well-informed analyses on the topic then you will probably realise that China's economy is a slow-motion disaster in progress. China's economy has been the setting for mal-investment on an unprecedented scale, the result of which will be one of the most spectacular economic busts ever recorded or, more likely, very many years -- perhaps even decades -- of lacklustre performance. The latter long-term possibility appears to be the more likely due to the central government's near-total control of the banking system and the money supply.

However, it would be a mistake to assume that China's economic problems mean that it would be a good idea to bet against China's stock market at this time. Massive economic imbalances do not imply future stock market weakness. In fact, the Shanghai Stock Exchange Composite Index (SSEC) is close to signaling the end of its cyclical bear market.

We currently aren't interested in trading China's stock market from either the short side or the long side, but the intermediate-term risk/reward looks more bullish than bearish.



On the monetary inflation front, since making a new 15-year low in January-2014 the year-over-year rate of change in China's M1 money supply has rebounded. The loosening of the monetary reins has undoubtedly had a lot to do with the gradual upturn in the stock market.



When the rate of change in China's M1 money supply has reversed direction in January, as it has done in 5 of the past 6 Januarys, the new trend has lasted until at least the following January. China therefore looks set to experience a further easing of monetary conditions over the next few months.

The Stock Market

The following chart shows the iShares US Home Construction ETF (ITB) and the ITB/SPX ratio.

ITB has essentially traded sideways since the first half of last year, but the ITB/SPX ratio commenced a major downward trend in May of 2013 and ended last week at a new 18-month low. This suggests to us that the rebound in the US residential real estate market ended during the second quarter of last year.



Some equity bull markets appear to have ended or to be close to an end. At the same time, there are signs that new equity bull markets are getting underway elsewhere. For example, the coal-mining sector, one of the worst-performing equity sectors over the past three years, is close to signaling a major upward trend reversal.

The coal-mining sector is represented on the following daily chart by the Market Vectors Coal ETF (KOL). KOL ended last week in a similar position to the SSEC (a proxy for China's stock market), in that any significant additional strength from here would signal the end of its cyclical bear market.

As an aside, although almost half of the entire world's coal production is consumed in China, we doubt that there is a direct causal relationship between the budding upward reversal in China's stock market and the budding upward reversal in KOL. However, both could be indirectly related to the loosening of monetary conditions in China.

We might be interested in buying KOL following a 10% pullback in the broad US stock market.



The Hong Kong stock market, as represented by the Hang Seng Index (HSI), is short-term 'overbought' and at long-term resistance. Therefore, it probably won't make significant additional headway in the near future. However, the HSI's chart pattern suggests a bullish intermediate-term outcome for this market. It is also worth noting that the HSI/SPX ratio appears to be in the process of reversing a 5-year downward trend.

This week's important US economic events

Gold and the Dollar

Gold and Silver

Gold's 50-day, 150-day and 200-day moving averages established a likely range for a correction low. The 50-day MA in the low-$1290s had been tested during the week before last, but the price action and the relatively high speculative net-long position in COMEX gold futures suggested that gold would drop into the $1280s to test the 150-day and 200-day moving averages before the correction ended. This happened last Thursday, and Friday's upward reversal is a preliminary sign that the test was successful.



As we noted when it was peaking in the $1340s earlier this month, the gold price could drop to test the aforementioned daily moving averages but would probably remain above its 65-week moving average on a weekly closing basis. The following weekly chart shows that for all intents and purposes this has happened, as gold rallied enough last Friday to end the week within $1 of its 65-week MA.



In the 16th July Interim Update we mentioned that silver had support at $19.90-$20.40 and that this support would probably be tested before the correction came to an end. Silver traded in this support range last Thursday and then rebounded with gold on Friday.



With one exception, the short-term corrections in the gold and silver markets have now achieved as much as could reasonably be expected. The exception is the insignificant decline in the speculative net-long position in COMEX gold futures. At 160K contracts, the speculative net-long position in COMEX gold futures remains near a 52-week high. It would ideally drop to less than 130K contracts prior to the start of a tradable rally.

As explained in previous commentaries, speculators drive the gold price, and in the futures market the commercial position is simply an offset of the speculative position. For example, in order for speculators, as a group, to build up a 160K-contract net-long position, commercials, as a group, MUST become net short by 160K contracts. The sum of the net positions must always equal zero. Consequently, a short-term rise in the gold price will almost always be accompanied by an increase in the speculative net-long position and an offsetting increase in the commercial net-short position. It is therefore absurd to view a higher speculative net-long position or a higher commercial net-short position as bearish. That being said, a large and rapid increase in the speculative net-long position suggests short-term risk. It indicates that sentiment has become too bullish too quickly and that the potential exists for substantial 'long' liquidation in the futures market.

In a nutshell, the COT situation is nothing more than a sentiment indicator. As is the case in all markets, a sharp rise in bullish gold sentiment to a relatively high level makes the gold market more vulnerable to disappointment.

Further to the above, it's a concern that the speculative net-long position remains relatively high. However, it is not a big concern to us, because there is often a surge in bullish sentiment in the early part of a new bull market.

Our guess is that gold made its correction low when it traded at $1287 last Thursday, but we won't be confident that the correction has ended until after the price closes above $1325.90.

Gold Stocks

Unlike gold bullion, the senior gold-stock indices haven't yet made it down to moving-average support. For example, the 50-day MA for the XAU is around 94, whereas last week's low for the XAU was around 98. Refer to the following daily chart for details.

It's bullish that gold stocks have held up better than gold bullion during the correction to date, but it means that the gold-stock indices could spike a few percent below last week's lows before resuming their upward trends. Also, the GDXJ/GDX ratio hasn't yet signaled an end to the correction. It would do so by diverging positively from the senior indices, that is, by making a higher low while the XAU and the HUI made lower lows (as per December-2013 and April-May of this year), or by rising sharply.

The XAU has resistance at 104-105 and then at 112-115. We expect that the upward trend will resume within the coming two weeks, with or without a spike down to the 50-day MA, and that the higher of the above-mentioned resistance ranges will be tested within the coming two months.



The Currency Market

In the 25th June Interim Update, we wrote:

"The Canadian Dollar (C$) has moved up to intermediate-term resistance in the 93-94 range. There are no surprises here, just more evidence that commodity-related investments are slowly gaining popularity. However, it will be surprising if the C$ breaks above 94 within the next few weeks. As far as we are concerned, that would be too much too soon.

We expect that the C$ will make a short-term top in the 93-94 range and then 'correct' for at least a few weeks. The 50-day MA would be a likely target for a correction low."

Soon after, the C$ peaked near important resistance at 94 and began to 'correct'. It ended last week just below its 50-day MA, which means that it is now close to the most likely level for a correction low.



The Australian Dollar (A$), the other major "commodity currency", has been oscillating within a horizontal range since April. This is probably a mid-trend consolidation.

We expect that the A$ will resume its upward trend within the next three weeks. 97-98 is a realistic 2-month update target.



The Dollar Index has spent the past 10 months oscillating between 79.0 and 81.5. Until about three weeks ago we were operating under the assumption that the eventual breakout from this range would be to the downside, but now we are uncertain. A downside breakout would indicate that there was going to be one more decline to the low-70s as part of the Dollar Index's major bottoming pattern, whereas an upside breakout would indicate that the bottoming pattern was complete and that a substantial advance had begun.

The Dollar Index is now short-term 'overbought' and near the top of its 10-month range. This suggests to us that it will make a short-term top this week or next.

The position of the coming short-term top will be telling. If the Dollar Index manages to break solidly above 81.5 before making its next short-term top, it will tell us that the ensuing decline will be within the context of a new intermediate-term advance. However, if the Dollar Index reverses downward from at or below 81.5 it will tell us that the odds are still in favour of a final decline to the low-70s.

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 25th July 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]

  *Batero Gold (BAT.V) issued financial statements last week indicating that the company still has about C$0.15/share of cash and working capital, meaning that the stock is still trading at a sizeable discount to its cash (BAT ended last week at C$0.10).

BAT remains in hibernation pending a higher gold price. Its cash burn rate is low, but its gold project in Colombia won't begin to look viable until the gold price breaks above $1400/oz and it probably won't generate market-moving news anytime soon.

  *Pilot Gold (PLG.TO) reported a drilling result during the first half of June that constituted a new discovery at its TV Tower project in Turkey. The new discovery was the Valley gold-copper porphyry target and the discovery hole returned 0.99 grams/tonne gold and 0.39% copper over 153.1 metres starting from near the surface.

Last week PLG reported another exceptional intercept from the Valley target: 1.59 g/t Au and 0.48% Cu over 130.9 metres, again starting from near the surface.

PLG has many irons in the fire. There is a good chance that at least one of these 'irons' will pay off in a big way.

  *Pretium Resources (PVG) is issuing 6.8M new shares at US$7.25/share to a syndicate of underwriters to raise US$49.5M. Silver Standard Resources (SSRI) will be selling $10.5M of its PVG shares at the same price to the same syndicate of underwriters.

The financing is being done at a discount of about 10% to the market price just prior to word of the financing getting out, so it naturally prompted a quick decline of around 10% in the stock price.

In the 23rd June Weekly Update, we wrote: "Due to the value of the Brucejack deposit indicated by the FS, we think that PVG would be a buy if it pulled back to around US$6.50. At that price there wouldn't be much downside risk, because there is little doubt that the project has the potential to be developed into a profitable gold mine at the current gold price. The doubt/disagreement revolves around whether it should be developed into a 400K-oz-year operation using bulk mining or a much smaller operation using selective mining."

Thanks to the discounted financing and the gold market's consolidation, there is a realistic chance that PVG will soon reach our suggested buy zone (around US$6.50). We wanted to make it clear that we still consider the stock to be a good candidate for new buying at this level.

List of candidates for new buying

From within the ranks of TSI stock selections, the best candidates for new buying at this time are:

1) AAU (last Friday's closing price: US$1.36).

2) EDV.TO (last Friday's closing price: C$0.92).

3) EVN.AX (last Friday's closing price: A$0.77).

4) PVG around US$6.50 (last Friday's closing price: US$6.98).

5) SBB.TO (last Friday's closing price: C$0.84).

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html