-- Weekly Market Update for the Week Commencing 28th October 2019

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True Fundamentals Summary [Notes: 1) The date shown next to the current True Fundamentals Model (TFM) signal is when the most recent change occurred. 2) Charts of the Gold and Equity TFMs are included in the "Charts and Indicators" section of the TSI web site]

Last week's posts at the TSI Blog

A potential game-changer from the Fed

Summary of current thinking/positioning

1) The Dollar Index (DX) confirmed a short-term reversal to the downside three weeks ago and must end a week below 96 to confirm an intermediate-term reversal to the downside. We are anticipating such a reversal, but there remains a (diminishing) risk that the DX will first move sharply higher for 1-3 months.

2) The US$ gold price, the US$ silver price and the gold-mining indices are still immersed in corrections and are at risk of experiencing sharp price declines within the next couple of weeks, but new upward trends are expected to begin before the end of November.

3) The Fed's new asset monetisation program has increased the risk for bearish stock-market speculators and clear signs of equity strength have started to emerge outside the US. However, the senior US stock indices probably will reach short-term tops within the next two weeks and the final few weeks of the year could involve a 'flight to safety'.

4) The T-Bond probably will trade below its September low in the near future, but we expect that major price weakness (yield strength) in the Treasury market will be postponed until next year.

5) Industrial commodities such as oil and copper could be in the process of bottoming, but we expect that meaningful price strength won't show up until next year.

6) We are holding a cash reserve of 25%-30%.

Interest Rates

What will the Fed do?

There is an FOMC meeting on Tuesday-Wednesday of this week, which means that the Fed will make its next formal monetary-policy announcement on Wednesday 30th October. What is this announcement likely to say about interest rates?

In the minutes of the July FOMC meeting the Fed admitted that it was taking into account market expectations regarding rate cuts when deciding what to do. As we noted in a blog post on 27th August, the implication of this admission is that if the market expects the Fed to cut rates, then to avoid disappointing the market the Fed will cut rates. In the weeks leading up to an FOMC meeting the Fed's senior representatives have the opportunity to alter market expectations through their regular speeches, but if we get to the week before an FOMC meeting and the market is assigning a high probability to an X% rate cut then an X% rate cut is almost certainly what the Fed will deliver.

According to the CME FedWatch Tool, at the time of writing there is a 94% probability that the Fed Funds Rate (FFR) target range will be reduced from 175-200 basis points (bp) to 150-175bp at this week's FOMC meeting. Also, the CME FedWatch Tool shows a 73% probability of the FFR target range being 150-175bp after the 11th December FOMC meeting. These figures imply a near certainty of a 25bp rate cut on 30th October and a high probability that the Fed will then be on hold for the remainder of the year.

The Fed will cut rates by 0.25% this week, but what it does at the 11th December meeting will be determined by what happens in the markets in the meantime. For example, a sizable stock market decline during the weeks leading up to the December FOMC meeting would tip the scales decisively in the direction of another rate cut at that time.

Assuming that on Wednesday of this week the Fed does what most market participants expect, which is cut by 0.25% and signal that future rate cuts will depend on future data, a big market reaction is unlikely. However, there is a risk that the main 'safe havens', meaning gold and the T-Bond, will sell off.

Lower interest rates lead to slower growth

In one important respect, the average central banker is like the average politician. They both tend to focus on the direct and/or short-term effects and ignore the indirect and/or long-term effects of policies. In the case of the politician, this is understandable if not excusable. After all, the overriding concern of the average politician is winning the next election. The desire to be popular also influences the decisions of central bankers, but there is a deeper reason for the members of this group's short-sightedness. The deeper reason is their unwavering commitment to Keynesian economic theory.

All central bankers are Keynesians at heart (if they weren't they wouldn't be central bankers), and Keynesian economic theory revolves around the short-term and the superficial. It's all about policy-makers in the government and the central bank attempting to 'manage' the economy by stimulating demand under some conditions and dampening demand under other conditions, with the conditions determined by measures of current or past economic activity. For example, if certain statistics move an arbitrary distance in one direction then an attempt will be made to boost "aggregate demand". That the concept of "aggregate demand" is bogus is never acknowledged, because acknowledging that the economy comprises millions of distinct individuals as opposed to an amorphous blob would call into question the entire basis for central control of money and interest rates.

In the short-term, the manipulation of money and interest rates often seems to work. In particular, pumping money and forcing interest rates below where they otherwise would be can lead to increased economic activity in the form of more consumption and more investment. What's happening, however, is that false signals are causing people to make mistakes.

One problem is that people are incentivised by cheaper credit to consume more than they can afford, which guarantees reduced consumption in the future. The bigger problem, though, is on the investment front, in that projects and businesses that would not be financeable at free-market rates of interest are made to appear economically viable. This could seem like a very good thing for a while, but it means that a lot of resources get used in ventures that eventually will fail. It also means that the businesses that would have been viable in a non-manipulated rate environment suffer profit-margin compression due to the ability, created by the abundance of artificially-cheap credit, of relatively inefficient and/or unprofitable competitors to remain in operation.

Thanks to the investing errors and the general profit-margin compression that result from it, the policy of interest-rate suppression leads to reduced economic growth over the long term. Furthermore, it's not so much that central bankers weigh the long-term negatives against the short-term positives and opt for the latter; it's that their chosen theoretical framework doesn't even allow them to consider the long-term negatives.

A final plunge in the T-Bond?

On a short-term basis the T-Bond and gold markets are in similar positions. Both markets reached 'overbought' extremes about two months ago and have since been in correction mode. Also, it's likely that both markets are close to correction lows in terms of time, but in each case there is a high risk of a price plunge prior to a sustained turn to the upside.

The T-Bond market is represented on the following daily chart by the iShares 20+ Year Treasury Fund (TLT). We mentioned three weeks ago that TLT probably was about to commence a sharp multi-week decline and we noted two weeks ago that $130-$135 was a reasonable target for a short-term bottom. We still have this target in mind.

We suspect that whatever additional downside is going to materialise will do so within the next three weeks. It's the same story with gold, because there's a good chance that concerns about economic weakness and the trade war will soon return to centre-stage.



The Stock Market

Stock market volatility was low last week, but the price action was interesting nonetheless. Here are the most significant recent developments:

1) Although the S&P500 Index (SPX) only made a small gain last week, the upper section of the following daily chart shows that it was enough to enable the world's most important stock index to break above the top of its contracting triangle. The lower section of the same chart shows that this breakout was accompanied by impressive strength in the NYSE Advance-Decline Line (ADL).



2) Last week the Bank Index (BKX) moved above intermediate-term lateral resistance to a new high for the year. We've been expecting this breakout for a few months. Moreover, the BKX/SPX ratio broke the sequence of declining tops that dates back to early 2018.

Bank stocks are poised to perform well over the coming 12 months, both in nominal dollar terms and relative to the broad market. Note, though, that a weekly BKX close below 100 would invalidate last week's upside breakout.



3) Last week the NASDAQ100 Index (NDX) made a marginal new all-time high.



4) The Dow Transportation Average (TRAN) has gone from an 8-month low to a 5-month high in the space of only three weeks. It is now a little stretched to the upside and less than 3% from resistance defined by this year's high, so significant additional gains are unlikely in the near-term.



5) The Semiconductor Index (SOX) broke above the top of the rising 'wedge' that formed over the past 6 months and ended last week at an all-time high.



6) A week ago we wrote: "...it looks like the Emerging Markets Equity ETF (EEM) is about to break upward from the channel in which it has traded since April." Last week it broke above its channel top.



Last week's upside breakouts and other bullish developments were caused at least in part by the Fed's recent introduction of a new money-pumping program. The new program has the potential to extend the long-term equity bull market well into next year, but there are two reasons, one technical and the other fundamental, to believe that the market won't make much additional headway before commencing its next significant correction.

The technical reason is illustrated by the following weekly chart. The chart shows that over the past 18 months the SPX has commenced a sizable multi-week decline soon after making a new all-time high. If the pattern continues, the SPX won't go higher than about 3070 before reversing course.



The fundamental reason is that the so-called "Phase 1" US-China trade deal could be in trouble. Everything was supposedly agreed and all that was left was for presidents Trump and Xi to put pen to paper when they met on the sidelines of the APEC Economic Leaders' Meeting in Chile in mid-November. However, there now appears to be a difference of opinion as to what has been agreed. In particular, the US side is saying that the Chinese side has agreed to buy $40B-$50B per year of US agricultural products and that existing tariffs will remain in place for now, but the Chinese side is saying something along the lines of: "Let's go back to the way things were in 2017. We'll buy about $20B/year of US agricultural products and you eliminate most tariffs."

If the "Phase 1" trade deal were to disintegrate there would, we think, be a rapid shift away from general equities and a surge in demand for gold and T-Bonds.

This week's significant US economic events [Notes: 1) The most important events (to the markets) are shown in bold. 2) A list of global economic events can be found HERE]

Gold and the Dollar

Gold

During the early part of Friday's US trading session it looked like the US$ gold price was going to break above its channel top and its 50-day MA, but the early gains were given back. At the end of the week the gold price was at its channel top and below its 50-day MA, meaning that a breakout has not occurred.



The fundamental backdrop is finely balanced right now. Our Gold True Fundamentals Model (GTFM) is still in bullish territory, but a few of its inputs are very close their tipping points. It easily could turn bearish within the next two weeks, but it also could become more bullish. Further to comments earlier in today's report, the fundamental backdrop probably will become more gold-bullish in quick time if the US-China "Phase 1" trade deal collapses.

In any case and as mentioned in previous TSI commentaries over the past month, gold's main problem at the moment is sentiment. We are referring to the fact that the speculative net-long position in Comex gold futures remains unusually large. This creates downside risk and reduces the scope for the price to be driven upward by new speculative buying.

Is there any chance that gold could resume its intermediate-term upward trend without the magnitude of decline in price and speculator optimism that typically follows the sort of extreme that was reached two months ago? According to the historical record the answer is yes. Such a turn of events would be unlikely, but not unprecedented.

Late-2007 is the one time we know of that the gold market reached sentiment and momentum extremes that are comparable to those reached between mid-August and early-September of this year, but did not experience a sentiment reset before resuming its intermediate-term advance. Specifically, in early-November of 2007 the gold market was as 'overbought' based on the weekly RSI and as 'overbullish' based on the speculative net-long position in Comex gold futures as it was near this year's price peak. However, the November-2007 extreme was followed by a fairly minor multi-week correction, after which there was a 3-month rally of around 20% to an intermediate-term top in March-2008.

The late-2007 correction is indicated on the following long-term weekly chart of the US$ gold price. If the correction from this year's top is similar then a multi-month surge to well above the early-September price high will begin soon. A daily close above $1525 would warn that this scenario may be playing out.



In summary, the historical record suggests that an immediate resumption of gold's intermediate-term upward trend is unlikely, but not out of the question. The most likely outcome is that the correction continues until there has been sufficient price weakness to bring about a substantial reduction in the speculating community's optimism.

Silver

The silver price broke above its 20-day MA last Thursday and broke above its 50-day MA on Friday. However, because the bulk of the gain achieved during the early-going on Friday was subsequently relinquished, the price action was neutral rather than bullish.



Silver fell far enough during September to compete a normal correction. Also, October's boring price action is consistent with a bottoming pattern. The problem is that silver's correction probably won't end until gold's correction has ended, and at this stage the odds favour additional corrective activity in the gold market.

Regardless of whether or not the overall correction has ended, a daily close above $18.00 would suggest that silver was going to test its early-September peak.

Platinum

The two most likely places for platinum's correction to end were the $920s and $880-$890. Last week's price action suggests that the multiple tests of lateral support at $880 during October (refer to the following daily chart for the details) marked the correction low.



$880 is now critical, not only because of the lateral support at this level that survived several tests over the past month but also because the 20-week MA (the thin black line on the following weekly chart) has moved up to around $880. In the platinum market, the 20-week MA tends to limit substantial corrections during intermediate-term upward trends.

A weekly close below the 20-week MA would signal that platinum's intermediate-term advance was over. We do not expect this to happen anytime soon and continue to have $1200 (the 2016 high) in mind as a minimum intermediate-term upside target.



Gold Stocks

In last week's Interim Update we showed that the gold mining indices and ETFs had traced out potential wedge patterns since early September. The daily charts displayed below show that over the final two days of the week the Gold Miners ETF (GDX) and the HUI broke above the tops of their respective wedges.

The wedge patterns are open to interpretation and may or may not be valid. What's not open to interpretation is the 50-day MA. As illustrated below, last week's upward moves were limited by the 50-day MA, which is also what happened when the gold sector rebounded during the first half of October.

It's possible that a 1-2 week counter-trend rebound ended on Friday. However, if both GDX and the HUI close above their 50-day MAs it will suggest that a more significant rally, likely involving a test of the August-September high, is underway.

The most positive recent development for the gold mining sector is the performance of the HUI/gold ratio. As illustrated by the following chart, HUI/gold bounced off its 150-day MA in mid-October and closed above its 40-day MA last Friday. This is a preliminary signal of an upward trend reversal.

To solidify the reversal the HUI/gold ratio must hold above its 40-day MA this week. By the same token, if the gold sector is still in correction mode then HUI/gold probably will move back below its 40-day MA within the next few days.



Turning to our comparison of the present-day HUI and the Barron's Gold Mining Index (BGMI) of the 1980s, the updated chart displayed below suggests that the correction could be complete. However, a correction-ending plunge within the next two weeks also would be roughly in line with this model.



The upshot is that the gold sector's short-term risk/reward is neutral. There is still a high risk of a final correction-ending plunge that takes GDX and the HUI down to their 200-day MAs, but we are into the time window when the correction was/is expected to end and it wouldn't take much additional strength from here to shift the odds in favour of a sustainable up-turn.

The gold sector's intermediate-term risk/reward is bullish.

The Currency Market

The following daily chart shows that the Dollar Index (DX) has been oscillating within a channel since August of last year. The channel has an upward slope, but, as mentioned in earlier commentaries, the choppy price action does not have the look of an upward trend.

We think that a 1-2 year period of US$ weakness, driven by weakness in US equities relative to European equities and the narrowing of the US-Europe interest-rate gap, has begun or will begin within the next few months. It's possible that there will be a US$ surge in response to fear of a global recession prior to the start of an intermediate-term decline in the DX, but such a surge would be short-lived because it would provoke the Fed into becoming very 'easy' very quickly.



Last week the DX rebounded from its 200-day MA. Unfortunately, this doesn't tell us anything useful about the future, because the rebound could be a counter-trend move within a short-term downward trend or the start of a larger rally.

Updates on Stock Selections

Notes: 1) To review the complete list of current TSI stock selections, logon at http://www.speculative-investor.com/new/market_logon.asp and then click on "Stock Selections" in the menu. When at the Stock Selections page, click on a stock's symbol to bring-up an archive of our comments on the stock in question. 2) The Small Stock Watch List is located at http://www.speculative-investor.com/new/smallstockwatch.html

Company news/developments for the week ending Friday 25th October 2019:

[Note: AISC = All-In Sustaining Cost, EBITDA = Earnings Before Interest, Tax, Depreciation and Amortisation (a measure of cash flow), EV = Enterprise Value or Electric Vehicle, FS = Feasibility Study, FY = Financial Year, IRR = Internal Rate of Return, ISR = In-Situ Recovery, JV = Joint Venture, MD&A = Management Discussion and Analysis, M&I = Measured and Indicated, NAV = Net Asset Value, NPV(X%) = Net Present Value using a discount rate of X%, NSR = Net Smelter Return or Net Smelter Royalty, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Alkane Resources (ALK.AX) published its quarterly report for the September-2019 quarter (the first quarter of FY2020). The report was generally positive (as discussed below), but with one exception it contained no important new information. The one exception is the following comment:

"A demerger and listing of Australian Strategic Materials is under active consideration by the Alkane Board. Consultation with regulators is underway."

In other words, the separation of ALK into two companies, one focused on gold and the other focused on the Dubbo specialty metals project, is under consideration. This is exactly what we have been saying the company should do for the past two years, as it could unlock substantial value for shareholders. Due to the opportunities to expand the gold business that have cropped up this year, the separation makes even more sense now than it did a year ago.

The quarterly report included another above-plan performance from the Tomingley Gold Operation (TGO), with gold production of 7.5K ounces at an AISC of A$1268/oz (US$862/oz). This has led to production guidance for FY2020 (the financial year ending 30th June 2020) being improved from 27K-32K ounces of gold at an AISC of A$1300-$1450 to 30K-35K ounces of gold at an AISC of A$1250-$1400. Note: The current A$ gold price is around $2200/oz.

The Tomingley open pit is depleted and the current production is solely from the processing of stockpiles. However, the life of the operation has been extended by the construction of an underground mine that is scheduled to go into production during the March quarter of 2020. Also, exploration results indicate the potential to establish a new pit within a few kilometres of the existing plant.

With regard to the Dubbo specialty metals project, the commercial scale pilot plant being constructed as part of the investment in Clean Metal Processing Technology with Ziron Tech of South Korea is due to be commissioned in the March quarter of 2020.

ALK's balance sheet is strong. The company is debt free with cash, bullion plus listed investments of about A$74M. This figure is down by about A$7M since the end of the preceding quarter due to investments in exploration drilling, underground mine development and the Dubbo project's pilot plant.

  *Columbus Gold (CGT.TO) had noteworthy news over the past week. First, the company announced early last week that it had raised C$2.5M by selling 15.6M new shares to Sandstorm Gold at C$0.16/share. This means that Sandstorm now owns about 8% of CGT. Second, late last week the company noted conclusions from a recent government report that suggest increasing government support for the Montagne d'Or gold project in French Guiana. CGT's 45% stake in this project is by far its most important asset.

Project permitting is taking longer than expected and probably won't be complete before mid-2020. Permitting risk is probably the main reason that CGT is trading at a small fraction of the estimated net present value of its Montagne d'Or stake.

List of candidates for new buying

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

1) AAU (last Friday's closing price: US$0.66)

2) AOI (last Friday's closing price: C$1.18)

3) JRV.AX, JRV.V (last Friday's closing price: A$0.21, C$0.19)

4) OIH (last Friday's closing price: US$11.77)

5) TGB (last Friday's closing price: US$0.44)

The above list is limited to five stocks. It sometimes will contain less than five, but it never will contain more than five regardless of how many stocks are attractively priced for new buying.

Chart Sources

Charts appearing in today's commentary are courtesy of:

https://stockcharts.com/