-- Weekly Market Update for the Week Commencing 29th January 2018

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.

The BULL market in US Treasury Bonds that began in the early 1980s ended in mid-2016, but there will be many years of topping action in bond prices and bottoming action in bond yields before major new trends get underway. A major decline in government bond prices will unfold during the 2020s. (Last update: 11 September 2017)

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.), gold-denominated prices and inflation-adjusted prices. This secular trend will bottom in 2020 or later. (Last update: 11 September 2017)

A cyclical BEAR market in the US Dollar began in 2016-2017. (Last update: 11 September 2017)

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 in 2020 or later. (Last update: 11 September 2017)

Commodities, as represented by the CRB Index, 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 2020 or later. (Last update: 11 September 2017)

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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

Apple Confusion

Summary of current thinking/positioning

1) Expecting that gold will soon make a short-term price top but will go on to make new highs for the year during the second quarter.

2) On the lookout for signs of trouble in a very 'overbought' and over-valued US stock market, but at this time not seeing any reason to expect something more bearish than a normal short-term correction.

3) Thinking that industrial commodities such as oil and copper will make short-term price highs during the first two months of 2018.

4) Expecting the Dollar Index (DX) to commence a counter-trend rebound within the next two weeks.

5) Thinking that the T-Bond has almost completed an intermediate-term topping pattern within the context of a long-term topping pattern.

6) Holding a cash reserve of about 25% and looking for opportunities to boost this reserve to 30%-35%.

No Interim Update this week

Please note that we are taking a short break and as a result there will be no Interim Update this week. Therefore, the next TSI commentary will be the Weekly Update on Sunday 4th February.

It seems that the fundamentals don't matter anymore

Over the past few weeks it has seemed as if the most important fundamental drivers of the financial markets were irrelevant, in that strong short-term price trends in some markets were at odds with the true fundamentals. Here are the three most noteworthy examples:

1) There was a plunge in the Dollar Index, even though interest-rate differentials and relative equity-market strength, the two most important drivers of the US dollar's value against the euro, did not support such an outcome.

2) The US stock market's short-term trend accelerated upward despite the fundamental backdrop becoming less friendly due to rising interest rates and tightening US monetary conditions.

3) The US$ gold price quickly rose to intermediate-term resistance defined by its highs of the past two years ($1360-$1377) even though the fundamental influences represented by our GTFM were oscillating around neutral. This contrasts with the fast-paced gold rallies of Q2-Q3 2016 and Q3 2017, both of which took the price into the $1360-$1377 range (like the recent rally) and both of which were supported by bullish fundamentals (unlike the recent rally).

Contrary to the assumption in some quarters that gold's fundamentals are always bullish and therefore that significant declines in the gold price can only be explained by manipulation, the vast majority of significant advances and declines in the gold price are in synch with the true fundamentals. Consequently, the recent gold rally was unusual, although certainly not unpredictable given the sentiment backdrop.

In the currency and equity markets, however, it is not unusual for short-term price trends to be counter to the fundamentals. Strangely, considering that it is the most liquid of all the major financial markets, this is especially so in the currency market.

The currency market spends a lot of time being essentially trendless, but once a trend gets underway it tends to become relentless. In particular, if a breakout in the currency market is not quickly reversed then there typically will be substantial follow-through in the direction of the breakout as wave upon wave of speculative buying or selling reinforces the trend. It works this way almost regardless of what's happening on the fundamental front.

Of course, there will always be plausible-sounding 'fundamental' stories to support whatever the relentless price trend happens to be. For example, when the US$ is in a strong upward trend the "massive global US$ short position" story is invariably trotted out to explain the trend. The line of thinking here is that the non-US borrowers of trillions of dollars are scrambling to get hold of dollars to make their debt repayments, thus propelling the US currency skyward on the FX market. However, this massive debt (short position) exists during US$ bull markets and US$ bear markets. It therefore can never be the primary cause of a US$ upward trend.

For another example, when the US$ is in a strong downward trend one the most popular explanations invariably has something to do with countries deciding to trade oil in a currency other than the US$. The line of thinking here is that the demand for the US$ will take a hit if a significant portion of global oil trading starts happening in a currency other than the US$, but this is nonsense because the trading of oil accounts for less than 0.1% of international money flows.

Rather than always trying to concoct a fundamental story that justifies a price trend it is sometimes best to acknowledge that speculators are driving the price in a particular direction for reasons that have little to do with the true fundamentals.

The Stock Market

The US stock market is immersed in a speculative blow-off for the ages. By almost every measure it is now at its most extreme level ever. For example:

1) Measured in terms of either price/earnings or price/sales, the valuation of the median US stock is much higher than it has ever been.

2) The Investors Intelligence Bull/Bear ratio recently made an all-time high.

3) More money than ever before is now flooding into US equity funds.

4) The bottom section of the following weekly chart shows that the SPX's weekly RSI is 90.5. This is an all-time high. In other words, intermediate-term momentum has never been greater.



However, for two main reasons there probably won't be anything more negative than a 5%-10% short-term correction within the coming few months.

The first reason is that major momentum extremes have historically occurred well in advance of major price extremes. Weekly charts illustrating two examples are displayed below. The first chart shows that in 1987 the Dow's weekly RSI peaked in March but the Dow itself didn't peak until 5 months later and didn't crash until 7 months later. The second chart shows that in 1999-2000 the NDX's weekly RSI peaked in December-1999 but the NDX itself didn't peak until the following March.

The second reason is that our Equity True Fundamentals Model (ETFM), which combines credit spreads, the yield curve, the relative strength of the banking sector, the TIPS yield and the G2 (US + euro-zone) monetary inflation rate, is neutral. The ETFM is not supposed to warn of short-term corrections, but it should move into bearish territory a few months prior to the start of a bear market. For example, during the preceding cycle the ETFM made a sustained drop into bearish territory in March-2007 and turned very bearish in May-2007, but the SPX didn't reach its final high until October-2007.

Up until a couple of weeks ago our intention was to add a short-term bearish speculation to the TSI List and add to an existing small QQQ put-option position in our own account following evidence of a downward reversal, but due to the US stock market's extreme upward momentum that is no longer the case. Instead, the only bearish speculation of interest to us right now is Tesla (TSLA).

The speculative blow-off in the NASDAQ over the past few weeks gave TSLA's price a boost, but not enough of a boost to alter the chart's bearish appearance (see below). TSLA still appears to be tracing out a rounded top, with twin peaks in June and September of last year and major support at $300.



Ultimately the stock will lose most of its value, but the difficulty, as usual, is with the timing. The risk for the bears on this stock is that in the current manic market environment, if TSLA were to break above last year's top then it could move a lot higher before coming back to earth.

We have added the TSLA April-2018 $250 put option to the TSI List at the mid-point of last Friday's bid-offer spread (US$2.70). This position has a high risk of suffering a 50%-100% loss and a realistic chance of achieving a gain of several hundred percent. It all depends on WHEN the TSLA stock price breaks below $300. For example, our interpretation of the chart pattern could be correct, but if the breakdown occurs after mid-April it will be too late for these options.

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

Gold's current rally is almost solely a reaction to US$ weakness. This is evidenced by gold being near a 10-year low relative to the SPX, near a 2-year low relative to commodities in general, and only managing minor rebounds from its December-2017 low relative to currencies other than the US$. However, if there is sufficient additional US$ weakness to push the US$ gold price through resistance at $1360-$1377 then, genuine gold strength or not, the likely effect will be a surge in the demand for gold-mining stocks. The reason is that in the short-term the desire to own gold-mining stocks is influenced more by the nominal US$ gold price than by the real gold price. This is despite the fact that it's the real gold price (gold's purchasing power) that determines the profitability of gold mining.

The following weekly and daily gold charts indicate that last week the gold price tested the above-mentioned resistance range but ended the week below the bottom of the range. A breakout requires a weekly close above the top of the range ($1377). Our expectation is that a breakout won't happen during the first quarter of 2018 but will happen during the second quarter.

Although the rally in the US$ gold price looks stretched on a short-term basis, as pointed out in a few recent commentaries it will be reasonable for traders to give the rally the benefit of the doubt until there is a daily close below the 20-day MA. This MA will rise into the low-$1330s within the next two days.

By the way, the FOMC Announcement scheduled for this Wednesday (31st January) should not have a significant effect on the gold market or any other market. This is because the Fed won't make any change and no-one who has been paying attention expects any change. Unless something dramatic happens in the meantime, the next Fed rate hike will happen in March.

Silver

Silver has been in a downward trend relative to gold since July of 2016. This trend may have just ended.

We expect silver to outperform gold over the next 4-6 months, for the following reasons:

1) Silver's relative weakness over the past 18 months combined with today's historically-low silver/gold ratio creates the potential for a period of relative strength by silver.

2) Silver's COT situation is more supportive than gold's.

3) If the US$ gold price breaks out to the upside then the speculating community will turn its attention to gold-associated investments that are perceived to be leveraged plays on gold. These investments include gold-mining stocks and silver.

4) Being as much an industrial metal as a 'monetary' metal, silver should benefit from continuing strength in industrial metals relative to gold.

The following daily chart shows that last week the silver price broke above short-term resistance at $17.40. Furthermore, it did so after first spiking to a new low for the year, which makes the upside breakout more bullish than would otherwise be the case.

More important resistance is defined by the September-2017 high of $18.29. Ideally (from a bullish perspective), this resistance will be tested before the start of a multi-week correction.



Turning to silver's weekly chart, what we see is a picture of a market that has been basing, or coiling, for almost a year. This chart suggests the potential for a move up to the low-$20s within the next few months.



Gold Stocks

Current Market Situation

We do not expect the HUI to breach its December-2017 low, at least not this year. Furthermore, we expect the gold-mining indices and ETFs to have a strong upward bias during the first half of this year. That being said, nothing has happened to date to differentiate the current rally from the 1-2 month counter-trend rebounds that occurred during 2017.

During the first half of last week the HUI tacked-on 8 points and traded as high as 210 before giving up most of its gain and ending the week with a net rise of only 1 point. It therefore remains well below important resistance at 220.

A weekly close above 220 would leave little doubt that we are dealing with an intermediate-term upward trend, but even a successful test of 220 within the next week or two would have bullish implications. That's because triple tops (a triple top is what we'd be dealing with if the HUI were to reverse downward after reaching 220 in the near future) usually don't hold. The most likely outcome following a successful near-term test of 220 would be a few weeks of consolidation and then a sustained upside breakout.

We think that the gold-mining sector's prospects are neutral with regard to the coming 1-2 months and bullish with regard to the coming 3-5 months.



PVG stays in the 'too hard basket'

Due to the inherent difficulty of accurately predicting the output of a mine where the nugget effect is extreme and due to the disagreements between very knowledgeable geologists regarding the Brucejack project's resource model, we put Pretium Resources (PVG) into the 'too hard basket' long ago. Last week's news from the company was a reminder of the challenges posed by this incredibly high grade, but very inconsistent, deposit.

The company declared "commercial production" at Brucejack in July of last year and achieved gold production of 82K ounces during the first quarter of the mine's ramp-up (Q3-2017). This was an excellent result and temporarily allayed fears that the resource model was over-estimating the amount of recoverable gold. However, PVG reported last week that production was only 70K ounces during the second quarter of the mine's ramp-up due to the average grade being lower than predicted. This immediately rekindled all the old fears about the potential inaccuracy of the resource model, leading to a 35% plunge in the stock price.



According to the company's Feasibility Study, production was expected to average about 500K ounces/year in years 1-8, but the guidance is now for 300K-350K ounces during the first year. In other words, it seems that the first year's production will be at least 150K ounces less than originally expected.

Perhaps with additional information gleaned from grade-control drilling the mine will be able to start producing at the originally-forecast rate by its second year of operation, but the risk is substantial because even after last week's price plunge the stock is not cheap. The current enterprise value (market cap plus net debt) is about US$2.1B, which would be reasonable if the production ramp-up were on track but is a high price to pay considering the uncertainty.

We therefore won't be buying the dip.

The Currency Market

The Swiss Franc (SF) catches fire

In the 20th November Weekly Update and again in the 4th December Weekly Update we wrote that a substantial SF rally may be brewing and therefore that it would make sense to accumulate a position in this currency over the ensuing weeks. With regard to the SF's performance relative to US$, the first of the following charts indicates: so far, so good. The SF broke above intermediate-term lateral resistance at 106 last week and ended the week at its highest level since Q3-2015.

Based on the price action and the SF's still-constructive COT situation (the second of the following charts shows that speculators in the futures market have maintained a sizable net-short position in the SF despite the currency's recent strength), it's likely that the SF will trade at 110-112 before the middle of this year.

With regard to the SF's performance relative to the euro, an end to the relentless downward trend was signaled last week by SF/euro's first solid break above its 50-day MA in almost a year.



Relative to the euro the SF's short-term risk/reward is bullish, but relative to the US$ the SF's short-term risk/reward is now neutral at best due to the speed of its recent ascent. We expect that SF/US$ will spend the bulk of the next month in correction mode.

The Dollar Index (DX) extends its climactic sell-off

Here is a weekly chart of the DX including 20, 50 and 200 week MAs.



With regard to the US dollar's cyclical trend, the point of recognition for us came between the second half of last July, when the euro broke above important resistance at 1.15-1.16, and early-September, when the Dollar Index (DX) broke below its 200-week MA. We described the break below the 200-week MA as a virtual nail in the bull market's coffin. It indicated that there would be additional downside in the DX over the ensuing 12 months, although at the time of the breakdown the DX was so 'oversold' as to set the stage for a 2-3 month rebound.

The DX's rebound from its early-September low lasted two months and was followed by a new short-term downward trend. This short-term downward trend accelerated over the past three weeks and if it hasn't already done so should climax within the next two weeks, leading to another significant DX rebound. Our guess is that the next rebound will be shorter and sharper than the one that began in early-September of last year, but in any case it is reasonable to expect the DX to make new multi-year lows following whatever correction occurs during February-March.

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 26th January 2018:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, FY = Financial Year, IRR = Internal Rate of Return, ISR = In-Situ Recovery, 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]

  *Alkane Resources (ALK.AX) published its quarterly activities and cash-flow reports for the December quarter.

The combined amount of cash, cash equivalents and bullion increased by A$4.4M during the quarter and the balance sheet remains solid. At the end of December ALK had no debt and about A$58M of liquid financial assets.

Gold production during the quarter from the company's Tomingley Gold Operation (TGO) was slightly above plan and the production guidance for the current Financial Year (1st July 2017 to 30th June 2018) has been increased from 65K-70K ounces to 70K-80K ounces at a reduced AISC of A$1000-A$1100/oz (US$800-$880/oz). This implies expected production of 30K-40K ounces over the next two quarters and means that the TGO should continue to add cash to the balance sheet.

An underground mining study for the TGO is scheduled to be completed this quarter. This study has the potential to be a positive, market-moving piece of news.

For the fully-permitted Dubbo Project (DP), which is slated to produce zirconium, hafnium, niobium and REEs, the company advised that a project execution and financial model incorporating the results of the modularised build study will be released in February. This is the information that we've been eagerly awaiting. We expect that it will highlight the extreme under-valuation of ALK shares.

The economics of the DP have been given a boost over the past year by the stricter environmental controls being implemented in China. The reason is that the environmental crackdown in China is reducing the global supply, and therefore elevating the prices, of the DP's main commodity outputs.

At some point it will make sense for ALK to split into two listed companies, perhaps by floating-off the TGO. This is mainly because a much higher overall market valuation would result from forcing the market to separately value each of the company's projects.

  *Blackham Resources (BLK.AX) resumed trading and provided the full details of the entitlement issue (EI) under which eligible shareholders will have the right to subscribe for 5 new shares at A$0.04/share for every 2 existing shares. The scheduled closing date for acceptances under the EI is 12th February, so any eligible shareholder who wants to exercise his/her rights should do so well before that date.

Eligible shareholders who do not want to exercise their rights could choose to sell them on the market. Rights trading has begun and will end on 5th February. The rights trade on the ASX under the symbol BLKRA and were priced at A$0.02 at the end of last week.

As expected and as is normal in these situations, "eligible" shareholders are those with registered addresses in Australia or NZ. Other shareholders will have their EI rights sold on the market by the lead underwriter (Hartleys) and will have the proceeds of the sale sent to their brokerage accounts. No action is required.

A free 12-month option with an exercise price of A$0.08 will accompany every two new shares purchased under the EI. These options will be listed on the ASX at a date to be advised (it will be 20th February or later). At the current BLK share price the options will have minimal value, but they could attain significant value before year-end if the company achieves its production plan.

Note that if you are a non-eligible shareholder who wants to take advantage of the low price created by the EI, buying shares on the market at 0.06-0.07 (the current price) and receiving the proceeds of the rights sale should work out to be roughly the same net cost as exercising the rights. The only significant difference is that you wouldn't get the free options, but it may be possible to buy the options on the market at 0.01-0.02 within the next two months.

More information can be found in the letter and associated documents that were sent to shareholders early last week. A copy of the letter is posted HERE.

For TSI record purposes it will be assumed that the rights are exercised in full, that is, we'll assume the addition of 2.5 new shares at a cost of 0.04 for each existing share and the receipt of 1.25 free options for each existing share.

  *Energold Drilling (EGD.V) issued a corporate update to advise that:

a) In 2017 the company achieved a year-over-year increase of 27% in the number of metres drilled by its minerals division.

b) The minerals division is expected to put in another strong performance in 2018.

c) Higher oil prices are leading to increased business for the company's energy division, meaning that this division's financial performance should be much improved in 2018.

d) The manufacturing division is expected to return to profitability in 2018.

In summary, the intermediate-term prospects for EGD's business are much better now than they have been in years. This is not at all surprising. In conjunction with the depressed share price it is why we consistently included EGD in the list of candidates for new buying over the past three months.

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$0.91)

2) ALK.AX (last Friday's closing price: A$0.32)

3) ESM.TO (last Friday's closing price: C$1.29)

4) NSU (last Friday's closing price: US$2.37)

5) PRQ.TO (last Friday's closing price: C$1.50)

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

Removing the Asanko Gold (AKG) trading position

We have removed the AKG trading position from the TSI List. The stock has benefited from short covering over the past several weeks and is up by about 100% from its December-2017 low. However, we got the timing wrong and it is down by 34% since its addition to the List last June.

AKG attracted a lot of negative press over the past year, some of it justified and some of it not. The company has failed to meet production targets, but the situation on the ground does not appear to be as bad as portrayed by the short sellers. Also, there's a good chance that the company will be able to delay its debt repayments and maintain a sufficient cash reserve.

We hasten to point out, however, that despite its large price decline AKG does not offer great value relative to some other gold producers that are less risky.

Chart Sources

Charts appearing in today's commentary are courtesy of:

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