Big Picture View

Here is a summary of our big picture view of the markets. Note that our short-term views may differ from our big picture view.

In nominal dollar terms, the BULL market in US Treasury Bonds that began in the early 1980s will end by 2013. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 23 January 2012)

The stock market, as represented by the S&P500 Index, commenced a secular BEAR market during the first quarter of 2000, where "secular bear market" is defined as a long-term downward trend in valuations (P/E ratios, etc.) and gold-denominated prices. This secular trend will bottom sometime between 2014 and 2020. (Last update: 22 October 2007)

A secular BEAR market in the Dollar began during the final quarter of 2000 and ended in July of 2008. This secular bear market will be followed by a multi-year period of range trading. (Last update: 09 February 2009)

Gold commenced a secular bull market relative to all fiat currencies, the CRB Index, bonds and most stock market indices during 1999-2001. This secular trend will peak sometime between 2014 and 2020. (Last update: 22 October 2007)

Commodities, as represented by the Continuous Commodity Index (CCI), commenced a secular BULL market in 2001 in nominal dollar terms. The first major upward leg in this bull market ended during the first half of 2008, but a long-term peak won't occur until 2014-2020. In real (gold) terms, commodities commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

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Outlook Summary

The Fed strikes again

The Federal Reserve, the central planning agency responsible for manipulating US money supply and interest rates, issued its latest strategy statement last Wednesday. There were no surprises, but the following excerpt is worth highlighting:

"If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability."

The Fed is rowing in the wrong direction, because by purchasing assets with money created out of nothing it is placing obstacles in the way of a genuine recovery. This means that the harder it rows, the less likely the economy will get to the point where it is making strong real (sustainable) progress. Be that as it may, by repeating the above sentence the Fed has re-confirmed that it will row even harder if it doesn't perceive a return to strength.

Whereas last week's FOMC statement was almost an exact copy of the preceding one, there's a good chance that the next statement, which will be published on 12th December, will contain some significant changes. This is because the Fed's "Operation Twist" (selling short-dated Treasury securities and using the proceeds to purchase long-dated securities) is scheduled to conclude at the end of this year and probably can't be extended due to a lack of short-dated securities. That is, one string of the Fed's 'policy accommodation bow' will soon be no more. The question is: will the Fed find a new string to replace the one that can no longer be used? The answer is: probably, but we should know for sure on 12th December. 

Monetary Inflation Update

Here are short notes on what's happening to monetary inflation rates in the euro-zone and Australia.

The year-over-year (YOY) rate of growth in euro True Money Supply (TMS) moved a little higher in September, building on its upward trend. The probability of the euro-zone experiencing genuine deflation was never high, but it is now low and getting lower by the month. At the same time, the probability of a new European investment bubble is rising. The German property market is a candidate for the next bubble.



The large swings in Australia's YOY TMS growth rate evident on the following chart are mostly due to changes in the rate at which the commercial banks make new loans. Unlike the central bank in the US, the Reserve Bank of Australia hasn't done much in the way of direct money creation. It doesn't need to do anything yet, because the activities of the commercial banks are keeping the money supply growing at 5%-8%.

Australia had a very high monetary inflation rate during 2006-2008 and is undoubtedly still feeling the effects of this inflation (it takes a few years for the full effects of a money-supply surge to ripple through the economy). Adding more money at the rate of 5%-8% per year is only going to worsen the inflation problem.

The Stock Market

Apple and the Miners

The first of the following daily charts shows the performance of Apple (AAPL) over the past two years. The second chart shows the performance of the Diversified Metals and Mining Index (SPTMN) over the same period. An inverse relationship is evident, in that while AAPL has made a sequence of rising tops SPTMN has made a sequence of declining tops. To put it another way, over the past 18 months stock market participants have increasingly favoured AAPL at the expense of the mining sector.

Is a reversal in the works, with investor interest beginning to shift away from AAPL and towards the mining sector?

It's too soon to tell. It's possible, for example, that the mining sector has led to the downside and that tech favourites such as AAPL are about to join the long-term decline. The possibility that we favour is that diversified mining stocks will rally into early next year within the context of a long-term downward trend, regardless of what happens to AAPL. (Note: The gold mining sector is fundamentally very different from, and must therefore be analysed separately from, the diversified mining sector).

On a related matter, Apple's stock shows no sign of being immersed in an investment bubble. The company has net cash and cash equivalents of about $120/share, which means that at Friday's closing price of $604 its enterprise value is around $480/share. It earned $44/share over the past 12 months, so it is currently trading at a P/E ratio of only 11. Considering that its earnings are still growing rapidly a good argument could therefore be made that the stock is significantly under-valued.

While there is clearly no bubble in the stock's current valuation, the company's earnings may well constitute a type of bubble. AAPL could now be in a similar situation to the home-building companies in 2005. When the home-building stocks were reaching major peaks in mid-2005 they didn't appear to be expensive based on what they were earning at the time and what they were expected to earn over the coming 12 months, despite having made huge price gains over the preceding three years. However, the earnings had been boosted to an unsustainable level as part of an property investment bubble.

Current Market Situation

The S&P500 Index (SPX) dropped below support in the 1420s last week. This is evidence that an intermediate-term peak was put in place in September, but the evidence is far from conclusive. In fact, we think the odds are in favour of two of the three senior US stock indices making new multi-year highs before an intermediate-term decline gets underway (the SPX and the Dow stand a good chance of making new highs, but the NDX has probably peaked). The reason is that sentiment has become depressed and the market is quickly becoming 'oversold' despite the SPX having only fallen by 5% from its peak.

This week's important US economic events

Gold and the Dollar

Gold

What will a major gold top look like? (Part 2)

In the 1st October Weekly Update we described three signs that will likely be seen at around the time of, or just prior to, gold's ultimate price top. First, we said that by the time the ultimate top of gold's bull market is close at hand the general public will have given up on the idea that returning to economic health requires more money-printing, more government spending and more debt. The purveyors of such economic quackery will still have their fans, but they will most definitely be in the minority. Second, we reiterated the historical fact that the most important gold peaks of the past 40 years occurred well after the monetary backdrop had turned gold-bearish. We then said that as a consequence of gold's tendency to follow major changes in the monetary situation, gold probably won't reach its ultimate top until well after the Fed stops trying to 'stimulate' the economy using cheap credit and money-pumping. Third, we cited the strong tendency observed under the current monetary system for long-term bull markets to go to absurd extremes and culminate in spectacular upside blow-offs during their final 12 months.

Not one of these three signs has been evident during the past few years. Furthermore, based on the time it would take for the above-mentioned signs to appear it is reasonable to conclude that gold's ultimate price top lies a minimum of two years into the future.

We are revisiting this topic today because our 1st October commentary omitted an important indicator of a gold top. It's an indicator we've included in many TSI commentaries over the past ten years that for some unknown reason escaped our most recent discussion of what to look for when trying to determine if gold's bull market is nearing its end. We are referring to the relationship between gold and the US stock market. The relationship is illustrated below and can be expressed as follows: Secular trends in the Dow Industrials Index relative to gold go hand-in-hand with secular trends in stock market valuation (represented on the following chart by the S&P500's price-to-peak-earnings ratio, also known as the Hussman P/E). Due to this relationship, gold probably won't be close to a major peak relative to the Dow until after the SPX's Hussman P/E makes a prolonged move to single digits. To put it more succinctly, near a major gold top the US stock market will be very under-valued.

Note that the relationship between gold and the stock market isn't just a coincidence. It stems from gold being the world's most durable, transportable and widely accepted store of value. As other investments fall out of favour (as indicated, for example, by a long-term downward trend in the US stock market's P/E ratio) there is an increase in demand for the store-of-value function that gold has provided with great success for thousands of years.



            [Chart Source: The bottom section of the chart (the SPX P/E) is from www.decisionpoint.com. The top section is our creation.]

The US stock market is not remotely close to being under-valued at this time. Therefore, the link between gold and the US stock market's valuation is sending the same signal as the other indicators of a major gold top, which is that a major gold top is probably still years away.

Current Market Situation

In the 22nd October Weekly Update we used the performance of the euro-denominated gold price (gold/euro) to arrive at a downside target of US$1685 for gold's current correction. Nothing of significance changed over the intervening week. As illustrated by the following daily chart, the US$ gold price edged a little lower, moved slightly below its 50-day moving average (the blue line) and came within about $15 of the aforementioned downside target.



Sentiment in the gold market can best be described as mixed at this time. The speculative net-long position in COMEX gold futures is still at a moderately high level, but there's no good reason to expect it to fall much further if -- as we currently believe -- we are dealing with a routine short-term correction. Market Vane's bullish percentage has pulled back from the mid-70s to the mid-60s, which is about as far as it should pull back in reaction to a normal price correction.

The bottom line is that gold still appears to be experiencing a routine short-term correction. There is no evidence in the price action that the correction is complete, but the remaining downside potential looks small.

Gold Stocks

Current Market Situation

An end to the gold sector's correction has not yet been signaled, but it's a good bet that the HUI was at or very close to its correction low when it dropped to 480 on Wednesday 24th October. At that time it was slightly below its 50-day moving average (the ideal price level for a correction low) and its daily RSI(14) was in the low-40s (at the lower end of the range it usually reaches during routine short-term corrections). However, that doesn't imply it's now 'off to the races'. If a correction low is in place, the most likely price action from here would entail about three weeks of basing prior to the start of a strong rally.



Update on the SA Strikes

One of the mines operated by Gold Fields Ltd (GFI) remains shut down due to a labour dispute. Other than that, the strikes that disrupted gold mining in South Africa over the past two months have ended, with company managements and unions having agreed on wage hikes of between 1.5% and 10.8% for different categories of workers. Anglogold estimates that the terms agreed with unions will increase its South African wage bill by 2.5%. There will also be large extraordinary costs due to lost production and the re-starting of mines that were shut down.

As a result of the strikes the South African gold stocks were relatively weak over the past two months, although it is fair to say that the market took the strike news in stride as the weakness wasn't as pronounced as it could have been.

The most puzzling reaction to South Africa's recent labour unrest was in the platinum market. Unlike the gold sector, where mining has resumed at all mines bar one, large parts of South Africa's platinum mining sector remain idle. And yet, after rallying strongly during August-September the platinum price has plunged over the past three weeks (see chart below). This plunge in the US$ platinum price wiped out more than half of the preceding gain and is difficult to understand given the importance of South African mine supply to platinum's global supply-demand equation. Platinum's recent weakness relative to gold is even more difficult to understand given the irrelevance of South African mine supply to gold's global supply-demand equation. The bottom section of the following chart shows the platinum/gold ratio.



Almost immediately after the platinum price turned higher in August we suggested buying the Physical Platinum ETF (PPLT) for a short-term trade. This worked well. Another short-term trading opportunity is brewing in the platinum market, but the risk/reward isn't quite right just yet.

Currency Market Update

We don't know why, but over the past 10 years the euro has tended to make important reversals during November-January. These November-January reversals are indicated by green arrows on the following weekly chart.



The euro could be headed for another November-January reversal, in this case a reversal from up to down. However, for this to be the case it will have to break above its September high over the weeks ahead and rise to at least 135. Price action of this nature would probably eliminate the remaining speculative net-short position in euro futures and establish a sentiment platform capable of supporting an intermediate-term euro decline and Dollar Index rally.

Our view is that while the next big multi-quarter trend in the currency market is likely to involve euro weakness and strength in the Dollar Index, on a short-term basis the stage appears to be set for euro strength and US$ weakness. Our short-term US$ outlook has therefore shifted from "neutral" to "bearish".

Update on Stock Selections

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

Company news/developments for the week ended Friday 26th October 2012:

  *Clifton Star Resources (CFO.V) reported additional drilling results. The latest batch of results was mostly from holes drilled outside the Beattie, Donchester and Central Duparquet pit shells previously outlined (the conceptual mine plan for CFO's Duparquet project comprises three pits at this stage). That is, the results were mostly from exploration holes drilled to identify new resources. There were some decent intercepts, but nothing eye-catching.

We await the Preliminary Economic Assessment (PEA) for the Duparquet project, which remains on track for completion at the end of this year. The PEA will be the first test of whether CFO has its hands on a project with strong potential to be developed into a profitable mine.

  *Elgin Mining (ELG.TO) reported drilling results from its Bjorkdal gold mine in Sweden. The drilling was done with the aim of adding underground resources and appears to have been successful. Some of the best holes and intercepts were:

Hole 2012-007, which returned 5.0 metres of 9.71 g/t Au;
Hole 2012-015, which returned 3.0 metres of 10.53 g/t Au, 2.0 metres at 7.13 g/t Au, and 4.0 metres at 4.30 g/t Au;
Hole 2012-017, which returned 3.9 metres at 8.0 g/t Au, 1.0 metre at 116.0 g/t Au, and 3.3 metres of 9.16 g/t Au;
Hole 2012-027, which returned 4.1 metres at 4.30 g/t Au, 3.0 metres at 13.99 g/t Au, and 3.9 metres at 5.42 g/t Au;
Hole 2012-031, which returned 2.0 metres at 10.32 g/t Au, and 3.0 metres at 4.27 g/t Au;
Hole 2012-033, which returned 3.0 metres at 14.46 g/t Au, 3.1 metres at 8.20 g/t Au, 2.0 metres at 8.38 g/t Au, and 2.0 metres at 10.92 g/t Au;
Hole 2012-034, which returned 3.1 metres at 4.02 g/t Au, and 2.0 metres at 9.29 g/t Au.

These results are positive, especially considering that they are from the vicinity of an operating mine.

From our perspective, the big test for ELG will be the next set of quarterly production results from Bjorkdal. The results for the previous quarter were sub-par, with production coming in lower than expected and costs coming in higher than expected (the cash cost was $1,071/oz). The next quarterly report will probably be published 3-4 weeks from now and must show a significant improvement to maintain our interest. A significant improvement is likely.

  *Evolution Mining (EVN.AX) reported its production and financial results for the September quarter. Gold production was 94K ounces, or about 5K ounces above plan. The cash operating cost was $732/oz, which was better than planned and continues the positive trend (per-ounce cash cost was $809 in the March quarter and $762 in the June quarter). The Mt Carlton project is on track for commissioning in December of this year and is expected to contribute 25K-30K ounces to the company's total production during the first half of next year.

That's the good news. The bad news is that despite the solid production performance, EVN's operations didn't generate any free cash flow during the latest quarter. Excluding the $53M invested in the Mt Carlton mine construction and the one-off $21M stamp duty charge associated with last year's merger, EVN was roughly cash-neutral during the quarter. Almost all the cash generated by its operations was ploughed back into its operations via capital investment and exploration.

This, in essence, is why gold mining stocks generally make poor long-term investments. Even the best ones (like EVN) have to invest a lot of money in their operations every year just to stand still. They don't consistently have substantial free cash flow (money left over after paying ALL expenses).

EVN hit a high of A$2.14 last week before pulling back and ending the week at A$1.90. We highlighted it as a buy in the A$1.30-A$1.50 range several times earlier this year. There is very little chance of the stock trading below A$1.50 again, but with evidence emerging that gold's correction is almost over it would now be a good candidate for new buying in the A$1.80s. The stock will probably trade at least as high as A$2.50 and has the potential to trade above A$4.00 within the next 12 months.

  *Keegan Resources (KGN) confirmed that the revised Pre-Feasibility Study (PFS) for the Esaase gold project would be completed during the first quarter of next year and advised that in support of the PFS it was conducting additional metallurgical tests. These tests are required due to the change in the mine plan.

We expect the revised PFS to show much improved economics compared to the original PFS.

  *Pretium Resources (PVG) announced that the Feasibility Study (FS) for its high-grade Brucejack gold project would be completed during the second quarter of 2013 and would be based on a mining rate of 2,700 tonnes per day. The PEA published in February of this year was based on a mining rate of 1,500 tonnes per day to yield average life-of-mine gold production of 287K ounces, so the size of the planned operation is being substantially increased for the FS. It looks like PVG is aiming for an underground mine with average annual production of around 500K ounces.

  *Rio Novo Gold (RN.TO) reported a small increase in the resource at its Almas gold project in Brazil. The project now contains a Measured and Indicated mineral resource of 839,033 Au ounces grading 0.86 Au g/t and an Inferred resource of 496,131 Au ounces grading 0.84 Au g/t. The resource has a low average grade, but it should still be possible to develop a profitable mining operation due to a low capex requirement and simple mine plan. Whether this is, in fact, the case will be established by the FS that is scheduled to be completed within the next few weeks.

RN's market cap (currently around $20M) is extremely low relative to the potential value of its assets. Our main concern at this time is that there will be substantial financing-related dilution of the stock.

  *UEX Corp. (UEX.TO) reported the results from one more hole drilled into the new Kianna East discovery at its 49%-owned Shea Creek project in Canada's Athabasca Basin. The hole intersected 7.0m grading 4.72% U3O8, Including 3.5m grading 8.12% U3O8. This is another very interesting high-grade result. Kianna East could be an important find.

  *Volta Resources (VTR.TO) reported the results from 110 holes drilled into its Kiaka gold project in Burkina Faso. These drilling results included many good intersections and will expand the existing M&I gold resources, mostly by converting Inferred resources to the M&I category. However, we are concerned that VTR is chewing up too much of its treasury in an effort to grow its in-ground gold inventory. Aggressively drilling a low-grade deposit with the aim of quickly increasing its size would be the right approach if the market were rewarding such efforts and financing were easy to come by, but it's the opposite of the right approach in the present environment.

VTR needs to take a leaf out of KGN's book and shift its focus to the development of a smaller higher-grade resource. If it doesn't it will probably end up having to do a large equity financing at a very low price per share, thus greatly reducing the company's per-share value.

Endeavour Mining (TSX: EDV, ASX: EVR). Shares: 416M issued, 451M fully diluted. Recent price: C$2.42

EDV has substantial valuation-related upside potential. The chart (see below) also suggests the potential for large gains. There is resistance at C$2.50 and at C$3.00, but after that there is no chart-related resistance until C$5.00.

Rye Patch Gold (TSXV: RPM). Shares: 146M. Recent price: C$0.445

Our interest in RPM is solely due to the high probability that it will prevail in a court case and thus obtain ownership of a valuable portion of the Rochester project formerly owned by Coeur d'Alene Mines (CDE). When we added RPM to the TSI List two weeks ago it looked like the case would go to trial before the end of this year, but RPM announced last Friday that the trial might not happen until September of next year.

The delay is due to CDE not being ready in time for the originally scheduled November-2012 trial date, which supports the idea that CDE's case is weak. It makes us even more confident that the legal battle will eventually go in RPM's favour, but RPM was supposed to be a short-term trade and there is now a good chance that the winner of the battle won't be determined until around this time next year. Consequently, unless there is a new development we will probably exit the stock if it returns to the low-C$0.50s. In the mean time, the company's other projects should limit the downside in the stock price.

Frontier Rare Earths (TSX: FRO). Recent price: C$0.58

FRO is developing the Zandkopsdrift rare earths project in South Africa. It is a member of the TSI Small Stocks Watch List, which means that it is a small stock that we aren't following closely at TSI but has speculative merit and could be of interest to some of our readers.

FRO issued important news last week. In a nutshell, it is expanding its partnership with Korea Resources (Kores). Full details can be found HERE, but the key points are: 1) Kores will be paying $23.8M for 10% of Zandkopsdrift by 30th November of this year (2 months later than originally planned); 2) Kores will have the right to increase its ownership to 50% by paying an amount determined by the project's Feasibility Study (FS); and 3) the FS is scheduled to be complete in Q4 2013.

One reason that FRO is interesting is that it will have about $55M of cash once Kores pays $23.8M for 10% of the project. This equates to about $0.61/share, which means that the market is assigning zero value to the project. Another reason that FRO is interesting is that Kores' desire to spend $23.8M for 10% of the project implies that it perceives a value of at least $238M for the entire project and a value of at least $214M for FRO's 90% stake. $214M equates to $2.38 per FRO share. FRO is therefore potentially worth at least $3/share ($2.38/share for 90% of the project plus $0.61/share of cash).

It seems that a lot of patience will be required with this one, however, as the FS (the next big market-moving event) is 12 months away.

Chart Sources

Charts appearing in today's commentary are courtesy of:

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