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   -- Weekly Market Update for the Week Commencing 30th March 2009

Big Picture View

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

In nominal dollar terms, the BULL market in US Treasury Bonds that began in the early 1980s will end by mid-2010. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

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

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

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

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

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Outlook Summary

Market
Short-Term
(0-3 month)
Intermediate-Term
(3-12 month)
Long-Term
(1-5 Year)
Gold
Neutral
(17-Dec-08)
Bullish
(12-May-08)
Bullish

US$ (Dollar Index)
Neutral
(23-Mar-09)
Neutral
(16-Feb-09)
Neutral
(19-Sep-07)

Bonds (US T-Bond)
Neutral
(18-Mar-09)
Bearish
(22-Sep-08)
Bearish
Stock Market (S&P500)
Bullish
(11-Mar-09)
Neutral
(02-Feb-09)
Bearish

Gold Stocks (HUI)
Bullish
(12-Jan-09)
Bullish
(12-May-08)
Bullish

OilBullish
(17-Nov-08)
Neutral
(22-Sep-08)
Bullish

Industrial Metals (GYX)
Bullish
(26-Nov-08)
Neutral
(22-Sep-08)
Bullish


Notes:

1. In those cases where we have been able to identify the commentary in which the most recent outlook change occurred we've put the date of the commentary below the current outlook.


2. "Neutral", in the above table, means that we either don't have a firm opinion or that we think risk and reward are roughly in balance with respect to the timeframe in question.

3. Long-term views are determined almost completely by fundamentals, intermediate-term views by giving an approximately equal weighting to fundmental and technical factors, and short-term views almost completely by technicals.

The Relevance of the Fed

John Hussman wrote an article in August of 2001 titled "Why the Fed is Irrelevant". Commenting on this article in the 16th August 2006 Interim Update, we wrote:

"...Dr Hussman argues, quite correctly in our opinion, that the Fed generally has very little direct control over monthly or even yearly changes in the money supply because:

a) The quantity of bank reserves -- something over which the Fed does have considerable influence -- no longer determines the amount of lending carried out by commercial banks (the "money multiplier" taught in basic economics courses no longer exists in any meaningful way)

b) These days, a lot of money is created outside the banking system

c) The Fed tends to follow market-controlled interest rates rather than lead them"

However, we went on to say:

"...there's a bigger picture that will be missed by someone who draws conclusions about the Fed's relevance based solely on what the Fed does during its day-to-day operations. It's not, for example, a coincidence that during the 100 years prior to the creation of the Fed the US$ didn't lose any purchasing power and that during the 93 years since the creation of the Fed the US$ has lost more than 95% of its purchasing power. There's a cause/effect relationship at work here.

The important point missed by Dr Hussman is that it's the existence of the Fed that gives the government the ability to issue huge (unlimited, actually) amounts of debt. With the Fed in place the US Congress could vote to issue 10 trillion dollars of new debt tomorrow and if there were no other buyers of this debt then the Fed would buy it all with newly created dollars. If not for the Federal Reserve the US Federal Government would be a relatively small institution that never went far into debt."

We remembered the "Why the Fed is Irrelevant" article when reading Dr Hussman's 23rd March 2008 commentary. In this recent missive Dr Hussman rails against the latest plans of the Fed-Treasury combo on the basis that these plans will crater the US$, allow foreigners to purchase US assets at artificially low prices, and mortgage the future of the US economy; all for the sake of preventing the bondholders of US financial corporations from taking losses. Perhaps he now understands why the Fed is not irrelevant.

On a related matter, some analysts have emphasised that today's monetary system is credit based. Their point, as we understand it, is that the private banks create credit and then, some time later, the Fed boosts the monetary base to reflect the additional credit. That is, in the realm of credit/money creation the Fed follows, rather than leads, the private banking industry, the implication being that if the private banks don't lend then deflation must occur.

These analysts are effectively making the same point that Dr Hussman made in his August-2001 article, and it is a point that we agree with to a certain extent. Again, however, we think the bigger picture is being missed. For one thing, the banks only behave in this way (make new loans without regard to their current reserves) because they know that the Fed will always be around to top-up their reserves as needed. In other words, even though the Fed usually doesn't provide the initial monetary impetus to the credit expansion, it is the Fed's existence that makes the unrestrained expansion of credit possible. For another thing, when push comes to shove, as it has over the past seven months, the Fed has shown itself to be quite capable of taking the lead in the money-creation process. In fact, arguing at this time that the Fed can't keep the supply of money and credit expanding in the face of reduced lending on the part of the private banking industry is akin to arguing that it can't rain whilst standing in the middle of a rainstorm. It is happening right now and it has been happening since last September.

The Stock Market

The following decisionpoint.com chart shows the NASDAQ Composite Index and the NASDAQ's McClellan Oscillator (MO). The NASDAQ's MO reached its highest level in more than 20 years last Thursday.

The 20-year high in the MO indicated that the market was very overbought on a short-term basis following Thursday's advance. Furthermore, it was overbought at the same time as the NASDAQ was nearing important resistance at around 1600. Not surprisingly, then, the market pulled back on Friday.


While the market is overbought on a short-term basis, it is not overbought beyond that. The following weekly chart, for example, shows that the SPX was at a multi-year low only three weeks ago. The chart also shows the positive divergence between the SPX and the SPX's weekly MACD indicator that developed between November and March (the MACD remained in an upward trend while the SPX collapsed to new lows).


It would only take one or two more days like last Friday to completely relieve the market's overbought condition. Alternatively, the market could relieve its overbought condition by trading sideways for a week or so.

In last week's Interim Update we said that price action and 150 years of stock market history point to additional gains over the weeks and months ahead. The price action we were referring to includes the strong market breadth over the past three weeks, the almost total evaporation of new lows for individual stocks, positive momentum divergences such as the one mentioned above for the NASDAQ, and the fact that a number of important stock indices, including the NASDAQ100, held above their November-2008 lows earlier this month. With regard to the "150 years of stock market history", we were referring to the fact that massive declines such as occurred last year have always, in the past, been followed by either a new bull market (very unlikely in this case) or a strong counter-trend rebound lasting at least 6 months. The November-January rebound was neither long enough nor strong enough to qualify, which means that unless it's different this time then the bulk of the obligatory multi-month rebound lies ahead.

This week's important US economic events

Date Description
Monday Mar 30
No important events scheduled
Tuesday Mar 31
Case Schiller Home Price Index
Chicago PMI
Consumer Confidence
Wednesday Apr 01 ISM Manufacturing Index
Construction Spending
Thursday Apr 02 Factory Orders
Friday Apr 03 Monthly Employment Report
ISM Non-Manufacturing Index

Gold and the Dollar

Gold

In our opinion, gold's ability to remain above an upward-sloping trend line is a reason (perhaps the main reason) that the metal's pullback from its late-February peak has not yet caused a meaningful reduction in bullish enthusiasm. It looked like this trend line was going to be breached on Wednesday 18th March, but then the Fed made an announcement that prompted fear of US$ inflation and made sure the breach didn't occur at that time.

As evidenced by the following daily chart of the April futures contract, at the end of last week the gold market was poised at its 50-day moving average and was, again, threatening to break below its upward-sloping trend line. Further weakness from here would take gold below its trend-line and set up another test of the more important lateral support that lies at around $890 (also shown on the following chart). Due to the high level of optimism that currently exists, a break below $890 would probably set off a wave of selling that would ultimately take the gold price back to the low-$800s.


The following chart shows that gold is also at a critical level in euro terms. When gold/euro is in an intermediate-term upward trend it tends to find support near its 50-day moving average, with the first decisive break below this moving average signaling the start of a lengthy consolidation. Gold/euro was just below its 50-day moving average at the close of trading last Friday, so any significant additional weakness from here would strongly suggest that a multi-month peak was put in place last month.


The point we are trying to make is that the gold market is delicately balanced. It needs to resume its upward trend almost immediately to avoid signaling a larger-degree correction.

As an aside, don't believe the propaganda about the so-called shortage of physical gold. No such shortage exists. From time to time there will be a shortage of gold in one form or another due to mints under-estimating the demand for certain products, but there is currently no general shortage of physical gold and it's extremely unlikely that such a shortage will arise anytime soon (if ever). A lot more physical gold changes hands via the London Bullion Market Association (LBMA) in an average week than is mined by the gold-mining industry or consumed by the jewellery industry in an entire year, so changes in mine supply or jewellery demand will never be important drivers of the gold price. Also, a significant contango currently exists across the entire gold futures spectrum, which suggests adequate supply.

Gold Stocks

Current Market Situation

The HUI hit a new 5-month high on Thursday and then pulled back on Friday. We have no opinion as to whether the pullback will continue over the coming week or immediately give way to an advance to new multi-month highs. What we can say is that if the pullback continues then the HUI should find support at, or above, 300. As illustrated by the following chart, the 50-day and 200-day moving averages are about to come together at around 300. These moving averages should limit the downside during any correction provided that the gold price remains above support at $890.


There are never any guarantees with regard to short-term outcomes in the financial world, but all of the previous intermediate-term upward trends during the course of the gold sector's long-term bull market have concluded with multi-week rallies that took the HUI well above the highs of the preceding few months. In other words, if history is any guide then last week's move to a marginal new multi-month high should not be "all she wrote".

Compounding errors by learning the wrong lessons

It is obviously important to learn from mistakes, but it is equally important not to learn the wrong lessons. It seems to us that investors often learn the wrong lessons and therefore compound their errors. We are referring, in particular, to the tendency for investors to automatically do in the present what they should have done, or wish they had done, over the preceding 1-2 years. Based on emails we have received and on what we have observed, the investing community's collective appraisal of the merits of owning gold-mining shares exemplifies this tendency.

By way of further explanation, we get the impression that by October-November of last year many investors had come to the conclusion that large-cap gold mining shares represented the second worst investment idea ever, with the worst being small-cap gold mining shares. This was not just because these shares had tanked along with the broad stock market; it was also because they had tanked to a similar extent as non-gold commodity stocks even while the price of gold bullion was a) holding up well in US$ terms, b) rallying in terms of most other currencies, and c) rocketing upward relative to almost all other commodities. However, at the very time when many investors were swearing never to buy another gold mining stock and never to go anywhere near another junior gold mining stock, a phenomenal buying opportunity was staring them in the face. This buying opportunity was created by the simple fact that gold mining stocks were pummeled even while the economics of the gold mining business were improving in leaps and bounds.

Whether you were fortunate/smart enough to have stayed away from all stocks during July-November of last year or were amongst the vast majority of stock market investors that suffered large losses, the wrong lesson to have learned was to steer clear of gold mining stocks. Since the October-2008 bottom the AMEX Gold Mining Index (HUI) is up by around 125% in nominal terms and 75% relative to gold bullion. Moreover, this is very likely just the beginning. Over the coming two years the senior gold stocks are likely to make large additional gains in nominal dollar terms and significant additional gains in gold terms, while the juniors, as a group, are likely to do much better than the seniors. As a result, we think that two years from now the average investor will have learned a very different lesson.

Regardless of how optimistic we are about the prospects of any investment we will never express unbounded enthusiasm at TSI. There are two reasons for this: First, there will always be a chance that we are wrong. For example, we thought that gold's relative strength during August-October of last year would support the gold mining sector, but we were very wrong about that. Second, we don't want to encourage people to take-on more risk than they should based on their own financial situations and expertise. Therefore, when the gold sector was bottoming between late October and late November of last year we didn't say things like "this is one of the greatest buying opportunities the world has ever seen" and "you are guaranteed to make a fortune if you load up on junior gold shares at current prices". Here's what we did say:

a) In the 20th October 2008 Weekly Update we wrote: "The gold sector is now at its most oversold extreme ever..." and "... this month's low will probably be the major variety (the type that sets the stage for a multi-year bull market)...".

b) In the 22nd October 2008 Interim Update we wrote: "...the longer-term outlook for gold and gold stocks is an order of magnitude more bullish today than it was in October of 1987" and "...the sharp rebound that follows the 2008 crash should prove to be the first leg of a new cyclical bull market".

c) In the email alert sent on 21st November 2008 we wrote: "Perhaps there will be 1-2 more days of pain before the gold sector begins to rally, but whether it begins today (Friday) or early next week we suspect that the coming rally will be explosive".

d) In the 24th November 2008 Weekly Update we wrote: "The similarities with the early 1930s potentially pave the way for a more consistent upward trend in the gold sector over the next two years than was seen during the two-year periods following the corrections of the late-1960s and mid-1970s. In any case, regardless of whether we are talking 1930s or 1970s we should now be in the early part of a new multi-year upward trend in the gold sector".

e) In the 26th November 2008 Interim Update we wrote: "...we not only view the break above 225 as confirmation that a short-term bottom was put in place last month; we view it as confirmation that a new 4-5 year bull market has begun. As mentioned earlier in today's report and in previous commentaries, the gold sector's fundamentals were improving over the past few months even while stock prices were getting hammered in response to the global de-leveraging. This suggests that the gold sector has a lot of catching up to do over the months ahead."

The above excerpts are not presented to show that we were right (it's way too early to tell if we were right to anticipate a new multi-year bull market); they are presented to show that being too bullish about the gold sector during the three months leading up to the 24th October bottom didn't cause us to lose our objectivity and to compound our error by failing to identify a great buying opportunity.

The lesson that should have been learned from last year's drama doesn't revolve around the merits of any particular group of stocks; it revolves around money/risk management. First, every investor should embrace the reality that once in a while he/she will be completely wrong about something, and, consequently, never put himself/herself in the position where being wrong will create a big financial problem. One aspect of this is to never be 'margined to the hilt' if you are a full-time professional investor and to never be margined at all if you are a part-time investor. Second, an investor should always be in the position where he/she can take advantage of an unexpected opportunity such as the one presented by the gold sector last October-November. This involves maintaining a sizeable cash reserve at all times.

Currency Market Update

Referring to the following daily chart of the June Swiss Franc futures, notice that there was a big down-day just over two weeks ago that was followed, about a week later, by a big up-day. The down day was the market's reaction to news that the Swiss National Bank was going to inflate like crazy whereas the up day was the market's reaction to news that the Fed was going to inflate like crazy. This truly is a race to the bottom.


Most analysts use the Baltic Dry Index (BDI) as an indicator of global trade, but we use it primarily as a currency market indicator due to its tendency to bottom at around the time the Dollar Index peaks and peak at around the time the Dollar Index bottoms.

The following chart shows that the BDI has had an upward bias since last November. This upward bias has coincided with a correction in the Dollar Index (the Dollar Index reached a multi-year high last November).

If the BDI can take out its recent peak it would be evidence that the correction in the Dollar Index has not yet run its course.


Update on Stock Selections

(Note: 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)

Chesapeake Gold (TSXV: CKG). Shares: 38M issued, 43.5M fully diluted. Recent price: C$5.65

In last week's Interim Update we wrote: "It regularly happens that an under-valued junior with seemingly excellent prospects lies dormant for a long time, and then suddenly, for no apparent reason, springs to life." CKG's recent performance exemplifies what we were talking about.

The following chart shows that CKG traded as low as C$2.40 in January, traded at C$3.00 early this month, and then suddenly sprang to life. It closed at C$5.65 on Friday, up 13% on a day when most gold stocks fell by a few percent.

There was no company-specific news over the past month, so CKG's sudden up-move was not news-related. The price run-up could be in anticipation of news, the reason being that a NI-43-101 resource estimate for the company's flagship project (the Metates gold project in Mexico) is likely to be reported within the next few weeks, or it could be related to something else. We have no way of knowing. What we do know is that the Metates project probably has 10M-20M ounces of gold and that if this deposit is economic then CKG is extremely under-valued even after its recent surge.

It may or may not be prudent for CKG shareholders to take some money off the table in response to the recent price gains. It all comes down to money management. On the one hand and as noted above, the stock is probably very under-valued at its current price and market-moving news is likely within the next few weeks. On the other hand, someone who already had a sizeable position in CKG when the stock was trading in the C$2.40-C$3.00 range during the first two months of this year may now find himself/herself with an excessively large position. In this case it may be appropriate to do some selling for money-management reasons.

Another consideration is that the stock has resistance at around C$6.00, although this resistance won't present much of an obstacle if the upcoming resource estimate is positive.


CKG's recent surge was caused by a fairly small increase in demand for the stock. Just imagine, then, what junior gold stocks such as CKG will do once the general public becomes an enthusiastic buyer.

    Australian Gold Stocks

Here are quick updates on our three Australia-listed gold stock selections:

1. Dominion Mining (ASX: DOM). Recent price: A$5.48

DOM has a low-risk/high-margin gold mine in South Australia and a strong balance sheet, but at this time it doesn't have significant in-house growth potential and is close to being fully valued. It will probably make additional gains if the overall sector continues to trend upward, but we don't see a good reason for it to outperform over the months ahead. We are therefore going to remove DOM from the TSI List and record a profit of 96% based on our July-2008 entry at $2.87 (the profit calculation includes an 8c dividend).

2. Resolute Mining (ASX: RSG). Recent price: A$0.83

RSG traded below A$0.40 for a while in January, but is now 'on the mend'. The stock was crushed due to a large and very poorly managed capital raising -- a capital raising that got underway during the final quarter of last year and ended up being priced at such a low level that it destroyed a huge amount of shareholder value. The only way that shareholders could have protected themselves from the effects of the massive stock dilution was to 'double down' by participating in the capital raising or by purchasing shares on market once a lengthy trading suspension had ended.

Despite the value destroyed by poor management of the Q4-2008 capital raising, a lot of value still remains in the shares assuming that the company's management is better at building/operating mines than at corporate financing. Based on past performance this certainly seems to be the case.

Apart from the price of gold, the key to the stock's future performance is the company's nearly-complete 250K-oz/yr Syama gold mine in Mali. The Syama project is now in the final commissioning phase and if it can operate at close to its design criteria then RSG's group of projects should be able to produce about 400K ounces this calendar year and 500K ounces in 2010 at a cost that results in substantial cash flow. Assuming a gold price near the current level, this, in turn, should enable the stock to move back to around A$2.00. By the same token, the main risk is that Syama falls well short of its design criteria.

Due to the above-mentioned risk we do not view RSG as an ideal candidate for new buying at the current price, but new buying would be appropriate following a pullback to A$0.70-A$0.75. Also, investors who bought a lot of RSG shares near the recent lows in the A$0.35-A$0.50 range, either by participating in the capital raising or by making on-market purchases, should consider making a PARTIAL exit if the stock trades up to around A$1.00 within the next few weeks.

3. Lion Selection (ASX: LST). Recent price: A$0.92

We think the market is greatly under-estimating the value of LST's assets, especially the value of the company's recently-acquired 51% stake in the development-stage Edna May gold project. In our opinion, LST is a buy below A$1.00 and a strong buy below A$0.90.

Chart Sources

Charts appearing in today's commentary are courtesy of:

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



 
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