Big Picture View

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

In nominal dollar terms, the BULL market in US Treasury Bonds that began in the early 1980s ended in 2012. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2018-2020. (Last update: 20 January 2014)

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

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

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

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

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Outlook Summary

Temporary change to TSI format

We will be travelling over the next two weeks and will therefore be unable to post the usual TSI reports. We will, however, keep subscribers updated regarding our thoughts on the financial markets by posting comments in a "blog" format at http://www.speculative-investor.com/new/weekly060714.asp. This page will probably be updated every 3-4 days, although the actual frequency of updates will depend on market action and whether we have anything meaningful to say. We will notify subscribers by email whenever new comments are posted.

Note that the above-linked page currently doesn't exist. It will be uploaded to the web site with our first set of comments.

The next regular commentary will be the Weekly Market Update on 13th July. 

What are China and the US doing?

Reserves Confusion

One of the reasons that some commentators on the monetary system make statements that are plainly wrong is their belief that bank reserves deposited at the Fed are essentially the same as money deposited in accounts within the economy. They aren't. Reserves held at the Fed are not money that can be withdrawn and spent. That's why bank reserves are not counted in the money supply. Instead, reserves 'back' the money that exists in bank accounts within the economy. Part of the confusion undoubtedly stems from the fact that dollars are backing dollars, but that's the way today's monetary system works.

As at the end of May-2014, the US money supply was about $10.1T and US depository institutions had about $2.6T of reserves. This means that about 26%* of the dollars in the US economy were, at that time, backed by reserves. Although each reserve dollar is not linked to a specific dollar in the economy, it could be helpful to think of it that way if you are having trouble getting your head around the idea that reserves cannot be used like ordinary money. In other words, think in terms of each reserve dollar being attached to a dollar within the economy.

Due to the fact that banks can neither lend their reserves into the economy (reserves can only be loaned from one reserve account to another) nor withdraw and spend their reserves, the Fed's QE wouldn't have any effect on the dollar's purchasing power if it only resulted in additions to bank reserves. In this case, the S&P500 Index would almost certainly be a lot lower. Alternatively, if the Fed's QE injected money into the economy (via additions to the bank accounts of Primary Dealers) without adding an equivalent amount to bank reserves, that is, if the Fed added 'unbacked' money to the economy, then each purchase of assets by the Fed would boost the liabilities of commercial banks (bank deposits are liabilities of the banks) and therefore weaken the balance sheets of commercial banks. That's why for every dollar of assets purchased by the Fed under its QE programs, one dollar gets added to demand deposits within the economy (that is, to the money supply) and one dollar gets added to bank reserves. In this way, the Fed boosts prices within the economy without increasing the leverage of the commercial banking system.

As an aside, we get the impression that the Bank of Japan's QE adds to reserves, but not the money supply. That is, the mechanics of the BOJ's QE appear to differ from the mechanics of the Fed's QE. This would explain why the Yen supply continues to grow at a relatively slow pace despite the BOJ's huge QE program.

    *This is an unusually high percentage by the standards of the past few decades. Six years ago, only about 1% of the US money supply was backed by reserves.

The Stock Market

Contemplating the probability of a US stock market crash

Crashes are always low-probability events and we are not forecasting a crash for the US stock market. However, the combination of sentiment, valuation and the fact that the market has made it to the middle of the year without experiencing a significant correction has created the potential for a 1987-style US stock market crash during August-October.

To illustrate the similarities between the sentiment backdrops of 2014 and 1987 we present the following long-term chart of the S&P500 Index and the Investors Intelligence (II) bull/bear ratio. This chart shows that the bull/bear ratio extreme reached at the end of last year was the highest level for this ratio since early-1987. It also shows that the 1987 ratio extreme preceded the crash by about 8 months and that a lower bull/bear high was made just prior to the start of the 2-month crash pattern.



Next, we present a daily chart showing the S&P500's performance from the beginning of 1986 through to the end of 1987. Notice that the final short-term advance in 1987 lasted three months.



Lastly, we present a daily chart showing the S&P500's performance over the past two years. The S&P500's current short-term advance began on 14th April, so a duplication of the final phase of the rally that culminated in the 1987 stock market crash would result in a mid-July peak this year.



A comparison of the above two charts shows significant differences between the 1-2 years leading up to the 1987 crash and the past 1-2 years. In particular, the SPX traded sideways through most of 1986 and then experienced an upside blow-off during the first 8 months of 1987, whereas the SPX's performance since the beginning of 2013 can best be described as a consistent upward trend. This difference neither reduces nor increases the probability of a crash this year.

The main argument against a large stock market decline (a crash or a cyclical bear market) at this time is the monetary backdrop. Last year, US monetary inflation was almost 100% dependent upon the Fed, in that the commercial banking system created almost no new money. If last year's banking trends had extended into this year, then as a result of the Fed's "tapering" the US monetary inflation rate would now be at a level that would likely bring on the next financial-market crisis, but this didn't happen. Instead, the US monetary inflation rate actually increased slightly during the first half of this year due to the Fed's reduced rate of money pumping being more than offset by a faster pace of commercial-bank credit creation (rather than lending existing money, commercial banks usually add new money to demand deposits when they make loans).

Easy monetary conditions will never prevent an overbought/over-bullish/over-valued stock market from suffering a 15%-20% intermediate-term correction, but if they persist they will substantially reduce the risk of a far more serious decline.

Current Market Situation

It has now been about 10 weeks since the S&P500 Index last had a daily move of at least 1%. Such a long period of small daily price swings creates the impression that there will be minimal volatility for the foreseeable future, which is why S&P500 option premiums -- as indicated by the VIX -- are very low.

Volatility is likely to soon pick up.

In last week's Interim Update we noted that the CRX/SPX ratio (the Commodity-Related Equity Index relative to the S&P500 Index) had done enough to signal a reversal of its multi-year trend (from down to up). This suggests that commodity-related equities are beginning to outperform. However, it subsequently occurred to us that the recent outperformance of the CRX could mostly be due to the oil sector and that most non-oil commodity stocks were yet to show much strength relative to the broad market.

The commodity-related stocks represented by the Diversified Metals and Mining Index (SPTMN) are examples. As illustrated by the following daily chart, SPTMN has trended upward in nominal dollar terms over the past 12 months, but hasn't yet turned higher relative to the broad market. To be more specific, the bottom section of the chart shows that while the SPTMN/SPX ratio stopped trending downward in mid-2013, it hasn't yet begun to trend upward. A definitive upward reversal in the mining sector's relative strength is still to come.

This week's important US economic events

Gold and the Dollar

Gold

Long-time TSI reader SP drew our attention to the fact that in addition to other resistance near $1320, gold has resistance near this price in the form of the 310-day MA. The 310-day MA is roughly the same as the 65-week MA, which is shown on the following weekly price chart. It is presently at $1319. Notice that the 65-week MA regularly limited declines during the cyclical bull market and coincided with the short-term top in March of this year.

A solid weekly close above this MA would therefore be significant.



Since moving sharply higher, breaking out to the upside and becoming short-term 'overbought' on Thursday 18th June, gold has drifted sideways. This leaves us without an opinion on what the price will do over the coming fortnight. A 1-2 week pullback to the $1280s would not be surprising, but neither would a quick move up to $1350.

Looking out a bit further, price action, intermediate-term sentiment indicators, comparisons with previous recoveries from cyclical bear markets and fundamentals (the fundamentals that matter, not the ones that most gold-market commentators focus on) all point to $1400 being challenged within the next three months.



Silver

On a short-term basis, silver and the silver/gold ratio are very 'overbought'. This is indicated by the unusually high current level of the daily RSI shown at the bottom of each of the following charts. This doesn't preclude sharp additional gains in the near future, with a surge to as high as $23 being possible, but it does mean that silver's risk/reward is no longer skewed towards reward as far as the next few weeks are concerned.

In a similar vein to gold, however, the recent upside breakout combined with intermediate-term sentiment indicators and comparisons with previous recoveries from cyclical bear markets points to materially higher prices within the next three months. Our view is that silver will trade at least as high as $23 by September and will probably challenge major resistance at $25-$26 before year-end.

Gold Stocks

Current Market Situation

We suspect that the gold-mining sector is immersed in a 2-3 week consolidation that will continue until the HUI's daily RSI (refer to the bottom section of the following chart) drops to around 50. That's the message being sent by the downward reversal in the GDXJ/GDX ratio that occurred during the week before last. However, due to the fact that the HUI itself hasn't yet signaled an interim top, there is a realistic chance of the HUI moving quickly up to around 250 before embarking on a multi-week correction.

What would surprise us is a move to well beyond the 225-250 range over the next couple of weeks.



At the start of this year our 2014 upside target for the HUI was 300. Based on the historical record we thought that this target would be reached by the middle of the year, after which there would be many months of essentially trendless trading. 300 is still our 2014 upside target for the HUI, but it is obviously going to take longer than expected to get there. Our best guess is that it will happen by the end of September.

Gold stocks are influenced more by the expected future price of gold than the current price of gold. That's why the gold-stock indices don't automatically follow the daily moves in the bullion market. Currently, there isn't much optimism about gold's prospects. Most people, including most of the analysts at banks and brokerages, have low expectations and probably won't believe that there was a major turning point in the gold market late last year until after the gold price breaks decisively above $1400. Although it will only take an 8% increase to get the gold price back to $1400, due to the change in expectations that such an event would prompt it's likely that by the time gold achieves a weekly close above $1400 the TSI gold stocks will, on average, be trading at least 50% above their current levels.

Basing Patterns

As is the case with the HUI and GDXJ, basing patterns of 12 months or longer are clearly evident in the charts of many individual gold stocks. A bunch of examples is presented below. As always there are no guarantees, but it doesn't get any better than this.

Example 1: Almaden Minerals (AAU)

The top of AAU's basing pattern appears to be near US$1.70. The stock will encounter resistance near US$2.00, but US$2.50-$2.60 will be the chart-based target following a break above the top of the base.



Example 2: Agnico Eagle (AEM)

AEM has been a relatively strong gold stock since last October and has already broken upward from its basing pattern. The TSI Stocks List has exposure to AEM via long-dated (January-2015) call options that will be exited if -- as is likely -- the stock moves up to the low-$40s within the coming three months.



Example 3: Asanko Gold (AKG)

AKG recently broke out to the upside from a long-term channel, but the top of its basing pattern lies at US$2.50. US$3.25-$3.50 will be the target following a breakout.



Example 4: Dalradian Resources (DNA.TO)

DNA has already broken upward from its basing pattern. The TSI Stocks List has exposure to DNA via February-2015 C$0.90 warrants, which, unless advised otherwise, will be exited if they trade at C$0.50. For the warrants to trade at C$0.50, the stock will probably have to move up to at least C$1.35. We expect that this will happen within the next three months.



Example 5: Endeavour Mining (EDV.TO)

The top of EDV's basing pattern lies at C$0.90-C$1.00. An upside breakout would suggest a target of C$1.60-$1.80.



Example 6: Evolution Mining (EVN.AX)

EVN is in the process of completing a base that encompasses a double bottom. A break above the top of the base (A$1.00) would suggest a target of A$1.50.



Example 7: Golden Star Resources (GSS)

The top of GSS's base is at US$0.80-$0.90. The base appears to have encompassed a rare triple bottom.



Example 8: Lydian International (LYD.TO)

It looks like LYD is close to completing a major base, with the top of the base at C$1.40. Although the chart looks bullish, a revised FS is due shortly and we would hold off on new buying until after the results of the FS are assessed.



Example 9: Orezone Gold (ORE.TO)

ORE has already broken upward from its basing pattern. C$1.00-C$1.20 is the initial target suggested by this breakout.



Example 10: Premier Gold (PG.TO)

PG tested the top of its 16-month basing pattern last week. It is short-term 'overbought' and could pull back as far as its 50-day MA, but an upside breakout from its base is likely within the coming three months. Such a breakout would suggest that the stock was on its way to C$4.00-$4.50.



Example 11: Rio Alto Mining (RIOM)

Fortunately, the stock market is less concerned than we are about the high price being paid by RIOM for Sulliden's Shahuindo project. RIOM tested the top of its basing pattern last week and will probably break out to the upside within the next couple of months.



Example 12: Sabina Gold and Silver (SBB.TO)

SBB appears to have made a double bottom as part of a major basing pattern. The top of the base lies at C$1.00, although there is also important channel resistance at around C$0.90. An upside breakout from the base would suggest that the stock was on its way to C$1.50.



Example 13: Timmins Gold (TGD)

TGD came within a few cents of hitting our suggested buy price in late-May, but then suddenly reversed course and almost managed to break upward from its basing pattern. The top of the base lies at around US$1.75. A breakout would suggest a target of US$2.50.



The Currency Market

The euro has managed to work off its short-term 'oversold' condition by making only a small net gain from its early-June low. It has been unable to make enough progress to get back above its 200-day MA, which means that the recent small advance currently looks more like a counter-trend rebound than the start of a rally to new highs for the year.

The following daily chart suggests that the euro has short-term downside risk to its channel bottom. This means that if the rebound of the past few weeks proves to be the counter-trend variety, it could be followed by a decline to as low as 132.

However, the sentiment backdrop encourages us to maintain our short-term euro-bullish/US$-bearish outlook. The speculative net-short position in euro futures dropped a little last week, but it remains close to its highest level since May of 2013. The substantial net-short position in euro futures means that if the euro breaks below its lows of the past few months, there probably won't be much follow-through to the downside. It also means that there is ample short-covering fuel to power a rally to new highs for the year.

Updates on Stock Selections

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

Company news/developments for the week ended Friday 27th June 2014:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, IRR = Internal Rate of Return, MD&A = Management Discussion and Analysis, M&I = Measured and Indicated, NAV = Net Asset Value, NPV(X%) = Net Present Value using a discount rate of X%, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Endeavour Mining (EDV.TO, EVR.AX) reported that production has commenced at the Segala underground mine in Mali. The Segala mine will provide relatively high-grade feed for the Tabakoto mill and should help to lower overall production costs for the Tabakoto operation.

EDV also reported that it has received mining permits covering all eight of the known deposits on the Kofi property. These deposits have about 1M ounces of currently-defined gold resources and will provide feed for the Tabakoto mill beginning in 2015.

EDV's stock-market performance has recently been sluggish, but operationally it continues to perform well.

  *Premier Gold (PG.TO) issued a technical press release about pit wall slopes and inter-ramp slope angles for the proposed open pit mine at its Hardrock project in Ontario. In our opinion these design details did not warrant a press release.

  *Ramelius Resources (RMS.AX) announced a rights issue that creates a good money-making opportunity for current RMS shareholders or the buyers of RMS shares prior to 4th July (the date that the shares trade "ex" the rights entitlement), especially considering the evidence that the gold sector's intermediate-term advance has resumed. Unfortunately, it is only an opportunity that applies to shareholders with registered addresses in Australia or NZ. According to RMS's 24th June announcement, this is because the company has decided that "it is unreasonable to make the Offer to shareholders who have a registered address in a country outside of Australia or New Zealand having regard to the number of shareholders in such places, the number and value of the new shares that would be offered and the substantial costs of complying with the legal and regulatory requirements in those jurisdictions."

The Rights Issue will enable eligible shareholders to buy new shares at A$0.065/share (well below the current market price) on the basis of 1 new share for every 4 existing shares. Also, subscribers to the Rights Issue will receive 1 free option, exercisable at A$0.12 on or before 1 August 2015, for every 2 new shares subscribed for. The free options, which should trade on the stock market following completion of the Rights Issue, constitute a significant additional 'kicker'.

Unless there is an unforeseen fundamental change over the next three weeks it will make sense for eligible RMS shareholders to subscribe for their full entitlement to the new shares and perhaps even to apply for additional shares under the Offer. The current schedule is for the Offer documents to be dispatched to shareholders on 11th July and for the Offer to close on 25th July.

For TSI record purposes we will assume that the rights are exercised, with new shares purchased on a 1-4 basis at A$0.065/share.

  *True Gold (TGM.V) advised that it has awarded the engineering, procurement and construction management (EPCM) contract for the Karma gold mine (Burkina Faso) to SENET, a South African engineering firm. SENET is well regarded and is very familiar with the Karma project due to its involvement in the FS.

TGM plans to be in production by the end of next year. We suspect that it will be taken over well before it goes into production, although a takeover is more likely to happen next year than this year.

List of candidates for new buying

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

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

2) EDV.TO (last Friday's closing price: C$0.75).

3) EVN.AX (last Friday's closing price: A$0.71).

4) TGM.V in the low-C$0.40s (last Friday's closing price: C$0.43).

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html