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   -- Weekly Market Update for the Week Commencing 30th July 2012

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

Market
Short-Term
(1-3 month)
Intermediate-Term
(6-12 month)
Long-Term
(2-5 Year)
Gold Bullish
(26-Mar-12)
Bullish
(26-Mar-12)
Bullish

US$ (Dollar Index) Neutral
(28-May-12)
Neutral
(09-Jan-12)
Neutral
(19-Sep-07)

Bonds (US T-Bond) Bearish
(02-Jul-12)
Neutral
(18-Jan-12)
Bearish
Stock Market (DJW) Bearish
(30-Jul-12)
Bearish
(28-Nov-11)
Bearish

Gold Stocks (HUI) Bullish
(26-Mar-12)
Bullish
(23-Jun-10)
Bullish

OilNeutral
(30-Jul-12)
Neutral
(31-Jan-11)
Bullish

Industrial Metals (GYX) Neutral
(30-Jul-12)
Neutral
(29-Aug-11)
Neutral
(11-Jan-10)


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 fundamental and technical factors, and short-term views almost completely by technicals.

TSI Schedule Reminder

As advised in last week's Interim Update, our travel schedule has resulted in this Weekly Update being abbreviated (less text, no charts) and the omission of the coming week's Interim Update. The next full TSI commentary will be the Weekly Update on Sunday 5th August. 

More inflation on the way

"More inflation on the way" is how the financial markets interpreted the jawboning of the euro-zone's monetary and political leadership late last week.

On Thursday, the ECB President got the ball rolling:

""To the extent that the size of the these sovereign premia hamper the functioning of the monetary policy transmission channel, they come within our mandate…Within our mandate, the ECB is ready to do whatever it takes to preserve the euro…and believe me, it will be enough," said ECB Pres Mario Draghi at around 6am at a UK investor conference. On the heels of Nowotny's comments yesterday that he's open to discussing giving the ESM a bank license, we're seeing another instance of central bankers trying to save the day with the threat of their printing machine. Whenever Draghi talks about 'policy transmission' being hampered, it's his Morse code for restarting their bond buying program."
    - From http://www.ritholtz.com/blog/2012/07/draghi-swings-hammer-of-printing-press/

Then on Friday a spokesman for the German government added to the excitement:

"Germany said on Friday it stood ready, just like the European Central Bank, to do all in its power to ensure the survival of the euro but it reiterated its opposition to granting a banking license to the euro zone's bailout funds. "The president of the ECB said the ECB will do all that is necessary to maintain the euro and the German government will do all that is politically required to maintain the euro," government spokesman Georg Streiter told a news briefing. "The ECB makes its contribution and the German government makes its contribution," Streiter added."
    - From http://finance.yahoo.com/news/germany-says-euro-just-ecb-102409223.html

In reaction to these words the yield on Spain's 10-year government bonds plunged from 7.6% to 6.7%, stock markets rallied, the 'safe haven' currencies (the US$ and the Yen) weakened, the T-Bond market reversed downward and the gold price rose. At this stage, however, they are just words, and 'risk' markets won't make additional gains of significance unless the words quickly lead to inflationary actions.

More monetary inflation is definitely on the way, but the financial markets aren't necessarily correct to discount more inflation in the near future. In fact and as previously mentioned at TSI, the more the markets rise in anticipation of another round of money-pumping the less likely it is that the central banks will turn on the pumps. This applies more to the Fed than the ECB, because the ECB seemingly has an excuse to inflate right now whereas the Fed does not. For the Fed to have the apparent justification for a new inflation-promoting scheme, the backward-looking economic data and/or the stock market will have to get much weaker. This means that last week's market action in response to the possibility of more ECB-sponsored inflation has reduced the probability of the Fed doing anything meaningful at the FOMC Meeting scheduled for this week.

The Stock Market

The S&P500 hit a 2-month high last Friday. It closed at 1386, which is about 35 points (less than 3%) below its April peak. We don't expect it to do any better than test its April peak, so we perceive remaining short-term upside potential of less than 3%. Furthermore, the stock market is now set up for a Fed-related disappointment, assuming that some traders went long the stock market last week in anticipation of the Fed announcing a new QE program or something similar at the conclusion of the FOMC meeting on 1st August. We could be under-estimating the recklessness of Bernanke and Co., but in our opinion the only way that the Fed was ever going to embark on a new round of money-pumping at its August meeting was if the stock market had tanked in the lead-up to the meeting. Therefore, last week's stock market rally all but eliminated the possibility of definitive Fed action at this time.

With the S&P500 probably having additional upside potential of no more than 3% and with the FOMC meeting setting the stage for a negative surprise, we have shifted our short-term stock market outlook from "neutral" to "bearish".

By the way, August has historically been far and away the most bullish month of the 4th year of the Presidential Cycle (2012 is the 4th year of the current cycle), but at this stage we are putting no emphasis on this cyclical influence. The reason is that the fundamental basis for the US stock market's Presidential Cycle no longer exists. That will change if the Fed surprises us by announcing a new inflation program at the conclusion of the FOMC meeting on Wednesday.

This week's important US economic events

Date Description
Monday Jul 30Dallas Fed Mfg Survey
Tuesday Jul 31Personal Income and Spending
Employment Cost Index
Case-Shiller Home Price Index
Chicago PMI
Consumer Confidence
Wednesday Aug 01FOMC Statement
ISM Mfg Index
Construction Spending
Thursday Aug 02

Factory Orders

Friday Aug 03Monthly Employment Report
ISM Non-Mfg Index

Gold and the Dollar

Gold

Gold broke out to the upside in euro terms last week, but the breakout isn't yet definitive. In US$ terms, gold remains within its trading range of the past two months.

There's a good chance that the upside breakout in euro terms will soon become definitive and that an upside breakout in US$ terms will follow. The euro-zone (EZ) situation is the most likely catalyst for upside breakouts in the gold market, not that a specific catalyst is ever really needed to push gold up or down by $50 or less.

It looks to us like the EZ situation is going to become increasingly gold bullish from here, the reason being that the ECB has just drawn the proverbial line in the sand. If the markets again begin to discount a deflationary outcome driven by direct debt default, the ECB has said that it will monetise enough bonds to eliminate one of the symptoms of the debt problem (high and rising bond yields). Such an action could not possibly benefit the overall economy and would therefore not necessarily be of much help to industrial commodities, but it is usually bullish for gold when a major central bank uses monetary inflation to support governments and banks.

Gold Stocks

Current Market Situation

The HUI rebounded last week, but the rebound was unimpressive. It still looks like the gold stock indices will trade heavily until gold bullion breaks above resistance in the $1640s, because that's probably what it will take to generate widespread belief that gold has 'turned the corner'. As long as gold bullion is oscillating between the $1550s and the $1630s its price action will look more like a consolidation within a well-established downward trend than the early stages of a new upward trend, thus limiting the amount of speculative interest in gold mining stocks.

Barrick Gold (ABX) does some damage to sentiment

As part of the announcement of its Q2 results last Thursday, ABX reported a 50% ($2.5B) increase in the expected capital cost for its construction-stage Pascua-Lama project in Chile and Argentina (the project straddles the Chile-Argentina border). Just as well all of the money printing of the past few years hasn't caused any "inflation" to speak of. Imagine the extent to which mine-development costs would have escalated if there had been some "inflation".

ABX's press release also included the following comment:

"Barrick is evaluating its next tier of projects. Cerro Casale and Donlin Gold do not currently meet our investment criteria, primarily due to their large initial capital investments, and under our disciplined capital allocation framework we would not make a decision to construct them at this time. However, they contain large, long life mineral resources in stable jurisdictions, have significant leverage to the price of gold, and therefore represent valuable long-term opportunities for the company. We will maintain and enhance the option value of these projects by advancing permitting activities at reasonable costs which, in the case of Donlin Gold, will take a number of years. During this time, we will monitor the attractiveness of these projects and evaluate alternatives to improve their economics. This will provide the company with the option to make construction decisions in the future should investment conditions warrant."

This comment precipitated a large decline in the stock price of NovaGold (NG), the junior that owns the other half of the Donlin project.

The plunge in NG's stock price indicates that a lot of people were surprised by the 'news' that Barrick had no intention of making a construction decision at Donlin anytime soon. However, this information shouldn't have come as a surprise. At the current gold price Donlin is purely an option on gold, and a fairly expensive option at that.

Companies that are focused on large low-grade gold deposits with multi-billion-dollar mine construction costs probably aren't going to be strong performers in the stock market until gold bullion is well into its next intermediate-term advance.

Currency Market Update

As we explained in previous commentaries, evidence of increasing monetary inflation tends to be short-term bullish for the euro. This is regardless of whether the currency being inflated is the US$ or the euro. For example, last week's promise by the ECB to "do whatever it takes" caused the euro to strengthen. If the Fed surprises us by announcing a new inflation-promoting scheme this week, the euro will almost certainly strengthen some more.

The euro is likely to make additional gains, leading to additional weakness in the Dollar Index, between now and when the stock market commences its next multi-week decline. There's no way of knowing how much longer that will be. The stock market's rally could end within the next three days, but we won't be surprised if it continues for another 2-3 weeks.

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 27th July 2012:

  *Batero Gold (BAT.V) reported the results of metallurgical testing from the La Cumbre deposit at its Batero-Quinchia project in Colombia. The testing achieved gold recoveries of 93%-94% within 24 hours for mineralization in the oxide zone (the top 70m of the deposit) and 82%-86% within 48-72 hours in the Transitional Zone (the next 150-200m of the deposit). There's a long way to go, but these results are positive. The metallurgy is always a critical determinant of whether a gold deposit can be profitably mined.

  *Carpathian Gold (CPN.TO) announced that it has submitted all the documentation it needs to submit to the Romanian government to convert the current exploration license at its Rovina Valley project to a mining license. This is one more step along the path to obtaining the Building Authorization permit, which is the permit that will be needed to begin construction of a mine. The entire permitting process for the project is likely to take at least 12 more months.

  *Energy Fuels (EFR.TO) announced the completion of its $22M convertible note (CN) financing. The notes have a principle amount of $1000, trade on the TSX under the symbol EFR.DB, expire in June of 2017, are convertible into 3,333 common shares (meaning that the conversion rate equates to C$0.30/share), and pay a floating rate of interest based on the average annual uranium price. The interest rate ranges from 8.5% with uranium below $55/pound up to a maximum of 13.5% with uranium above $100/pound. EFR offers a lot of leverage to the uranium price and is the only US-based uranium miner with significant current production.

  *Evolution Mining (EVN.AX) issued its results for the June quarter. It had earlier issued quarterly production/cost figures, which we used in the 16th July Weekly Update to arrive at a conservative valuation of A$2.11/share and an aggressive valuation of A$4.80/share (the different valuations stem from different assumptions regarding the future gold price and production rate). Nothing in the quarterly report requires a change in our valuation for this stock.

Since our 16th July write-up the stock price has risen from the low-A$1.30s to the high-A$1.50s. We consider EVN.AX to be a buy at A$1.50 or lower.

  *Golden Star (GSS) reported the results of recent drilling at its Wassa mine in Ghana. The results suggest the potential to expand the existing pit and are therefore positive, but from our perspective they aren't significant. A large gain in the GSS stock price over the next 12 months will depend on the company generating a lot more cash, which will require a rise in the gold price and/or improved performance (higher production and lower costs) from the current operations.

  *Pretium Resources (PVG.TO, PVG) announced a phenomenally high grade intercept from the on-going drilling program at its Brucejack project in BC, Canada. The intercept was 3.0m grading 8,330 g/t, including 0.5m grading 41,582 g/t (forty-one thousand grams per tonne). If this were an isolated result it would be interesting, but not necessarily economically important. However, far from being an isolated result it adds to a long line of spectacular results from the "Valley of the Kings" zone. There were multiple chances to purchase PVG.TO at/near our C$13.00 buy level over the past two weeks.

  *Resolute Mining (RSG.AX) issued its quarterly activities report. There were no surprises, as production results for the latest quarter and a production forecast for the next 12 months had been announced about two weeks earlier. Our A$2.50/share valuation for this company was explained in last week's Interim Update.

RSG.AX also reported that it had awarded a new $540M 5-year mining contract, covering all of the contracted mining activities at the Syama project in Mali, to Ausdrill Ltd. This change in contractors doesn't affect our RSG valuation.



 
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