[This blog post is a brief excerpt from a recent commentary at www.speculative-investor.com]

We get the impression that some major sentiment extremes are close. In particular, we appear to be at/near peak optimism about the US stock market and the US dollar, peak pessimism about the US T-Bond market, and peaks in the expected effects of Trump’s policies on US economic growth and inflation. These sentiment extremes are inter-related, in that the very popular view that Trump’s policies will drive US economic growth and inflation upward has magnified the decline in the T-Bond price (the rise in the T-Bond yield), which has, in turn, magnified the rally in the US$.

In the T-Bond market, an intermediate-term reversal is likely during the next month. Possible catalysts for the reversal are more evidence of weakness in the US labour market, a surprisingly low CPI or PCE number, a downside breakout in the oil price, an announcement by the Fed that it is ending QT and a steep pullback in the stock market, but note that with such a high level of general bearishness about the T-Bond’s prospects it won’t take much to bring about the initial ‘turning of the tide’.

At around the same time as or soon after the T-Bond price reverses upward, the US$ should begin to weaken on the foreign exchange market. Further to the comment we made above, this is because it was the rise in the T-Bond yield that extended the US dollar’s rally from its September low to the point where it recently made multi-year highs against most other currencies.

The US stock market (the SPX) also could make an intermediate-term reversal soon, although for two reasons there is a realistic chance that the stock market’s inevitable reversal will be delayed despite the apparent sentiment extreme. One is that the stock market could be given a boost by declining interest rates after the T-Bond price begins to trend upward. The other is that the passive investing funds that now dominate the stock market will continue to support equity prices as long as there is a net flow of money into these funds, and there probably will be a net flow of money into these funds until the economy becomes significantly weaker.

The upshot is that the stage is set for some important trend reversals in the financial world. What we are now awaiting is evidence of reversal in the price action.

[Below is a brief excerpt from a commentary published at www.speculative-investor.com on 22nd December 2024]

Interest rates are always among the most important determinants of currency exchange rates, but over the past two years they have dominated. We cite the following two charts as evidence.

The first chart compares the US$/Yen exchange rate (the black line) with the yield on the US 10-year T-Note (the green line). This chart only illustrates the strong positive correlation between these two markets over the past two years, but the relationship has existed and has been tracked at TSI — normally via a chart that compares the Yen with the price of the 10-year T-Note — for much longer.

The second chart compares the Dollar Index (the black line) with the yield on the US 10-year T-Note (the green line).

These charts show that over the past two years the US$ has strengthened against other fiat currencies whenever the US 10-year T-Note yield has risen and weakened against other fiat currencies whenever the US 10-year T-Note yield has fallen. The relationship operates on a trend basis rather than a daily or weekly basis, although it was evident last Friday when a slightly lower-than-forecast Personal Consumption Expenditures (PCE) Index prompted a dip in the T-Note yield, which, in turn, prompted a pullback in the US dollar’s exchange rate.

The overarching message being sent by the above charts is that for the US$ to continue strengthening, the US 10-year T-Note yield will have to continue trending upward. This is unlikely, because we probably are now seeing a sentiment peak related to the expected inflationary effects of Trump’s policies, US economic strength, US stock market outperformance and Federal Reserve ‘hawkishness’. What we haven’t seen yet are any signs in the price action that the trends of the past 2-3 months have ended.

[This blog post is an excerpt from a recent commentary published at www.speculative-investor.com]

The phrase “Drill baby drill” has been around for a long time, but Trump embraced it during his recent campaign to describe the approach to drilling for oil that would be taken by his administration. What will be the likely effect on the oil price of this approach to oil industry regulation? The short answer is: The effect probably will be minor. For a longer answer, read on.

One reason that the effect of this new approach won’t be substantial is that for all its words to the contrary, the Biden Administration did very little to hinder oil drilling. Therefore, the Trump Administration’s “Drill baby drill” approach will not constitute a major change.

The second and most important reason is that in the absence of regulatory roadblocks the actions of the oil industry will be determined mainly be the oil price. It’s reasonable to expect that drilling activity would ramp up if the oil price were to make a sustained move above $90/barrel, but it’s also reasonable to expect that drilling activity would be slowed if the oil price were to make a sustained move below $60/barrel. Therefore, Trump’s opinion that in the absence of regulatory obstacles the oil industry will drive the price down to very low levels is not plausible.

The reality is that although the oil industry is notoriously undisciplined, due to what transpired over the past ten years the one thing that will instil discipline in the future is a low oil price. In the future, an oil company CEO who continues to expand, or more likely fails to cut, production in response to sustained weakness in the oil price probably won’t keep his/her job.

It’s therefore likely that the future response of US-based oil producers will act to keep the oil price in a wide range. That is, it’s likely that in the absence of other influences the future supply response of the US oil industry will create both a ceiling and a floor for the oil price.

Of course, there will be other influences, one of the most important of which will be the actions taken by OPEC+. OPEC+ has about 5 million barrels/day of spare capacity that could be brought on line relatively quickly and cheaply. This represents a bigger threat to the oil price than the “drill baby drill” policy in the US.

In all likelihood, OPEC+ will act similarly to the US oil industry and only increase its production in response to a sustained rise in the oil price to a much higher level. However, there are plausible scenarios under which OPEC could ramp-up its production despite weakness in the oil price. It has done so in the past with the aim of creating financial problems for its competitors in the West and forcing these competitors to reduce production. It could do so again for this reason or because the Saudi leadership does a deal with the Trump Administration that involves guarantees of security/weapons in exchange for a price-suppressing boost to oil production.

Our view at this time is that a much higher oil price is a realistic possibility for 2026-2027, but that the oil price will spend the next 12 months in the $60-$90 range. Furthermore, whereas it probably would take a war-related supply disruption to push the oil price well above the top of the aforementioned range, a move to well below the bottom of the range could result from either OPEC ramping-up production for the reasons mentioned above or a severe recession.

[This blog post is an excerpt from a commentary published last week at www.speculative-investor.com]

Jurisdictional risk materialises with no warning

Jurisdictional risk is any additional risk that arises from doing business in a foreign country. The problem with this type of risk is that when it materialises, it does so without warning.

As exemplified by two recent events, jurisdictional risk for gold mining companies is relatively high among the countries of West Africa (the countries highlighted on the following map). The first of these events was a statement in early-October from the president of Burkina Faso that the government may withdraw existing permits for gold mines. This statement affected a number of Western gold mining companies, including TSI stock selection Fortuna Mining (FSM). FSM currently generates about 25% of its gold production in Burkina Faso.

The aforementioned statement by Burkina Faso’s president caused a 10% single-day plunge in the FSM stock price. The company put out a press release that soothed fears and the stock price quickly recovered, but the risk remains and could move back to centre-stage at any time.

The second of these events occurred early this week when Australia-listed Resolute Mining (RSG.AX), which is not a current TSI stock, advised that its CEO and two other employees had been detained by the government of Mali due to a disagreement over the government’s share of revenue from RSG’s Syama gold mine. In response to this news the RSG stock price immediately dropped by around 30% and, as illustrated by the following daily chart, is down by more than 50% from last month’s high. At the time of writing the employees are still being held hostage by the Mali government, which apparently is demanding a $160M payment.

In response to the RSG news, the stocks of some other gold mining companies with substantial exposure to Mali were hit hard. The hit to the B2Gold (BTG) stock price was relatively mild, however, even though the company’s most important currently-producing mine (Fekola) is located in Mali. We assume that this is because the company negotiated a new agreement with the Mali government only two months ago.

When nothing untoward happens in a country with high jurisdictional risk over a long period, investors tend to forget about the risk and the risk discount factored into the stock prices of companies operating in that country becomes small. As mentioned at the start of this discussion, the problem is that when this type of risk materialises, which it eventually almost always does, there is never any warning and therefore never time to get out prior to the price collapse. This is not a reason to avoid completely the stocks of companies operating in high-risk countries, but it is a reason to only buy such stocks when the risk discount is high and to manage the risk via appropriate position sizing and scaling out into strength.

Balance sheet risk materialises WITH warning

Unlike jurisdictional risk, balance sheet risk doesn’t suddenly appear out of nowhere. The signs of trouble are almost always obvious for a long period before the ‘crunch’. If management doesn’t take decisive action soon enough to recapitalise the company, there will no longer be an opportunity to recapitalise in a way that doesn’t destroy a huge amount of shareholder value. On Wednesday of this week the shareholders of i-80 Gold (IAU.TO) learned this lesson.

The IAU stock price was down 58% to a new all-time low on Wednesday 13th November in reaction to the company reporting its financial situation, operating results and a new development plan. In a nutshell, it was an acknowledgement that the company is under severe financial stress. However, this should not have come as a big surprise given that the company reported a working capital deficit of US$60M more than three months ago and has a loss-making business, meaning that the working capital deficit was bound to increase in the absence of new long-term financing.

A strong balance sheet is especially important for gold mining companies that either are in the mine construction phase or have commenced production but are not cash-flow positive. That’s because such companies need a sizable ‘cash/financing cushion’ to stay in business. For exploration-stage companies, having such a cushion is not as critical because these companies can survive by either temporarily stopping their exploration work or doing the occasional small equity financing.

The crux of the matter is that close attention should be paid to the balance sheet, which forms part of the information that public companies issue on a quarterly basis.