oil

As long as oil remains weak the stock market is going to struggle, as energy companies make up a big percentage of the S&P.

We have a couple of scenarios playing out at the moment. The first one is the test of the T1 pattern consolidation zone. Once the test is complete oil should move back up to new highs.

I'm a bit leary that this is how it's going to play out as there is no fundamental base for oil moving up with the global economy sinking deeper into the depression.

I think what we might be seeing is the left shoulder of a multi year bottoming process that should complete in late 2010 with a slightly higher low. From that point I'm guessing the deflationary forces will have run their course and we will enter the inflationary or more likely hyperinflationary end game.

It's time to hold on

Back on May 2nd I posted this chart of the S&P in the weekend report. At the time the market was still working it's way up to the final top of this counter trend rally. Many bears had tried repeatedly to short this move and gotten stopped out.

I thought at the time that we would probably see the topping process cause the bears just enough pain so that when we did get the final top the shorts would be so gun shy they would not only be unable to sell when they should but would probably be unable to hold their shorts very long. Certainly not for the full ride down into the weekly cycle bottom.

The chart shows my opinion of what most shorts would end up doing as the next leg down unfolds. I suspect most of the bears are going to make little to nothing or even lose money during this decline because they won't be able to hang on to their position. I also expect most of the bears will get comfortable on the short side right about the time we put in the low and then they will hang on too long to their positions as the next counter trend move gets underway and give back a big chunk of any profits they might make.

As I browse the Internet that's exactly what I'm seeing. The number of bears now expecting one more trip up to test the 956 high is large even though the current daily cycle has now failed. Not to mention many other signs that the decline has begun in earnest.

This is how bear markets work. They make it as hard as possible for the shorts to stay on board while at the same time almost impossible for the longs to get off.

The odds are very high that the intermediate trend has turned. That means bears should hold their positions and ignore the short term bounces. Bounces are for adding to shorts not for trying to catch short term long trades.

Remember, this is a secular bear market. That means that timing mistakes on the short side will eventually be corrected. Timing mistakes on the long side will be magnified.

Secular bull markets

Let me explain how secular bull markets work. They start from a fundamental supply and demand imbalance. As they start to rise only the true believers, really smart money or the lucky get on board. The rallies are slow and grinding. The corrections are swift and scary (I think that accurately describes what gold bugs are experiencing now).

Usually this first phase lasts up to five years long. At some point a secular bull market will undergo a massive correction that will serve to wipeout all the optimism that was built up during the first phase.

I think that correction occurred in 06. Notice how long it took to move to new highs after gold crashed from the 725 highs. Over a year and a half.

In the second phase institutional money will start to come in to the market. However in the second phase the corrections are much larger than the first phase, making it harder for riders to stay on board the bull. Most investors will still doubt the bull all the way through the second phase. Many will try to short him.

In the third phase the public will come in and the asset will become entirely detached from any fundamental underpinnings. Overbought levels will be meaningless. Excessive sentiment will be meaningless. The bull will ultimately move to levels that virtually no one will foresee and as such very few will be able to ride the bull to completion.

Now let me tell you exactly what's going to happen in the coming months and years. First off gold is going to do whatever it takes to wipeout as much bullish sentiment as possible so that when it does finally move above $1000 almost nobody will trust the move. Many will try to short the move because gold will most certainly be overbought at that point.

I've pointed out before that gold and especially silver are thin markets. That means they are volatile. So here's what invariably happens to shorts. Maybe they get lucky and catch a short term decline and they make a little money. The problem is that volatility. At any moment the buyers can come in and when they do the metals can move big and quick as shorts panic. The shorts profits can evaporate in the blink of an eye. Often they evaporate before the market even opens. One never even gets a chance to book their profits.

I can guarantee once gold goes above $1000 it won't be long before the shorts are trying to pick a top and nervous longs sell way to soon and then sit on the sidelines as the bull goes up and up and up. This is going to happen all the way up. The vast majority of investors are going to turn the opportunity of a lifetime into no profit. Those gullible enough to short gold will lose massive amounts of money as this bull progresses.

Shorting a secular bull market is like walking through a dynamite factory with an open flame. Sure you may get lucky once or twice but you still have a very short life expectancy.

Now look at that first chart. Gold never dropped below the 200 week moving average even during one of the worst market crashes in history. The 75 week moving average never even turned down. There is no other asset that one can make that same statement for. What earthly reason could one have for trying to sell short that kind of strength?

Now look at the other chart. The Dow:gold ratio has been moving steadily down since 01. Is there any logical reason to expect that this time the Dow gold ratio bottomed at a level almost 7 times higher than it has at any other time in history? I don't know of one, although I can think of several trillion reasons why it may bottom lower than any other time in history.

1-2-3 reversal in the Dow

On Thursday the Dow completed the 1-2-3 reversal that I pointed out on June 17th. The odds are now stacked against this rally continuing.

I also pointed out the 4 day rule trend reversal two weeks ago in the June 24th nightly update.

I think the cycle of negativity has started. With Thursday's decline we now most likely have all three time frames (secular, intermediate and short term) back in gear to the downside.

This is probably not a good time to try and take long side trades. Notice I said trades not investments. I will not touch my junior mining stocks. Like I said in one of the other posts; I'm trying very hard not to do something stupid anymore.

Why should one own gold?

The answer is to preserve your purchasing power. Everyone seems to be worried that during a deflationary period the price of gold will drop. First off let me explain something. Gold is money. Has been for the last 5000 years.

Let me also point out that during a deflationary period money becomes more valuable. During the last deflationary period of the Great Depression the only thing that went up was gold.

From September to March we just experienced a massive deflationary shock. So what happened to money during this period? For one the dollar exploded higher. For instance, you could buy a gallon of gasoline (at least here in Vegas) for about 1.6 dollars.

Now a gallon of gas is always going to be a gallon of gas, that didn't change. The only thing that changed was the value of our currency.

Last year it took 4.3 dollars to buy a gallon of gas and this winter it dropped to 1.6.
The value of the US dollar increased by almost 300% when expressed in purchasing power based on a gallon of gasoline.

In September before the deflation hit 1 oz. of gold would buy 300 gallons of gasoline. At the height of the deflationary panic gold bought over 1000 gallons of gasoline. A little more than 300% increase in the purchasing power against our measuring standard...a gallon of gasoline.

These three charts are going to look similar whether you measure purchasing power in a specific commodity, college tuition, housing or a loaf of bread.

Folks gold is money and in a deflationary environment money becomes more valuable. So when I see people freak out because gold drops a little bit I have to wonder what they are thinking. They haven't lost any purchasing power, as a matter of fact, they have made a tremendous gain. A gain that any one of us would be ecstatic about if one had the insight to see the real picture.

Now consider the mining stocks and how undervalued they are right now. You want to talk about a gain in purchasing power over the next couple of years? Don't even get me started.

And people wonder why I won't sell any of my mining stocks. Deflation? Bring it on I say, I'll be happy to gain another 300%.

The times may be changing

For the first time in four months the 20 DMA is rolling over. So far during this entire bear market every time the 20 has turned down it has led to at least a significant decline and in most instances a major leg down.

The fact that everyone seems to know that the day before the 4th of July holiday is almost always positive has me wondering if too many investors got long today looking for a "sure" thing.

I've got news for everyone, there is no sure thing when it comes to the stock market.

Has the economy bottomed and does that guarantee the stock market will rally?

Let me ask a question. When the recession ended in 2001 did it coincide with the stock market bottoming?

Did the market collapse in 87 signal a coming depression or even a recession?

Did the push to marginal new highs in Oct. 07 signal that the economy was running on all eight cylinders?

The answer to those questions are no, no and hardly.

Stock markets are and always have been governed by human emotions. Does anyone realistically think that the stock market, no matter how many investors this includes, really has the ability to "see" the future? I guarantee you it does not.

The stock market will just continue to cycle through periods of hope and negativity like it's always done for hundreds of years. At times the cycle of hope will correspond or even lead an upturn in economic activity. At other times the cycle of negativity will continue to bring the market down despite obvious economic improvement.

It really has no bearing on whether the economy has bottomed or not, the market still has at least another year to year and a half before we can expect the secular cycle of negativity to reach a final bottom.

As I've said many times before I expect at that bottom to see true bear market conditions as human emotions do their work and take valuations to absurd levels.