Inflation is here to stay

Today I'm going to point out what I consider to be critical fundamental conditions that virtually guarantee the continuance of the bull market in commodities. Consider that the economy is now in recession. I don't think too many people will try to deny this fact. What is the only realistic response from the Fed to this? They have to print money. There's just no way they are going to drain liquidity during a recession. This is the road to deflation and depression. I just don't see any realistic possibility that the Fed would start to constrict money supply during a recession. So if the Fed is expanding money supply I just don't see any sensible reason for either the dollar to appreciate or commodities to fall other than for a short term correction of an overbought level. Next consider that we have unpayable debts in the form of Social Security and Medicare. Add to that two wars and again we have fundamental conditions that exclude the possibility of reducing the money supply. So even when we do come out of the recession these debts will still be there. Debts that are only payable by debasing the currency. So until I see a Fed raising rates aggressively to control inflation I just don't have any reason to expect a reversal of the long term trend of higher prices for commodities.

BTW does anyone find it funny that we are now giving the Fed responsibility for financial regulation when it was the Fed who caused all the problems in the first place by lowering rates to 1% and trying to avoid any pain when the tech bubble burst? The very same Fed who are now expanding money supply and again lowering rates as inflation is soaring. The very same Fed who are now laying the foundation for the next catastrophe.

A Bull and a Bear

So far the bull market in commodities and the bear market in stocks are doing exactly what they should be doing. By that I mean the bear is in the process of taking stock valuations down to extremely depressed levels and the bull market in commodities is in the process of taking commodity prices to levels of ridiculous overvaluation.

Notice the trailing PE has gone from 45 (I think that's pretty close) in 2000 to 29 at the bottom of the last 4 year cycle low. BTW 29 is still ridiculously expensive. 29 is higher than almost every other bull market topped out at. That alone made it clear that the bear was hardly over in 2002. Now today the S&P has despite rallying for 5 years dropped to 18 times trailing earnings. PE ratios are compressing despite record earnings. Still 18 is hardly undervalued. As a matter of fact it's a little on the high side of average. No the bear still has a lot more work to do yet. It won't happen overnight especially with the Fed willing to debase the currency to any extent to keep the bear at bay. Unfortunately all this is going to do is make the process all that much longer and more painful.

Now let's look at the Dow:Gold ratio. Here we see the bull in the process of doing what he does, namely taking commodities to extreme overvaluation. At the top in 2000 it took 42 oz. of gold to buy one share of the Dow. That ratio is now down to 13. Again hardly ridiculous overvaluation yet. Seeing as how the last two commodity bulls took the Dow ratio to 2.5:1 and 1:1 we still have a long way to go here also.

Now look at the last chart specifically from 66-82. The Dow went nowhere. However in valuation terms it dropped sharply. The trailing PE in 74 was around 7 if I'm not mistaken. Also notice that the stock market was unable to make significant new highs during this entire 16 year period. Now look again at the first chart. See any similarities? Keep in mind that in inflation adjusted terms the S&P was still very far below the 2000 peak at it's high in Oct. of last year.

Possible low pole reversal coming?

One more X and we will have a low pole warning on SLV. Notice the long tail down. Also notice that this occured above the rising trend line. A bullish configuration would form if SLV can recover at least half of that long tail down. About 20-30 cents on silver will do the trick.

There's been a lot of concern about the correction in PM lately. While it's never fun to watch your position go down I can assure you that the real worry is not having a position. Before this is over all these corrections are going to seem trivial. Just look at a 5 year chart of silver. The corrections back in 03 and 04 hardly show up on the chart. When I say that all timing mistakes are going to eventually be corrected by the bull I'm not kidding. So there's no need to beat yourself up if you happen to enter too late in a cycle. There is a need to beat yourself up if you don't get in and stay in. Well that is unless you want to miss the opportunity of a lifetime.

Is the stock market a screaming buy?

When should you buy? The age old question. The old Wall street adage says "buy when there's blood in the street" There's a lot of truth in that one. Here's my signal for when to buy. When I'm scared to death I'm going to lose money. It's that simple. Look at the first chart of the S&P. I remember investors were sure we were headed for the end of the world at the time. Nobody was brave enough to buy back in Aug. However the COT's were wildly bullish. Result the market rallied back to new highs. Now look at silver during the same time. Again popular opinion was that silver was only headed lower as it had not confirmed the strength in gold. If you had bought then you surely would have lost money. I can tell you it was tough to make that phone call on the 17th and place a huge order for physical silver. I think my knees were actually weak. Now look at the stock market over the last 4 days. The sentiment has gone from bearish to wildly bullish in less than a week. The large contract in the S&P is negative and getting more so. Smart money unloaded a ton of stock into Thursday's rally. This rally is not investors buying because they are scared to death of losing money. This is investors buying because they are scared to miss a rally. I'm seeing some of the same sentiment in the PM from e-mails I'm receiving. Investors are worried about missing the next move in the PM. This in my opinion is not a good reason to buy stocks or PM either one. I want to wait until everyone is scared to death (including me) before I commit my capital.

The stock market as a discounting mechanism

Well sometimes anyway. Then again sometimes the Fed tries to interfere with the markets. I would have to say the Fed is desperately trying to tinker with the markets lately. In Aug. we had the big correction. The market was trying to discount a coming recession. However if you notice the dollar line on the chart this is where the Fed decided to debase the currency and prevent the market from doing it's job of discounting future earnings. This is the point at which the dollar was allowed to break below historical support. This is the point at which the Fed decided to run the printing presses full speed ahead. So what was the outcome of all this money printing? The market popped back up to nominal new highs. Yeah! But wait a minute the market quickly rolled over into a bear market. Despite the all the Fed's efforts they have not been able to stop the recession from happening. All they have succeeded in doing is making it worse by adding a growing inflation problem to the mix. Remember all the PPT proponents out there who would cry wolf every time the market rallied? As I said then and I'll say now the larger trend of the market can't be controlled for any length of time. Just look at the above chart and you will see that despite titanic efforts by the central banks of the world the recession came anyway. Has the Fed learned anything? Apparently not since they are still doing the same thing, namely debasing the currency. Now some free money might be good for a few investment banks that are about to go under but it is not good for the US economy that has to live with a growing inflation problem. The bottom line is that as inflation rises margins get squeezed and consumers get pinched. None of that is good for future earnings. If earnings are going to be declining then I really don't see the rational for paying up for those decreased earnings. So while we may or may not be in store for a bounce in the market because sentiment got a little too stretched on the bearish side I still don't see any fundamental change that would make me a buyer of anything other than commodities (once the correction is over).

Commodities correcting

I know there are many who don't see much value in the COT's. With the correction in commodities now upon us this is where the COT's will be worth their weight in gold (pun intended). As I noted last week I reduced my precious metal holdings back to my core position. Now I need some kind of signal to let me know when it's safe to get back in the water again. This is where the COT's come in handy. I don't want to start buying again until the commercials are doing the same. I don't want to stand on the tracks in front of the train just follow behind it. At some point in the next few weeks or months we will likely get a buy signal for the metals from the COT. Until that time I will patiently sit and twiddle my thumbs. I'm also looking at the T1 signal. A trade back to the consolidation area of $800-$850 would satisfy the second part of a T1 trade before going higher. I expect it won't be long now before we hear the commodity bears coming out in force and telling us the commodity bull is dead. (believe me they will be squealing for years yet) I'll tell you right now that nothing is happening that hasn't happened before. For those that bought late and pushed it a little too far and are now caught in the correction my advise to you is what are you worried about? This is a secular bull market. The bull will eventually correct all timing mistakes. Stick those gold coins or silver bars back in the vault and forget about them.

One side note Robert L pointed out in the last thread the huge selling on strength today similar to what we saw in late Dec. right before the waterfall decline. As I pointed out in tonight's update I have no desire to trade the market from the long side. The larger trend is now down and I don't trade against the larger trend. I would have no idea when to sell as the larger trend can reassert at any time. If I had to guess I would think that commodities and the market will probably bottom at the same time. That's just a guess though and I have no special insight as to whether we've seen the 4 year cycle low already or not. Let's just say I'm still skeptical that the greatest financial crisis in history along with a spike in energy can be sidestepped with a meager 19% decline no matter how much money the Fed throws at the market. More in tonight's update.

Money Supply

I'm again having trouble downloading charts from the road so no chart with this one. I'll add the chart when I get back in town.

There seems to be some debate about whether the Fed is increasing the money supply. IMO all one has to do is take look at a chart of the dollar from 01 to the present. The dollar responds to supply and demand just like anything else. Too many dollars and the value drops. It's pretty easy to see that the Fed is printing too many dollars. Notice that in Oct. when the Fed allowed the dollar to break long term support the stock market began to struggle. This is the point where I said that the fun part of monetary expansion was probably over. Recently the dollar had a chance to find support but with the recent trouble in the credit markets not to mention the swoon in the stock market the Fed has opted to again sacrifice our currency in the attempt to avoid a recession. The results so far have been the same rising commodities and fading stocks. I'm not sure if there is a point where this strategy will work or not. I suspect that stocks are going to have to get cheaper before the excess liquidity will stay in the stock market instead of draining into commodities.

There also seems to be some discussion about commodities rising solely on speculation. While commodities do from time to time get ahead of themselves the underlying reason for commodity price increase is simply supply and demand imbalance . The bear market from 1980 to 2000 made sure that the infrastructure in the commodity markets was unable to keep up with the demand from emerging markets including China & India. We still have years before the supply side of the equation catches up to the demand side. This bull market will continue until it does. 

I also notice but can't get a chart up that the Yen has now broken out above long term resistance. The next level of resistance is 80. If this level is reached it will put a lot of pressure on the markets. As I stated in the previous thread we should be able to rally from the extreme sentiment readings we've seen in the past couple of weeks. I suspect there's a lot of big money betting on the market rally at this point. If this money has to now sell then it could get ugly quick. I don't think the BSC insolvency is the only broker/dealer in trouble just the first. There is never just one cockroach. 

The XBD broke to new lows Friday. Not a good sign. Without the financials this market is going to have trouble sustaining any serious rally.

Back to the core position

I'm using a friends computer in Kansas City and for some reason I can't get charts to upload to blogger. I'm going to sell back to my core position this morning in PM. As I've said before the final drop in the 4 year cycle low takes down everything and this will include the PM. I think we are now starting that leg down (we may even have a third leg). There where some topping signs in last weeks XAU action and the break lower from the pennant in GLD makes me think that the T1 move is over. We should get a test of the consolidation zone now before the next leg up. Hopefully I will be able to make the early flight this afternoon. If so I will have the charts in tonights update.

funeral and vaction

I will be out of town this weekend for my fathers funeral. I won't be back until Monday night. Then I will be leaving Wednesday for a week long climbing trip. I will try and check in once or twice while I'm gone but I won't be doing any posts while I'm away.

Commodities in a bubble? What a joke

Anyone who reads the blog by now knows the ongoing debate about whether commodities are in a bubble or not. I just have to laugh when I see these kind of comments. This is the bulls way of shaking off only the most determined riders.

Anyway I'm going to show you how long term secular bull markets work. First off they almost always have a very scary correction usually around the 5th year that kicks off only the most die hard bulls. We saw that correction in the stock market bull in 87 in the form of Black Monday. Now take a look at the last chart and we can see that despite that being the worst crash in history it was hardly the end of the bull market. As a matter of fact looking back over the whole bull from 82-2000 it's an almost insignificant blip. Now in 06 we saw that 5th year correction in the commodity markets. I remember at the time hearing countless analysts calling for oil to drop back down to $10-15 a barrel. I had to laugh then too. We simply had not found and brought online the oversupply needed to end the commodity bull market. No this was just the expected correction that bull markets go through around that time frame. We are now into the second phase of the commodity bull. Take a look at that long term chart of the Dow again and you will get an idea of how long the second phase can last. Folks the second phase of the commodity bull is just getting started. We will see another very scary correction sometime in the future and everyone will think the bull is dead. However it will recover quickly and then the public will start to come into the market in droves. This will be the 3rd and final phase of the bull. We saw this correction in 98 in the form of the LTCM crisis. As I've noted previously during this final phase you will have about 1 - 1 1/2 years as the markets turn parabolic. After that it will be time to get out and go looking for the next bull which will of course be in paper assets again. This is just how the cycles work. At the moment commodities are so undervalued it's ridiculous. They only seem expensive because we are comparing them to the last 25 years of bear market pricing. Bull markets tend to increase values whether they be stocks or commodities by 1000-2000%. the stock market went from 600 to 11750 during the last bull. That's almost 2000%. Gold is only up a little over 300%. We haven't seen anything yet. So you can decide to take this once in a lifetime opportunity and get rich or you can listen to that little negative voice in your head and blow the greatest chance at financial freedom that many of us will ever see. It's your choice.

Bonds overvalued

Read the whole story here. I suspect we are going to see a repricing in the bond market sooner rather than later.

As a matter of fact it may have already started.

Another leg down for the dollar

As I write this I'm listening to Larry Kudlow complain about a weak dollar and gold heading towards $1000 an oz. Now correct me if I'm wrong but wasn't it Larry Kudlow, Jim Cramer and the media in general that were screaming for rate cuts in Jan. as the market was falling? I said at the time they should be careful what they wish for as they might get it. Well we did get the "Shock and Awe" rate cuts and now we are paying the price. People just can't accept the fact that there is no free lunch in this world. The consequences of cutting rates is a weak dollar. Did these people really think there would be no after effects of slashing interest rates? That all the Fed had to do to fix all our problems was to cut rates and expand the money supply? Do these people really believe this nonsense they spout? Ahh if it was only that easy to avoid recessions. Let's just keep interest rates under 1% and print all the money we'll ever need and we'll never have bad times again. Wait a minute hasn't Japan been using this solution now for 17 years? If I remember correctly the Japanese economy has been in and out of recession during this entire time and it apears they are headed back in at the moment.

If the dollar is starting another leg down then we probably have more room on the upside for the precious metals. Major lows in the dollar haven't occurred until the dollar has dropped 7.5-9% below the 200 DMA. The dollar is currently only 6.2% below the 200 DMA. We have plenty of room on the downside for the dollar to drop before it gets oversold enough to trigger a bounce. More in tonight's update.

I'm back on line

Finally I'm back on line and the old e-mail address is working again. gsavage4997@cox.net