Is Deflation back?

The action today in the dollar is suggesting that it may very well be. It's now possible that no mater how much money the FED prints, the forces of deflation are going to overwhelm it. One way or another the massive amount of debt that has been created over the last 20+ years is going to have to be destroyed. The million (or should I say trillion) dollar question is whether it is going to be hyperinflated away or destroyed through deflation.

With the introduction of the 700 billion bailout package it looked like hyperinflation was going to carry the day. However as we all know that fizzled. I'm going to be watching gold closely now. The rest of the commodity complex is deflating spectacularly. The only hold out is gold.

I expect gold will test the $850 level sometime in the next week or two. If it can hold above that level then perhaps the powers that be can induce one more inflationary surge. If however gold sinks back below $850 and follows the rest of the commodity markets down it may be that the end game is here and deflation is now unstoppable.

Either way the end game was always going to be a massive deflation. The only question was how long could it be postponed.

New Charts

New charts on the Chartlist.

Bailout plan will accelerate the fall into depression

I don't have the exact details of the bailout plan but as I understand it there are provisions to stop foreclosures. I can tell you that anything that stops foreclosures or tries to prop up real estate prices will only accelerate the slide into depression.

First off real estate is still overvalued. Until it moves back to sane valuations there will be no real demand for housing. Especially in a recessionary or depressionary environment how will keeping prices artificially high create demand for all the inventory that's on the market? Common sense will suggest that it won't.

Any bill that puts a halt to foreclosures would lead to catastrophe. If all of a sudden there was no penalty for defaulting on your house (the bank won't take it) and prices continue to fall, how long will it be before home owners in mass decide to stop paying their mortgage?

This would result in a tidal wave of defaults crashing onto an already stressed financial system.

As I've said before there is no easy fix for the mess Greenspan created and now Bernanke is exacerbating.

New Charts

I've posted new charts on the public chartlist .

HUI

The Hui is now in the process of working through a potential 1-2-3 reversal. I suspect that eventually congress is going to pass the bailout package. Once that happens the hyperinflationary signal will be given. The dollar will weaken and gold should take off. The timing band for gold to make it's trading cycle bottom is between Oct. 6- Oct. 20. I think the longer Congress delays on the bailout the more the odds increase that the Fed will surprise with a rate cut. Either outcome is going to be inflationary and positive for gold.

New charts

I've posted new charts to the public chartlist. As always, if you would take a second to click the tally link I'd appreciate it.

End of a bear market

I've pointed out to subscribers in the past that often a secular market, be it bull or bear will end with the market breaking out to higher highs or lower lows and then reversing. In the first chart we can see the cyclical bear and bull market in the S&P ended with this pattern. Dumb money sees the breakout or break down and follows the trend at the same time that smart money seeing the changing fundamentals takes the opposite side.

A couple of weeks ago I sent out what I considered my most important update of the year. What I was watching was the 30 year bond to see if it was going to follow this pattern. Sure enough bond yields broke to new lows as everyone was witnessing deflation grip the world. A couple of days later though yields reversed sharply. Even though the stock market has since come off the rally sharply in the last two days bond yields are showing no signs of coming back down. In my opinion the 30 year bond is now telling us that the FED is going to risk hyperinflation to save the banking system.

I think what we've just witnessed is the end of a 28 year bear market in bond yields. Unless this reverses soon I think we are now in for many years of rising interest rates. This has nothing to do with an improving economic outlook in my opinion. It has everything to do with what I fully expect to be 70's style inflation. Actually I expect it to eventually become much worse than the 70's before this is over. One way or the other I think we are headed for a depression. The question has been whether it would be a deflationary or a hyperinflationary one.

So far the bonds think we are heading down the hyperinflationary route. This is how the groundwork is laid for a Dow:gold ratio of 1:1.

Oops!

I'm going to go through the chain of blunders the FED has made over the last 8 years. Well actually Greenspan started all this in 1987 when he found out he could just cut rates and print money to alleviate any crisis. This worked all way up to 2000. Thus was born the phrase "dont fight the FED"

However something changed in 2000. If you followed the rule of never fighting the FED you just guaranteed that you rode your losses all the way down. Oops ! As you can see Greenspan sacrificed the dollar to avoid a recession and halt the bear market. As I said it didn't work. The 2002 4 year cycle was a left translated cycle and it finished it's run into the 02 low despite the FED's best efforts to halt it.

All the FED really accomplished was to make the problem much much bigger. By holding rates at 1% the FED created not only the real estate bubble but the credit bubble. Oops! This was the point where monetary inflation was still fun, as a matter of fact it was the greatest party the world had ever seen.

However we already were seeing warning signs as commodity prices were on the rise. Oops! By 06 the economy was starting to falter. Well that wasn't acceptable for an election year so a little rejiggering here and there with weightings in Goldman's commodity index and we get a massive sell off in oil. The 4 year cycle which should have bottomed in 06 was avoided. As you will notice this coincided with another steep devaluation of the dollar.

The end result was a final parabolic run in the markets. However a cancer was already growing as the housing bubble had already burst and the credit bubble started to leak. Oops!

As usual the FED's response was to print more and more dollars faster and faster. This time however those dollars just went straight into the commodity markets especially oil. Big Oops! That was the straw that broke the camel's back and the world tipped over into recession.

Now the government is at it again. It's election time and the politicians are crying for a fix. So the powers that be are now using taxpayer dollars to artificially prop up the financial and real estate sectors. They continue to make the same mistakes over and over. The cure is to let the system cleanse itself. Japan already tried this approach and it led to an 18 year recession. Oops!

The end result of all this meddling will be much higher taxes and most likely a hyperinflationary depression. It's simply not possible to legislate or print the credit bubble away.

Artificially propping up housing prices just means that housing remains unaffordable. Oops! That means inventory remains high. Throwing trillions of dollars at the problem just means taxes will have to rise and inflation will heat up again. Just what you want as unemployment continues to rise. Oops! If inflation starts to rise again interest rates are going to move higher. As subscribers know I think we saw the end of a 28 year bear market in bond yields last week.

Combine ever rising interest rates with housing prices that are not allowed to correct and you get the ingredients for more foreclosures and ever larger inventory. Oops!

Now the powers that be have decided that short selling is the root of all evil in the financial sector. It has nothing to do with banks being insolvent of course. So by making shorting illegal the SEC has taken away a very powerful supply of buyers from the market. When the next leg down in financials finally comes there will be no shorts to cover and put a floor under the banks. Oops! The next leg down will probably only be halted by making it illegal to sell financial stocks. Imagine that, you won't be allowed to sell stock in a bankrupt company.

I know it sounds ridiculous but then who could have dreamed in Jan. that shorting would be abolished. If the FED's meddling had been aborted back in 2000 we would already be through this and on to much better times. Instead we are looking at years and years of tough times ahead. Oops!

Manipulation

There are historic changes going on in the markets. The government now is in the business of monetizing bad debt. On top of that the markets can no longer even be considered free with the ban on short selling. This is simply amazing to me.

Now let me tell you that in the end the overall trend of the market can not be manipulated. The Fed has been trying to manipulate the markets since 2000. When the tech bubble burst the FED debased the dollar and lowered rates to 1%. The unintended consequences where the real estate bubble and credit bubble. When the credit bubble burst the attempt to keep the bubble inflated spawned a surge in inflation, most apparent in spiking oil.

Does anyone seriously think that the current meddling will have no long term consequences? Of course the "powers that be" want to bandaid over all of the credit problems prior to the elections.

I've got news for everyone, there is no freebie fix for what ails us. We simply have to take our medicine in the end. Pumping a cancer patient full of morphine may mask the pain but its not going to cure the cancer.

We just had the largest credit bubble in history. The last one spawned the Great Depression. The continued attempts to manipulate the markets is almost sure to guarantee we are now headed down the same path as 1930. The only question is whether it will now be a deflationary depression or a hyper inflationary one.

Weekly charts

I've posted a few weekly charts in stockcharts public chartlist. I always check to see what the weeklies are telling me before I try and wade through the noise of the daily charts. I would appreciate it if you would take a second and click on the tally link at the bottom of the chartlist.

Gold's largest one day move in history

I remember having a debate some time back about gold. I felt confident that at some point we would see gold moving higher by $100 a day. While I still think we are many years from the top in the gold market and I'm not even sure if commodities are in a cyclical bear market or not, I think we got our answer yesterday as to whether gold is capable of moving by huge amounts daily.

I still have no doubt we are going to eventually see a Dow:Gold ratio of 1:1 before this is over.

Watching the 30

On Sept. 9th I sent out what I considered my most important update of the year. The subject of that update was the 30 year bond. The conditions are now playing out. We should have our answer shortly although the move in gold today is suggesting it knows where the 30 is going.

A pair of 2b's

The market topped in May with a 2b reversal. Now it looks like it's bottomed with that exact same 2b reversal. As I pointed out in yesterdays update we were setting up for an intermediate term bounce as panic selling was starting to show up almost everywhere.

It's time to get long for another bear market rally in my opinion. Actually it's "normal" for the market to rise into a presidential election.

I'll have more in tonights update.

The market is nearing an intermediate bottom

We are finally seeing true panic today. This is how intermediate bottoms are made. Just look at the put call levels. These kind of spikes are indicative of bottoms. This is just one of a myriad assortment of breadth and sentiment indicators that also spiked today. I'll explain in more detail in tonight's update.

I have to take note that the S&P is nearing the 50% Fibonacci retracement level. We may have a bit more downside tomorrow to push the market down to tag that line but the odds are now in favor of a relief rally soon. These levels of fear just can't be maintained forever.

Of course whenever we get a decline like today we start hearing the calls for a crash or it's 1929, 1987 all over again. While anything is possible it's not likely. Crashes come either in bull markets or at the very beginning of bear markets following a parabolic rally. They don't come after we've been mired in a bear market for almost a year and have already lost more than 20%.

Besides that I think its safe to say there is now very little doubt we are in a very left translated 4 year cycle. These left translated cycles don't crash. They slowly bleed you to death over the course of a couple of years. The next expected 4 year low is either summer or more likely the fall of 2010.

As I've been alluding to in the daily and weekly updates, I think there is a much better place to play the likely rally than the general market. Details in tonight's update.

Gold charts

I've posted a few gold charts to stockcharts public chart list with info on what I think is going to unfold in the next couple of months. If you find them helpful feel free to click on the tally link at the bottom of the screen.

weekend report

We've been waiting a long time for this one :)

Finally this week the COT has given us the signal we've been looking for.

I'll explain in the weekend report and how I intend to play this signal.

Market setting up for a crash?

The Nasdaq appears to be in the early stages of a waterfall decline. So far there is no indication of a midpoint consolidation. The problem is that both of the bellweather tech stocks AAPL and GOOG are breaking down. A break below $150 for AAPL and below $400 for GOOG will likely send the market into a tailspin.

The energy stocks where strong today. I have to wonder if oil is going to bounce on the production cut by OPEC. In it's fragile state I'm thinking the market may be ready to fall apart and this may be as good a reason as any. Not to mention there is roughly 600 billion in short term debt that needs to be rolled over this month by the financial system. One has to wonder who is going to step up with fresh credit.

Now if we do see a crash right before elections you can bet your bottom dollar the FED is going to freak out and start cutting again. If that happens you can say good bye to the dollar rally and hello to hyperinflation.

I find it hard to believe Bernanke would be that stupid but so far neither Bernanke nor Greenspan have let me down.

The most important chart

This is the key to the markets right now. Tonight's update will probably be the most important report I write this year.

The end of the bear?

I saw quite a bit of talk this weekend about how the FNM & FRE bailout was going to signal the end of the bear. Let's step back for a minute and consider this shall we.

First off let me remind you what bear markets do, especially secular bear markets. They take valuations back to ridiculously cheap levels. They do not take values back to the average. That's not how human behavior works. The current trailing P/E ratio for the S&P is about 20. Granted prices have come down a lot so theoretically P/E ratios should be falling right? Well the problem is that earnings are coming down even faster.

Unemployment is still rising. housing prices are still falling. Pray tell how are earnings going to rise if more and more people are out of work? If those same people can't rely on asset appreciation then how is consumption going to be maintained? In a recessionary economy how are earnings going to grow? If earnings aren't growing or heaven forbid contracting (which they are) what is the incentive to bid up stocks?

In the end all the chart patterns, COT reports, trend lines, price of oil, etc. etc. are meaningless. If earnings are contracting stocks are going to be moving down. It really is that simple.

At the moment wall street is projecting next years earnings at $100. The problem is that this years earnings look to come in around $63. One has to wonder how in a global economic recession earnings are going to grow by 50% next year. I suspect the market is going to be sorely disappointed. I have to wonder how likely a disappointed market will be to bid up stock prices.

So let's see, did the bail out of the GSE's do anything to change the economic outlook? Did it in anyway change the employment picture? Will it somehow prevent upside down home owners from walking away from their homes. Will it in any way increase demand for still overpriced real estate? Does it somehow shrink the national deficit? Does it stem the tide of rising credit card and auto delinquencies and defaults? I have to think the answer to every one of those questions is no.

So what exactly did happen this weekend. It seems to me that the powers that be just stuck another finger in another hole in a severly leaking dike. I have to wonder how many more holes are ready to spring up and how soon before the leaks get too big to be plugged.

Realistically does anyone think that this bailout has fixed the underlying problems that have sent the markets into bear mode?

18 week cycle bottom?

As I posted in stockcharts public chart list gold is getting very close to a major 18 week cycle low. I think there is a good chance that the bail out of the GSE's may have manufactured that low just a little bit early. I wasn't expecting it for a few more days. As you can see in the chart the gold:XAU ratio is about as stretched as it has ever gotten. We should see a powerful rally in mining stocks maybe starting tomorrow and if not tomorrow, soon.

I'm still expecting that rally to ultimately fail but if gold can regain $850 there is a good chance it will at least test the 200 DMA again. That could put gold back in the $900 range.

Newton's Third Law

I'm guessing everyone knows Newton's third law of motion. It states for every action there is an opposite and equal reaction. I think we can apply this law to investing and to economics.

Have you ever noticed that for almost every parabolic spike there is a parabolic collapse. Have you noticed that the longer a sector spends at the top of the market the further and harder it falls once it tops out. Take the energy sector for instance. Oil stocks were at the top of every one's list for most of 08. However for the last couple of months they have been one of the worst performing sectors. Commodities soared during the first half of the year. Now they are falling just as fast if not faster.

I've been saying for quite a while that the world is going to suffer through a very serious recession. The more I think about this the more I think I'm going to be wrong. I don't think we are going to fall into a recession, I think we are most likely going to fall into a depression.

Let me explain. First off history has shown that the world suffers a depression about every 70 years. It takes that long to work through a generation of investors so that we have time to forget the mistakes that led to the last one. They are of course massive credit expansion.

So let's take a look at recent history and see if we are heading down that same road. In 98 Greenspan flooded the world with liquidity to stop the bleeding in the financial system brought on by the collapse of LTCM. That gave birth to the largest stock market bubble the world had ever seen. Of course since there is always an equal reaction we then witnessed the total collapse of that bubble. Unfortunately Greenspan and the powers that be were not willing to accept the fact that we needed to take our medicine and let the excesses work their way out of the system. So the FED went on an even bigger liquidity binge in the process inflating the largest real estate and credit bubbles the world had ever seen. Now these bubbles are bursting. So what does Bernanke do? Of course he follows down the same path as Greenspan and floods more liquidity into the system. Since the real estate and credit markets are broken that liquidity went into commodities causing a parabolic spike in energy prices.

We are now on the reaction side of this whole mess. The historic rise will demand a historic fall before this is finally over. I don't see how we can possible cleanse the system of these incredible excesses without a global depression of similar magnitude.

There is no way that oil is going to stop at $100 after the move we just saw from the 07 bottom. There's no way the real estate market is going to bottom in 2 years from the stratospheric levels it reached during the bubble. The last time we witnessed a credit bubble even close to the magnitude of the recent levels was in the 20's. The reaction from that bubble was the Great Depression. There is no way in the world the financials have bottomed in only a little over a year and with only 10 banks so far going belly up.

In the real world there is no Goldilocks. The real world is going to demand full payment for creating the three largest bubbles in history. This is not something that is going to happen over night. It's also not something the government can stop by bailing out FNM & FRE. (The market has known this was coming for months now. It's already priced in). No there is no way to stop what's coming. All the FED can do at this point is continue to make it worse. So far that's exactly what they've done.

It could have stopped with the tech bubble bursting. If the Fed had just let the system work, the casualties would have been limited to stock market investors. Of course they didn't stop there. They created the real estate bubble and credit bubble. At it's high point this bubble affected almost 70% of the US population, not to mention a big part of the global population. When that collapsed they brought everyone on board by spiking commodity prices especially energy and food. Now we are all going to pay for the stupidity of a few people in power who think they can control the global economy. The same people who apparently think that monetary policy comes with no strings attached and that it really is possible to get something for nothing. I've got news for them it's not going to be different this time.

Not only have we come to an end of the fun part of monetary inflation but now we are entering the hangover stage of that party. It was one heck of a party and its going to be one hell of a hang over.

Bear Flag or T1 consolidation

I've been warning for weeks now that gold should likely have another leg down. Now I want to look at the mining stocks. I'm seeing a very destructive behavior amongst the gold bugs right now. Denial is it's name. There is way to little fear and way to much bottom calling in the precious metals sector.

The XAU is on the verge of breaking through major long term support. The current 18 week cycle still has 5 to 15 days to go yet before reaching the timing band for a low. I have to wonder, can the miners hold above that $120 level that long?

Now here is a scary thought that I dare say none of the gold bugs are even considering. What if the bear flag is in reality a midpoint consolidation of a T1 pattern. If it is we could see the XAU drop fairly quickly to the $70/$80 level.

I will say that this decline probably won't halt until precious metal investors experience enough pain to put an end to the bottom calling. From the comments I see on most of the gold blogs that's not even close yet.

Channel break

I've gone over historical data with subscribers that suggests we should see some kind of rally attempt after today's weak decline. However there are some disturbing signs popping up.

First the S&P looks to be trying to break down out of the rising channel. It actually moved outside the lower trend line today before managing to close back above it.

More disturbing is the relative weakness of the Nasdaq. The tech sector has clearly broken the trend from the July rally and has taken out the Aug. lows. It has failed three times to move back above the 200 DMA and is now threatening to break below the 50 DMA. If this rally were healthy we should see the speculative tech sector leading.

Remember all those analysts pumping the tech sector as sub prime proof and recession proof? Funny, I don't ever remember a recession where tech was a safe haven, do you? One has to wonder if anyone really believes this crap.

The next chart is equally disturbing. Money continues to flow into the safety of bonds. To top it all off Lowry's selling pressure is starting to rise again.

I'll say it again, bear markets end in multiple 90% down volume days followed by a buying stampede as smart money comes roaring back into the market looking to buy value. We've had one 90% down day since June and there's been no rush of institutional buying. The smart money is still trying to exit this market. The only ones buying into this rally are the retail investors listening to Cramer.

These are the same investors who bought housing stocks at the top when Cramer was pumping them in 06. Or tech in Oct. 07 when Cramer was calling for 16,000 in the Dow. Recently the minnows got caught in the great wildcatter bonanza of the summer of 08. Want to take a guess what Cramer's pumping now? Financials and housing stocks!

I can hardly wait to load up tomorrow on these buys of a lifetime???

Bear or No Bear

Tonight I've got another long term chart for you. Over the last 28 years the 20 month moving average has only turned down in bear markets. It's turned down again.

I started to hear a lot of talk this moring on the financial media how falling oil prices would save the economy. Amazingly enough I even heard that lower gas prices would translate into home owners being able to pay their mortgage and thus foreclosures would slow or cease.

All I have to say is where do they find these people? The damage has been done, we are in a bear market no matter how much one wants to deny it. Actually denial is what caused investors to ride the last bear all the way down into the 02 bottom.

Necessary Correction

Recently I've come to the conclusion that commodities have now joined the rest of the markets in a cyclical bear market. I pointed out to subscribers a while back that whenever the CRB has topped out in 19 months or less it has signalled a longer term top 100% of the time. The 3 year cycle for commodities should bottom somewhere around 2009/10.

I've pasted the Fibonacci retracements on the long term gold chart. I suspect by the time this bear is over we will see gold trade down to the 68% level. We may even make it back to $450 which is where gold took off on the Katrina disaster. Note how three years later we are in the process of taking another hurricane hit but gold and oil are trading down instead of rallying. There is a gap on the GLD chart that has never been filled from Sept. of 05. The next couple of years would be the perfect opportunity for GLD to fill that gap.

I'm going to point out that because of how human emotions work it is absolutely critical that the metals go through a major correction at this point and if not now, soon. Without it there would be little hope of this secular bull market reaching it's ultimate potential. That potential in my opinion will be a Dow:Gold ratio of 1:1 sometime in the next decade.

I'll elaborate in more detail in today's update for subscribers.