Last month I pointed out the gap through the trend on the financial ETF. This often signals a fundamental change in the market. Now a month later we can see that the financials are still locked in a downtrend. Today we have the potential for the SPY to gap through the trend line. If the gap holds and we close below the trend line today then the odds are probably on the side that this intermediate rally is done. This rally was born from the Fed cutting rates 125 basis points. So far no cuts have worked to support the market. Pure and simple we have two problems. The first one is spiking inflation especially energy costs. The rate cuts are just making this problem worse not better. The second problem is foreclosures in the real estate market are hurting the financial system. I think that in order to put in a bottom the market is going to have to see some kind of end in sight for this bleeding in the housing market. Unfortunately I don't think we are there yet. With a large supply of ARMs adjusting this year we could see another wave of stress in the real estate market. At this point it's probably to early to have an idea how big this foreclosure cycle is going to be. Until this uncertainty is clarified I believe we are still going to see stress in the financial sector.
Subconsciously I knew the Fed was going to opt for this since they have been going down this road for 7 years but I still find it hard to believe. The dollar has now broken to new lows. In an attempt to save the markets and wall street banks the Fed has now opted for hyperinflation. The process of devaluing the dollar to inflate the markets that has been in cruise control since 01 has now gone into overdrive. We now have a front row seat to a massive explosion in inflation coming down the road. The question is simply how fast the liquidity is going to leak into commodities. We've already seen the CPI and PPI show the largest jumps in years and that's the governments version of inflation. The question as to how fast this will crush the economy is how fast and far the price of oil rises. It has already broken out of a very large consolidation and closed over $101. Platinum, Palladium and now silver are all trading parabolic. Copper is trading parabolic and most of the softs are moving up in parabolas. Gasoline has jumped 20 cents at the pump in the last 2 weeks. The Fed is now guaranteeing that the slowing economy is going to be pushed into a very severe recession.
Now how can we have a rising stock market if the economy is going into a recession? Why are stocks moving up on bad news? The answer is right there in the chart. The Fed is creating artificial demand by pumping the money supply. We aren't at the bottom of a recession yet. That's when stocks are cheap and represent good value. That's the time when real demand will come in. The current rally is soley due to massive amounts of currency being injected into the markets. It is now a race between how much money the Fed can print and how fast it will leak into hard assets.
Think of it this way. Let's say instead of paper dollars the medium for currency was sand. Well sand is pretty abundant right. You can just go out and scoop up a bucket full of it. Well if anyone can obtain as much as they want why would you sell your products at a fixed price? The answer is of course you wouldn't. If everyone has access to the beach then you are going to start raising your prices. Well in the world we live in we don't all have access to the beach but the governments do. Believe me they are scooping sand like crazy right now. The laws of supply and demand will still apply. If the Fed wants to flood the world with money then people are going to want more and more of those dollars for their real products. Here's an example that I already find myself doing. The price of gas as everyone has probably noticed is rising. I now find myself stopping even if I don't need to fill up at a station that hasn't raised prices yet. All that means is that station will run out of gas faster and will quickly be raising prices since they can't keep the tanks full at these lower prices. We see the magic of inflation at work in real life. I do the same thing at the store. Anything on sale I buy it now instead of waiting till next week when the price has increased.
We've got a 4 year cycle low coming sometime in the first half of this year I suspect. As I pointed out in the previous thread when this final low comes in it usually takes down everything and that includes commodities. I'll say right now that commodities are going to hold up better than the paper markets. They certainly have held up much better during the first leg down. The second leg is going to be when the real panic will be generated. This will probably play havoc with margin calls and everything is going to get hit including commodities. We'll see all the old familiar faces coming out and predicting the end of the commodity bull. The media will tell you that commodities were in a bubble and it's now bursting, yada, yada, yada. It will all be baloney and here's why.
Take a look at the first chart. This is the S&P/CRB ratio. What we see is a historic rise from 1980 to 99 in the price of paper assets compared to commodities. From 99 to the present we see a major trend change from paper to hard assets. Now let me digress for a second and remind everyone how human nature works. Our emotions take us from one extreme to another. The larger the extreme in one direction the larger will be the swing back the other way. We don't go from one extreme to average back to extreme. It would be much better if we did but that's just not how human emotions work. So now we are in the process of swinging back to extreme overvaluation in hard assets. Keep in mind the run from 1980 to 1999 was the biggest in history...by a long shot. So far we haven't even come close to approaching the level we saw in 1980. We're only half way there and 8 years have gone by. Now the average for a hard asset cycle is between 15 and 20 years. The shortest was 9 years from 71-80. At best we're likely only half way through this commodity cycle and if human nature unfolds like I'm sure it will, we will correct the historic undervaluation from 80-99 with a move to historic overvaluation before this is over. This bull should make the 71-80 commodity bull look like child's play. This makes sense as we are now seeing a huge segment of the global population expanding at a tremendous rate of growth. Fuel for this growth has to come from somewhere. It needs energy for one thing. Energy that hasn't expanded it's infrastructure or found a giant oilfield in 40 years. It needs basic materials. Again an area that has not expanded as the devastating bear market crushed prices for almost 20 years. If the price of what you sell is consistently going down I can tell you that you are probably not in a big hurry to find more of this cheap stuff. It costs a lot of time and money to bring more production online in the commodity bussiness. Not a big priority if you are barely hanging on to profitability.
Next take a look at the ratio of the S&P to commodity related equities. We see a steady move down as the S&P consistently under performs commodity based companies year after year.
In the last chart we see the Dow/Gold ratio for the last three great secular bull markets from 21-29 the gold ratio declined to almost 20/1. Meaning that it took 20 oz. of gold to buy 1 share of the Dow. When the trend changed that ratio declined to almost 2/1. Then the next great secular bull market from 32 till 66 took the Dow/Gold ratio back up to 28 oz. of gold for 1 share of the Dow. This was followed by another commodity bull cycle and a trip back down to 1:1 on the Dow/gold ratio. Then we have the greatest secular bull market of all from 82 to 2000. Gold was crushed to the point where it took 45 oz. to buy one share of Dow paper. Now we are in the process of correcting this gross undervaluation. I have no doubt that we will see the Dow/Gold ratio approach 1:1 again and if the extreme nature of the undervaluation is any indication then we could very easily see gold surpass the Dow this time.
Today I’m going to go over second legs down in bear markets. First off let’s go over the historic stats. The average gain for final legs up in bull markets is roughly 34% if my memory serves me right. As you can see from the chart we logged in a 29% gain which was pretty close. Something else that is important and that I’ve pointed out on the chart is the nominal new high in Oct. Remember me pointing out the huge net long position in the COT’s that kept getting bigger as the market dove into the Aug. lows. With hindsight we see that the long position was justified as the market hadn’t made that nominal new high yet. Now look at the 02 low and you will see the same pattern of nominal new lows that was the springboard for this cyclical bull market. These nominal new highs and new lows are pretty typical as investors become euphoric and buy the breakout or panic and sell the breakdown. Remember me pointing out the big reduction of longs in Sept. right before the final top? Some of that smart money was sneaking out the backdoor as the top was being put in.
Now we’ve had the first leg down in the bear market. The average decline for all bear market first legs down is 20% in about 4 months. The S&P logged in a 19% loss in 3 months. Pretty close. At the moment we are in the counter trend rally that should separate the first leg from the second leg down. The average decline for second legs down is roughly 19% in about 4 months.
I'll elaborate in today's update for subcribers with some historic charts and a look at some specific sectors.
I've been watching the charts of the cubes. I've noticed that the price pattern over the last month has been much weaker than the rest of the market. This is starting to look like a midpoint consolidation in a larger technical rule #1 move. Moving to the weekly chart we see the pennant pattern forming. Again these typically form about half way through a move. Also notice that the NDX didn't close below the 07 seasonal cycle low like the rest of the market. I suspect it eventually will, it's just a matter of time. The first half of the year has been a weak time for tech. We can see on the 5 year chart that the Jan. lows were never the final lows for any of the preceding 5 years of this bull. This has actually been the case for the last 7 years. Now that we are in a bear market I really doubt that the Jan. lows are going to hold on the tech stocks during a seasonally bad time of year, during a slowing economy and one that likely is already in a recession.
I pay attention when Jim Rogers speaks. He has his own money and unlike many analysts or CNBC guests has no ulterior motives and no one he has to answer to. He tells it like it is. Here is his latest interview and his views on oil, gold and the commodity markets in general.
The breakdown out of the Pennant is still intact. IMO the strong Yen was the thorn in the Fed's side. No matter how much money they threw at the markets as long as the 1.2 trillion in carry trades were unwinding it wasn't going to do any good. Now the Yen is correcting the last advance. As long as this continues then I suspect the market should continue to drift upwards as the Fed unloads massive amounts of liquidity on to the markets. The key words here are "drift higher". The problem is that a great amount of this liquidity is leaking faster and faster into the commodity markets. When inflation starts to rear it's ugly head money will start to gravitate towards real things and away from paper assets. Sound familiar? Like maybe something we've been seeing for 6-7 years now. Only now it's starting to accelerate. ouch!
I will be watching for the Yen to approach that long term uptrend line and reverse as a sign to intiate shorts again.
This morning Gld gapped above the upper trend line of the consolidation pennant. As I've mentioned before these often form at the midpoint of a move. Remember anything can happen and this mornings gap is no guarantee that the rally will continue. But it does push the odds a little more in favor of the rally continuing. The public is just starting to take notice of gold at this time. This is what's needed for a parabolic move to finish off this intermediate move, similar to what's happening in the Platinum and Palladium markets.
Today I'm going to point out something that I normally reserve for subscribers but I think it's important enough to put on the blog for everyone to see. So far the COT reports for gold and silver have continued to build larger net short positions as the price of gold and silver move up. That's about normal as miners use the futures market to lock in high prices. However there are also bullion banks that use the futures markets to suppress the precious metal prices. If gold was allowed to rise to $1000, $1200 or $1500 it would be readily apparent that we have an inflation problem. Rising oil can be written off as limited supply for the escalating price. Which to some extent is true. However all the gold ever mined is still around so it's not like we have a supply shortage. The major cause of the rise in gold is solely the fault of excess liquidity created by central banks around the world. I've stated many times that I'm not brave enough to short gold. If it corrects then I will be happy to buy more but no way will I short. It's just too risky. Now let me show you what I mean. I'm going to use Platinum and oil as an example. Both had extremely large short positions in the COT's at the beginning of Jan. For oil the commercials used any weakness to drastically reduce shorts. What has happened oil's decline was halted and it's now in a trading range and apparently back on its way to test $100 again. Keep in mind this is happening as the economy is at the minimum in a drastic slow down and likely in a recession. I don't buy the idea that commodities are going to take a huge hit in a recession. Nope not for one minute. The Fed is printing too much money to allow commodities to fall much. Now let's take a look at Platinum because I think it shows us extremely well the danger of being short when the commercials have a large short position. Since Jan. the price of Platinum has refused to drop no matter how much the commercials shorted it. Then the news about mining delays in South Africa surfaced. The price of Platinum started to move up even faster. What did the commercials do? They panicked and started to cover into strength. A short squeeze followed. What has happened to the price of Platinum? It has now gone parabolic which has caused the commercials to cover even more.The bullion banks are in the exact same situation in the gold and silver markets. They have a huge short position on. They have been losing billions as the price of the metals move up. If this continues they are going to panic also and have to cover into strength. If this happens we are going to see the same parabolic move in gold and silver as we've seen in Platinum.This is why it's so dangerous to try and short the metals at this time. If there is a pullback then use it to buy more but this thing is a ticking time bomb and I don't have any idea whether the powers that be will get it defused before it goes off or not. Let's just say I want to be in the rocket chair just in case it does.
I'm watching the small pennant forming in GLD. Usually these occur about half way through a move. A break to the downside and I would expect a move back down to the consolidation area of Nov. and Dec. However if GLD breaks up I would expect a move of similar magnitude as the first leg from Dec. to Jan.
We've had this discussion before as to whether stocks have been in a secular bear market since 2000. The recent market action over the last 4 months makes it a little easier to accept the fact that we are in fact in a long term bear market in paper assets. In 2000 the P/E on the S&P was over 40. Today it's down to the 14-15 area. 15 is about the long term average P/E for the market. So we aren't overvalued here by any stretch of the imagination. When the market bottomed in 02 the P/E for the S&P was roughly 27 if my memory serves me. So basically at the last 4 year cycle low the market was still extremely overvalued. What's happened? Well the Fed turned on the printing presses. That liquidity flowed not only into commodities but also into corporate earnings. So the E side of P/E's has increased. Unfortunately there has been a cost for those increased earnings. Of course one of the prices we are paying is higher inflation. However that's not the only price we are paying. It was easy money that created the tech bubble. In 2002 to 2007 easy money also created the real estate bubble and the credit bubble. Bubbles aren't sustainable. We've seen the real estate bubble collapse leave a swath of destruction in its path of falling home prices, foreclosures and home owners in dire straights. Following hard on the heels of the bursting housing market we are now watching the collapse of the credit bubble with the attendant collapse in the financial sectors. The lesson of course is that there is no free lunch. The Fed was unable to "cure" the fall of the tech bubble with easy money. All they did was create two larger bubbles that are now blowing up and in the process are affecting a lot more people than the stock market bubble popping did. We are getting a front row seat as to how secular bear markets work. There is no easy way around them. There's no quick fix. As a matter of fact all the efforts to side step the bear are just making the problems bigger and badder.One thing that you can count on from the markets is that they will swing from overvalued to undervalued over long periods of time. They don't swing from overvalued to fair value and then back to overvalued. Not once in history has this been the case. So far the market has moved from extreme overvaluation in 2000 to fair value. Mostly on the back of easy money. Now that policy is coming back to bite us in the ass. The Fed's response is more easy money. It has to go somewhere. I seriously doubt we are going to make the same mistake again so quickly and reflate either the real estate or credit bubbles. No this time the money is going to go into the commodity markets. The Fed is sowing the seeds for the next leg down in the bear. That of course will be soaring inflation. Make no mistake this bear isn't going to end until stocks become extremely undervalued, just like every other time in history. We are going to have rallies that will fool everyone into thinking that the bear has been conquered but I guarantee he won't be until his work is finished. For the last 7 years the Fed has just been feeding the bear more and more food.
It appears that the runaway move in gold is still intact. The corrections now fall in the $50-$60 range. The odds are now strong that the move will continue until we see a correction that exceeds this magnitude.
Yesterday we got the answer to whether the Yen would break up or down out of the consolidation. We also saw the Euro dropping big yesterday. The pound has been going down for some time. This is one of the things I was looking for as a signal that the rest of the world was going to capitulate and join the inflation train. Britain has been on board for some time but I think the odds are now good that the Euro zone and Japan have finally panicked and turned on the printing presses. This may be a positve for the dollar but it's also going to be a positive for commodities in general. Yesterday we saw the unusal occurence of the dollar very strong and gold also moving higher. As long as the Central banks around the world are going to flood the globe with paper then commodites are going to continue to move higher in every currency.
Yesterday something happened that doesn't bode well for the market. When the market gapped down through the trend line it was a signal that something fundamental had changed in the market. The obvious answer is the ISM report made it clear to everyone that we are in a recession. Here's the next thing that has me worried. It seems the media pundits have come the full spectrum from no way we are going to have a recession Goldilocks is alive and well. Then it progressed to only a very slim chance of a recession. Then: well maybe a 50/50 chance. Now it's: we are probably going to have a recession with the caveat that it will be mild. That caveat has me worried. Investors have been in denial the whole way. In secular bear markets recessions tend to be rather nasty. I don't know how many are old enough to remember but we had multiple recessions during the last secular bear market from 66-82. Most of them were not pleasant. The markets inability to rally today after yesterday's 90% down volume day also doesn't bode well.
At the moment I'm watching the pennant forming in the Yen. If this breaks to the upside it's going to put a lot of pressure on the markets as the carry trades begin to unwind again. If it breaks to the downside then there's probably a good chance the Jan. lows will hold. Usually these little triangle consolidations form about half way through a move which doesn't bode well for the market. The last explosive rally spawned the waterfall decline in the global markets. I suspect that another such rally would have similar effects. So far we've seen 200 basis points of cuts from the Fed with no effect. You have to wonder at what point do they finally figure out that you can't cure inflation with more inflation. Granted we are going to experience deflation if the economy slips into recession. The problem is that when we emerge from that recession we will have put into place all the ingredients for soaring inflation again which will most likely have the same effect next time that it did this time. That being spiking energy prices and constrained economic growth. The vicious cycle of stagflation then emerges. By trying to save the economy before the elections the Fed just guarantees that the problem gets bigger and bigger.
I'm sure everyone knows by now I'm not a big pattern fan. There are two patterns that I do pay attention to. One is triangle patterns. These are almost always a consolidation or distribution pattern. The other is the technical rule #1 pattern. (The tech rules are on the lower right side of the home page). The more I see this pattern the more useful I find it. More on this pattern in tonights update for subscribers. Looking at the chart above we see the tech rule 1 pattern playing out to a tee. the first move down followed by a short consolidation and then a second leg down of similar magnitude. Then a retracement back to the consolidation area. I've also noted the resistance level from the Aug. & Nov. lows along with the declining trend line. I suspect somewhere around 1400-1425 the market is going to run into stiff resistance and we are going to break the rising trend out of the Jan. low for a retest of the lows and possibly another leg down.
Despite the latest rally the monthly charts are showing a deteriorating picture. The 12 month moving average is now turning down. Something that hasn’t happened during this bull market. I would like to se a test of that moving average and failure before adding to any shorts. In the last 28 years any time Jan. has been a down month there has always been lower lows to follow later in the spring or summer. At this time I don’t think we’ve put in the final 4 year cycle low. I do think we most likely still have more upside to this rally though before the bear returns to finish his work. The COT’s showed a large increase in longs which would also suggest that there may be more upside yet to come.
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T1. A move followed by a sideways range often precedes another move of almost equal extent in the same direction as the original move. Generally, when the second move from the sideways range has run its course, a counter move approaching the sideways range may be expected. T2. Reversal or resistance to a move is likely to be encountered: - 0n reaching levels at which in the past, the commodity has fluctuated for a considerable length of time within a narrow range - On approaching highs or lows T3. Watch for good buying or selling opportunities when trend lines are approached, especially on medium or dull volume. Be sure such a line has not been hugged or hit too frequently. T4. Watch for "crawling along" or repeated bumping of minor or major trend lines and prepare to see such trend lines broken. T5. Breaking of minor trend lines counter to the major trend gives most other important position taking signals. Positions can be taken or reversed on stop at such places. T6. Triangles of ether slope may mean either accumulation or distribution depending on other considerations although triangles are usually broken on the flat side. T7. Watch for volume climax, especially after a long move. T8. Don't count on gaps being closed unless you can distinguish between breakaway gaps, normal gaps and exhaustion gaps. T9. During a move, take or increase positions in the direction of the move at the market the morning following any one-day reversal, however slight the reversal may be, especially if volume declines on the reversal.
General Trading rules
G1. Beware of acting immediately on a widespread public opinion. Even if correct, it will usually delay the move. G2. From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume increases. G3. Limit losses and ride profits, irrespective of all other rules. G4. Light commitments are advisable when market position is not certain. Clearly defined moves are signaled frequently enough to make life interesting and concentration on these moves will prevent unprofitable whip-sawing. G5. Seldom take a position in the direction of an immediately preceding three-day move. Wait for a one-day reversal. G6. Judicious use of stop orders is a valuable aid to profitable trading. Stops may be used to protect profits, to limit losses, and from certain formations such as triangular foci to take positions. Stop orders are apt to be more valuable and less treacherous if used in proper relation the the chart formation. G7. In a market in which upswings are likely to equal or exceed downswings, heavier position should be taken for the upswings for percentage reasons - a decline from 50 to 25 will net only 50% profit, whereas an advance from 25 to 50 will net 100% G8. In taking a position, price orders are allowable. In closing a position, use market orders." G9. Buy strong-acting, strong-background commodities and sell weak ones, subject to all other rules. G10. Moves in which rails lead or participate strongly are usually more worth following than moves in which rails lag. G11. A study of the capitalization of a company, the degree of activity of an issue, and whether an issue is a lethargic truck horse or a spirited race horse is fully as important as a study of statistical reports.
Investing in the financial markets can involve considerable risk. Past performance is not necessarily an indication of future performance. The information included in The Smart Money Tracker and The SMT subscribers daily updates is prepared for educational purposes and is not a solicitation, or an offer to buy or sell any security or use any particular system. Information is based on historical research using data believed to be reliable, but there is no guarantee as to its accuracy. G.D.S L.L.C., nor Gary Savage, do not represent themselves as acting in the position of an investment adviser or investment manager for funds that are not under their direct control and fiduciary responsibility. GDS L.L.C., Gary Savage, will not provide you with personally tailored advice concerning the nature, potential, value or suitability of any particular security, portfolio or securities, transaction, investment strategy or other matter. From time to time, GDS L.L.C., Gary Savage, may hold positions in securities mentioned, but are under no obligation to hold such positions.