HERE WE GO AGAIN

When the tech bubble burst in 2000 it took the Fed two years to get the bear back under control. Actually two to two and a half years seems to be about as long as most bears can be sustained. So it probably had nothing to do with the Fed. The bear just ran out of sellers. But eventually when the bottom was reached it arrived at that point with a whole lot of liquidity sloshing around from the Fed’s printing presses. The result was a very powerful bull market that, thanks to continued liquidity injections, lasted longer than all but one bull market in history. Unfortunately the unintended consequences of the Fed’s interventions in the market came back to bite us in the ass.

Ultimately what we ended up with was the largest real estate and credit bubbles the world had ever seen. The fallout from the bursting of those two bubbles has not been pleasant to say the least and the mess that was created is going to be with us for a long time.

Anyway it’s pretty easy to see the effects of printing billions of dollars. A spectacular bull market lasting over five years followed by one of the worst market crashes in history.

So now Bernanke, following in Greenspan’s footsteps, has decided to go down the same path again. Only this time the intervention isn’t measured in billions, it’s measured in multi trillions. Let’s step back and take a look at the effect this insane monetary policy has had so far. What we see is a much more violent rally than what happened during the last cyclical bull. This is a bull on steroids.

When viewed from a longer term perspective the current correction can be seen for what it really is, a minor blip so far. As I’ve said all along, this is just a profit taking event in an ongoing liquidity fueled cyclical bull. But instead of being fueled by billions of dollars this bull is being fueled by trillions of dollars. If you look back at the earlier chart you will notice the last bull “tested” the lows in March `03. This bull has been powered by so much money that no test of the bottom was even vaguely possible. That alone should be a clue that something unnatural was happening.

Now here’s what I hear from most analysts. By far most people are in the camp of a continued bull, but one where the gains come much slower. Something similar to what happened from `04 to `07. The other camp believes this is the beginning of another leg down in the secular bear market.

Here’s what I think is probably going to happen. Both camps are going to be right, but they are also going to be wrong. Let me explain.

First off there’s no question we are in a secular bear market. One that still hasn’t reached true secular bear market bottom valuations yet. In that context yes the market is going back down. Let’s face it, all the printing didn’t stop the bear last time. All it did was give us a temporary high followed by a much bigger headache than we had to begin with. Does anyone seriously think the same formula only 1000 times bigger is going to produce a different result? Well I guess Bernanke does, but in his defense I think he’s probably insane. In any case I can assure you that it will not achieve a better outcome. As a matter of fact it’s going to produce an outcome many multiples worse than what we just went through.

So yes, we are going back down eventually, but to think that the trillions of dollars being pumped into the market is going to only produce a meager 10 month two leg rally is probably unreasonable. We’ve already seen those multi trillion dollars produce one of the most violent rallies in history. I would say the odds of this bull market ending here are slim. Especially considering that Bernanke has no qualms about printing another trillion or two or twenty if need be. No, I think the bulls are going to be correct on the continuation of the bull. Where I think they are going to be wrong is the speed in which this bull unfolds. I’m beginning to question whether the next stage of the bull is going to “slow down” like it did from `04 to `07. As a matter of fact I think there’s a decent chance the massive liquidity condenses the rest of this cyclical bull into one more leg up that may take the market close to the old highs.

Bull markets tend to see the most rapid advances at the beginning and end. The first leg up tacked on 300 points. The second leg 200 points. Is it really all that hard to imagine another move of 300 points over the next 4 or 5 months resulting in a three legged bull market. I’m guessing that no one is expecting that scenario. Most bulls are hiding in the corner right now and most of the bears are planning for Armageddon. Both will be completely unprepared for a third powerful push higher. I’ll also say that no one will be prepared for the massive catastrophe that will surely follow.

GETTING CLOSE

The waterfall decline the market is experiencing is now in the second leg down. These second legs tend to burn out fairly quickly, usually lasting from 3-5 days.

Friday was day two. So I don't think I would be looking for a bottom just yet. Probably Tuesday or Wednesday are more likely targets.

We are getting close though. Sentiment is pushing extremes that were last seen at the March bottom on some indicators. The dumb money sentiment is now at levels lower than it was at the July intermediate cycle bottom. Smart money sentiment is now more  bullish than any other time during this cyclical bull.

I have to ask which side of the tracks would you prefer to be on? The side that trades based on emotion, charts and guesswork or the side that controls most of the money in the market and trades based on logic, inside information and statistically data?

Longs need to be prepared to hold on through a few more ugly days  though, as I expect the S&P is going to tag the 1040ish level before this selling climax exhausts itself.

It's not unusual to see an exhaustion move on the last day with a big intraday reversal. And once the bottom is in the snapback rally tends to be violent. Usually recovering all of the second leg down very quickly and if the market is in a cyclical bull like this one is, then it's usually not long before all the losses are erased and new highs are seen.

Actually the odds are very high that we will see new highs within a month. During the last intermediate cycle low in July the market was back at new highs 9 days after the final bottom was in.

We are already seeing signs of institutional buying on down days. Almost always a reliable sign of an impending bottom.

The average gain out of an intermediate cycle low is between 6% and 10% for the initial thrust out of the bottom.

So while I expect the next couple of days to be pretty ugly the rebound after the selling climax exhausts itself tends to be fairly violent.

WHAT DO YOU BELIEVE?

I've found that one's belief in an asset tends to be directly proportional to how well they time their entry. Just as an example let's say you are still in cash waiting to enter mining positions. I'm sure there are some in this position. My guess is that those people are drooling at the mouth waiting to get in. They believe!

Of course on the other side of the spectrum we have the guy who entered at $1225. This guy is freaking out. He's knows for a fact that the secular bull is dead. He can't wait to get out!

Now let me ask you this; pretend you have no position at all. Would you be a buyer or a seller of gold & miners at this level? If you would be a buyer with no position why in the world would you be a seller with a position?

Weirdly enough  a short seller will be more confident in his position at the moment of entry. The exact time he has the most risk, than if he's already into profits by a healthy margin.

So if you sold gold short at $1225 do you add to shorts here or are you looking to cover at these levels?

It's all in what you believe and that belief is heavily influenced by the accuracy of your entry.

WATERFALL DECLINE ENDGAME

The markets are entering what appears to be the second leg of a waterfall decline. I've noted in the past that the second leg of these kind of moves typically last 3-5 days. Yesterday was the first day of the breakdown out of the consolidation so if history is any indication we should see at least 2 more down days before this ends.

As strange as it sounds since I'm long, I want to see this move complete. I need to see this drop at least -8% peak to trough to be sure this is in fact the correction separating the second leg of the bull from the third.

I do expect at least three legs up in this bull market. Under similar conditions the Nikkei in the 90's managed at least 3 uplegs in each cyclical bull.

If this does continue it will confirm that this is in fact an intermediate degree correction. The initial thrust out of that kind of low once the selling pressure exhausts tends to be fairly explosive averaging +6% to +10%.

A further corrective move would also confirm this is the bottom of a very stretched intermediate cycle that started in July. That would open the door for another 10-15 weeks of higher prices before the next cycle low would be expected.

It would be much easier for the second stage of the C-wave to unfold if it doesn't have to fight a declining market.

GOLD BUBBLE?

The talk today is all about George Soros call that gold is in a bubble. First off let me remind everyone the Soros isn't an idiot. He's one of the most savvy investors in the world. I expect George knows what a bubble looks like and what it doesn't look like.

Currently less than 25% of all professional money managers have ever owned gold. Does that sound like a bubble?

I'm just guessing but I doubt that 1 in 100 average Joe's have ever owned a gold coin. (I'm being generous. I suspect the true number is less than 1 in 10,000). I doubt 99% of the population has ever even seen a gold coin. Does that sound like a bubble?

During the housing bubble it wasn't unusual to see people camped out overnight waiting to bid on real estate. Sometimes the builder hadn't even broken ground yet.

Has anyone seen a line in front of the local coin dealer waiting for the doors to open lately? When you do then we can talk about a bubble.

I suspect that wily `ole George is interested in knocking the price down so he can buy in at cheaper prices because I'm pretty sure George Soros knows what a real bubble looks like and it ain't gold.

SAME `OLE PATTERN

In bull markets when an asset gets stretched far above the mean one of two things happen. Either the asset goes through a period of consolidation to allow the 200 DMA to "catch up" or it corrects.

I consider the second phase of the secular bull in gold to have started with the C-wave advance in `06. We are now into the third C-wave of this stage of the bull.

Each one of these advances has followed this process. The first half of the C-wave takes gold and miners well above the mean. Then follows a period of consolidation or correction to work off that overbought condition followed by the second half of the C-wave which has ended in a large parabolic move both times (I expect this time will be no different).

In both cases so far gold has consolidated and the more volatile miners have corrected.

So far it appears that this time we are just following the same `ole pattern that every other C-wave has followed during the second stage of the gold bull market.

DON'T MISS THE FOREST

Most investors have such short little attention spans they never see the forest from the trees. It's exactly this preoccupation with the immediate that prevents the vast majority of people from making any money in the stock market much less get rich.

The simple fact is that the strategies with the largest reward almost always have the largest drawdowns. If you want to make the big money you have to adjust your thinking. I can tell you that you are never going to get rich by day trading the market. You might make a living but you are never going to be the next Warren Buffett, George Soros, or Jim Rogers.

Patience my friends is a priceless commodity in this business. One that is in very short supply in the retail community.

Let's step back, look past the trees at the forrest, and see what's really going on in the precious metals market.

That breakout above the old highs at $850 is a major breakout. One that I doubt will ever get penetrated again during the rest of this bull market.

During the crash last year, in a period when everything was being thrown overboard, the demand for gold was so great that you couldn't buy it...anywhere. There was none to be had. And even though the paper price for gold dropped to $680 the real price, the price you had to pay to order actual gold, that you might take delivery on in 2-3 months if you were lucky, was almost $100 higher.

Now we are hearing calls from every angle about the imminent collapse of gold. But what is the real story? The real story is that despite a powerful rally in the dollar gold hasn't even tested the recent breakout level. It's not even very close to testing that level.

When you stand back and look at the big picture it's easy to see that gold is exhibiting tremendous relative strength. The two strong sisters Palladium and Platinum are showing even more relative strength having already eclipsed their December highs by wide margins.

While I think it's virtually impossible that gold will ever penetrate the $850 level again I also doubt we are going to see sub $1000 gold for the rest of this secular bull.

SIMILARITIES CONTINUE TO DIVERGE

I've been expecting a correction to separate the second upleg of this cyclical bull from the third for some time now. There have been 7 other bull markets with similar DNA to the current bull. The average historical decline for the counter trend move has been between -10% to -14%.

Orginally I was expecting that move to unfold gradually like it did in `04.

However the recent price action is suggesting that the market is going to diverge from the `04 scenario and correct quickly with a very sharp move lower. While scary the whole correction should run it's course quickly. My guess is that this should be over within a week or less.

If historical precedent holds the market should correct to at least the 1035 level before the third leg begins.

I expect any move to that level will have the Fed freaking out. That should get the printing presses running full blast again. You know what that is going to be good for :)

COLD HARD REALITY

I'm sure everyone has heard the old phrase "if it sounds too good to be true, it is".

I've had traders inform me repeatedly that it would be ill advised to buy and hold even during a secular bull market because occasionally during bull markets we get a severe correction like `08. The hypothesis was that one could exit if they were a trader and allocate capital somewhere else during the correction and continue making money while the bull corrected. Ultimately making a lot more money by trading the bull than just holding.

Now first off let me say I will always prefer not to ride a D-wave down if at all possible, so to some extent I will trade the bull sparingly, but the reality is that 95% (I'm probably being generous here) will not make more money by trying to avoid drawn downs with a trading approach.

Let me explain. First off one is making a huge assumption that they are going to be able to make any lasting gains by trading during a bear market or even during a correction. I dare say very few bears made any lasting money during the crash and the few that did are now in the process of giving it all back.

Next let's take a look at what you are actually competing against if you think you can outperform a simple buy and hold strategy. Let's say you bought silver at roughly $5 in `03 when it started to become apparent a secular bull market in commodities was beginning and just held on through all ups and downs. Even after the recent correction you would still be up 240% as of last Friday.

Now how many traders can say they are up 240% in 7 years? Like I said it's probably 5% or less.

Realistically what's involved in trying to produce a 240% gain in 7 years? You have to compound almost 20% annually to do those kind of numbers. Do you know how many people can manage 20% annually over any significant period? I can tell you it's not a very large number. And if this year unfolds like I expect that 240% gain may turn into a 500% gain. One would have to produce an annual gain of almost 30% to match those kind of returns.

Now I know someone will come on and proceed to tell me how they did 200% last year alone or 50% last month or some other ridiculous number. I say ridiculous not because I don't believe they did it, but because the only way one does those kind of numbers is by taking huge risk or heavy leverage. And heavy risk always means bankruptcy in the end. So I know that the person who's bragging about trading his way to fabulous gains isn't going to be around long. I'm only interested in looking at traders who are intelligent enough to recognize the real limitations in this business. Idiots taking 20 to 1 risk or even 3 to 1 risk are of no concern to me as they aren't long for this world. They certainly aren't going to survive 10 years.

The cold hard reality is that the only, and let me stress only, way for a trader to make lasting money is by strictly controlling risk. That means a trader absolutely must keep position size small if they want to have any chance at all of having more money 10 years from now than they do today. That simple fact alone makes it very very hard to even average 20% annually much less 30%.

So all in all, the chances of a trader out performing a simple buy and hold strategy during a secular bull market, even if the long term investor must occasionally hold through a wicked correction, are almost nil.

So perhaps one might want to think twice before buying into the BS peddled by gambl ... I mean traders, spouting get rich stories.

It's not what you know, it's what you think you know that just ain't so, that gets you in trouble.

DOW:GOLD RATIO

I've been  been asked if I think the C-wave is over and possibly gold's D-wave has begun. Well as always anything is possible but the fact that we still haven't seen many of the typical conditions of a C-wave top makes me think this C-wave still has one more leg up to go.

For one the Dow:gold ratio never made a lower low at the December top.

This has happened at all but one other C-wave top. Since gold entered the second phase of its bull market in `06 both C-wave tops have moved the Dow:gold ratio to new lows.

In three of the last four C-wave tops speculation in the silver market has spiked the gold:silver ratio down to at least 50 oz. of silver to 1 oz. of gold.

You can see at the December peak the gold:silver ratio was a long way from 50. Sentiment obviously hadn't reached the fevered pitch that has marked most of the previous C-wave tops.

Finally the magnitude of this C-wave has been too mild so far.

Considering the size of the consolidation and the fact that the A-wave during this cycle has been the most powerful of the entire bull market, along with the B-wave being the weakest of the entire bull market, that suggests we should see one of the most powerful C-waves of the bull market. The last two C-waves managed a 275 and 309 point gain above the prior C-wave top respectively.

So far this C-wave has only taken gold 190 points above the prior C-wave top.

I think gold has one more leg up before this C-wave is finished.

DOLLAR BEAR

First off let me start by noting that almost all bear markets tend to unfold in at least three phases.

In 2001 the secular bear market began for the US dollar. Cyclically we tend to see a major bottom on the dollar about every 3 to 3 1/2 years. These major cycle lows are powerful enough that they can and do change the cyclical trend of the dollar. That means they rally powerful enough that they reverse the 200 day moving average.

Ultimately these are still just large counter trend rallies in an ongoing secular bear market so they eventually succumb to the secular trend and roll over again.

We saw the first phase of the bear come to an end with the 3 year cycle low in early 05. The next cyclical trend change came with the next 3 year cycle low in 08. This was accompanied by a severe deflationary threat as the credit bubble popped. But ultimately that still didn't change the fact that the dollar is in a secular bear market and this rally too eventually succumbed to the secular trend.

Interspersed between these major cycle lows we get a yearly cycle low that bottoms about every 9 months. These rallies are much weaker than a three year cycle low and just serve to relieve some of the bearish sentiment by regressing to the mean. None of these lows however are powerful enough to reverse the secular trend. By that I mean turn the 200 DMA.

The next major 3 year cycle low isn't due until 2011. The secular trend has again resumed as the 200 has now turned sharply lower. The odds are against this minor yearly cycle low being able to turn the secular trend.

In my opinion the dollar is now in the middle stages of the third leg down in this secular bear market that will bottom sometime in 2011.

At that point the secular trend for the dollar may or may not reverse depending on the actions of the Fed.

VIEW THIS FOR WHAT IT IS

I think folks would do well to view the recent market action for what it really is. Nothing more than profit taking in an overbought market. There is no fundamental reason for the bear to come back yet. Until there is the stock market trend will remain up, interspersed with periods of profit taking.

I've been pointing out to subscribers for some time now the extremely stretched condition of this daily cycle. We got something very similar in `04 as the second leg of that bull topped. Fundamental conditions at the time where very similar to now. A liquidity driven rally and the beginnings of slightly better economic conditions.

I really don't think the correction separating the second leg of the bull from the third leg is going to last all the way into Aug. like it did in `04. I also doubt we've put in the final top for the second leg yet either. Let's jsut say I won't be surprised if we bottom quickly and then move back up to higher highs before beginning the real correction. I expect that isn't going to arrive until at least March and maybe even as late as May.

Exceptionally long cycles like this tend to bottom fairly quickly as more and more people get more and more nervous as the cycle stretches. So when the decline does come for real everyone tends to hit the sell button quickly, which makes for sharp declines but it also means we can run out of sellers quickly.

That's what I expect to happen here. Today was probably a 90% down volume day. Those tend to occur at or very close to cycle bottoms. So while I think we probably aren't at the bottom just yet, we should be getting close.

REGRESSION TO THE MEAN RARELY MEANS TREND CHANGE

All markets regress to the mean. However, only rarely does that signal a true trend change. Right now the dollar is regressing back to the 200 DMA. But does that really mean the trend of the dollar is about to change? Is inflation as measured by the dollar about to revert to deflation?

In the last 15 years the dollar has regressed to the mean 14 times. Out of those 14 occurences only 4 of those signaled a trend change and one of those only briefly reversed the larger trend.

If history is any indication the odds of this move back to the 200 DMA changing the trend of the dollar are not good.

ONLY TRADERS CAN MANAGE TO LOSE MONEY

I've said this many times in the past but it bears repeating. The only way to lose money on the long side in a secular bull market is by trading. Unfortunately the one trait most investors have in abundance is impatience. Ironically that is the one trait that can produce losses in a bull market.

As long as one has patience the bull will eventually correct any timing mistake.

It's just senseless to take a long position in a bull market and then place a stop under it. Unless you feel that a move to your stop means further weakness and you intend to buy back at lower prices after getting stopped out there is no good reason to stop out of any long trade as it will be a winning position.

Let me show you what I mean by the bull correcting any timing mistake.

An investor could have bought the very top of every preceding C-wave and as of Friday still be in the green. I dare say they could have bought the recent top at $1225 and they will ultimately be just fine as they have a winning trade. Even if by some small chance the recent peak ends up being the top of this C-wave you still have a winning trade all you need is patience.

I will point out that all other C-waves when they topped collapsed fairly quickly back to the 200 day moving average. That's not happening here which is a pretty strong signal in my opinion that this is just the pause between the first and second phase of this particular C-wave advance.

The reality is that there are only two ways to lose money during a secular bull. One is by shorting (one has to have a death wish to short gold). Or two by trading with stops. As long as you avoid those two things it's almost impossible to lose money on the long side.

Now I know what you are going to say. What happens when the secular bull comes to an end? After all every bull eventually ends.

Absolutely true every bull does come to an end. But we know what to look for at the end of this bull.

We need to see the public flooding into precious metals. We need to see billboards everywhere touting gold. We need to see a massive parabolic spike upwards. We need to see every analyst convinced that the price of gold will never drop again. And finally we need to see a Dow:gold ratio at or close to 1:1.

We aren't even close to any of those requirements yet. Until we are the only way to lose money is by trading.

SOUND FAMILIAR?

In 1933 Roosevelt decided that the key to ending the depression was to create inflation. To that extent he took the US off the gold standard. Actually he just arbitrarily revalued gold from $20.00 to about $35.00.

The value of the dollar quickly dropped about 40%. By this time Europe was already off the gold standard and competitive currency devaluation was already well underway on the continent. In order to compete the US followed suit.

So what was the result of Roosevelt's inflation scheme?

Initially the economy saw a small uptick. Employment picked up slightly although it still remained high all the way into WWII.

But there are always unintended consequences when the government meddles in the market and this time was no different.

Commodity prices immediately shot up. Much of the agricultural markets soared up to 25% in a matter of days. The stock market took off.

The incessantly high unemployment acted to keep wages depressed. The end result was that now the average American couldn't afford to buy food and still couldn't get a job. The people that did have jobs soon discovered their paychecks couldn't keep up with the rise in commodity prices.

This gave rise to the formation of unions, strikes and ultimately civil unrest, not just in the US but throughout the  world culminating in WWII.

Last year the Fed and governments throughout the world again resorted to the printing press to combat the specter of deflation. What has been the end result so far. Well it does seem that economic activity has picked up slightly which I guess is to be expected if the government spends a trillion or so dollars on stimulus.

Stock markets around the world have soared with the influx of an ocean of liquidity.

We haven't seen much effect on employment and wage growth yet, but I guess if history is any indication we probably won't. Commodity prices have surged higher pretty much the same as they did in the severe deflationary climate of the 30's.

The only part of the equation left to play out is whether surging commodity prices combined with high unemployment and stagnant wages eventually lead to civil unrest and another major global conflict.

THROW THOSE DAILY CHARTS IN THE TRASH

One of the best pieces of advice I can give investors at a time like this is to throw those stupid daily charts in the trash where they belong.

In a raging bull market and especially in the second phase of a C-wave advance watching the daily charts will only cause you to do something stupid...like losing your position!

Trust me, C-waves will throw every possible curve ball imaginable at you to knock you off the trend. The best way to battle the bull is simply not to play his game. 

Nicolas Darvas made a fortune in the 50's by only checking the markets once a week. Darvis, a professional dancer working in Europe, made a small fortune by mostly ignoring the market. His broker would send him market data on the weekend as it was virtually imposible for him to get up to date information in Europe at the time. Amazingly enough, as long as Nick stayed in Europe and only got info once a week he was able to turn an $8,000 stake into a $2,000,000 fortune.

When he changed tactics and moved to New York so he could keep track of the markets on a daily basis he immediately started losing money.

I highly recommend his book "How I made $2,000,000 in the stock market"

So here is all one needs to know about precious metals and the dollar.

Probably the biggest favor you could do yourself at this time is to do anything else besides watching the markets. Checking the weekly close on Friday only, will probably make you a lot more money than sitting in front of your computer all day, every day.

CHALLENGE TO THE DEFLATIONISTS

The fact is that the US has now racked up over 12 trillion in debt and climbing. (If one adds in all unfunded liabilities the number is upwards of 100 trillion)

Unless one thinks that the United States of America, the largest economic power in the world, is going to willingly default on our obligations and willingly send ourselves and the rest of the world into a massive depressionary spiral I don't see any way out of this mess other than to inflate the money supply.

If someone can show me how we can possibly pay our skyrocketing debt in any other way then I might buy the deflationary scenario.

By the way I put the odds of the US willing defaulting on our debt at 0%.

And the odds of inflating the money supply at about 110%.

DOLLAR CYCLE

In the long term chart below I've marked the major 3 year cycle lows with red arrows (actually the cycle tends to run about 3 to 3 1/2 years). The shorter yearly cycle lows I've marked in blue.

You can see that only major 3 year cycle lows have been able to rally strong enough to penetrate the 200 day exponential moving average to any significant degree. All shorter yearly cycle lows (marked in blue) during this secular bear market have ultimately been turned back by a declining 200 day EMA.

Also notice that despite the severe deflationary scare last year the most recent rally out of the 3 year cycle low was unable to make a higher high above the `05 rally. The trend of lower lows and lower highs is still intact. This is still a secular bear market.

The recent rally in the dollar slightly penetrated the 200 EMA and has been declining now for almost four weeks. The next major cycle low isn't due till at least the spring of 2011 and the current 3 year cycle is apparently very left translated having lasted only  a year before topping out last March. Left translated cycles almost always move below the prior cycle lows. (The cycle that started in `01 is an example of a left translated cycle.) That puts the odds heavily in favor of this cycle moving below the March `08 lows by 2011.

On another note almost all bear markets manage three major phases. So far this bear has only put in two major down legs. The first bottomed in Dec. `04 and the second in March of `08. We appear to be in the process of putting in the next phase down of this secular bear market.

So often we as investors and traders get caught up in the day to day swings of the market that we completely forget to take into account the big picture.

Does anyone really think gold is going down if the dollar breaks to new lows? Does anyone really think inflation is going to be controlled with the dollar becoming more worthless every year?

WHERE ARE THE EXCESSES?

I've heard the deflationist argue that we can't have inflation because credit is contracting. Their stance is that since consumers aren't borrowing there is no way for liquidity to get into the system.

I've got to say that anyone who thinks credit is contracting is grossly missing the big picture.

Surely the consumer is trying to deleverage, but the slack is more than being made up for by governments. The US has doubled it's national debt to over 12 trillion in just the last few years. If you take into account unfunded liabilities estimates are around 100 trillion.

Folks that is not debt contraction, that's debt expansion on an astronomical level. What is the government doing with all that money? They are spending, spending, spending in the vain attempt to spend our way out of this recession. Anyone who thinks this money isn't getting into the economy hasn't looked at the price of gasoline lately.

The excesses have moved from Main street & Wall Street to Washington. So the question now is who is going to bail out Washington when the s**t hits the fan? ...And it will eventually hit the fan.

Unfortunately the same people that bailed out the financial system are going to bail out the government when everything starts to go sideways. Those people are the American taxpayer.

Here's what happens when Washington gets in trouble. They just turn on the printing presses and print money. That printing leads to inflation. So we the American taxpayer are going to pay for Washington's excesses when inflation starts to eat away at our purchasing power.

I dare say it's already starting, just go take a look at the aforementioned price of gasoline.

`04 SIMILARITIES ARE STARTING TO DIVERGE

A couple of weeks ago I noted the similarities between our market today and the initial push out of the `03 bottom. We may be starting to diverge a bit from that scenario.

During the corrective phase in `04 market momentum was stifled by the dollar rally out of the yearly cycle low in Jan.

We are in a similar situation right now as the dollar has rallied out of another yearly cycle low. The rally began when the Dec. jobs number came in much better than anyone expected. Traders used that positive news to cover shorts and end one of the longer down legs in history for the beleaguered dollar under the assumption that the Fed would be raising rates sooner rather than later.

This month however it's a different story as the Jan. jobs data didn't confirm the rosy picture from last month. Traders are now wondering if it's really that wise to buy the dollar. In the last year the Fed has spent, lent or guaranteed 11 trillion dollars. Money they created out of thin air. With that kind of insane supply does it really make sense to bid up the value of the dollar? In reality it is going to be politically impossible for the Fed to raise rates with unemployment still above 10%. (And no real possibility for much improvement as we can't blow another tech or real estate bubble to create jobs anymore.)

The fledgling rally in the dollar already looks like it may be running into trouble. If the dollar does roll over quickly it's going to act to support the markets and make it tougher for the correction to unfold. Unfortunately it's also going to support the massive inflationary pressures I'm expecting during the first half of this year.

My conclusion is that the market may resist the correction but I expect the resulting inflationary storm to ultimately put an end to this cyclical bull much sooner than many are expecting. I doubt this cyclical bull will make it past three uplegs and I think there is a strong possibility we will see a final top sometime later this year.

Right now I'm closely watching how the intermediate cycle in the dollar unfolds as it will probably determine the fate of not only the stock market but also the global economy going forward.

There are going to be consequences to printing 11 trillion dollars... and they aren't going to be good.

WHERE IS THE CATALYST?

I know many bears are expecting another market collapse. We are in a secular bear market after all. But the fact remains that you can't have a bear leg down (I'm talking recession) unless you have a catalyst. Let's face it the Fed is always going to be increasing money supply. As long as that holds constant there is just no way for a bear market to take hold unless there is a catalyst.

Invariably throughout recent history there has been a common denominator in every recession. The price of oil has spiked at least 100% within a year's time. A gradual rise in energy prices can be dealt with. The economy can slowly acclimatize to gradually increasing energy costs. However when an event occurs that dramatically spikes the price of oil it has always led to a recession.

Economies can't adjust to rapidly increasing energy costs. It crushes discretionary spending. And if you happen to add in a bursting credit, housing or tech bubble on top of it you can end up with a severe (more than 40% decline) bear market in stocks along with the economic recession.

I'm constantly seeing bloggers predicting the next leg down in the bear market, usually based on some meaningless trend line or pattern on a chart. Sheesh, are these guys serious?

Markets don't work that way. You don't get a bear market because a line on a chart hits a trend line. Bear markets aren't caused by technical analysis. Bear markets are caused by deteriorating fundamental conditions.

So if we are going to get another bear leg down I have to ask what is the fundamental change to get the ball rolling? Real estate has already crashed, the credit bubble has already burst, there is no tech bubble, and Bernanke isn't jacking up rates to halt runaway inflation. So what is going to send the economy back into a deflationary collapse as the deflationists are so direly predicting (and have been for the last 10 months)?

I'll tell you what's going to send the economy back into recession. The same thing that sent it or contributed to every recession since 1974... spiking energy prices.

The Fed, and every central bank in the world has printed oceans of money to support the failing financial system. That liquidity is, and has been, looking for a place to roost. Throughout history whenever governments debase their currency it has always led to inflation.

The price of oil has already spiked from $35 to $83 so I dare say the damage is already starting. But what's worse is that we still have all that money floating around out there. Central banks have made no attempt to drain this liquidity from the system, mainly because it hasn't cured any of our economic problems yet. Unemployment is still high. Until we see strong gains in employment it's going to be politically impossible for the Fed to drain liquidity.

But like I've pointed out in past posts no amount of money printing is going to lead to prosperity.

It's like trying to turn a giant ocean liner. You can't start to turn it 100 yards before you hit the iceberg. The same is true for inflation. You can't start to fight it after it's already begun, by then it's too late. Bernanke should have begun draining liquidity last March. But like I said, at that time it was politically impossible, and still is.

So now we are at the beginning of what I expect will be a colossal inflationary storm during the first half of this year. And that is the catalyst that will ultimately put an end to this liquidity driven rally in the stock market. As strange as it sounds spiking inflation will be the trigger for the next deflationary chapter of this secular bear market, just like it was last year. 

CAN GOLD DECOUPLE FROM THE DOLLAR?

Of course it can! It's already happened three times during this secular bull market.

Everyone seems to be worried that continued strength in the dollar is going to take down gold. We've already seen the stock market and oil defy the dollar. Why should gold be any different?

Remember gold is in a secular bull market. That is a force that is not going to be halted by anything the dollar does, especially not a technical bounce in a long term bear market.

Gold is also entering the final phase of this C-wave. The upward pressure during the blowoff top in a C-wave advance is going to overpower anything the dollar does.

I suggest investors quit worrying about the dollar and start paying attention to what's happening in gold. The explosve rally this week is just about what we would expect as gold emerges from an intermediate cycle low.

WORST DECADE IN HISTORY

The mess we are now in probably had its beginnings in the financial debacle of 98. When LTCM collapsed and threatened to take down the financial system Greenspan responded by cutting rates and printing money. The result was a brief party as the tech bubble peaked. Of course as we all know that bubble was unsustainable and soon burst. The chickens of Greenspans meddling came home to roost.

In `00- `03 Greenspan had a second chance to do the right thing. If he would have just let the bear do its job and clean out the excesses that he himself created with low rates and too much liquidity we would have suffered through a nasty 2 or 3 year recession but we would now be on our way back up.

Instead he resorted to cutting and printing again. The result was one hell of a party as the credit and real estate bubbles formed. Unfortunately those kind of excesses have consequences and soon we were mired in the second worst bear market in history.

Now Bernanke is at it again only Ben is printing on steroids and has cut rates to 0.

All of this meddling in the markets hasn't stopped the bear. All it's done has given us our first lost decade.

If Bernanke really thinks he can print trillions of dollars and the US can rack up trillions of dollars of new debt every year and there will be no consequences they are sorely mistaken. The market has already given them two stern warnings that this strategy doesn't work. I wonder how many more times we have to go through this before they learn the lesson.

THE RALLY HAS BEEN TOO SMALL

If you look at a long term chart of gold you will see that most C-waves tend to rally about as far as the previous consolidation. The bigger and longer the consolidation, the bigger the C-wave tends to be.

This consolidation was huge. Roughly the same duration as the last one at a year and a half. That consolidation spawned a rally from $650 to over $1000.

The current rally has just been too small compared to the size of the consolidation for this C-wave to be finished yet.

As I pointed out in my last post we still haven't seen the signs of rampant speculation in the miners and silver that occur at C-wave tops either.

I continue to believe we've only experienced the first phase of this C-wave and the best part of the rally is yet to come.

MINERS & SILVER ARE STILL TOO CHEAP

I was hoping for a bigger correction in gold before the next leg up but the recent strength is suggesting the correction is probably over.

A larger correction would have generated the extreme pessimism that could drive the huge rally I'm expecting during the second phase of this C-wave. However we could generate the needed skepticism by having the dollar continue to rally. Just like everyone didn't believe the stock market could rally in the face of a higher dollar so everyone assumes that gold will necessarily fall as the dollar rallies.

I will say I'm a lot more confident that gold can decouple from the dollar than I am the stock market. Gold is in a secular bull market after all. That trumps any assumed currency correlation.

So far silver and miner valuations have not been corrected. Both are still way too cheap compared to the price of gold.

Before this C-wave comes to an end I expect the gold:XAU ratio to fall to or below 4.

I also expect the gold:silver ratio to spike down under 50, maybe even below 42.

CRASH 2?

I frequently see bears forecasting the next crash. Folks we've only really had three of them in the last 100 years. The most recent being last year. What do you think the odds are of another one happening this quickly? I'll tell you what they are...slim.

This obsession with an impending market crash is nothing more than wishful thinking by bears who made a lot of money last year and are now in the process of giving it all back because they can't read the tea leaves.

Folks we are now in another cyclical bull market. The credit markets aren't even close to signaling any kind of dislocation in the near future. Sure we are going to have corrections. We are due for one anytime now. But they are going to be just that, a correction in an ongoing bull market and they should be bought.

The next bear market isn't going to be started by the same catalyst that caused the last one. Housing has already crashed. We aren't making anymore subprime loans. The market is in the process of cleaning up this mess (although it's being hindered by the actions of the Fed and the new administration).

The catalyst for the next leg down in the secular bear is going to come from an entirely different direction, one no one is expecting right now. Personally I think it's going to originate in an inflationary storm and possibly a currency crisis. That is the one area of true excess as every central bank in the world is madly printing, printing, printing!

Bear markets come when the excesses created during the previous bull market come back to bite you in the ass. If Bernanke thinks that all the trillions of dollars he printed to halt the credit crisis aren't going to cause problems, big problems, then he's sorely mistaken. Just like Greenspan was mistaken when he thought he could print our way out of the tech implosion with no consequences.

CAN WE REALLY PRINT OUR WAY TO PROSPERITY?

Let me ask a question, what is money? I know what it should be. It should be a way to store productivity. Let me explain.


Let’s say you are a shoe maker. You work really hard and in 6 months you produce enough shoes to secure your financial needs for the rest of the year. Well in the case of the shoe maker you can simply store your excess product in your shop and when you need to purchase something you just pull out a few pairs and trade them for food at the local grocery store or a pair of overalls at the neighborhood clothier, etc. The problem of course arises if you are a dairy farmer. Milk & eggs don’t tend to last all year. So without some way to store excess productivity your eggs will go bad and your milk will sour. This is where money comes into play.

Our shoemaker, once he’s finished producing as many shoes as he wants, can immediately sell all of them and convert his shoes into cash. The same for our dairy farmer, he doesn’t have to worry about his eggs going bad or his milk spoiling as he will simply sell all of his product and convert his productivity into cash. So in reality all money really is is a way to store productivity and a convenient way to convert that productivity into purchasing power for virtually any product one wishes to buy. Let’s face it, how many ranchers are going to want to barter 20 pairs of shoes for one cow. With fiat currency the shoemaker can easily convert 20 pairs of shoes into the purchasing power needed to buy meat to feed his family thorough the winter.

Now let’s say our shoemaker produces and sells enough shoes that he has excess money. He would like to earn some kind of return on his excess productivity so he puts that money in the bank earning an acceptable rate of return (well in normal times he would receive an acceptable rate. Greenspan and Bernanke have destroyed that option). Now let’s say our dairy farmer would like to expand his farm because demand has been exceeding what he can produce. Unlike the shoemaker he doesn’t have excess productivity…yet. So he goes to the bank and borrows some of the extra productivity that the shoemaker “loaned” to the bank. He uses that capital to enlarge his farm so he can meet the extra demand and soon he too is depositing his excess productivity in the bank to be used for expansion in other parts of the economy. This is how a healthy economy grows ...or should grow.

Now let me show you how our government…and all governments think. They don’t see money as a store of productivity. They want to believe money is productivity. They believe they can simply print money and produce productivity. Well, any second grader can probably understand that simply putting some ink on a piece of paper doesn’t mean anything of value has been produced.

So let me run down in simple terms how we’ve gotten ourselves into this mess and why we are nowhere near getting ourselves out of it. And in fact we are just making things much worse.

Even though this has been going on for a couple of decades, the doody really started to hit the fan in 2000 as the tech bubble burst. Actually what should have been a very prosperous period of high productivity driven by the emerging internet business model turned into a bubble because Greenspan kept interest rates too low and printed too much money. All this excess money made it appear that we had way more productivity than we actually did. Businesses were lured into reckless over expansion by what appeared to be true demand. When in reality it was nothing more than money being created out of thin air. Eventually it became apparent to the market that there was massive over production but no real demand for product. As the bubble started to implode all those jobs that were created by the appearance of a robust economy vanished. Eventually the tech sector settled back to a level consistent with real demand. The problems arose in that there was no new burgeoning sector like the internet to create jobs for all those people who were displaced when reality hit the tech bubble.

In its misguided effort to create jobs the Fed printed more money, lots more money, again vainly trying to create productivity and demand with the printing press. That money had to go somewhere and it certainly wasn’t going to go back into the tech sector, that party was dead and gone. What it did was create a bubble in the financial and real estate markets. That eventually produced the much sought after job creation that had been missing. As a matter of fact it produced so many jobs it created good times the likes of which had rarely been seen in history. Unfortunately that still didn’t change the fact that there was a cancer growing in the economy. The fact remained that this wasn’t a real economy stemming from true productivity and savings. It was another phony bubble economy created with the printing press. And as such, misallocations of capital soon began. Financial institutions became terribly overleveraged. The average American became terribly overleveraged. Real estate inventories ballooned on the appearance of massive demand but what in reality was only massive speculation.

Again the bubble imploded. All those jobs that were created in finance and construction disappeared. As unemployment started to soar, the over investment in businesses of all kinds started to get hit. I don’t know how it is where you live but when I drive around Vegas, every, and I mean every, strip mall has at least one vacancy and many have multiple vacancies. Most of these businesses would never have opened if it weren’t for the incredible excesses of `04-`07 that made it appear there really was enough demand for 10 Starbuck’s or 20 fast food restaurants in a two mile radius.

Now we really have an employment problem. There still is no new emerging business model to create the jobs needed to put the massive amount of unemployed people back to work. By the way I don’t buy the ridiculous 10% figure. At some point the government will probably figure out a way to not count people if they’ve lost their car and can’t look for work or are over 50 because they aren’t really part of the workforce anyway…right? Does anyone else wonder how unemployment dropped from 10.2% to 10% last month even though we still lost jobs? Even if we did only lose 11,000 jobs (questionable) how does 10.2% minus 11,000 equal 10%. I don’t know about you but that kind math will usually earn one an F in school.

Realitically unemployment is at least 12% and probably 15%-17% is closer to the truth. And we still have no way to create new jobs. The only bubble that can be created this time is an inflation bubble and that kind of bubble isn’t going to create jobs. On the contrary, an inflation bubble is going to cause many millions more jobs to be lost.

So is the stock market really discounting a V-shaped recovery in the economy? Not unless all this money being printed by the Fed can now do what it wasn’t able to do the last two times they tried it. That being create true productivity and real sustainable job creation.

Hint: It won't!

THE ODDS REVERSE

At the beginning of the month we were told how bullish the month of December always is. Actually December ends positive only about 64% of the time with an average gain of a little over 1.2%. You can see in the next chart that's just about what we got...another average December.

Now however those odds reverse as 6 of the last 10 January's have produced negative returns. For the many reasons I've gone over in the nightly updates I think we are probably going to see another January swoon this year.

I certainly don't expect it to be anything like last year though. Probably something on the order of a -10% correction is the most likely scenario before we start the next leg up in this cyclical bull, which by the way, I doubt will have more than three legs before rolling over into the next extended bear market phase.

More in the weekend report.