DOLLAR KEY

A while back I asked the question "Can the markets and the dollar rise together?" They certainly weren't able to do it during the last cyclical bull and they haven't been able to do it so far during this one.

In the next chart you can see that just as soon as the dollar bottomed gold's C-wave ended. The stock market managed to drift a bit higher due to seasonality and momentum, although I will add that the last little spurt higher in December and January occurred as the dollar was correcting into a daily cycle low.

The fate of the markets now rests with the dollar. If Ben can get the dollar headed back down assets will head back up. If not we are going to continue to flounder around until the full forces of the secular bear grab hold of the market again and suck it back down.

The problem is that public opinion has turned against stimulus and printing at the moment. So it's going to be hard to rationalize more printing. (I will add that the government has figured out they can still sneak in more stimulus as long as they don't call it stimulus. Now it's a jobs bill.) If however things start to weaken appreciably public opinion will quickly shift back to "do whatever it takes to fix the problem".

Sooner or later that is going to happen. Of course if we want to see another leg up in the C-wave we need it to happen quickly. Actually because we are running out of positive seasonality (no C-wave has topped later than early May) we probably need to see the dollar top next week.

I'm going to say if we don't put in a weekly swing high on the dollar chart next week then we can probably kiss any more thoughts of a C-wave continuation good bye.

At that point we will just have to twiddle our thumbs for another month or two as we wait for the A-wave to begin.

Maybe this will help understand why I did what I did.

If you understand how the 4 wave structure in gold works you will understand why I want to take some profits out of the C-wave. If I hold on to a winner it will just get dragged down by the extended corrective process after the C-wave tops and will turn into a loser and then it will be dead money for many months as the next C-wave builds a base.

If I have some dry powder then I can put that powder to work in the A-wave advance, which while it won't make new highs could still be good for a 40-50% gain in a stock like SLW as long as I get in close to the bottom of the A-wave, which isn't too hard to do if one watches the COT report. That's a much better use of my capital than just watching one of my winners bump around for months.

LINES IN THE SAND

If gold is now stuck in a D-wave decline all daily cycles should be left translated. By that I mean if a cycle averages 20-25 days trough to trough any cycle that tops in 10-12 days or less would be a left translated cycle.

Gold is now sitting on the fense. At the moment the cycle appears to be left translated with the top occuring on day 10.

It that top holds we should expect gold to drop below $1044 at the next cycle low.

If however gold can move above $1131 in the next few days we will have a right translated cycle in play. That should not happen in a D-wave decline. The play then would be to get aggressively long at the bottom of the next daily cycle low.

CYCLICAL BULL VS. SECULAR BULL

The reason I don't want to mess with the stock market at this time is because it is in a secular bear market. Any rallies are always going to eventually be doomed to failure in this environment. Now that doesn't mean the cyclical bull is finished. I doubt it is. What it does mean is that one can't make a timing mistake and expect to be rescued by the secular trend.

For instance; from 1982 till 2000 the stock market was in a secular bull market. The fundamental driver for that bull was the personal computer and the internet. Those were world changing new technologies. Millions and millions of jobs were created during this period.

There were certainly nasty corrections during the secular bull, 1987 was an example. But the secular trend was up. So as long as one was willing to hold on to ones position any entry would eventually end up being a winning trade. Like I've said before the only way to lose money in a secular bull market is to buy high and sell low. (I seem to be having trouble getting that point across lately). In a secular bull market there's nothing wrong with buying high as long as you sell higher. That means sometimes you have to be patient and let your positions work. Sometimes you have to endure drawdowns.

Ultimately though as long as you don't sell for a loss then every position will end up a winner (I'm talking index ETF's not individual companies)

The problem with the stock market since 2000 is there is no longer a fundamental driver to produce a secular bull. Now all we are getting are phoney bull markets built on money printing. Those are not the kind of fundamentals that can support a sustainable bull market. So what happens? Eventually the false fundamentals fail and the market collapses.

The Fed is now at it again trying to build another bull market on a fundamental base of nothing more than trillions of dollars of liquidity. It didn't succeed when Greenspan tried it and it's not going to succeed for Bernanke.

Until we get the next fundamental driver (personal computer, internet 1982-2000: electronics 45-66: automobile 20-29: trains in the late 1800's) we are not going to have another secular bull market for stocks.

There is a secular bull market that does florish on a fundamental base of money printing though. That secular bull would be commodities in general and precious metals specifically.

Gold is in a secular bull market. That means several things. First off we can expect this bull to continue until the fundamental driver is taken away. That means the presses have to be turned off. Second, any entry will ultimately turn out to be a winning position as long as one is willing to hold on till the bull corrects any timing mistakes.

The one area where investors can rely on the buy and hold strategy at this time is in the precious metals markets and will be for quite some time yet.

GOLD'S A-B-C-D WAVE STRUCTURE

THE BULL IS STILL ALIVE

I believe the secular gold bull is still intact. As long as I believe that to be a fact then I have to ask what's the point in selling losing positions and locking in a loss?

If I had sold my losers in April they would never have had a chance to become profitable. The same for July, Sept. and Oct.

The only difference between now and then is the time I think it's going to take for my positions to become profitable.

Since I think gold has now entered a D-wave I may not get the quick rebound on underwater positions that I got over the last year but that doesn't mean I need to throw out a winning hand. It just means these particular positions are going to need more time to work before they move into the green. I'm willing to give them all the time they need.

I'm not overlooking the fact that a D-wave is followed by an A-wave that should at least test the $1161 pivot. I'm also not overlooking the fact that the last three A-waves produced HUI gains of 18%, 37% and 116% gain in 1 month, 1 month and 3 1/2 months respectively.

As miners are still incrediably cheap we should see the HUI come close if not better the highs at the next A-wave top. Especially if oil continues to hold below $100. At the least they should test the 475 pivot that they were at during gold's last move back up to $1161.

C-WAVE OR D-WAVE

I've been racking my brain tonight trying to decide if gold is still in a C-wave or whether a D-wave has managed to sneak right past me without me ever noticing.

On one hand the C-wave never really generated the kind of excessive speculation we normally see at C-wave tops. The silver gold ratio never spiked, miners never even got to normal valuations much less expensive, which is what would be expected as gold fever hits hard at C-wave tops.

The massive year and a half consolidation only spawned a meager 190 point new high? That doesn't sound like a C-wave top to me. We had the most powerful A-wave, along with the weakest B-wave of the entire bull market so far and all it could gain was 190 points above the old highs? Hard to believe.

Trillions and trillions of dollar printed and thrown at the market and all we got was 190 points? Again hard to believe.

We even have a broken trend line.

Despite a very strong dollar gold is still holding well above the lows.

Everything seems to be saying this is still a C-wave...except the miners.

The HUI should have broken through the 420 resistance like a hot knife through butter. It should be breaking the down trend.

It hasn't done either. Instead it immediately turned tail as soon as it got short term overbought and has now closed back below the 200 DMA.

We have two lines in the sand. If gold can break the pattern of lower lows and lower highs by moving above $1161 then the odds are the C-wave is still intact. If however it moves back below the Feb. low we are almost positively caught in a D-wave.

Which ever way gold breaks out of the box should tell us were we stand. I will say that if this is a D-wave we should be getting close to the bottom. I would expect a test of the 65 week moving average and the $1000 mark will probably be about it before the next A-wave gets underway.

Remember the A-wave should test but probably not exceed the highs.

So at the moment we just have to wait and see which line gets broken first.

PROFIT TAKING CORRECTION IS FINISHED

Since November I've been looking for a profit taking correction of 10-14%. The recent pullback managed 9.2%. Not quite the 10% I was looking for but considering the trillions of dollars sloshing around the world that's probably all we are going to get.

All in all I think the odds are very high that the correction has run it's course and we are now beginning the third leg up in this cyclical bull market.

I've mentioned before that the initial thrust out of an intermediate cycle low tends to be very powerful. The average gain is between 6-10% in the first 8-13 days before any kind of meaningful pullback can be expected.

We seem to be right on track as we've rallied 6.5% trough to peak so far.

There is so much liquidity in the market that neither the March bottom nor the July intermediate correction were tested. I don't have a lot of confidence that we are going to test the Feb. 5th low either.

Now I don't know if we are going to rally 17% like we did out of the July bottom but I will say the dollar is way overdue to move down into the daily cycle low and probably begin the move into the intermediate low also.

When the dollar starts down it's going to be like putting afterburners on the markets.

At this time all the signs are in that we are in the initial thrust out of a major yearly cycle low. Holding shorts in that kind of environment is terribly risky. One certainly doesn't have to be long (although this is when the biggest gains come the quickest) if they don't trust the move, but you certainly don't want to get kicked in the teeth standing in front of the bull.

This is one of those times when the best option for bears is to do nothing and just sit in cash.

WHICH SIDE OF THE ESCALATOR ARE YOU GOING TO CHOOSE?

A bull market is like a rapidly rising escalator. Now one can certainly run down the up escalator but it's not the most efficient way to travel (invest).

The same can be said for a bear market. Why would anyone want to run up the down escalator?

Doesn't make a lot of sense does it. Any intelligent person would just step on and go for the ride. But this is exactly what most retail investors do. They repeatedly try to short bull markets or go long in bear markets.

And for whatever insane reason they seek out contrary opinions to support their position.

Folks in a bull market you don't listen to the likes of Mish, Karl Denniger or Xtrends. Doing so will destroy your account. And I don't say that because I think what they say is untrue. Many of the things they talk about are absolutely true. The problem is that we are in a cyclical bull market, the escalator is running uphill, so negative fundamentals don't matter.

You pay attention to permabears when we are in a bear market. In a bull market you take advise from perma bulls.

The escalator is running uphill. Now is not the time to try and get to the bottom. It's time to relax and take the ride to the top.

MUCH ADO ABOUT NOTHING

Last night it was the news that the IMF was going to sell 191 tonnes of gold. Tonight it's the 25 basis point rate hike in the discount rate.

I'm going to let you in on a secret. Neither one of those things is going to materially affect the stock market or the gold market.

As a matter of fact over 75% of the time the market ends up higher by the third day after an initial hike in the discount rate. The Chicken Little's of the world see the sky falling but the reality is this has been a positive for markets almost 8 times out of 10.

Folks I'm going to let you in on a secret. The damage has already been done. The trillions of dollars the Fed has pumped into the market is not going to be withdrawn by a mere 25 basis point hike in the discount rate. By the way the discount rate is the rate the Fed charges banks to borrow. Very few banks even bother to borrow from the discount window. For all intents the rate hike today was basically the same as the Fed jawboning. All bark and no bite.

If the Fed really wanted to withdraw liquidity they would have to go on a massive treasury selling spree.  The problem is this would crash the bond market, spike rates, and drastically raise the cost of servicing our massive debt mountain. If the Fed were to do that, just the interest payments on our debt would soon sink the country. Not to mention it would still take months and months if not years to reverse the liquidity mess they created.

They didn't cram 12 trillion dollars into the market in one day and they certainly won't be able to withdraw it in a day.

The truth is there is no easy way out of this mess the Fed has gotten us into. I can tell you that human nature being what it is, I'm confident we will continue to kick the can down the road for as long as possible. So I wouldn't count on the Fed withdrawing liquidity anytime soon.

The reality is that the market is bouncing out of an intermediate and probably a yearly cycle low. Those kind of major cycle lows tend to produce the most powerful rallies. The average initial thrust out of an intermediate cycle low has been between 6% and 10% in 8 to 13 days. And that is just the initial thrust.

So far the market is behaving exactly as expected.

Don't forget we still don't have anything that looks like a daily cycle bottom on the dollar yet. This is what the markets have done in the face of a strong dollar. When the dollar decides to move into the daily cycle low we could literally see all markets explode higher still.

It's going to take a lot more than a mere 25 point hike, in a virtually meaningless interest rate, to derail the kind of powerful rally that happens out of a yearly cycle low.

WEAK EURO DOESN'T EQUAL STRONG DOLLAR

The Fed has printed literally trillions of dollars in an ill fated attempt to jump start the economy. Folks it's not fundamentally possible to have a strong dollar with that kind supply.

If one looks at a chart it does appear that the dollar is rallying. But is it really, or is the Euro just falling?

When measured against a stable source of value the dollar is actually losing value rapidly.

Just since the Feb. 5th bottom oil has rallied 12%, gold 8% and copper 17% despite the illusionary strength in the dollar.

Far from being strong, the dollar just happens to be a slightly better choice than the Euro right now.

Consider that the sentiment on the dollar has now reached extreme bullish levels and the Euro bearish extremes. Plus the dollar is moving deep into the intermediate cycle and at jeopardy of an intermediate trend change at any time.

Once the dollar cycle tops commodities are set up to explode higher.

THREE'S A CHARM

Today I'm going to forward a theory of where I think we may be headed based in part on what happened under similar fundamental conditions in Japan during the `90's.

I've been saying since November we should expect a profit taking event of around 10% that would ultimately separate the second leg of this cyclical bull from a potential third.

While the recent correction didn't quite reach the 10% level I was looking for, I think at -9.2% it was close enough considering the trillions of dollars the Fed has thrown at the markets.

Under similar conditions in `04 with Greenspan madly pumping liquidity the market only managed an 8.8% correction.

So all in all I think we probably now have our corrective move in place. I'm not ruling out a test of the recent low before heading higher, but I will point out that there is so much liquidity sloshing around the world that neither the March bottom nor the July intermediate low was tested. So I don't think I would bet heavily on a retest of the 1044 bottom.

Typically the largest gains in bull markets come at the beginning and end of the bull. Which makes sense as smart money will recognize and jump into the move early as they know that's when the largest percentage gains occur the fastest.

At the end of the bull we finally reach a state of complacency that  retail investors finally becomes convinced that good times are here to stay. This is the period where smart money unloads to frantic retail buying.

I think we may be approaching an interesting point in this cyclical bull. First off let me show you what happened to the Nikkei during similar fundamental conditions in the `90's.

Notice how every cyclical bull had at least 3 legs. Also notice how every cyclical bull exploded higher in about 1 year before rolling over again as the secular bear fundamentals eventually pulled the Nikkei back down.

I doubt anyone could look at a 10 year chart of the S&P and not come to the conclusion that we are and have been in a secular bear market since 2000. That means this is probably just another cyclical bull within the context of a secular bear market.

So just like the Nikkei this bull is going to come to an end as the bearish fundamentals will eventually overbalance all the Fed's liquidity just like they did repeatedly in Japan.

What I'm wondering is if this cyclical bull will, like the Nikkei, compress the rest of the bull move into a final third leg.

  

The 1450 target is just a guess, but if the market surges higher we could see the third leg match the point gains of the first leg before finally rolling over into the third phase of the secular bear market.

Either way, if the Nikkei is any indication, we should have at least one more leg up before this bull expires.

I STILL LIKE THOSE APPLES

The challenge now is that a longer term view will reveal the true relationship between interest rates and gold.

You can see from the following chart that gold topped about a year before interest rates entered a multi decade bear market. Gold also began a long term secular bull market 7 years before interest rates bottomed.

One can plainly see that each asset class marches to its own fundamental driver. If the last cycle is any indication we shouldn't expect a top in gold until interest rates near the end of the secular bull cycle. Since these cycles tend to run for many years and this one appears to be just starting we could see gold rising for a long time yet using this criteria.

The truth is that the secular bull will run until it becomes extremely overvalued. At that point liquidity will start to leak out of the commodity markets, specifically gold, and find its way into undervalued assets.

This will happen when we reach a Dow:gold ratio of 1:1 or close to 1. At that time we will see a buying panic as the public becomes convinced that gold is a "sure thing". Just like they were convinced that tech was a no brainer and just like they believed that real estate never goes down.

Trust me we will see the same mentality in the commodity markets. You want to know how I know? Because human nature never changes. When something goes up long enough and far enough the masses will pile in, they always do. It's how all major secular bull markets end.

When that starts to happen smart money, money driven by logic instead of emotion, will start to sell gold and go looking for undervalued assets. By that time it will be stocks. Stocks will be so beaten up by then that no one will want to own them. We will see the Dow trading at single digit P/E's. Dividend yields will be between 6 and 10%.

At that point smart money will recognize true value in good companies that are being given away for pennies on the dollar.

Let's face it no matter how much we want to believe otherwise gold only has value because we say it does. If all the gold in the world were to disappear tomorrow it would only cause a minor blip on the global economy.

Real value is companies producing goods that the world must have to continue. At some point people will start to recognize that gold, a nonessential shiny metal, is being priced completely irrationally and that good companies with real profits making essential products for continued human existence are being given away. At that point the secular trends will flip and gold will re-enter another long term bear market and stocks a new secular bull.

Going back to the chart. Gold is still in a secular bull and that bull has nothing to do with interest rates and everything to do with human nature.

All in all, I still like those apples :-)

NOT QUITE THE APPLES HE WAS EXPECTING

A comment in the last post challenged me to put up a chart of gold compared to bond yields. I think the poster was somehow insinuating that rising rates are bad for gold. Let's put it to the test shall we?

I don't think any one can deny that gold is in a secular bull market..at least not with a straight face.

I now believe that interest rates are also now in a secular long term bull market. As you can see from the chart they have had no trouble rising together since the beginning of the year.

I kinda like those apples ;-)

THE BOND MARKET IS PRICING IN INFLATION

If we were really on the cusp of another deflationary event and the end of the cyclical bull like so many bears want to believe, we should already be seeing warning signs in the bond market.

At almost every major turning point in the stock market we have seen bonds lead the way. In `07 bonds topped out 4 months before the stock market. The same thing happened in 2000. Bond yields started to rise 3 months ahead of the March bottom in stocks last year.

Far from topping out, bond yields are still rising. As a matter of fact they are still holding above a sharply rising 200 DMA.

If this was going to be something more sinister than just an ordinary profit taking event in an ongoing cyclical bull, bond yields should have begun dropping several months ago.

I believe we saw the end of the secular bear market in bond yields last year when Bernanke assured us he would artificially hold rates down to stimulate the sagging real estate markets.

Realizing that the only way Bernanke could have any chance of accomplishing his goal was to print untold trillions of dollars out of thin air, the bond market responded by rapidly reversing Bernanke's manipulated move and rates have been rising ever since.

Since the beginning of `09 the bond market has been discounting the future and deflation is not what it's been discounting. 

IS IT REALLY WORTH THE RISK?

Deflationist can and have offered up countless reasons for their view. I suspect most are trying to rationalize a short position in the market. But I have to ask is it really worth the risk?

Let's face it if you managed to catch the exact top and covered at the exact bottom last Friday you would only have profited 9.2%. And realistically I doubt anyone has managed to catch more than 6-7% of the decline. In the last two weeks the HUI has tacked on 11.8%.

One is never going to get rich on the short side of the market. Especially not in a cyclical bull. (It is an excellent way to get poor though.)

Now we've got a multitude of factors starting to line up in favor of the correction either being over or very close to being over.

Sentiment has reached bearish extremes, some even worse than what we saw at the March `09 bottom.

The yearly cycle low for stocks is due anytime now (and looks like it may be in).

The market has rallied in the face of extremely bearish news this week. Never a good sign for shorts.

The dollar's intermediate cycle is due to top any time now. Sentiment on the dollar has reached bullish extremes last seen at the March `09 top. And commercial traders now have the most bearish position on the dollar in the last 9 years.

Commercial traders now have the most bullish position on stocks in the last 18 months.

The expected 10% decline separating the second leg of the bull from a probable third has more or less occurred.

The fundamental picture hasn't changed. The Fed has flooded the world with liquidity and despite tough talk, has made no attempt to withdraw any of it.

Finally we are starting to see institutions coming back into the market.

With all these factors lined up against the bears and with the relatively small gains possible on the short side compared to the long it's probably not the best of times to continue holding short positions.

Now of course if one doesn't believe in the bullish view they certainly don't have to go long but it would be much safer at this time to at least go to cash than to continue holding shorts. The odds are starting to pile up against the bears and it's probably just not worth the risk for a minimal gain even if the bear still has one last roar.

Heck even if we have somehow entered another cyclical bear (doubtful) all the factors I've outlined above should lead to a violent bear market rally.

The only two rational options right now are long or cash. Pressing shorts at this point is tantamount to gambling, and if one wants to gamble you can find 24 hour action at any casino. There's no need to wait for the stock market.

WEAR YOU OUT, OR SCARE YOU OUT

When I see the frustration levels that we saw last week amonst gold bugs I know the bull is doing its job.

When I see someone slamming body parts in a file cabinet, I know the bull is intact.

When I see cavity-boy and his Baby Ruth's I'm confident the bull is still alive and well.

These are all signs that the bull is doing what it needs to do to shake off as many riders as possible. And that is exactly what must happen before a big move can begin.

I've said it before, the bull will either scare you out, or wear you out. This is how big moves start. They first shake everyone off. They have to make it almost impossible to buy. Just at that point when you feel like you're going to throw up that's when the next leg up begins.

Gold has gone through two scare you out phases and three wear you out periods during the last 4 years.

Amazingly enough the bull has now managed to shake just about everyone off and he's done it without even coming close to testing the $1000 level. As a matter of fact he hasn't even tested the $1034 breakout.

I think the brief break below $1075 last week was very telling. There had to be a ton of sell stops below that level. You just know every technician in the world was selling at that point. But gold didn't follow through. Someone was buying what the dumb money was selling. If the trend was down gold should have plummetted. If this was a D-wave gold should have crashed. It didn't!

The miners on the other hand almost always follow the scare you out strategy and this time was no exception. It probably explains how gold managed to create such negative sentiment despite the minor correction.

At 11 weeks the dollar is now in jeopardy of starting the decline into the intermediate cycle low at any time. That move, when it starts, should power the second leg of this C-wave.

For those that can hang on to the bull through all his tricks the reward will be big.

SECULAR TREND INTACT

We've been hearing for some time now how the dollar is in a long term bull market. Consequently gold is going down, stocks are going down, commodities are going down, generally it's the end of the world. :-)

Nothing could be further from the truth. Despite the worst deflationary event since the 30's the secular trend of the dollar has not changed since 2001. It has been and still is in a secular bear market.

The only thing that's happening is the normal regression to the mean that occurs in every market. When sentiment gets too bearish we get a counter trend rally back to or close to the mean. Once the market works off the extreme then the secular trend resumes.

Until we discover the next big technological advance (think internet, personal computer, electronics, trains, canals, automobile) the dollar will continue to languish in a long term bear market because the powers that be will continue to try and print their way to prosperity. It's never worked in history and it's not going to work this time either.

Money isn't productivity, it's a store of productivity. We need real productivity before the value of the dollar can enter the next secular bull market. These temporary rallies because of stress in the financial system cannot take the place of real productivity and as such they are never going to reverse the secular trend.

We've been hearing quite the cacophony of reasons lately for why the dollar is going higher. The thing is, we always hear this at or close to tops.

The fact is that retail traders now have the largest long position on the dollar in history. Large specs, the second largest long position. Meanwhile the largest, most knowledgeable traders, (commercials) have the largest short position in 10 years.

As bearish as sentiment was back in November it has now reversed 180 degrees and is now as bullish as it was at the March top.

When everyone is thinking the same thing, then no one is thinking.

The market is getting ready to hand the bag off to the retail trader again.

HAPPENS EVERYTIME

Selling pressure at intermediate and yearly cycle lows is intense enough that it takes down just about everything. This time is no exception. Until the market started to crack gold and mining stocks were just going through a mild correction. Gold was consolidating in a T1 pattern.

Once the correction in the stock market has run its course I expect the secular trend for gold to resume and I expect miners to get back to the business of correcting the massive mispricing that occurred when the market crashed in `08.

Right now we are witnessing irrational selling in almost everything, which is par for the course at a yearly cycle bottom.

For those that can keep their heads about them, wonderful bargains can be had in times like this.

IN THE RANGE

For a while now I've been expecting at least a 10-14% correction to separate the second leg of this cyclical bull from what I expect will be at least one more leg up before this bull expires.

Friday's intraday low got close at -9.7%. The pattern has been for the correction between the second and third leg to be larger than the one between the first and second. We've now accomplished that goal also as the correction in July racked up a 9.5% decline.

As you can see in `04 the correction turned into a multi month affair finally bottoming in August. This time it appears to be unfolding much faster (which is the norm by the way for bulls with our DNA).

We are still a bit short so I'm not sure this is done just yet but we're in the range of what I've been looking for. At this point I think we are probably just waiting on the dollar cycle to top. Today is the 17th day of the daily cycle which rarely runs much longer than 25 to 30 days so we are in a live area for a top in the dollar and probably a bottom in everything else.

I'll also note that we are close enough to March that this bottom should also mark a yearly cycle low. As the last two major cycle lows have occurred in March I am expecting this year to continue to follow that pattern.

I'm not really expecting this decline to make it all the way to March as sentiment is already reached bearish extremes, but I think we are close enough that we could get a slightly shortened yearly cycle bottom any time now.

I'll also add that the rallies out of yearly cycle lows tend to be extremely powerful. The average rally out of a yearly cycle bottom since 2000 has been 19% with the median being 15%.

Even if the bull has topped (which I doubt) we should expect a violent bear market rally soon.

ALL CURRENCIES ARE SUSPECT

A comment on the blog last week got me to wondering. One of our Canadian friends made the comment that he's made nothing off of gold because the Canadian dollar has been strong. I think he was insinuating that the price of gold was only rising in the US and that only because the Fed is destroying the US dollar.

After looking at the preceding chart I have to conclude our Canadian friend is simply a poor trader :-) Actually as we all know gold is a very volatile asset and pretty tough to trade successfully so his mistake was probably that he was trading instead of holding. Even priced in a strong (relatively speaking) Canadian dollar gold is still up 200%.

The next set of charts speak volumes about the global monetary policy.

Every country in the world is printing at a furious rate. No one is innocent.

Recently the Australian and New Zealand central banks are showing a bit more commonsense than most, but it's certainly only a recent occurrence as gold rose 300% before backing off a bit. Besides who knows how long commonsense will last? Probably only until politicians start to feel the heat again.

THE SKY IS FALLING

I know it seems like the losses in miners are so huge that we will never be able to recover. Like I said projecting the past into the future is just human nature.

But nothing could be further from the truth. If you want to get an idea of how violently miners can rally all you have to do is take a look at November.

From almost the exact same level they are at now miners rallied to new highs in one month. Don't forget this was an advancing bull leg that was getting mature. A rally from extreme oversold conditions back to old highs can unfold much more violently than a final leg up as hot money floods into a beaten down sector. (Just look what has transpired since the Nov. `08 low)

Once the selling pressure coming off the stock market exhausts I have no doubt miners will quickly get back to the business of correcting the massive mispricing compared to gold.

Liquidity always finds its way into undervalued sectors.

END OF THE BULL?

So are we witnessing the end of the cyclical bull market? Probably not.

All bull markets go through corrective phases. They all break trend lines. We've already broken three of them in this bull market.

The previous bull market broke four major trend lines. None of them being anything more than a temporay pullback.

I've been calling for at least a 10% correction for several months now to separate the second leg of this bull from the third.

Birinyi and Ass. point out that of the 117 corrections greater than 5% since 1945. Only 11 of those 117 actually turned into a new bear market. So the odds of this correction signaling the end of the bull are 9.4%. Not great odds to say the least.

We can probably expect a move down to at least the 1040ish level. But once we exhaust the selling pressure the odds are very good we will see new highs.

As I mentioned in last night's report, it's becoming apparent this is not only an intermediate level correction, but it's stretched far enough that this should also be the yearly cycle low. The only time selling pressure is greater than at a yearly cycle bottom is at a 4 year cycle low.

So while they are certainly scary and tend to exert tremendous pressure on everything they also tend to show the most powerful rebounds once the cycle bottoms.

The average rally out of a yearly cycle low is 19% with the median gain for the last 7 yearly cycle lows coming in at 15%. Since we are obviously in a cyclical bull, and the odds are against this correction signaling the beginning of a new bear, we can probably expect the rally out of this bottom to take the market to new highs.

WHY JUST ONE?

I want to start off today and talk about something that…I wouldn’t say bothers me, maybe puzzles me is a better way to put it. Of all the different tools we as investors and traders can use to give ourselves an edge almost without exception, when asked, any individual will almost always have one he trusts or relies upon when making his investment decisions.


For some it’s big picture fundamentals. Smart money investors tend to choose this path. People like Jim Rogers, Warren Buffett, George Soros, etc. These are people with lots of money and patience. When they see a fundamental shift in the market they get on board and just hold on till the secular move has run its course. Needless to say there is a reason these people are rich. Riding a secular wave is the easiest way to amass a fortune. But unless you have the patience of a Buffett or Rogers it’s hard to do. Most people tend to get knocked out during the corrections… and there are always some doozies in any secular bull.

There are others who follow sentiment. They attempt to time the markets based on extreme sentiment levels, taking the opposite side of the trend as a contrarian play when sentiment levels get stretched too far in one direction. www.sentimentrader.com is an excellent source for monitoring sentiment levels.

Some watch market cycles. Because human emotions move through periods of ups and downs, and let’s face it the markets are really just a reflection of human emotions, cycles are often a pretty decent tool for timing market moves as they tend to occur with fairly predictable regularity.

Others follow the smart money, i.e. the COT reports and WSJ money flows. Knowing that big money players are probably privy to information that the rest of us don’t have, it makes sense to watch what these players are doing. Since this group controls most of the money in the market it's probably safer to follow behind the train instead of standing in front of it.

And then there are the multitudes that base their investment decisions on technical indicators. These are people who believe the future can be discounted by looking at lines, patterns or indicators on a chart.

Whatever tool one uses, the point I want to make is that almost without fail investors will fall into one of those categories. What I’m puzzled about is why? Why do most investors limit themselves to only one or two tools? Is it because of some misguided search for the holy grail of investment? When we find something that works for a while do we then make the mistake of assuming that it’s always going to work?

Every single one of those tools I outlined above (fundamentals, sentiment, cycles, smart money, and technicals) are useful in achieving an edge in the market. Why would one throw out any of those in favor of only one?

My one real talent for most of my life, other than a moderate ability to hang on to the side of a cliff and, when I was a younger man, the skill to lift fairly heavy weights over my head, has been to see the big picture. To see how all the parts fit together. So I have to ask why not use all of the tools at our disposal? That is of course what I attempt to do. Sometimes with pretty good success, and sometimes... not so much ;-)

To start off I think everyone simply must be able to see the big fundamental picture. If you can’t or won’t do that then how are you going to know when a major shift in the market has occurred. When it does it could affect every other tool in your arsenal. In my opinion the big picture fundamentals for the market changed in 2000. At that time we entered a long term bear market for paper assets and a long term secular bull market for commodities. As long as this fundamental underpinning remains I don’t really want to buy stocks and I do want to buy commodities.

After the big picture fundamentals I would say it’s a toss up between cycles and sentiment as my next most useful tool. Both are excellent tools for the most part but both have their limitations if a fundamental shift occurs. As an example, during the crash last year extreme sentiment levels had no bearing on market behavior. The underlying fundamental driver of the market was so strong that it really made no difference that sentiment had reached extreme bearish levels, the market just kept on falling. The same can be said to some extent for the rally out of the March bottom. There was so much liquidity in the system that extreme bullish sentiment really had no bearing on market direction other than occasional short term corrections.

The same could be said for cycles. As the market rallied out of the March lows the unimaginable amount of liquidity accomplished something that’s never been done before. It aborted the path of a left translated 4 year cycle. I’m completely guilty of missing that this summer. At the time I knew the Fed had pumped trillions of dollars into the markets but I just didn’t believe it would be able to alter the path of a 4 year cycle. I put too much trust in one single tool at the expense of ignoring a major major fundamental change.

Following the smart money is another useful tool. Except just like everything else it too fails from time to time. The COT reports used to be one of my most trusted tools. Except in 07 when they basically stopped working as a timing tool for the stock market. Watching money flows in the WSJ has also been a pretty dependable tool for spotting trend changes except sometimes the signals come too early. During the crash in `08 we saw several days of heavy buying on weakness but none of those led to anything other than a brief bounce. The recent sell signal was first given in Nov. yet we had to wait till the middle of January before anything became of it.

I think we all know the limitations on purely technical signals. For one they can be easily overridden by any of the other tools, (fundamentals, smart money, sentiment or cycles). Secondly, it’s pretty easy for big money players to run trend lines and support/resistance levels in order to get the typical retail technical trader to do what they want. Those stuck using purely technical signals are always going to be at the mercy of the big boys pulling their chains.

All in all every tool we use has its limitations and from time to time market conditions pop up that will completely negate some or all of our tools. But in my opinion the least likely way to succeed is to pick only one tool and trust it to give you an edge in every market environment.

I think a much higher success rate can be achieved if one uses all the tools at our disposal, especially when most of those tools are telling the same story.

INFLATION TRADE MAY BE STARTING

For a while now I've been of the opinion that Bernanke's massive flood of liquidity last year is going to have unintended consequences. I think those consequences are going to manifest as a huge inflationary surge in commodity prices this year.

I understand the deflationary argument. I think even the deflationists believe we are going to see inflation become a problem, they just think that it will come after the deflationary phase.

Recent history would seem to contradict that theory though. From `03 to `08 we saw inflationary pressures gradually building until they finally came to a head as the tax rebates hit the economy and spiked the price of oil over $147 and the price of gasoline over $4.00.

Combined with the collapsing real estate and credit bubbles these severe inflationary pressures collapsed the global economy and led to the worst recession since the Great Depression. For about 6 months we experienced a severe deflationary period.

Take note that the deflationary period followed, not led, the inflationary period. It seems like a contradiction but inflationary pressures lead to deflation not the other way around. As the price of energy spikes strapped consumers shut down and demand for everything except necessities grinds to a halt. Prices plummet as demand collapses. Deflation!

In order for a deflationary period to spawn inflation we have to have the government print money. Which we have in spades I might add. In order for deflation to begin all we need is for the governement to allow the inflationary pressures to get out of control. At that point the process will complete all on it's own.

Now we are starting the process all over again. I think the completely outsized moves in energy, gold and stocks the last two days compared to the rather small decline in the dollar are suggesting this isn't just a short term top in the dollar.

I think there's a high probability that the inflation trade I've been expecting is about to begin.

This, and not another credit event, is what I think will be the catalyst for the next leg down in the secular bear market and the next deflationary scare.

A STORY OF RISK

I'm going to tell you a story about a fella I once knew. He was a young lad, full of confidence ...full of testosterone :)

During his first trip to Vegas this young man discovered a brilliant way to "beat the odds". He figured out that if you can continue to double down on your bet you will always walk out of the casino with a profit.

Here's an example let's say you bet $5 on blackjack and you lose your first hand. Your next bet is $10. If you win that hand you will recover your loss from the original bet and make $5. The same logic applies whether your bet is $10, $20, $40, etc. As soon as you win a hand you will increase your stash by $5.

And let's face it how many hands can one lose in a row? Maybe 5 or 6 if you're really unlucky?

Well as you can guess his initial foray into the blackjack pits was successful, wildly so. He tripled his money in almost no time at all.

Then he got to thinking why in the world am I playing $5 chips, that's going to take me forever to make a fortune. He had visions of owning the strip by this time :) $25 chips would get me where I want to go much much faster.

You probably see where the story is going by now. It didn't take very many losses before our young hero was down $1000, which at the time was a lot of money. At that point he ran out of money and had to retire for the night.

Completely dejected that his fool proof system had let him down so badly our hero decide to buy a deck of cards and run a little test. He wanted to see just how often one runs into a large losing streak, one that would be deeper than his pockets could cover.

To his amazement he discovered that in blackjack one will run into a 15 hand losing streak about every hour or two.

Now if you hit a 15 hand losing streak and are playing $5 chips you have to be willing to bet $163,000 to make a measly $5.

Our hero just learned his most valuable lesson in leverage and odds on that day in the casino.

Now when I hear about these fantastic returns traders are making I know they are in the casino. They're doubling down (leverage) and at some point the market is going to take the system, that they believe is fool proof, away from them (large losing streak). When that happens the massive leverage is going to destroy their account in the blink of an eye. And if they are really leveraged like 20-1 it doesn't take 15 losing hands in a row to do it. You can easily blow out in 4 or 5 trades.

Now let me say this, if and this is a critical if, you are young you could take a very leveraged bet. Knowing that if you are wrong you have the rest of your life to recover from your mistake.

If that bet pays off then you have to be satisfied and return to sound investing principles for the rest of your career. That's the only way you are going to be assured of keeping those gains.

For us older folks there's just no way we can take that kind of risk. We don't have enough time to recover from a fatal mistake.

So when you hear these fantastic tales of monstrous profits take it with a grain of salt. I've heard it all before. And I can tell you that not one single trader who chose this path was able to step off the path after a big score. Once the dark side gets it's claws in you, it's very hard to shake loose. Not one single one of the "big winners" is still around. The odds always get them.

That young man by the way, in case you haven't already guessed, was me.

TIME IS RUNNING OUT FOR THE DOLLAR

A while back I opined that the market would not be able to sustain upward momentum in the face of a stronger dollar. So far that's pretty much what's been happening. 

Other than a minor 30 point blip up as the dollar worked its way down into the last daily cycle low the market has basically gone nowhere since the dollar rally began.

I think if Bernanke wants to keep asset prices inflated he's going to have to get the dollar headed back down just like Greenspan had to do in `04 to get the market headed higher again.

The average duration for a yearly cycle counter trend rally is 50 days. Friday was day 46, so in that sense the dollar is in a live area for a final top in what I believe is just another counter trend move in an ongoing secular bear market.

Commercial traders now have the largest short position on the dollar that they've had in over a year and a half and sentiment has gone from extreme bearishness at the beginning of Dec. to levels of bullishness that have the marked tops of previous yearly cycle counter trend rallies.

Duration wise and sentiment wise the dollar is now setup to resume the secular trend. If Bernanke wants asset prices to continue rising he's going to have to continue pumping liquidity.

With real unemployment stubbornly holding over 15-17% does anyone really think Ben is going to start withdrawing liquidity?