Well, it has been a long time since our last letter, Eyes Wide Shut? and it is good to have more time, post-blog, for the main website.  This letter will not focus so much on the disaster in progress that is the consumer driven, debt levered economy and associated financial markets because the major media, presidential candidates (only one of the would-be leaders, Ron Paul appears to have any clue about how a healthy economy is supposed to run, where inflation really comes from and how we can begin to get on a path to secure a future for our children), talk radio and of course the Decider-In-Chief and his SecTreas are on the job.  The public's eyes are indeed finally wide open with fear and the time for taking precautionary measures was before the panicked herd began looking for answers.  Now those who have suddenly 'come to the lord' need to get in line.  Sensible measures like paying off or down your debt, having exposure to gold and for liquidity, short term US Treasuries can still be undertaken but the 'ask' has risen on the trade.  While I do not agree with Robert Prechter's EWI on all counts, I found his 'Conquer the Crash' invaluable and have followed many of its suggestions, including keeping cash in short term treasury instruments, since 2002.  A review of our past articles shows a heightened level of caution throughout the 'inflation bull' that is now wrapping up.  I guess the one that said it in the most colorful manner was Abbott and Costello Meet FrankenMarket.  There is nothing wrong with a little entertainment while chronicling the fundamentals of disaster.  So all that said, on to the state of various markets.

The Good

Gold climbed to the 900 target off of a weekly symmetrical triangle laid out in the previous letter and in fact came within $4 of our refined target of 920 off of a subsequent daily symmetrical triangle/consolidation.  Because our focus has changed from cautionary preaching to trading/investing in a market that is ever more volatile, I am not focused so much on the metal for the purposes of this letter.  The focus is as it has been since mid-summer 2007 on the precious metals miners and a stance of always holding significant exposure to favored miners.  That was in spite of a nagging propensity of oil to outperform gold, which was not helping the miners' bottom lines.  But the yield curve, credit spreads and gold outperforming most other commodities relevant to miners' costs have long since turned favorable for the gold sector.  Now, the gold-oil ratio joins the other fundamentals in presenting a bullish picture. 

Gold/Oil has finally broken out on the weekly chart and may have a bit of resistance short term, but indicators like MACD, PPO and TRIX show a move in its infancy.  Gold miner CEO's (at least the smart ones) prepare for good times ahead when they see an oncoming economic contraction because their costs will decline as their product declines less than most other assets, if it declines at all.  Gold has been and will continue receiving the monetary bid, but at this point there are likely many 'commodity bull' speculators still to be wrung out.  It is painful suffering through events like last week, but my discipline has been that no matter what the technicals say - and they surely called for a correction/consolidation - I must maintain core positions.  That has been the stance ever since precious metals miners' fundamentals began falling in line like dominoes last summer.  The stance also calls for having substantial cash percentage available at all times to take advantage of these events.  I am doing so all in and around this process.  

The chart of HUI shows some parameters.  We have already 'fibbed' to 50% and while bottom picking can be fun, it is wise to save powder and discreetly buy quality stocks at logical support levels.  HUI definitely has the potential to go lower, but so too has it satisfied enough levels to call this a solid correction.  If the stock market does not catch a bid in here soon, the HUI could see the 400 level again, but since that is nowhere near a given and since there is no crystal ball in my possession, I hold with the realization that "it don't come easy".  A caveat however; make no mistake that the gold and silver miners are stocks and if the markets have a genuine 'liquidity event' (see below), the woodshed awaits we holders of paper derivatives of gold.

The Bad

Santa came to Wall Street and delivered wonderful bonuses as usual and as expected.  Then he grudgingly went to Main Street and emptied his bag of all the leftovers, mainly a bunch of crappy toys made in China (just yesterday my daughter asked me to put a battery in a little blow dryer for her doll and the battery housing had no contacts in it, just a raw plastic compartment).  Somehow I do not feel all is lost for American manufacturing.  Not by a long shot.

But back to the paper pushers on Wall Street.  They have created, brokered and marked up all manner of vehicles for overly trusting investors to buy in to.  Despite the warnings found on this website along with several other excellent sites that publish independent financial writers, most investors have chosen to follow the piper, ride out the rough patches and keep that stiff upper lip.  This has always worked in the past and while moral hazards have become strikingly apparent today, in the long run it may well continue to work as long as inflation is successfully used as a tool for Ponzinomic growth.  That does not help folks caught in the short to medium term however.

The chart of the S&P 500 really needs no commentary.  This thing is snapping support level platforms like balsa wood and it is doing it on heavy volume.  Rats are scurrying to get off the sinking ship and while I have been very reluctant to use the 'C' word, especially with so many expecting one, the potential is there for a crash, if we are not already part way through one.  As astute observers have noted, crashes tend to happen from oversold levels as the drive toward capitulation becomes overpowering.  By the same token a sharp snap back rally is possible at any time but it is unlikely the usual hope filled news will do the trick given the failure of Ben Bernanke's jawbone and President Bush's money drop plan; no, the Fed will need to deliver a larger than expected rate cut.  The trick for Mr. Bernanke will be to determine whether a cut before the scheduled meeting will inspire more confidence than continuing to jawbone and delivering upon meeting with the FOMC and pretending that there is really any debate on the matter.  Note the MACD back in bear market territory with Trixy about to follow.  Here is the same chart going back to 2000.  The breakdown of MACD should leave little doubt what kind of market we have in the big picture, especially so if the TRIX confirms.  In the near term, at the very least another 'C' word may come into play; capitulation.

The Ugly

Deflation.  In a word, this is the condition nobody wants to see happen, where dollars are bought up and held like a security blanket.  Least of all do public officials want to see this (see Mr. Paulson's telling quote on the front page of the website).  If the US economic system was actually grounded by productivity a deflationary impulse would be well and good as it cleans the excesses out of markets and decides the winners and losers.  But as the inflationary game of hide the bubble morphs into musical chairs, casino patrons rush to find a place to sit this one out with the knowledge that untold levels of debt and derivatives are unable to find real markets.  In fact, the US is now in the midst of a 'bailout' (buyout) to some degree from the likes of USD cash rich supposed allies (Saudi) and vendor financiers (China).  The same patrons, the same funny munny that had to have stocks, commodities and resources of all kinds may now seek out the US Dollar in a rush out of assets.  I will be surprised if the Dollar ever sees north of 80 for a long while if ever, but in a world of competitively inflated munny, anything is possible.  Again, how long does confidence hold sway?  Meanwhile, if the USD rallies, will gold bugs go scattering back down Hamburger Hill?  Has the correction already led a Dollar rally?  Or is the Gold-Oil ratio noted in the lower panel of the chart going to continue to lead the Dollar?  If that happens, the miners may experience continued USD rally pressure even as their fundamentals get stronger with gold outperforming oil as it should most assets in a deflationary impulse.

In my bias toward strengthening long term rates I previously saw the potential worst of all worlds with pressure on the short end with long rates in an uptrend, but as the monthly chart of the 10 year yield shows, that bias was wrong... or at least too early.  The bond market's message that inflation is not a problem, while totally ridiculous is actually good news to a system built to function on just the sort of stimulus that our leaders are currently cooking up.  We would not be hearing so much talk about rate cuts and stimulus if long rates were crying INFLATION.  So it is quite possible - especially if gold remains in a correction/consolidation - that policy makers will have the cover they need to reflate this mess once again and one day the bull touts are again bullhorning the wondrous elasticity and flexibility of the US economy and its ability to weather a storm.  But of course, this will just be the next (and more severe) round of inflation manifesting itself in assets.  Wash, rinse, repeat.

The Speculative

I currently hold gold and silver miners and explorers of the highest quality I can find.  There is also exposure - at least for the short term - to copper, which looks bullish for a continued short term bounce.  Note that copper is in a daily uptrend, weekly downtrend and in the big picture still hanging on to a bullish trend on the monthly.  So the picture here is murky beyond a trade.  Also cash and equivalents are at 60% with the majority in short term treasury instruments.

The Pitch

If you would like prompt technical analysis on the stock(s) or market(s) of your choice, give us a try at Biiwii.com's TA onDemand.  Whether the trend is bull or bear, TA is very useful tool when trying to gauge the short term (daily), intermediate term trend (weekly) and big picture (monthly). 

Post Script

We will try to write a new letter each month or at least as time allows.  Blogging was cool but it also made it too easy to write too often.  Market related time will now be devoted to research of individual stocks for my own purposes and macro events for this space.

Be well, stay safe out there and keep your eyes open!

http://www.biiwii.com

-- Posted Monday, 21 January 2008 | Digg This Article