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-- Posted Sunday, 23 February 2003 | Digg This Article
We’ve enjoyed a correspondence that began a few months ago with Pierre-Jean L., a Canadian subscriber who shares many of our views concerning the inflation/deflation conundrum. Here’s a piece of that dialogue that I hope will shed further light on the topic, as well as on diverging prospects for gold and the dollar. Pierre-Jean writes, in part, as follows: Governments cannot go bankrupt, since they have the power to tax. But banks can. It will happen when the monetary system that we take for granted collapses. That is the real definition of the word deflation. We will know deflation has lurched into high gear when banks start going bankrupt. It has not happened yet in this economic cycle, thanks to the way derivatives have spread risk throughout the financial system. But the next time there is a hedge-fund failure on the order of the one that befell Long Term Capital Management, the world will quickly learn the meaning of the word 'domino.' The contributing factors are all in place. Stock market P/E ratios are sky-high and dividends are near historic lows. On a global scale, and, following a supply-side model, we have pushed consumption and credit beyond the edge as never before in history. The question is not whether consumer binging and the real estate boom will collapse, but when. In some developing countries, most particularly Japan, that question has already been answered. It will be our turn when the dollar begins to implode -- a process begun last year. When the process begins to accelerate, everyone will see the game is over. For the investor, what could possibly soften the unwinding of derivatives and government debts? Gold is the only obvious answer, as you have pointed out so forcefully in your newsletter. Our reply, in part, was as follows: Banks Thriving Till the End "You say the banks will continue to thrive until the day they begin to collapse -- an assertion with which I have always agreed. If you accept that the banks' main business lies in 'manufacturing' and 'servicing' dollars, it is possible to infer that business will be good so long as the dollar itself appears healthy. "Until recently, it appeared that they couldn't lose, since they've been able to borrow dollars for as little as 1.25%, and to re-lend them to businesses and consumers for up to 15-20%. Judging from the number of 0% teaser loans I receive in the mail from issuers of bank credit-cards, I would infer that the banks are using their 1.25% borrowing privilege to expand loans and increase their customer base. They can hope to recoup the difference in several ways: 1) when customers make actual purchases with these cards, rates of 10% or more apply on the new balance until the amount borrowed at 0% is completely paid off; 2) when the 0% teaser rate expires, the entire balance is shifted to a 10-15% rate; 3) if you are late making a payment, the entire balance becomes subject to such punitive rates. "Where the banks lose is a year or so down the road, when the unthinkable happens: the dollar is falling, interest rates are climbing, and 0% teasers are no longer possible. Then, every revolving-credit junkie in America is faced with the prospect of paying off huge debit balances that have been carried for zero but which are suddenly accuring interest charges in excess of 10%. If we are experiencing deflation of 1-2% at that time -- as I believe we will, best-case -- and if wages are stagnant and joblessness soaring, as they almost surely will be, imagine what a crushing burden it will be to pay back a 10% loan. In the end, I fear, the banks are going to face writeoffs that will make the 1930s look like a picnic. Meanwhile, only an imbecile could buy Citigroup shares at their current price. The banks are headed for a fall, and it will be coincident with the fall of the dollar. [The + symbol means we have an open position, while $ means there is actionable advice.]
Gold
APR GOLD (351.80): The futures will struggle to hold their own if non-bullion stocks extend Friday’s rally. Thursday’s low at 349.80 is the closest obvious support, but we cannot predict with any great confidence whether it will endure if tested. Alternatively, a close above a hidden pivot at 360.80 would set the futures on course for a run to 379.20.
+ GG (11.60): We hold 200 shares for an average 4.65. A promising rally was aborted by strength in non-bullion shares. Now, if the stock can’t get traction at 11.34, a hidden pivot, it is likely to slip down to the next at 10.45.  
DURBAN DEEP (NasdaqSC:DROOY) : Quote - News - Profile - Message Board - Website
+ DROOY (3.77): We own 600 shares for an average 4.38. The closest support worth noting is a hidden pivot at 3.61 that has already been tested once. If it is touched again and fails, Durban would likely fall to around 3.40 before bottoming.
RGLD (24.13): Friday’s low fell within 4 cents of our worst-case target for the short-term, 21.48. If the support is exceeded today, look for the decline to continue to at least 21.12, a Fibonacci-based level.  
DJIA (8018.11): The Dow managed to slightly exceed an unnoted hidden pivot at 8029 intraday, but that is sufficient to imply the rally will continue today and possibly into tomorrow. Our upside target is 8205.23, but because there is no way we can simplify a day-in-advance strategy and still control tightly for risk, you’ll be on your own in using these numbers. $ E-Mini S&Ps (847.25): We nailed Friday’s low with two decimal accuracy, but a defect in our instructions could have hindered at least some of you from gathering the fruits of the 23-point rally that followed. We’d intended to advise that no trade be initiated if the futures exceeded 843.25, but, looking at the wrong peak on the chart, wrote 840.50 by mistake. This could have made a crucial difference, since there was a rally to 842.25 before the recommended trade was triggered. Happily, I heard from two subscribers who took the trade anyway, but one noted that he’d been filled on only two contracts of a 20-contract bid. Such are the problems of buying and selling on targets that happen to coincide exactly with actual tops and bottoms. For today, based on the 1.00-point breach on Friday of a hidden pivot at 850.75, we are projecting follow-through to at least 869.75. You can short there until the final hour with an 870.25 stop-loss, but you’ll be on your own thereafter. MAR BONDS (113.04): We’ll adjust our rally target downward, from 115.30 to 115.07. It will remain viable so long as the futures do not fall below 111.27. $ OEX (429.87): Based on Friday’s analysis you could have gone long on Friday when the index touched 426.14. If you did, take profits on half the position on the opening, then scale out the rest to a target of 441.46. A trailing stop of 2.90 points is advised. QQQ (25.17): Like numerous other vehicles tracked herein, the cubes slightly exceeded a hidden-pivot resistance in the closing hour of Friday’s session. This implies the rally will continue, probably to at least 26.20, a hidden pivot. MAR NASDAQ 100 (1015.00): A rally to 1062.00 is possible over the short term, but the futures will first need to get by a hidden pivot at 1028.00 – still our immediate upside target. It is a bullish sign that the March contract was able to exceed intraday a lesser pivot at 1019.75.
-- Posted Sunday, 23 February 2003 | Digg This Article
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MarketWise Black Box is published on weekdays 240 times per year. Copyright 2003 by MarketWise. For further information please go to www.marketwise.com. All information was gathered from sources believed to be reliable The risk of loss in futures, stocks or options can be substantial; therefore only genuine risk s should be used for such trading. Futures, stocks and options may not be a suitable investment for all individuals, and individuals should therefore carefully consider their financial condition in deciding whether to trade. Commodity option traders should be aware that the assignment of a short position will result in a futures position. Past profits are not indicative of future profits.
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