“It’s just money; it’s made up. Pieces of paper with pictures on it so we don’t have to kill each other just to get something to eat.” – John Tuld, as played by Jeremy Irons in Margin Call – Before the Door Pictures 2011.
Tuld’s cynicism was not misplaced. He was the CEO of an unnamed Wall Street firm that had discovered its assets (primarily its MBS or mortgage-backed securities portfolio) were worth less than originally thought. The losses on the portfolio would wipe out the firm’s capital. Tuld decided to sell as much of the portfolio as possible in order to mitigate the losses before the market fully grasped what was going on. The quote was a part of his response to the fact that his decision would trigger a market collapse and put people out of work and firms out of business.
Similarities to the 2008 financial crisis which was triggered by stunning losses in the portfolios of MBSs held by Wall Street firms, and the subsequent collapse of Lehman Brothers, are not lost on the audience. Even Tuld’s name is a play on Richard Fuld, CEO of Lehman at the time.
For Tuld it was his “End Times” and 2012 is supposed to bring the “End Times” as prophesised by the Mayan calendar. Or at least that is what many would like to believe. However, they would be wrong. It is not the end of the world. It is merely the end of a calendar era, not unlike 2011 moving into 2012 although on a much broader and longer scale.
But what will 2012 bring? More to the point, what will the changeover to the new Mayan calendar bring? The Mayan calendar is pointing to a new period, not at 2012 specifically. Will it usher in an increasingly dangerous time in a world that is overpopulated; over-polluted and over indebted, and where errors in human judgment could trigger a nuclear war? Or will it usher in a new renaissance that will benefit the entire planet?
As 2011 came to a close the stock markets were hanging by a thread. Hope was being generated by some better-than-expected economic numbers, and some signs that Europe was working through its crisis and that the euro might not collapse nor any Eurozone country default.
But danger signs abound in a world that remains heavily indebted, where sabre rattling continues in the Mid-East over Iran’s alleged nuclear program, where unemployment remains high in a number of countries, where social unrest has become a possible new norm as a response to government austerity programs and as a rebellion against bailing out banks but not people, where there is growing polarization in many countries between haves and have not’s and between left-leaning social democrats and liberals and right-leaning libertarian and social conservatives, where the US and China continue with military manoeuvres directed at each other, where the Eurozone remains in crisis, where the world’s ability to feed itself is under increasing pressure, where pollution is rampant and the effects of global warming are being felt with increasingly dangerous and more frequent natural disasters.
2011 was not a good year for world stock markets. Only three stock indices were up: the Dow Jones Industrials (6.1%), the Indonesia JSX (2.3%) and the Venezuela IBC – yes, Venezuela – (79%). The S&P 500 was flat for 2011 while the S&P TSX Composite lost 11.3%. The TSX Venture Exchange fell a sharp 35%. The worst performing index was the Greece Athex Composite that fell 53%.
After twelve years of the new century, stock markets around the world remain down. The S&P 500 is off about 20% from its 2007 high, the Dow Jones Industrials is down about 13%, the S&P TSX Composite is off 23% and the NASDAQ is down 48% from its 2000 highs. Many markets are not only below their highs over the past decade but lower than where they started in 2000.
But all markets are not alike. The past 12 years have been good for golds, metals and energy. Gold is up 440% since December 31, 1999, oil has gained 286% and the CRB Index that represents a basket of commodities including metals is up 173%. Strong commodity markets have contributed to significant gains for the commodity stocks over the past decade, despite the broader markets being weak.
Looking at markets in the broader context rather than in a one-year snapshot gives a more accurate picture of trends. Here is the performance of a number of sectors since the beginning of this century.
1 year %
3 years %
5 years %
12 years %
Dow Jones Industrials
S&P TSX Composite
TSX Gold Index
TSX Energy Index
TSX Financials Index
US Thirty Year Bond
US Ten Year Note
US Two Year Note
Cdn Ten Year Bond
US Dollar Index
Source: MGI Securities
As one can see, the century has thus far been dominated by gold, energy and commodities. After 12 years the US stock markets remain largely down although the TSX Composite has had some small gains thanks to its heavy exposure to golds, energy and commodities. Canadian financial stocks have done well but US financial stocks have been a disaster, losing 48.1% since January 1, 2000 (as measured by the PHLX KBW Bank Index). Bonds have been a safe haven with a steady but unspectacular performance to the upside (before coupon).
The TSX Venture exchange has lived up to its wild reputation with an up and down ride over the past twelve years. Over the past year and the past five years it has been the biggest loser, although since the start of the century it has performed well if unspectacularly.
For 2011 the markets did well in the first four months, making their high for the year in early May. Looking back at the forecast made here a year ago, the expectation was that the stock market peak “could occur before June”. It was also noted that “cycles in the second half of 2011 are not as favourable as they are in the first half”. The TSX Composite peaked in March but fell about 16% from the top during the rest of the year.
Looking forward a year ago, the concern was the looming fight over US debt limits. While that fight did play a role in the market collapse that got underway in July and August, the real catalyst was S&P’s unexpected downgrade of US debt from AAA to AA+. Add in the Eurozone crisis that threatened the very survival of the Euro and one had the making of a swift decline that took roughly 20% off the markets. The low was seen in early October.
That the long US Treasury bonds had such a stellar year in 2011 seems to fly in the face of the debt downgrade. But the Eurozone crisis was considered more serious and market participants rushed to the US dollar and US Treasury bonds as a safe haven.
One of the most consistently-used tools here for past forecasts has been the decennial patterns. Turning to the New Year, the record for years ending in a 2 ranks 8th out of 10 in performance for the Dow Jones Industrials since the index started trading back in the 1880s, with seven up years and six down years, as shown in the table on the next page. Three of those six down years experienced sharp declines. Others that did close higher on the year saw the culmination of sharp bear declines.
The years with sharp declines were 1932 (80 years), 1962 (50 years; more about this below) and 2002 (10 years). Two other down years saw the start of a bear market that culminated in a crash the following year: 1892 (120 years) and 1902 (110 years). Note the large losses in 1893 and 1903.
Bear market culminating bottoms were seen in 1942 (70 years) and 1982 (30 years). In 1972 (40 years) there was also the culmination of a bear market, although the actual low was seen in late 1971 with a secondary higher low in early 1972.
While the up years ending in a 2 do (just) outnumber the down years, given the current financial and political environments, as well as a possible “war” environment, it is hard to ignore the down years.
Ten-Year Stock Market Cycle
Annual % Change in the Dow Jones Industrials Average
Year of Decade
9 up 5 dn
12 up 1 dn
10 up 3 dn
Source: Stock Trader’s Almanac 2012
The 50-year cycle falls on some important harmonics. Fifty years ago was 1962, the year of the Cuban Missile Crisis, when it looked for a while as though WW3 might be imminent. It was also the year that US President Kennedy confronted steel companies over price hikes, and that spooked the markets.
In 2012 there are similar war and confrontation themes. There is potential for war with Iran over its alleged nuclear weapons program, and President Obama has been in constant conflict with the Wall Street banks over executive pay and the banks’ resistance to re-regulation following the financial collapse of 2008.
Looking further back, at other 50-year harmonics, we arrive first at 1912 (100 years ago). That was an up year but the seeds were being sown for the most devastating war ever – WW1, the so-called war to end all wars – that began in 1914. Symbolically, it was the year the unsinkable Titanic sank in the North Atlantic on its maiden voyage.
150 years ago was 1862, the year the US Civil War escalated.
200 years ago was the War of 1812, with the British burning the White House. In Europe, Napoleon invaded Russia.
250 years ago was 1762 and the French and Indian Wars (or the Seven Years War) that dramatically changed the world and set in motion the later revolutions in the US and France.
300 years ago, 1712 saw the start of a long war known as the Fox Wars (1712-16 and 1728-33) between France and its Indian allies against other Indian tribes. There was a slave revolt in New York City, which took place not far from the present-day Occupy Wall Street protests.
This year is a Presidential election year. The record of Presidential election years since 1833 shows 29 up years and 15 down years. The last election year was 2008, the year of the financial crisis and crash. Also of note is that in the 15 down years, there was a changing of the guard nine times as the other party won the election.
Since 1833 there have been eight Presidential elections held in years ending in a 2. Here, the record is six up and two down. Significantly, the down years were 1932 and 1892.
With high unemployment, a sluggish economy and a cranky electorate, the odds appear poor for Obama’s re-election. If the markets are down in 2012 the odds look even worse for him. Yet polls show that none of the current Republican candidates appear capable of defeating Obama. Naturally, things could change. Given the current polarized divide in the US the Republican candidates for the most part appear as cranky, extreme and backward-looking (The Economist – December 31, 2011).
There are good odds that the first part of the year will be positive. An upside breakout and a run into March/April or even into May or July could occur if the economic news holds together, if Europe holds together, and if the sabre rattling with Iran grows no worse.
The start of the trading year is giving some positive signs as the S&P 500 broke out above a resistance zone near 1,265. If the markets can hold the gains past January 20 then odds would favour a positive first quarter or so. There is a lot of cash on the sidelines and the monetary authorities continue to grow the money supply. While the economy will likely remain lethargic, there remains a disconnect between what happens on Wall Street and what happens on Main Street. Above 1,325 the S&P 500 could be stampeded as high as 1,370-1,400 or even up to 1,450. The high in 2011 was at 1,370.
Even in the most bearish years of 1892, 1932, 1962 and 2002, the markets were up into March/April before succumbing to the bear cycle.
2012 is also on the well-known four-year cycle. This cycle can sometimes contract and be shallow, in which event the next low often resulted in a crash. Since 1932, lows were seen in 1934 (contracted, shallow), 1938 (crash), 1942, 1946, 1949, 1953, 1957, 1962, 1966, 1968 (contracted, shallow), 1974 (crash), 1978, 1982, 1987 (crash), 1990, 1994, 1998, 2002, 2005 (contracted, shallow), 2008-09 (crash).
Also looming over the markets are the long-term cycles such as the Kondratiev Wave cycle (55-60 years), and possible 72-year and 90-year cycles. These have been discussed in earlier articles and will not be commented on here to any great extent.
Briefly, then: the Kondratiev winter got underway with the market top in 2000 and if past history provides any direction, that winter is only about half-completed. There is some evidence to suggest that the 72-year cycle trough may have been seen with the financial crash of 2008, coming as it did 70-76 years after the Great Depression crashes of 1932 and 1938. The 90-year cycle trough is years away but could occur as early as 2016 and as late as 2032. Again, this would be measured from the Great Depression lows.
Stock market crashes are often triggered by what is now known as a “black swan” event. A black swan event is characterized by being a surprise (at least to the observer), having a big impact, and being rationalized in hindsight. It does not necessarily have to be negative.
Banks and trading firms are vulnerable to black swan events as they can suddenly be exposed to losses far beyond anything predicted in their financial models. Many financial institutions are still leveraged as much as 30 to 1 – down from the heights seen before the crash of 2008 but still abnormally high, leaving them vulnerable if a black swan event were to appear.
John Tuld, the fictitious Wall Street CEO in Margin Call, knows about black swans:
“And it’s certainly no different today than it’s ever been. 1637, 1797, 1819, ’37, ’57, ’84, 1903, ’07, ’29, 1937, 1974, 1987 – Jesus, didn't that fuck me up good – ’90, ’97, 2000 and whatever we want to call this. It’s all just the same thing over and over; we can’t help ourselves. And you and I can’t control it, or stop it, or even slow it. Or even ever-so-slightly alter it. We just react. And we make a lot of money if we get it right. And we get left by the side of the road if we get it wrong. And there have always been and there always will be the same percentage of winners and losers. Happy foxes and sad sacks. Fat cats and starving dogs in this world. Yeah, there may be more of us today than there’s ever been. But the percentages – they stay exactly the same.”
So if there is a black swan event in 2012, where might it come from? The Mayan calendar may be coming to an end on December 21, 2012 but it is not the End Times. The event could come from any one of the following: a sovereign debt default in Europe and the collapse of the euro; a sovereign debt default in Europe that causes a major bank collapse; another unexpected downgrade in US debt; a US election with an inconclusive result; an accident in the Gulf that causes a war with Iran; an accident in the South China Sea or in south-east Asia where there is manoeuvring by both China and the US that triggers a confrontation; North Korea, Syria or Egypt; an accident that leads to a confrontation in Pakistan involving its nuclear arsenal; or an unexpected hard landing in China, given what many believe is a housing bubble waiting to burst. Then again it may be an event out of the blue that is not as yet known.
The monthly chart of the S&P 500 shows the long run-up in the 1990’s followed thus far by 12 years of a secular bear market. On an inflation adjusted basis the S&P 500 has been even weaker. While 2007 saw a nominal new high on inflation adjusted terms it was a lower high. The high thus far on a nominal basis remains well below the highs of 2007.
As noted if the first part of the year remains positive there is a chance that the market can break above 1,325 and see objectives up to 1,400 and even 1,450. Thus far the pattern of the rally from the March 2009 lows appears as a possible ABC type correction followed by a possible Wave 1 to the downside. This would be the 2nd wave and these waves can be higher than the previous peak. Major support is at 1,140. Under 1,140 a decline to major support at 775 or even down to 620 could occur.
Chart created using Omega TradeStation 2000i.Chart data supplied by Dial Data.
The year 2000 saw a shift to commodities from the broader stock market. Following 18 years of a bull market (1982-2000) the stock markets shifted into a long-term secular bear market. The Great Depression secular bear market and War lasted from 1929 to 1949, a period of 20 years. The stagflation secular bear market of the 1970s lasted from 1966 to 1982, a period of 16 years. The current secular bear market is only 12 years old, suggesting it could have years more to run.
While the stock market was in a secular bull market from 1982 to 2000, commodities were in a secular bear market that started with the peak in oil and gold prices in 1980. That bear market ended in 1998 (for oil) and in 2001 (for gold). Since then commodities have been in a secular bull market.
The previous secular bull market for commodities got underway in the 1950s and peaked in 1980. The best gains were seen in the final decade as both oil and gold and other commodities soared. Secular bull markets in commodities can last for 20 to 30 years; the current one has now run for 12 years. Commodity bull markets can, however, be interrupted by very steep corrections as was see particularly in 2008.
Interest rates have also been in a secular bull market since the early 1980s. Given the current environment and the desire of the monetary authorities to keep official interest rates low, the likelihood of any significant rise in interest rates in 2012 is low to nil.
There is, however, a well-known six-year cycle in bonds. This cycle last bottomed in 2007 so the next one is not due until sometime in 2012 to 2014. The bond market is still rising (yields falling) so no crest has yet been seen. While interest rates could bottom in 2012, any rise in rates should not be rapid. The expectation is that interest rates will remain low for the foreseeable future, although they could start to drift higher in the latter part of the year. This refers to long rates only. The monetary authorities are expected to maintain official rates at the current low levels, or in some cases, such as Europe, the ECB could lower official rates further.
Money growth continues to be abnormally high. This is demonstrated by the chart for MZM Money stock. MZM is defined as the total amount of money in the financial system at any time and includes currency and demand deposits. Over the past year MZM money stock growth has been around 18%, a very high level. The chart below shows the velocity of MZM money growth. Velocity has been falling. While there is monetary growth the falling velocity suggests that the money is not turning over and is not getting into the broader economy. This type of situation can be positive for the stock market or the bond market but poor for the economy. With the economy sluggish at best or even in an ongoing recession it is often surprising that the stock market is going and bond prices are also rising which is the current situation.
Source: St. Louis Fed
Source: St. Louis Fed
Oil prices could soar to $150 a barrel or more if a black swan were to visit Iran. Oil usually has its best period before June and 2011 was no exception as oil prices peaked near $114 in late April. Oil made its major bottom in December 1998 at $10.35. That may have been the trough of a longer 15-23 year cycle. If that is correct then the collapse from $147 to $32 in late 2008 was probably a half-cycle low of the larger cycle. If so, then oil is now in the second phase. If the 10-year cycle unfolds in series of threes, then the low seen in October 2011 may have been the first phase of the next 10-year cycle (range 8-12 years). That low was just under $76.
Oil appears to be forming a head and shoulders bottom that could have objectives up to a minimum of $130 once it firmly breaks out over $103. The key is the dance with Iran. As long as this involves only parries and thrusts on the part of Iran and the US, and no war, it will pressure oil prices higher but shouldn’t result in a major spike. That would change if war broke out.
Oil can be quite volatile as the monthly chart demonstrates. Sharp corrections were seen in 2001 and especially in 2008. By comparison the corrections in 2007 and 2011 were shallow. Over the past 12-14 years these are the only instances of oil prices breaking under the 18 month MA. The 2008 low was above the 2001 low confirming oil’s long term uptrend. The most recent low near $76 held above lows seen in May 2010. A firm breakout over $106 could see oil prices move to higher to potential objectives near $145. The weekly charts are pointing to objectives near $130.
Chart created using Omega TradeStation 2000i.Chart data supplied by Dial Data.
2011 was a difficult year for precious metals. Gold soared to a record $1,912 an ounce in September and went into a swift decline. Silver peaked in late April at $49.50 an ounce and its correction was also swift.
If there was a bad call here in the past year it was that no strong bull market developed for the precious metals in the latter part of the year, as the seasonals usually suggest. This in particular negatively impacted the junior exploration sector, which had a sharp decline in 2011 even though fundamentally there was nothing wrong with the junior companies. The senior and intermediate gold stocks traded in a range throughout the year, with numerous whipsaws.
Gold appears to be in the process of completing a possible 34-month cycle trough. If that is correct then new highs above $1,912 would confirm that the next up cycle is underway. Since the last few months were weak, seasonal cycles suggest that the first few months of 2012 could be strong. In 2011 there was a low in January and the first phase of gold’s 2011 rise topped first in late April before a shallow correction set in. Silver’s correction was considerably steeper at the same time.
Since the secular bull market in gold got underway in 2001 the yearly low has tended to come in the first few months of the year, with lows in January or February not unusual. As long as gold (and silver) are not making new lows after February 2012, the low for the year is probably in. Potential objectives for gold once new highs are seen could range from $2,200 to $2,600. Silver could see $50 once again and go as high as $60 to $70. Their performance in the first half of the year may determine their strength in what is normally the strongest seasonal period in the last few months of the year.
The monthly chart of gold shows the classic stair step rise in a bull market. This bull market has been particularly strong and gold has been up every year since 2001. Only once during the past 10 years did gold break down under the 18 month MA. That was in 2008 confirming that it was a significant correction. A new bull market was confirmed once gold rose to new highs in 2009. The 2008 low is suspected to be a known 8.5 year cycle low. If that is correct the next one is not due until 2016-2018. The 8.5 year cycle breaks down usually into 3 phases of a 34 month low. The current correction appears to fit with that cycle. As with a number of past corrections gold has to date held the 18 month MA. Above $1,700 gold breaks out to suggest it could see new highs above $1,912.
Chart created using Omega TradeStation 2000i.Chart data supplied by Dial Data.
2012 could be a dangerous year. There are too many areas where things could go wrong. But if this forecast is correct, the first few months of the year could see a short squeeze that pushes the market higher. The short squeeze would be based on economic numbers that show no recession on the horizon, Europe holding together, and the Iran/US sabre rattling to stay just that – sabre rattling. But the cycles in the second half of the year bode poorly, and that is when some unforeseen event could sideswipe the market. However, one thing is for sure for 2012. That it is not the “End Times” as some suggests the Mayan calendar predicts.
To help you to survive the year and not suffer your own End Times, here are some words of wisdom, once again from John Tuld: “There are three ways to make a living in this business: be first, be smarter, or cheat.”
David Chapman is a director of Bullion Management Group Inc. the Manager of the BMG BullionFund and the BMG Gold BullionFund www.bmgbullion.com
Copyright 2012 All Rights Reserved David Chapman
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