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October 27, 2003

Final Top
by David Chapman

From the lows in March 2003 to the highs in June 2003 the markets put on an impressive show. The S&P 500 gained 25.8%, the Dow Jones Industrials (DJI) was up 23.9%, and the TSX Composite was the laggard with only a 14.3% gain, while the tech laden NASDAQ shone, up 37.1%. Since those highs in June the markets have been grudging slugs. To the recent highs this month, the NASDAQ may still have impressed up 10.5% and the TSX Composite put on 9.2% but the DJI and the S&P 500 lagged up 5.1% and 3.5% respectively.

Still overall it has been impressive period. But one needs to keep things in perspective. At the recent highs the S&P 500 was still down 30.5%, the DJI lagged by 16.4%, the TSX Composite was off 31.3% and the NASDAQ was down a whopping 61.6%. We are reminded that we are in a bear market not a bull market. The markets have not seen new highs for over three years.

Gold and the precious metals stocks, however, have continued to shine throughout the same period. From March 2003 to June 2003 the Gold Bugs Index (HUI) put on an impressive 32.9% just below the performance of the NASDAQ. But from June to now the HUI is up another 39.5% leaving the major indices in the dust. And the HUI is up 506% since its lows in 2000. Even the moribund Philadelphia Gold and Silver Exchange (XAU) (the XAU includes hedgers whereas the HUI has only non hedgers) is up 130.8% since those lows of October 2000. So where would you have rather been?

Yet if one listens to a steady stream of analysts, fund managers, portfolio managers and market pundits we remain on the cusp of a new bull market. While the overall market has been held up by massive dosages of liquidity injections and interest rate cuts particularly after September 11, 2001 and the Iraq war in March 2003 those liquidity injections have been soon lost as the market plunges to new lows following the period of higher prices pushed on by the liquidity injections. And this time will be no different with the only question being when will the market makes its final top.

Gold and gold shares have remained buoyant primarily because the US Dollar has fallen some 24% since it topped in July 2001. Gold during the same period has gained almost 51% since its low in February 2001. The US Dollar and Gold maintain their negative correlation. And with the US Dollar pointed lower still, gold can only go higher. High levels of debt with the government in the budget, trade and the current account, plus the unsustainable debt levels of the consumer and corporations is a real Achilles heel that will ensure that the US Dollar falls further while gold will move higher.

Yet all we hear is the economy is improving and turning the corner; the Fed will cut interest rates further to ensure a climate conducive to growth or leave interest rates at their current low levels; the US will lead the world once again to a robust recovery; and business spending and job growth are just around the corner and the Fed has laid the conditions for that happen. But the US is bogged down in an unwinnable war in Iraq and the Israeli/Palestinian situation remains a tinder box.

The war in Iraq is a drag in cost both financially and in lives that has no discernible end even as alternatives might be even worse. Expenditures due to the war have made up a large part of the GDP growth over the past year while domestically infrastructure, health and education remain under funded. The Israeli/Palestinian conflict is one that begs for a political solution but remains strictly a military one while the United Nations sits neutered by the veto power of the US. Political and financial instability are two things that will ensure gold remains a powerful and positive force even as the broader market appears to both treat gold and precious metals benignly or in some instances still as a barbarous relic to be ignored.

And even as a recovery is hailed as just around the corner the unemployment continues to grow. 2.6 million jobs have been lost since 2000 and there is little sign that this is going to turn around even as companies have reported generally better results. Jobs are being shed in manufacturing and as well as high tech jobs. They are being replaced by McJobs or they are going to Asia (particularly China). Unemployed people dont spend and even such stop gap measures as mortgage refinancings to keep the consumer spending are beginning to wane. As interest rates the buoyant housing market is beginning to falter and the rush to re-mortgage is falling back.

Rising interest rates are poor for the economy but as the US Dollar falls interest rates will have to rise to continue to attract funds to finance the debt. The budget and trade deficits alone require $2.6 billion per day to finance. But as countries increasingly fall into large trading blocks each are reluctant to give up their relative trading advantages to see their currency fall against the US Dollar. But that is what is happening and it sets in motion a downward spiral of currency devaluations to compensate. All of this is very positive for gold.

The four year cycle last bottomed in October 2002. But the four year cycle itself does not have a consistent history as there is discernible short cycles and long cycles seen over the years. Since the 1920's we saw clear lows in 1921, 1924, 1926, 1932, 1938, 1942, 1946, 1949, 1953, 1957, 1962, 1966, 1970, 1974, 1978, 1982, 1987, 1990, 1994, 1998 and 2002. Half cycle lows can often be seen as well during these periods.

There is often talk as well of the Presidential cycle and in this case the fourth year of the cycle is usually an up year for the market. Indeed the record here is quite good as most are indeed up with a few relatively flat such as 1948 and 1956 but some did see down years such as 1932, 1940, 1960 and 1984. Some such as 1980 did see a sharp drop before recovering in the latter part of the year in time for the election. The premise is that the incumbent President will want to ensure that the economy is growing, jobs are being created and the monetary conditions are favourable to either the re-election of an incumbent President or to ensure his party is re-elected.

Of course all of this is clearly the case going into the 2004 elections. But the incumbent President is waning in popularity as the war in Iraq continues with no evident exit strategy and a rising body count. As well he is being weighed down by the accusations that war was started under false pretences. There are no weapons of mass destruction. In some circles beginning impeachment procedures has been discussed although at this stage the odds of that happening are very low. A more likely target would be Dick Cheney if any impeachment procedures were started.

The economy continues to muddle with jobs being lost even as there is some economic growth even though a large part of the growth is attributable to defence expenditures. The cost of empire weighs heavily on those who wish to maintain one. Ask the Romans, the Greeks and more recently the Spanish and even more recently the French, the British and the Russians. While low interest rates remain in place that may be compromised by a falling US Dollar. The massive liquidity injections that prevailed during other periods of financial stress are harder to justify going forward unless there was a crisis. Intriguingly money supply (M3) actually fell in September. Fuel for the economy and the stock market is clearly waning.

The market may have made its final high in the week of October 20. On October 21 the market gapped higher on a raft of good earnings news then reversed and closed lower on the day. These reversals are often only noted in hindsight as important highs but if that high is not taken out over the next couple of months it will gain in importance. The VIX volatility indicator, a measure of fear and greed in the markets, was at levels seen at highs seen in 1998, 2000 and early 2002. The bullish consensus had been and remained in the mid-sixties levels usually not sustainable for any length of time. And all of this coming on a constant stream of reports stating the economy is turning the corner, the global economy is rising again that the bad news is behind us.

But bear markets are very tricky. The bear retreats appearing to be gone then will suddenly re-appear with unexpected viciousness. If, as we believe, that we are in the downside of the Kondratieff Wave cycle and as well a number of other long term down cycles are converging during this decade then periods such as the past six to twelve months will merely prove to be temporary respites in a longer term bear market. All major cycles that we follow are pointed down into 2006 so while Presidential cycles may have been a positive influence in the past as the famous disclaimers say it is no guarantee of future performance.

It may very well be that any pullback we get now is shallow and we will after a possible sharp correction resume the up trends that began first in October 2002 then continued from March 2003. But to do that a number of things must fall into place including a continuance of the low interest rates, maintenance of rabid money growth, a recovery in the US Dollar, an easing of tensions in both Iraq and Israel/Palestine and a recovery in the waning popularity of the President.

We want to show again our favourite set of charts. The Tokyo Nikkei Dow of 1989-1994 versus the current chart of the S&P 500. We have been intrigued for some time with the ongoing similarities in the two charts. Of course that may change going forward but thus far it has acted as a interesting roadmap.

We are also showing the US Dollar Index and what may be a massive complex head and shoulders top. As fold back patterns this one is quite intriguing. It projects down to at least the mid 60's. If any of these charts are true it bodes poorly for 2004 and the Presidential hopes of the current incumbent.

DavidChapman.com
Technical Scoop

Charts and technical commentary by:
David Chapman of Union Securities Ltd.,
69 Yonge Street, Suite 600,
Toronto, Ontario, M5E 1K3
(416) 604-0533
(416) 604-0557 (fax)
1-888-298-7405 (toll free)

David Chapman is a director of Bullion Management Services the manager of the Millennium BullionFund www.bmsinc.ca

Note: The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete.

The information in this report is drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does Union Securities Ltd. assume any responsibility or liability. Estimates and projections contained herein are Union's own or obtained from our consultants. This report is not to be construed as an offer to sell or the solicitation of an offer to buy any securities and is intended for distribution only in those jurisdictions where Union Securities Ltd. is registered as an advisor or a dealer in securities. This research material is approved by Union Securities (International) Ltd. which is authorized and regulated by the Financial Services Authority for the conduct of investment business in the U.K. The investments or investment services, which are the subject of this research material are not available for private customers as defined by the Financial Services Authority. Union Securities Ltd. is a controlling shareholder of Union Securities (International) Ltd. and the latter acts as an introducing broker to the former. This report is not intended for, nor should it be distributed to, any persons residing in the USA. The inventories of Union Securities Ltd., Union Securities (International) Ltd. their affiliated companies and the holdings of their respective directors and officers and companies with which they are associated have, or may have, a position or holding in, or may affect transactions in the investments concerned, or related investments. Union Securities Ltd. is a member of the Canadian Investment Protection Fund and the Investment Dealers Association of Canada. Union Securities (International) Ltd. is authorized and regulated by the Financial Services Authority of the U.K.

Copyright © 2002-2008 David Chapman

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