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December 15, 2008

No Free Lunch
by Captain Hook

The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Wednesday, November 26th, 2008.

I will never forget the walk down the long narrow hallway to the offices of my economics professors in university, and in particular, on the door of one a solitary sign permanently fixed saying 'NO FREE LUNCH'. At the time, this particular professor was not my favorite because I viewed him as a bit of a 'hard-ass', where I was unable to calculate the exacting standards he wanted in my work. However as time has passed, this has all changed. Now, with the experience of life behind me, it's almost as if I am viewing the world through his eyes, looking at all the rot and corruption that permeates almost every aspect of our society. To an economist, such conditions are measured in imbalances and deficits, which are essentially reflections of our inability to pay set against unbridled aspirations. That's what these conditions (imbalances and deficits) are measuring in the end, people attempting to get something for nothing, or a 'free lunch' as it were.

Fast forward to today, and it doesn't take very long to calculate that based on the above standards we have more people looking for a free lunch than ever before, typified by bureaucrats and bankers enacting the biggest begging bowls in history. And of course with this mentality, a mentality one could label the 'economics of hedonism', it's so bad these days things may have finally gotten bad enough to trigger change, change characterized by radical revolution that will be necessary to rebuild economies as the present system goes bankrupt. And again, this is because there is no free lunch in this world, meaning there's no way the US public will be able to shoulder the burdens it's corrupt bureaucracy is saddling it with while providing us with the best example in history why fiat currency based economies don't work. Go ahead, bail us all out, but with no self generating multipliers to accompany the largess, the prognosis is doom, no matter.

Of course we can't blame it all on the bankers and bureaucrats, albeit this is where ultimate responsibility lies. No, we all must take some degree of responsibility, as essentially, we allowed it to happen in searching for our own free lunch. Never before have so many had so much for doing nothing, with perhaps the most flagrant example of this being subprime. Here, people with little to no incomes or assets were allowed to borrow to buy homes due to increasingly lax lending standards as bankers attempted to extend the credit cycle, which was a win - win situation while the party lasted. As you undoubtedly know however, the party is over now. In the appearance of shock and surprise it's become evident one is actually responsible your debts, but please, don't tell the bureaucrats this or they might stop giving the bankers more bailout money, with a quicker end the result.

No, for most it's better to continue living in illusion, where for many not having the collection man at the front door is apparently license to conjure things will remain this way. Of course the thing one must remember here is bailouts should not be associated with growth, and only legitimate economic growth will get the economy rolling again. So, for those looking for a big rally in the stock market here, you are likely dreaming. According to Charles Biderman of Trim Tabs, corporate buybacks are down 75% from levels a year ago, and retail investment is just as bad, meaning there is increasingly scare cash flow entering the market to keep the balloons inflated. People need the money to pay for higher living standards, bigger houses, and increased debt payments that too many years of 'good times' will bring to the weak minded. This leaves increasingly less for investment, especially as retirement is approaching, as people get the lunch tab.

And the thing about this understanding one should realize is 'the tab' has not come for just the lowly subprime types, people that never should have had a house anyway - right? No, the tab is coming to mainstream America increasingly very soon, where on top of the increasing budget deficits all the bailouts will foster, which will need to be paid for with a lower dollar ($) since the consumer is already broke, a whole new series of Interest Only (IO's) and Option ARMS readjustments are also scheduled to kick in starting in May of next year, running right through 2012. That's what the charts below show courtesy Credit Swiss. They show (in billons of $'s) the amounts of these balloon payment type loans coming due beginning in May of 2009, along with how much payments will increase in the second chart. Between the two it adds up to over a trillion $'s between 2009 and 2012, which may not sound like much in relation to all the trillions being given away these days, however it should be recognized this is not bailout money, but actual increasing (income depleting) obligations that will hit mainstream America a huge tab at exactly the wrong time for an already stretched consumer.

Option ARM Recast and Payment Shock Forecast

What does this mean for the stock market at present with a gap here between now and next May, where consumer obligations will remain steady from this perspective. Perhaps a little more spending, which would surprise economy watchers, with increasing numbers on deflation watch now. Combine this with the possibility of speculators turning increasingly bearish as prices rise due to attempts to pick a top because the consensus has turned to the deflation view, and we could have a possible recipe for a more robust rally than just about anyone is counting on over the next several months. You will remember that recovery wise both the 1929 and 1937 post crash patterns allow for 50% retracements into April of next year, which would put the S&P 500 (SPX) back above the large round number at 1000, an unlikely prospect to most at present given deflationary attitudes. (i.e. 1576 - 741 = 1158, our ultimate possible target for this bounce.) Of course the SPX must be able to close above the Fibonacci 233-month exponential moving average (EMA) for at least two days before any such thoughts can realistically be contemplated. (See Figure 1)

Figure 2

As you know from our numerous discussions on the subject however, in order for such an outcome to become a reality speculators will need get bearish moving forward, which is a possibility given the fact both the public and officialdom are now waking up to possibilities associated with deflation. This of course means open interest put / call ratios on US indexes will need rise to provide the fuel for a short squeeze facilitated by a temporarily reinvigorated hedge fund community. In this respect it should be noted redemptions could turn in to modest inflows for the funds in coming months if price stability overtakes the macro for reasons outlined above. So, if the 920 resistance on the SPX is taken out, then it's off to test 1,000, the large round number and key Fibonacci resonance related resistance, as can be seen on the chart below that dates back to 1980. Such an outcome would be quite impressive considering the 'crash signatures' still in the trade, but given the overbought nature of the $, anything is possible. (See Figure 2)

Figure 3

When looking at the open interest put / call ratios posted above however, you will notice that in general, unless the trade gets increasingly bearish as we move into December, a more likely outcome for the stock market(s) is nowhere near as bullish as otherwise could be the case. And in this respect we will be watch post Thanks Giving Day trends very closely, where with any luck bad news on the shopping front this weekend could help to turn increasing numbers bearish, subsequently causing absolute put / call ratios to rise. This is what we are hoping for at the moment, where the spike higher in the Philadelphia Gold And Silver Index (XAU) open interest put / call ratio that can be seen in the attached above in Figure 9 is somewhat encouraging in this regard as the golds are expected to lead, again, because the trade goes bearish on deflation expectations. A move and confirmed (3% > for 3-days) close above 105 on the XAU would be a strong 'buy signal' in this regard, and telegraph a bullish outcome for the larger equity complex as prescribed above. (See Figure 3)

Figure 4

These are the things we will be watching for over the next week or so, where I must admit from a bull's perspective it's encouraging to see precious metal share investors finally getting bearish. And I see the Gold / Silver Ratio is declining this morning, where a break of the 50-day moving average (MA) would be solid confirmation the intermediate-term trend has turned here too (expect a move to the 200-day MA), along with providing another reliable leading indicator the larger equity complex will see further strength. Moreover, we have gold itself closing above its 50-day MA for two days now as well, with the same today being a confirmed 'buy signal' in this regard. All we need now is for silver to do the same and the break lower in the Gold / Silver Ratio should be fait accompli, with the $ following lower.

Unfortunately we cannot carry on past this point, as the remainder of this analysis is reserved for our subscribers. Of course if the above is the kind of analysis you are looking for this is easily remedied by visiting our continually improved web site to discover more about how our service can help you in not only this regard, but also in achieving your financial goals. For your information, our newly reconstructed site includes such improvements as automated subscriptions, improvements to trend identifying / professionally annotated charts, to the more detailed quote pages exclusively designed for independent investors who like to stay on top of things. Here, in addition to improving our advisory service, our aim is to also provide a resource center, one where you have access to well presented 'key' information concerning the markets we cover.

And if you have any questions, comments, or criticisms regarding the above, please feel free to drop us a line. We very much enjoy hearing from you on these matters.

Best of the season all.

Captain Hook
TreasureChests.info

Treasure Chests is a market timing service specializing in value-based position trading in the precious metals and equity markets with an orientation geared to identifying intermediate-term swing trading opportunities. Specific opportunities are identified utilizing a combination of fundamental, technical, and inter-market analysis. This style of investing has proven very successful for wealthy and sophisticated investors, as it reduces risk and enhances returns when the methodology is applied effectively. Those interested in discovering more about how the strategies described above can enhance your wealth should visit our web site at Treasure Chests.

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