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September 30, 2005

The Shell Game
by Captain Hook

There has been much talk about stock markets being poised to crash in October this year. And, we are interested in whether stocks are poised to 'crash' here in October once again or not, because in a general sense it's no secret from both technical and fundamental perspectives, they may do exactly that. Why do stocks have a tendency to crash in October? Although we do not have time to delve into all the intricacies, the stars must be aligned, where in addition to having suitable technical and fundamental circumstances, the investing public's sentiment must show complacency, which it definitely does right now thanks to the Greenspan Put.

Greenspan was out warning everybody that accidents in financial markets do happen again Tuesday, and in his words 'ironically' this kind of thing can happen 'as a result of prosperous times', where the Fed could not be held accountable if those unidentifiable bubbles start bursting. What he should have said was he cannot believe his luck investors are so stupid, because he has been keeping the liquidity fed short squeeze against a sea of never ending negative bets going far longer than he thought possible, but now it looks like people might be having trouble with their interest payments, so the 'house of cards' might crash. Therein, if one thinks the Fed is raising bank rates because they are being fiscally responsible you are dead wrong. Greenspan is a bubblehead.

The Fed is raising bank rates primarily to attract foreign capital to the States in an effort to stabilize debt and currency markets, maintaining his bubbles. He knows his bubbles are there, and he also knows he cannot deflate them completely or his asset based economy will implode, so he is just trying to let some air out slowly. Then, when he sees the possibility the bottom might fall out he hits the gas pedal again, much like a day trader, which has essentially been the game over the past twenty years. Trying to figure out when Mr. Bubblehead will hit the gas pedal (money supply growth rate) again.

Today, the Fed has money supply management down to a science, where daily injections (never withdrawals anymore) are added to the system when the need is perceived. Added to the above, the Fed's 'coupe de grass' shell game is the one played on hedge funds and speculators in that outwardly they make it appear an attempt to slow the economy down is underway, like now with their current tightening cycle, while at the same time they are goosing money supply behind the scenes to squeeze the put buyers. Greenspan must pinch himself every morning when he wakes up because he just can't believe his luck. He actually looks like he is doing something other than blowing up bubbles, when nothing could be further from the truth.

Anyway, now that I have that rant out of my system, and since its almost impossible to tell if the Fed's games have become unmanageable with any degree of certainty in real time, let's take a look at some indicators that can possibly provide us with a reasonable indication trouble is on the way. The idea here is to stay ahead of the curve. We highly doubt this is possible however, as for example, today the International Swaps and Derivatives Association reported that global credit derivatives market increased 48 percent to $12.2 trillion notional value in just the first six-months of this year. The question then arises, 'how do you stay ahead of a snowball heading down at a steep slope that appears to be picking up momentum?' The answer is you don't, which is why everybody should have a strong precious metals component in his or her portfolio right now. That way you don't have to worry about staying ahead of the game because you are already there.

If there is any kind of trouble the Fed could not handle right now, as Greenspan alluded to in his speech the other day, its an exhausted consumer, a consumer no longer willing to take on debt. This is why close management of the Fed's shell game is becoming both increasingly important and difficult for them right now, because the consumer is in fact all borrowed out, meaning authorities have a much harder job keeping the bubbles inflated. That is why you see gold outperforming all other assets, because 'the need for speed' in money supply growth rates is ever-present, where one has to wonder what justification could have been provided for recent stimulus surges if the hurricanes had blown past the Gulf. (See Figure 1)

Figure 1

Actually, there is no shortage of indicators out there in this regard, but one that is being watched closely by the 'smart money' right now is the Canadian Dollar (C$), where because of the resource asset buying binge global players have been on over the past few years, it has become fiat currency of choice. Interestingly, it has been sputtering over the past couple of days however, where the charts definitely point to a possibility fundamentals may have to take a backseat to bearish technical indications for a while. A confirmed break below 85 on the cash index would send this message. This would send out a message the Greenspan modeled 'global boom' is in trouble. (See Figure 2)

Figure 2

Taking a look through both the rear-view mirror and ahead, it does seem somewhat appropriate for the C$ to begin fading soon, since trends in commodity related currencies can change well before price trends in the actual commodities. And in looking at the 'big picture', where the US is currently enthralled in a 'economic crisis', which may remain 'peaked' until hurricane season passes, unless traders see the likelihood of a cold winter this year keeping petroleum-prices rising, we would not be surprised to see the 'Loonie' break lower soon in anticipation of commodities easing at some point.

Of course this could all be wishful thinking (looking for 'normal' business cycles), as we could be caught in a hyperinflationary loop at present (authorities will manage the economy / markets based on circumstances associated with a runaway credit cycle), one that does not allow for pressure releases. If this is the case, current trends in commodities can be expected to maintain until fundamentals associated with such circumstances are completely burned off, with only the very shallow pullbacks we have seen since last year continuing to characterize trends until they die of exhaustion. Nobody in their right mind wishes to see such a scenario develop because once this type of sequence is completed, the economic collapse that would occur afterward, likely involving a 'breakdown' in the global fiat currency system as we know it, would be upon us sooner than it has to be. That is to say at some point in the future, all current fiat currency regimes will fade away in spite of sequential considerations, where new systems (partially precious metals backed) will emerge to replace them, but a rapid pace in the process will hurt more people financially than otherwise would have occurred with a moderated candor.

Unfortunately, we may not be so lucky as to escape the ravages of a less palatable scenario, as gold is signaling Easy Al and his band of merry men are not about to slow down their daily manipulation of money supply and markets, which in turn will cause US trading partners to do the same, disrupting the best laid plans. As mentioned earlier this week, gold may have to run up to $490, the 38 percent retracement off 1980 highs, before a more meaningful correction back down to the $450 level sets in, with an interim top possibly coincident with a cessation to historical seasonal strength early in October. (See Figure 3)

Figure 3

If however, we do see more hurricanes in the States delay repairs to damaged oil and gas production facilities of the Gulf area, cold weather shows up, and / or troubles escalate in the Middle East, maintaining a firm tone in energy prices, enough damage to the economy could be done Greenspan decides to open the money supply spigots full throttle, where a hyperinflationary wave of liquidity would hit the world system, again causing foreign counter-parties to do the same or import US inflation. This is what would keep a firm tone in the price of gold, where it is not inconceivable conditions could get so 'out of control' in the States, and that an extreme acceleration in monetary growth rates actually begins about the time things should be cooling down in this respect during October. One must remember Al is leaving his post at the end of this year, so he will not want to attend his going away parties with egg on his face.

We will know for sure this is the case when the Dow / Gold Ratio takes out previous lows / Fibonacci resonance related support as denoted in the attached, where if this were to happen soon, we would either see a crash in the Dow, gold rocket higher, or perhaps a combination of both scenarios. Notice the next Fibonacci resonance related support level comes in at approximately 17, meaning if the Dow only declines to 10,000, gold would temporarily top out at $588 within the mix. If gold were to top out in the $525 area however, the next significant Fibonacci related resistance past $490, the Dow would not bottom until it reaches approximately 9,000. One should note that such an outcome would invariably increase the possibility that an ultimate low in the Dow / Gold Ratio (at 1) could involve a disastrously weaker stock market profile in the end, where for example, gold tops out in the $3,000 area. You might want to puff on that one for a while, as one must remember the Dow corrected almost 90 percent in the last Supercycle event in 1929. It was the debt you know, it's a killer.

Extending into a little more ratio work to help us out with keeping track of what the creatures over at the Fed are up to, lets take a quick look at the S&P 500 (SPX) against the CBOE Volatility Index (VIX) at present, because here to, some big surprises for market participants could be in store quite soon if the boys don't keep the 'pedal to the metal'. With the SPX up for five days in a row now, but only making meager progress, and in fact tracing out a 'bear flag', one must view the recent surge in the SPX / VIX Ratio as being corrective, most likely testing the break of the 200-day moving average last week. (See Figure 4)

Figure 4

The reason we chose to focus on this relationship as a 'key' indicator right now is that if we see a turn lower here, breaking the previous pattern, not only will significant Fibonacci related support be violated, but a significant signal will be triggered telling you that unless Easy Al engineers another stick save, the complacency ruling investors since 2002 will have snapped, setting the stage for a rather abrupt adjustment in equity values. As mentioned above in our opening remarks, it appears Greenspan is trying to let a little air out of his bubble economy slowly based on the 'measured' increases in bank rates; but, that he does not want to see things slow down too much, because he knows his asset based economy could not handle a 'normal' corrective slowdown (recession).

Hence the title of this piece 'The Shell Game', referring to the Fed's current 'con game' of making it appear a responsible effort to keep inflation under control is at the forefront of policy, all the while money supply growth rates remain more than accommodative through open market operations involving the purchase of junk paper on the street. That is to say, they are doing one thing in a slight handed fashion, attempting to keep your eye 'off the ball', hoping you will not notice your hard earned savings being inflated into oblivion via an accelerating currency debasement agenda. Perhaps you were wondering why trading volumes are declining for the brokerages but their stocks and profits continue to head for the heavens. It's because the game is rigged.

Further to this, could it be Greenspan is a captive of his own design now however, where if equities were to turn lower here in spite of recent efforts to keep conditions stable, more severe price failures occur anyway due to inflation concerns? What's a bubblehead to do under these conditions? The answer to this question is easy; as he will do what a bubblehead does best, make it OBVIOUS he is now printing money. Gee, I wonder what the price of gold would do if that happened? Best not wonder too long, as this is bound to happen if Fannie Mae (FNM: NYSE) is any indication of where the US stock markets are heading. To be forewarned is to be prepared for the sound minded.

Good investing is definitely possible in precious metals.

Captain Hook
TreasureChests.info

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