Pivotal Events

By: Bob Hoye | Tue, Jun 22, 2010
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The following is part of Pivotal Events that was published for our subscribers June 17, 2010.


Last Year:

"The cap-and-trade legislation recently passed by a House committee is Smoot-Hawley in drag."

- George Will, June 7, 2009

It is widely considered that Smoot-Hawley protectionism added to the severity of the post-1929 contraction.

"The Federal Reserve's balance sheet is so out of whack that the central bank would be shut down if it was subjected to a conventional audit."

- James Grant, CNBC, June 12, 2009

"Ron Paul's 'Audit the Fed bill' gets majority support"

- USLaw.com, June 12, 2009

* * * * *

This Year:

"House Lawmakers Seek Wider Fed Audit"

- Wall Street Journal, June 15, 2010

"Don't Worry About the Rich, They're Spending"

- Wall Street Journal, June 15, 2010

"Greater Investor Appetite for Risk"

- Wall Street Journal, June 15, 2010

"Government to the Rescue"

"Historians will look back at this time and say the three-pronged strategy of TARP, fiscal stimulus and bank stress testing kept us out of the abyss."

- Alan S. Blinder, Wall Street Journal, June 16, 2010

Blinder is still a Prof at Princeton and during the 1980s published a best-selling textbook on economics. In 1989 he, along with other economic text authors were admirers of Soviet central planning. Central planning by an authoritarian government had to be good. Right?

"The real question is not whether we want elements of socialism on planning to abridge our personal freedom, but by how much."

That clanger was by Blinder, but Harvard's Robert B. Reich was very specific in 1989 with:

"Stalin's economic organization has been remarkably successful."

The fall of the Berlin Wall marked Eastern European citizens' adjudication upon how well Soviet central planning was really working.

Blinder and other fellow travelers are again celebrating the genius of central authority. If they were not so influential the amusement could be more thoroughly enjoyed.

* * * * *


Using the S&P as the proxy, we have been looking for a rally to around 1133. This would be assisted by a correction in the DX and firming base metal and oil prices.

So far the high has been 1118 yesterday, which is close enough to say that the best is in for the rebound. In the meantime, the advance has been just building the first step down from a clearly defined top. May provided an instructive loss of liquidity in stocks and corporate bonds. That there has been little internal strength in the stock rally confirms this.

Of interest is that the low of 1040 set in early February held and after this relief rebound rolls over it should not offer much support on the way down.

Taking out 1000 would likely lead to last July's low at 869.

Yes, the establishment is talking up earnings and the prospects of yet more "stimulus", but the tide of public opinion is turning against the radicals in Washington. This may begin to thwart the administration's ambition to change the US into a corporatist "Utopia". But before the reform movement is confirmed in the November elections ambitious radicals will likely accelerate their scorched earth policies.

This will not be a friendly environment for investors.

Since bottoming in April, the gold/silver ratio warned of the setback and rising through 72 would signal the advent of the next discovery of troubles.


In a world of wild speculation in financial assets, the key will continue to be the action in credit spreads and the yield curve. This worked very well in May-June 2007 and again in 2008.

Money market spreads as represented by the Ted spread reversed trend to widening in early April. Combined with Libor turning up this provided a warning on the May hit to stocks and corporate bonds. The latter continued in a state of carry-trade bliss until April 26 when the price plunged as spreads widened.

This sector has been expected to find some relief with the stock market, but deterioration continued until Friday, which has been concerning. This week has provided some relief.

Hope mongers (formerly cheer leaders) from Washington and Wall Street have been quite vocal with the upbeat message. This may have overwhelmed the "wall of worry", but underneath the bright surface the action seems to be on a knife-edge that can turn in an instant.

The action in corporate bond prices and spreads has been lagging the stock market. This could enjoy a brief improvement over the next couple of weeks.

The best of sub-prime mortgage bonds have been rising in price, with the worst (BBB-) rallying strongly since May 26. Risk is, indeed, the flavor of the month. This sector has enough life in it to set up a reversal, which would be the warning on all risk items.

Long-dated treasuries continue to trade opposite to the stock markets and with the rally in the latter the bond was likely to decline to the 120 level. The low was 122.5 on Tuesday and as stocks become uncertain the bond has popped to 124.5.

There is a longer-term pattern that we have been monitoring. It requires a strong move to conclude the overall rally and initiate a significant decline.

That's the technical side. Fundamentally, each real flight to quality is to the liquidity of gold and the US treasury bill market. This, not the Fed, lowers these rates. The long end enjoys speculative attention which provides a bid for the enormous amount of bonds being offered by the treasury.

During a long post-bubble contraction the bond revulsion goes from lower-grade issues to eventually those of the senior economy. In our example, this initially took out the sub-prime in 2007, then the corporate market in 2008 and for this year sovereign debt has been the casualty.

The treasury is issuing massive amounts of paper in a futile speculation to "fix" the post-bubble credit contraction. This speculation by reckless authoritarians rests solely upon the speculative bid by reckless investors and traders.

Quite likely this will resolve to the downside and, hopefully, our technical work will seize the day.

It is a good time to reflect upon Professor James Tobin's definition of a bubble:

"Speculations on the speculations of other speculators who are doing the same."


The big perspective seems to be working. Senior gold shares (HUI) would trade up and down with the major swings in the NYSE. But, over time, the golds would accomplish outstanding gains as the S&P netted out a significant decline.

The record high for seniors was 519 in 2008 and the high for the S&P was 1576.

On the best rebound for the big market in generations the S&P made it to 1219, some 23 percent below the record high.

The rebound high for the HUI was 516 last November and the recent rebound made it to 502 in April. The record high of 2008 has been matched.

Also, this was the year when the action in exploration stocks would broaden with more stocks rising as more investors and traders participated in the sector. Moreover, the juniors would begin to outperform the seniors. From the early February lows the HUI gained 38% as the GDXJ gained 47%.

The index of juniors has only existed since last fall and while it has outperformed on the rally it has outperformed on the slump. So it has been more volatile, but it is likely that the exploration stocks will outperform over a longer period.

In the meantime it looks like the NYSE is preparing to roll over and most gold stocks would correct their uptrends.

Out of the May hit, silver was likely to outperform gold. The high close for the ratio was 70 on June 4 and the decline to 66.5 on Tuesday is appropriate. However, political and financial conditions remain precarious and an increase in the gold/silver ratio through 71 would signal the return of troubles.


Link to June 18, 2010 'Bob and Phil Show' on Howestreet.com: http://www.howestreet.com/index.php?pl=/goldradio/index.php/mediaplayer/1683



Bob Hoye

Author: Bob Hoye

Bob Hoye
Institutional Advisors

Bob Hoye

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