Canaries in a Coalmine

In the past miners of all minerals used to keep Canaries in cages at various place throughout the mine to identify when unknown "No smell" dangers of Natural gas or carbon monoxide were emerging. When they would see the canary pass out or die they knew there were dangers emerging and to get out. The US economy also has warning Canaries, in this case it is the ISM survey that has been declining since January and as Dennis Gartman is fond of saying it is going from the upper left to lower right, in other word trending downward take a look at the numbers.

Longtime readers will remember the August 22 edition of Tedbits (see archives at: www.TraderView.com) outlining my belief that a recession has begun based on Year over year declines in Auto sales and retail employment, both with excellent predictive histories over the last several decades. Then several weeks ago I mentioned about how the Philadelphia Fed survey had gone negative, now we learn the Richmond Fed survey has also gone over a cliff as well. Bonds are now back near their highs in price and lows in yield. Now we also have the latest GDP reading of 1.6%, a tepid reading at best. And according to many experts it will be revised downward to little or no growth after adjusting for inventory misstatements.

One by one we get little signs of impending recession. The employment gains of the recent weeks, which reflect huge upward revisions, should be taken with a large grain of salt, as the GOP was fighting for its life in the pending elections. In other words they are probably baloney. LOL. The real estate market has continued to slump and went into a nosedive in the third quarter and probably will only be revised downward. The only thing signaling strength is the stock market at nosebleed levels, however the Stock market reflects the unloading of dollars by foreign holders of dollars if you look at the money flows. As I have outlined the Fed is printing money and issuing credit at prodigious rates so you can expect that to cushion any decline. However I believe when we look back on the third quarter 2006 we will see we entered a recession!

The Exodus continues

Today the dollar fell to 2 ½ month lows against the euro as the Central bank of China announced they will diversify into other currencies and gold. And of course they have 1 trillions dollars worth of reasons to do so, the largest hoard of dollars on the planet. The dollars failure to rally on the just released trade data's downward revisions, and lower than expected number for September are also reflective of dollar holders bailing out. As outlined by a recent Wall Street Journal article;

The U.S. currency tumbled Thursday, surrendering early gains. The downturn coincided with Zhou Xiaochuan, governor of the People's Bank of China, saying at a conference in Frankfurt, Germany, that China has very clear plans to diversify its reserves and is considering lots of instruments.

The foreign-exchange markets "prolong the assault on the U.S. dollar as global central bank rhetoric raises the volume on the need to diversify from U.S. dollar assets and to further tighten monetary policy at a time when the Fed shifts to a less hawkish stance," said Ashraf Laidi, chief foreign-exchange analyst at CMC Markets in New York.

And of course Gold promptly rocketed $18.50 on the Comex exchange. This is only the beginning as the Mandarins of Washington DC murder our futures and our Children's futures to win elections with sugar plumb give-aways and promises of something for nothing.

"Financial Genius is a short memory in a rising trend." - John Kenneth Galbraith

November 14, 2006

In past Alerts we have stated that the market has been climbing a wall of worry. This means that there are numerous things that create worry and doubt in the collective mind of the investing public with respect to the market - debt, deficits, derivatives explosion, inflation, major increases in money supply, weak dollar, terrorism, war and on and on. It is almost an endless list. Lately, the outcome of the elections was added to this list. A Democrat victory was a sure sign the market would have a correction - if not collapse. So far, the market has had a hiccup .... and that's about it. The market's relentless advance appears to be intact. Those investors who forgot about the 83.5% crash in the NASDAQ 100 that culminated in 2002 are enjoying this advance - hence, "financial genius is a short memory in a rising trend."

Let's take a look at this advance and see what it might tell us: It appears that the entire move is the result of just 11 days that seem to represent short covering rallies. The advance from the mid July low has lasted for 84 trading days - so far. Virtually, the entire advance is accounted for in those 11 days (see arrows on above chart) - in fact, we may be setting up for another such day today or tomorrow. Next, notice the angle of ascent for the market - it is remarkable. It is not only because it is so steep, but also because it has maintained the angle for almost 4 months. This market has now had what appeared to be (at the time) an exhaustion top as well as a divergent sell signal. Typically, such events would have the market in an aggressive decline after such a long advance. Although, that may be the eventual outcome, it hasn't happened yet.

Many European markets closed last week at five-year highs and the Swiss market made an all time high. These markets as well as the US market did so under weakening technical conditions. As mentioned, the US market made an exhaustion top (albeit briefly) and gave a divergent sell signal. As the market was making new highs, the technical underpinnings of the market have been getting weaker. This is classic topping action and should be followed at some point by the first meaningful correction in this extended price advance in the equity markets. Hence, "One of These Days."

The crosscurrents are nothing short of amazing. The negatives are all of the obvious ones that have been with us which have lately been bolstered by rising energy prices and a falling housing market. However, if you look closely, you'll see that the recent trend in oil prices has been down. Some are even calling for a bottom in housing. The economy is improving and we just completed mid term elections and are in the period of time where, historically, the market should be good throughout the remainder of the current president's term. That's the balance to the negatives. So, let's look at the short term. The market is very extended and is overdue for a correction. It seems to be losing momentum, but it has just dropped to the bottom of the price channel and is likely to see some support. The manner in which the market moves from its current positioning may tell us a lot. Clearly, we could make a sharp move to the top of the channel to complete this advance - that is not out of the question. A real break of the trend line would suggest moves to the retracement levels in the above chart (this will occur at some point, but probably not right now). As I am writing this Alert, the price action has taken the S&P to a higher high. The NASDAQ Composite, NDX and Russell are all above last week's highs and NDX and Russell are moving to challenge their highs earlier in the year. It will be interesting to see they can succeed and confirm the breakout in the NASDAQ Composite of just a few days ago. We could get a strong move this week that takes the S&P above the 1400 level. Should this occur, I would then draw tighter trend lines and focus on discipline. Breaking a prior low would be another thing to watch for. Clearly, the most important would be a valid sell signal - particularly a divergent sell signal. This is obviously not a market for opinions - it is important to have your discipline in place because once a reversal occurs, it is likely to be volatile.

That brings us to the Volatility Index (VIX). When the volatility index is declining, the market is rising and when the VIX is rising, the market is declining. The following chart is a weekly chart of the VIX. It appears that we are setting up for a reversal in the VIX. That would mean that the VIX appears to be getting ready to move higher. If you take a look at the blue arrows you will see the positioning of the three indicators. The indicators are such that it appears that the next move of any significance would be to the upside.

Following the VIX chart is a chart of the Advance/Decline line. It is obviously setting new highs and is in the process of a very robust move. If you look at the white channel lines, you will notice that it broke out above the upper channel line, came back to touch the line and is now accelerating to the upside. This is a classic technical breakout. The Dow Jones price chart below the A/D line chart has broken out in exactly the same manner. This is bullish action, but it is very important to be on the alert for a reversal.

Gold has reversed off its previous low and broken out to the upside through its steep downward sloping channel. I got a buy signal in early October and gold has acted accordingly. For the near term, gold appears to be losing some momentum. If you look at the last chart, gold rallied exactly to its 50% retracement line and in now correcting off that line. Gold may work its way down to the downward sloping tops line (red) and look for support at that point. I have a potential cyclical low point for the precious metals in the early part of the new year. That is a moot point at the moment, but for those readers who are constantly looking for a time when the precious metals can be purchased, that is my next time period. For the big picture, I am looking for gold to be an excellent performer in 2007. Any opportunity to purchase gold on dips should be taken advantage of. I do not see the potential for a large correction in gold or silver at this point in time.

All the best,

Garrett Jones
garrett111@comcast.net

NOTE: THIS E-MAIL REPRESENTS THE VIEWS OF THE AUTHOR AND IS INTENDED FOR EDUCATIONAL PURPOSES ONLY. THERE IS RISK OF LOSS IN ALL TYPES OF TRADING. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.

Thank you Garrett,

In conclusion inflation is set to run away as dollar holders flee the printing presses of the US treasury and the credit creation of the Federal Reserve and the fractional banking system. As the softness in the economy accelerates so will the money printing and credit creation. The world is gagging on dollars and are warily eyeing one another so as not to miss the inevitable exit from the dollar. NO ONE wishes to yell fire as the house is burning. Asset prices will continue to climb as these people and central banks park their money anywhere but the dollar!!! The Democrats are gleefully celebrating their capture of the US Congress, planning all sorts of nasty surprises for the public at large, letting the dividend, capital gains, and personal income tax cuts expire, increased regulation of American business, anti trade rhetoric, attacks on "BIG OIL" (the profit margins of EXON MOBIL are less than that of McDonalds on a percentage basis) are just a few of their goals. But they must be careful of what they wish for as the American public has a short memory and if the economy tanks between now and 2008 they will be left holding the Bag!! And this victory may be sweet now but could become very bitter...

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