Signs of the Times

By: Bob Hoye | Sat, Jan 12, 2008
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From Last Year:

"U.K. Sold 395 tonnes of gold at an average price of $274.9 per ounce. The first sale at $254 caught (or caused?) the low point in a 20-year slide in the price of gold.

The losers are us, Brown's gold sales raised around $3.49 billion.."

-- , January 2, 2006

That was written when the price was $627 and at today’s gold price of $895 the position would be worth $11.4 billion. And - remember the reason for selling was to improve central bank returns - what did they buy with the funds?

"Bernanke has engineered not just a soft landing, but a perfect landing."

- ROB TV, January 3, 2006

Well they didn't say at what level.

From This Year:

For the start of this year, Newsday surveyed strategists at 8 major securities firms and the summary was:

"Even the most bearish strategist in the group recommended that investors keep a majority of their assets, 60%, in equities."

Then in a separate article, the economist with a Ph.D in salesmanship, Larry Kudlow exclaimed:

"Meanwhile, the Goldilocks economy is alive and well. It's still the greatest story never told."

"The Fed needs to deliver a 50 basis point cut at its January 30 meeting. A big-bang cut would help."

The article's title was Goldilocks Needs Tax Reform.

For anyone who has done the research there is considerable irony. The "big bang cut" will occur and be followed by a number of cuts - until close to the end of the credit contraction.

Stock Markets: Our view last May was that the bull market would end with a burst of "Rational Exuberance". By that we meant that the conclusion would be exciting and likely to be timed to the key change in the yield curve.

The outline was that typically the final stage of a boom runs for some 12 to 16 months against an inverted yieldcurve. As it turned out, June was the sixteenth month and the critical point would be when the curve reversed to steepening, which was accomplished by the end of May. At the time, it was explained that the change seemed to be an indicator of reduced demand for short term funds by speculators, and it worked again.

A more long-term observation also worked out, which was that "Every bull market climbs a wall of worry, and in a rush of exuberance leaps over only to find 'Murphy' waiting."

Initially, Murphy's Law brought abrupt steepening and credit-spread widening in July, ending in a panic in August. Overall, the stock market went into a technical decline. Usually the early phase of a serious decline is in the face of robust fundamental reports. And this was the case until the last few weeks when orthodox economic reports began to indicate a business contraction.

After working over the most leveraged speculators, Murphy is now doing a number on the fundamentals of business and harmony is established. In so many words, the travails in Wall Street are moving out to Main Street.

This accord could run for as long as it takes to wring out all of the excesses, and if the past continues to guide, at the eventual bottom the stock market will be first. But this could run for a few quarters against the continuation of discouraging economic reports. This will seem another world from now.

Sector Comment: On the big picture, the change in the curve leads the change in the stock market and within this the banks led the recent slump. The BKX, which had a huge complacent weighting, was the first important index to take out the August low. That was in late October and was the "conduit" to this week's failures in the Nasdaq as well as the S&P. Monday's memo Markets And Fundamentals Unite! noted that on Friday the Transports as well some other indexes had taken out the August lows.

Base metal mining stocks usually provide seasonal opportunity, and on our exit in July we had in mind a re-entry late in the year. This was mentioned in November with the advice that nimble traders could begin to get long, with the possibility of another slump in the stocks down into January.

The SPTMN had a low of 722 in late November and bounced to 828, from where it has declined to 710. Our metals index slumped to 605 on December 18 and the 12% rally has accomplished a lot and seems eligible for a rest. This now needs a test and we will see where this takes the equities before we consider the next long trade.


The Long Bond continues to rally as the stock market declines, which is still considered as the flight to "quality" story. And we will continue to point out that in the credit storm we are in, the key is the flight to real liquidity, which is the US treasury bill. The advice to investors is to sell each rally as it gets overbought and another such condition is approaching.

The bond reached 119.18 yesterday, which compares to the 118.88 reached on November 26, and 119.72 in June, 2006.

Once again the action is approaching overbought, and with dreads coming in about a recession how far can it rally?

Not much, a recession will trash lower grade corporate bonds, as well as turn some high-grades into low-grades. A revulsion for longer maturities could spread to long-dated treasuries.

We are watching for the next exit.

The Yield Curve from the 10s to the 2s has steepened a little since the distortions often seen in the latter part of December. However, the full curve, from bonds to bills has flattened somewhat from 160 bps to 110 bps for the last 3 trading days.

The breaks in the stock market are serious and any steepening in the full curve would be a downer. There are some considerations. Money market spreads have come in - possibly due to the credit the central bankers are flushing into the system.

It is doubtful if this will work out to longer maturities, and at some point the huge depressant of unsupportable debt will feed into the money market desks. Treasury bill rates starting another decline would provide another warning--particularly if commercial paper or Libor rates turn up.

Credit Spreads were quiet at the longer maturities through most of December. For example, the BBB, over treasuries, trading around 175 bps, with 168 bps being the "low" on Friday. It has since widened to 181 bps.

However, over in sub-prime land there has been some deterioration. After rallying up to 23.06 in mid December, the BBB declined to 20.57 on January 2. On a quick slide to 17.59 it has taken out the previous low at 18.61 on November 21. The breakdown of this one in June, anticipated last summer's crisis. The issue that was more immediate was the breakdown of the so-called higher ratings such as the AA. This and the AAA have yet to take out the last low, but the A has.

The sub-prime is a proxy for most derivatives and it is beginning to roll over - again.

Investors may wonder where to hide. Usually in a contraction it is best to be positioned around the fulcrum of the curve, which could be around the 4 to 5-year maturities. This is not only defensive but it will be one of the few sectors that can go up in price. Non US accounts could get an extra bang out of a moderate appreciation in the dollar index.



Bob Hoye

Author: Bob Hoye

Bob Hoye
Institutional Advisors

Bob Hoye

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