The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Friday, October 3rd, 2008.
As you know from yesterday's brief message I had a very bad feeling about what was coming based on the tentative title of today's piece, and sure enough Awaiting Armageddon appears to have been right on the mark in terms of outcomes in the equity markets, but certainly sooner than anybody had expected. And although I was not quite sure if precious metals would join this party concurrently or not, I did have my suspicions that were confirmed in yesterday's bloodbath, with not just the shares being dragged down due to liquidity fears, but also, the metals themselves. Why did this occur? Answer: Because in essence what we have here is a 'deflation scare' that could quickly turn into the real McCoy if growth rates of the M's do not begin to accelerate upward immediately.
And that's it in a nutshell. That's why the equity markets were trashed yesterday led by precious metals. Because essentially investors are betting on deflation now as key stock (looking for Dow Theory confirmation now) and commodity groups break down structurally as a result of worsening liquidity constraints. You see with the election just over a month away now, and as discussed previously, politicos must put on a good show for concerned citizens who oppose the bailout package if they hope to get re-elected, which is why the House, led by republican's who are attempting to distance themselves from Bush (because it's being billed as his package so he can be the scapegoat next year when he's out of office), are taking so long to pass it. So you see, it's their own greedy self-interest that is causing the delay, not that the bill in its current form will be effectual anyway.
Naturally then, in addition to concerns of inadequate size and improper structure, people are watching this charade and voting about it's success probabilities themselves by phoning their mutual and hedge fund managers on the 1-800- Get Me Out lines, which is causing a self-fulfilling prophecy in the markets. What's more, and in addition to Paul O'Neill's concerns about the effectuality of the plan, aside from the special powers to print currency that will be given to the Fed (discussed further below), even with the extra pork belly measures added on by the Senate, this bill is essentially just a special interest bailout for the banks, which again, is too narrow in scope because badly needed liquidity is not reaching the public. You see the greedy buggers are monetizing their own needs, leaving the average citizen hanging out to dry because they are smart enough to know inflation is bad, so they have decided to only print enough currency to meet their own needs.
Why will no amount of these narrowly placed pork belly measures help the economy? Or perhaps a better question is, 'how do I know this for sure?' One should ask this question because some are suggesting an awful lot of pork bellies are flying around these days. Answer: Because the markets are telling us to expect such an outcome. That's right, this is not a guess on my part, but the most highly probable outcome based on historical precedent and empirical evidence, not to mention common sense. This of course cements the importance of cautionary comments put forth the other day not just with respect to unexpected volatility in October, but unfortunately, what I am about to show you implies a prolonged fallout, one that will unfortunately continue to affect positive outcomes in precious metals as well.
Now I am not suggesting buying physical gold and silver is not the thing to do, not with the wealthy cleaning out supplies at warp speeds. This is because to an increasing degree the gap between paper and physical precious metals pricing mechanisms is likely to continue growing until something snaps in favor of holders. Moreover, holding physical metals is recommended in terms of real purchasing power in the case of inflation or deflation, because even if deflation becomes a reality sooner than anticipated due to self-serving US politicians, what your bullion will fetch you in goods and services ultimately will outstrip any fiat currencies you see floating around today. Unfortunately the reality of the situation does not guarantee such a fortuitous outcome for precious metals shares however, especially with respect to the juniors, where it now appears the collapse in this market may be prolonged.
You may remember the stern warnings from summer about future prospects of precious metals juniors, with particular attention to non-producers. Not that this is news now of course, but sure enough, our worst nightmare has indeed come true, with staggering losses witnessed over the past few months. And unfortunately, now we can take these warnings one-step further believe it or not, where although some degree of an oversold bounce will likely materialize no later than January (think January Effect), sustained weakness in the economy and credit conditions will likely continue to plague the juniors on a more prolonged basis, as suggested above. Again, this is what our study of the most pertinent technical evidence we can find suggests, which will be reviewed for your consideration below.
As part of our numerous warnings concerning precious metals juniors in summer, you may remember the structural delineation of a measured move (MM) in the SPX/TSX Venture Composite Index (CDNX) suggestive of a crash all the way down to the 1300 proximity was underway due to tightening liquidity / credit conditions. And without fail, as these things have a tendency to do, the MM is now almost complete, suggestive of an alleviation in credit markets soon, which is exactly what a passage of the proposed bailout is suppose to accomplish. This is of course why stocks around the world have been attempting to be buoyant, accounting for strength witnessed in Western markets after the Gray Monday plunge as the junkies continue to speculate on another 'credit fix'.
What's more, and also discussed earlier in the week, with the Fed's new powers to inflate the money supply by paying interest on all deposit accounts likely to be ratified by the House soon, who knows, maybe a more substantial equities bounce in anticipation of growth in the M's materializes with the need for net withdrawals due to target rate spreads removed. A good explanation of how this mechanism works is attached here. Of course this is all speculation, and at this point, in the absence of proof the Fed is actually inflating, could prove dangerous, because like their brethren politicos, they too know inflation is bad, and might wish to continue being cute about inflation techniques. (i.e. narrowly placed monetization practices are maintained too long triggering an unstoppable deflationary spiral.)
What's worse, and on top of this, enter the eternally bullish investing public, as measured by the various sentiment measures discussed on these pages throughout the years. One cannot help but be amazed at the calamity of errors being made by all sides in the equation right now, where without understanding that authorities are actually botching things up on the inflation front, investors have been buying every dip in equities (attempting to stubbornly insist stocks higher like spoiled children), as measured by not just consistently low open interest put / call ratios, but also, the accumulation / distribution (A/D) to on-balance-volume (OBV) divergences discussed in our last meeting. And if you need further evidence to support the thesis excessive bullish sentiment still exists in the market, which of course implies no washout in the stock market has occurred as of yet, I will of course be happy to oblige.
How do we know this for sure? Simple. Just look at how much higher the Rydex Ratio (pictured below) needs to rise before capitulation extremes associated with the present Primary Degree affair in stocks needs to go, as measured by the 2002 spike highs. In this respect, and as you can plainly see, we are nowhere near the extreme premiums investors are willing to pay for bear funds at capitulation points, significantly increasing the possibility the CBOE Volatility Index (VIX) could pull a 1987. (i.e. shoot up above 100 in a market crash.) This prospect is predicated on the belief a mass panic out of the market (hedge funds) is underway, and that a long overdue margin debt crash could frame the present sequence within the context of a Grand Super Cycle Degree event, at a minimum. (See Figure 1)
Figure 1
What does this mean? It means that the stock market could do something unthinkable to most over the next few years. It means that stocks could decline unimaginable amounts as crazed investors continue to roll the dice in a losing game. You see our society is full of gamblers who think they are immune from the laws of nature, potentially making the consequences of a fall-out associated with such a mindset 'biblical in nature', one where 'the meek shall inherit the earth', and implying gold will be the 'last man standing'. This is of course the important point, as most have their assets concentrated in stocks, many with high weightings in precious metals shares, where it should be recognized we are not talking about precious metals shares in the same context as gold. This is because in deflation, precious metals and precious metals shares can have quite different outcomes, where if for example the broad market is destined to fall 90-percent plus in a Grand Super Cycle Degree event, many, if not most of the existing companies could be wiped out.
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.
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Good investing all.
