Market Wrap

Week Ending 12/19/08

The Economy

The U.S. current-account deficit decreased to $174.1 billion in the third quarter of 2008. It was $180.9 billion in the second quarter. As a share of U.S. GDP, the deficit decreased to 4.8% from 5.1%.

Net acquisitions by foreign residents of assets in the United States less net acquisitions by U.S. residents of assets abroad were $135.2 billion in the third quarter, up from $122.9 billion in the second.

U.S.-owned assets abroad decreased $9.5 billion in the third quarter after decreasing $102.7 billion in the second.

Foreign-owned assets in the United States increased $125.7 billion in the third quarter after they had increased $22.7 billion in the second. This contributes to the presently existing negative U.S. international investment position, which means a greater percentage of our country's assets are owned by foreign entities: not a good trend. Refer to last week's report for a chart of the negative investment position.

The Federal Reserve lowered the fed funds target on Dec. 16 to a range of zero to 0.25 percent, the lowest among all major world economies. The Fed also stated that it plans to purchase agency debt and mortgage-backed securities and said it is considering buying longer-term U.S. government debt. Below is the press release from the Fed after its decisions to lower rates:

Release Date: December 16, 2008

For immediate release

The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.

Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

It is obvious from the language employed that the Fed is willing to use any and all means at its disposal to provide funds to the financial system. They are even trying to come up with new ways to support the markets. This means that excess credit creation will continue for the forseeable future. Gold has picked up the scent.

The Bank of Japan cut its key interest rate to 0.1% and said it would buy corporate debt. A worsening recession has reduced financing for business loans. This is an on-going problem all the central banks are facing: although they have injected huge sums of liquidity into the system, most of it is not being put to work (loaned out). It is piling up and sitting as reserves on deposit.

Since Sept. overnight deposits at the ECB have surged. Deposits are up to 200.4 billion Euros as of Dec. 17, almost four times the daily average of 534 million Euros. The ECB has cut the interest rate it pays banks to deposit money with it overnight and lifted the rate it charges for emergency loans in an attempt to get banks to loan the money out instead of hoarding it.

The Conference Board's Index of Leading Indicators for November fell 0.4% to the lowest level in four years. Although the Fed has increased the money supply it has not been enough to overcome the weakness in building permits, housing prices, stock prices, and jobless claims. The Conference Board directly addressed this issue by stating:

"Without the very large increases in inflation-adjusted money supply since September, the leading index would have been significantly weaker."

This is the difficult task the Fed faces: it must overcome the deflationary pockets of weakness without creating inflation. I wish them luck - they will need it; and this is accepting that such monetary policy is desirable and valid to start with; which I do not believe is true.

Later in its report, the Conference Board provided further proof that the economic problems run deep:

"All in all, the continued widespread deterioration in the composite indexes suggests that the recession that began in December 2007 will continue into the New Year and the contraction in economic activity could deepen further in the near term."

Gold

Gold was up 16.90 closing at 837.40 for a weekly gain of 2%. Earlier in the week gold closed over the 850 price level, which marks the intermediate term trend.

A weekly close above this level would re-establish the trend as bullish. The weekly chart below shows gold bumping up against its 50 day moving average and both horizontal resistance at 850 and its declining upper trend line just above.

If gold can close above these three levels on a weekly basis, it will signal a new move up is beginning.

MACD has made a positive crossover and the histograms have turned up into positive territory as well.

Silver

Silver was up +0.62 cents, closing the week out at 10.67 for a gain of 6%. Gold was up 2% for the week, so silver outperformed gold by 3 to 1: a very good showing. I like the way silver has been acting the past few weeks.

Gold Stocks

The GDX Index closed up 6.66% this week at 30.58. This was three times gold's rise, and was positive confirmation of the overall strength of the gold sector.

A long term cup & handle formation was broken below in mid-2008, which turned long term support into resistance.

Now, the horizontal trend line has been regained and becomes support. This has very positive long term implications.

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Good luck. Good trading. Good health, and that's a wrap.

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