The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, October 13th, 2009.

Call it what you want, the primary condition our condition is in is not inflation, or deflation, or even stagflation for that matter, although it's much closer than the other two definitions in describing the macro. Why would the term stagflation better describe macro-conditions? Answer: Because the mature state of globalization that guarantees us a constant state of overproduction moving forward, which depresses prices, is being countered by monetary inflation, which has increased certain prices, but primarily only those under government influence, leaving the rest of the economy sluggish. And it gets worse when one realizes our fiat currency monetary system is also mature from this perspective as well, with gambling now the backbone of non-government activities within aged economies (US, Europe, etc.), which cannot go on indefinitely.

That's right, largely we are a society of gamblers these days that reaches far past the casinos, with speculation in stocks, bonds, or whatever being what makes our derivative controlled (the betting parlor) faulty and fraudulent markets go up or down. This is because unfortunately sentiment controls market direction in our casino driven faulty and fraudulent markets to a far greater degree than it should, where as long as liquidity is adequate married to a predominantly bearish gambling population, equities will rise (due to short squeezing) no matter how absurd the valuations or technical conditions become. (i.e. the broad indices are overbought on both a daily and weekly basis, showing negative divergences within indicators.) Surely, if it were not for the declining US Dollar ($) this would not be the case, raising the question of how long present trends can go on for.

If you were to ask a bearish $ speculator why it should keep going down, the answer would probably be because the States is still debasing its currency faster than it's trading partners. You only need to look at the entitlement programs to come to this conclusion. Of course in spite of this, at some point the stock market speculators clue into this in earnest and will stop fighting the tape (they are likel close to this point now), and the present extremes will reverse short of price managers monetizing everything in sight. What's more, this is when the direction of the stock market will likely begin to drive currency trends, which is what happened last year when the $ attempted to push through 90 as equities were crashing. The stock market was in the driver's seat, not the currency markets, with both paying deference to bonds. (More on this below.)

Some think present stock market technicals are downright scary, and who knows, maybe they are right. This would be the day when the game of musical chairs actually stops, and everybody still in equities falls down. Supporting this vein of thinking is the possibility the NASDAQ / Dow Ratio has topped out, the rally in stocks continues higher on declining volume (see attached above), and short sales are at historical lows, all important technical / sentiment related factors suggestive stocks are rising on borrowed time. And I would be compelled to agree if open interest put /call ratios on the major US indexes take a big hit post expiry this Friday and stay down, unlike this month where they have rebounded with stocks. I thought they might have turned lower late last week, however a surge to a new short-term high in the SPX series that showed up in reporting this morning indicates there's still enough bears alive to continue supporting the rally.

So, next week should be down for stocks post options expiry this Friday, however one has to wonder from what level this weakness will develop with the Dow poised to punch back above psychological resistance at 10,000. Price managers would like nothing more than to have the Dow finish this week above five-figure resistance. And if they can get bank shares (see Figure 3) up to test the 21-month exponential moving average (significant monthly swing line) they my get their way. What happens after that is anybody's guess, as we will need to get an idea of which way index put / call ratios trend in the November cycle, however one thing is very likely - next week will be down - so gamble accordingly. Moreover, if the S&P 500 (SPX) hits the 50% retrace into the 1120 vicinity this week, it would be unwise not taking precautions (hedging), if not outright short side gambles at that point.

In the realm of nagging concern with respect to such thinking however, I offer the following observations concerning the Baltic Dry Index (BDI), which is finally poised to rally apparently. That is to say, while I think the BDI can rally from here, giving off the ultimate 'false signal', one does need to wonder just how far such a rally would go. What's more, if a rally here is not the straw that breaks the collective backs of bearish speculators I will be very surprised. It may take a while, with some editorializing required for the less endowed, however again, once the collective consciousness of speculators gets a hold of such a development, married to other pivotal (in their eyes) factors like seasonals, who knows, maybe my seasonal inversion hypothesis works out. We do have all the way into November for process to unfold in this respect. (See Figure 1)

Figure 1

Source: Investmenttools.com

In the meantime however, as mentioned above it does appear the BDI is set to move higher on the sea of liquidity a collapsing $ is providing, as can be seen in Figure 1 with a technical breakout close at hand by the looks of things. And this possibility is strengthen further by the simple observations found in Figures 2 and 3, the first suggestive shipping rates could play some catch-up to highly correlated equity markets, as demonstrated with the divergence against the SPX (see other equity market correlations attached here), and the second (Figure 3) suggestive the divergence against bond prices may get normalized somewhat as well. (See Figure 2)

Figure 2

Source: Investmenttools.com

Figure 2, and the BDI's correlation to all equity markets (including commodities) is self explanatory, that being a rising sea of liquidity will lift all boats (some people call this inflation - heavy on the sarcasm). Figure 3 takes more explaining though in that it should be noticed prior to the divergence that developed last year between bond prices and the BDI during the financial meltdown, a fairly tight positive correlation existed prior to this, with both debt and equity prices rising with the inflation cycle. When the credit crunch hit however, and yields plunged as investors bought the deflation scare, as you can see below an extreme divergence between the BDI and bond prices developed, and largely still exists today, but is possibly set to close if equities / liquidity can hang in long enough. (See Figure 3)

Figure 3

Source: Investmenttools.com

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Good investing all.