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Pivotal Events

The following is part of Pivotal Events that was published for our subscribers June 10, 2010.


Last Year:

"Larry Summers is one of the World's most brilliant economists."

- Chief White House Economist, The New York Times, June 6, 2009

Sure! Summers, as head of the treasury in late 1999 and early 2000, was aggressively and loudly buying bonds out of the market. That was adding fuel to the climax of the Tech Bubble. How reckless, how unwise!

"Obama's the man, and the image he projected of cool control as crisis manager was exactly right."

- Donald Coxe, Basic Points, June 2009

This implied that without the great man's guidance the panic would have gone on forever. Last year we noted that the fall part of the 2008 crash replicated the 1929 Crash with remarkable fidelity, and that the panic into March 2009 was partly due to the recognition that Obama was a corporatist, without the Fascist symbol.

When will the establishment learn that even in the most severe contractions that markets clear - on their own?

"U.S. College Grads Shun Wall Street for Washington"

- Thomson-Reuters, June 1, 2009

* * * * *

This Year:

"The U.S. needs to keep the monetary spigot open."

- Financial Post, June 2, 2010

"Spain Braces for Austerity"

"He [the Spanish president] spends money on everything, from cars for his ministers to recreation facilities for the trade unions. But we can no longer afford all that."

- The New York Times, June 2, 2010

"Germany to unveil cuts to welfare, government jobs."

- Berlin AP, June 7, 2010

As Frederick Bastiat (1801 - 1850) observed: "The state is the great fiction by which everyone tries to live at the expense of everyone else."

The Fed was intentionally designed with monetary spigots and essentially they have been open since January 1914.

The proof of this is that the dollar has lost some 96 percent of its purchasing power since the Fed opened its doors.

As the saying goes "You don't have to be a rocket surgeon to grasp this one".

* * * * *


The rebound from March 2009 to this April could be described as the greatest rebound out of a classic crash in history. The rebound was likely to reach terrific enthusiasm and run for some six months, but the forced-feeding by the Fed and the constant drumbeat about the wonders of China extended the game in New York.

Ironically, the rebound high for Shanghai was set in August and the decline to this week amounts to 28 percent.

Of interest is that the rally out of the January setback registered enough on our technical work so that our April 22 edition included our "Checklist For A Top". What was needed next was the S&P, for example, setting a lower low than the week before. That was accomplished on May 4.

Last Thursday's edition noted that the strong dollar action had reached an Upside Exhaustion and that an important currency change was at hand. A weaker dollar would stabilize orthodox investment markets and set up a brief rebound.

The NY stock market seems to be bottoming. Today is encouraging. As it turns, Ross should be able to provide some upside targets.

On the bigger picture, the collapse of speculative abilities since late April has been impressive in showing a critical loss of liquidity in stocks, base metals, crude oil and corporate bonds.

After a brief rebound the downtrend can resume. On the S&P the low of early February at the 1040 level held. The next discovery that artificial liquidity can disappear rather quickly will take out that critical support.


The corporate market suffered a distinctive hit into the latter part of May. On the "trip" since April 26 when junk had traded as low at 10.87% the yield jumped to 12.95% and the spread relative to treasuries widened from 631 bps to 886 bps. On the same move the high-yield went from 7.98% to 9.33% as the spread widened from 331 bps to 526 bps.

After a week of relief these levels were tested on renewed corporate bond selling into Tuesday. This market could recover in price for a few weeks.

Going the other way, the long treasury bond became the flight to "quality" and soared from support at 115 in early April to the 125 level at the end of May. This placed the bond into a possible topping pattern. After a correction it could have shot to new highs with enough momentum to conclude an important top.

Instead, the correction only set up a pop to 125 which looks like a test. This is a weak rebound and with a probable stock rally the bond could decline to the 120 level.

The main instruction from the "plethora of dislocations" in May is that liquidity can disappear in an instant. Another is that when the seasonal tendency of spread-narrowing into May becomes outstanding the reversal can be immediately painful. Then after some churning around credit widening can trend towards greater dislocations late in the year.

This worked very well for us in 1998 when market forces took apart all of the intellectual theoreticians at Long Term Capital Management (LTCM).

That one was based upon the theory that the European Union would narrow spreads for all countries in Europe because they would all abide the requirement to keep budgets in line. Our view was that even with the brutal demands of a gold standard there was a significant difference between British and German yields, not to overlook Italian, which were almost at the bottom of the heap.

Freer trade within Europe has always been a benefit, but "managed" trade by a huge and unaccountable committee in Brussels has not been a practical idea. The notion that all countries would benefit from equally low interest rates set up the disaster that is now called the "PHIIGS". Although some brief relief is possible, our late February study Sovereign Debt Follies concluded that the contraction in sovereign debt would continue until both lenders and borrowers vowed they would never be foolish again.

Financial history is not there yet.

On June 8 the president of the Federal Financial Supervisory Authority in Germany observed that the "regulatory systems worldwide failed miserably" and claimed that a new regulatory system is needed. Well, they made the same claims after the collapse of the 1929 bubble.

It is amazing that the intellectual establishment is still thinking that regulation can prevent bubbles from collapsing. At least in the 1930s some of the establishment understood that the depression was caused by the boom to 1929. The SEC and Glass Steagall were designed to prevent another dangerous bubble. It did not work in 2007 and as all of history shows the other nonsense is that throwing credit at the consequent contraction will not make it go away.

The head of Germany's Financial Authority (Jochen Sanio) went on with his urgings for a super-regulator with "If we do not succeed, a dangerous monster will be around that could destroy the world's financial system."

This shows how limited the research is behind the establishment's mandate. The so-called modern world of "Western" democracies has been suffering one of the greatest experiments in authoritarian (think regulation) government in two thousand years. Like two previous examples, it has been accompanied by the deliberate policy of currency depreciation.

The latter has been an endless monetary experiment by central bankers that in itself has been a remarkable speculation. Society has had no alternative but to protect itself by becoming equivalently reckless.

The establishment cannot "regulate" its own experimental behaviour, let alone "regulate" another long and nasty post-bubble contraction out of existence.

Previous great experiments (Third and Twentieth Centuries) in authoritarian government ran for around a hundred years until the excesses collapsed on their own accord. This one began in the early 1900s and the excesses of increasingly predatory government are becoming obvious.

Of considerable moment is that many Americans are finding the excesses intolerable and are insisting that government returns to the deliberate constraints imposed by the constitution.

This will be assisted by the next phase of the credit contraction, in which case "the world's financial system" as built by interventionist economics will be seriously reduced.


Energy Prices: On May 26 the Chartworks identified the Downside Capitulation on crude oil and looked for the rebound. That started the day before at 67.15 and the high has been today's 76. So far so good and the trend could run for a few more weeks.

Our May 27 edition noted the Capitulation and called for a brief rebound in oil stocks (XOI) and gas stocks (XNG). There was a bounce and then the slide continued with the XOI reaching 881 late yesterday. This rebound could run for a few weeks.

Natural gas became very oversold at 3.85 in late March and after churning around a rally started at 4.03 on May 26. The jump to Tuesday's 5.00 has accomplished an RSI of 70, which has limited a number of rallies since 2008.

Also there is a tendency to set a seasonal high in June. Natural gas is now vulnerable to an intermediate decline.

Gas stocks set their low at 470 on May 26 bounced to 530 last week. With, perhaps, the best in for gas there may not be much left on the upside for the XNG. The chart shows overhead resistance at the 535 level.

Base Metals Prices: Goldman's GYX index of metal prices ran the gauntlet from very overbought at 436 in mid April to reasonably oversold at 315 on Monday. Down by 28% in only 7 weeks is an impressive comment on sudden losses of liquidity.

The rebound could run for around six weeks or so.

Similarly, mining stocks (SPTMN) fell 31% to a close at 803 on May 26, bounced to 930 and tested the 803 level on Tuesday. The rebound could run for around six weeks.

Link to Friday, June 11 'Bob and Phil Show' on Howestreet.com: http://www.howestreet.com/index.php?pl=/goldradio/index.php/mediaplayer/1677


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