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Dichotomies, Divergences, and Distrust

The following is an excerpt from a commentary posted at Treasure Chests on Tuesday, October 18th, 2005.

Dichotomies, divergences, and distrust are three words starting with 'd' that go a long way in describing what's happening in financial markets these days, and are especially effective when put together in one sentence. And while we will not go through all of the specific reasons why the first two 'd's' in the above sentence characterize financial markets well today, we take a quick look at why there is so much distrust. As I see it, it all boils down to greed. Wall Street year-end bonuses are estimated to be $ 17.5 billion this time around, and the higher stocks finish by Christmas, the more trading desks, floor traders, and money managers will receive. That's a powerful incentive to attempt steering stocks higher into year's end, and if the Fed will give brokers the capital to do it, which history has proven to be the case, chances are we will see some sort of Santa Claus rally in December again. That is unless enough of them think it's a good idea to play it conservative during some kind of a problem, like the Tequila Crisis that gripped investor concerns at the turn in 1994.

When do such instances occur? In a nutshell, and as you would learn upon a review of the attached study above, 'economic crises' are generally developed as a result of allowing imbalances to run for too long, where for example, perhaps the largest impending disaster we have building at present is in the US Dollar (USD). Why would a USD collapse be such a big deal? In short, and as you likely well know, because the US consumer will be 'shut down', meaning foreigners will no longer be willing to finance the extravagant lifestyles North Americans have become accustomed. Such a development would of course go a long way to fix the dichotomy between US wages and those in China, where they now finance domestic consumption by supporting artificially lower rates in the States. (i.e. by buying Treasuries.)

This could happen because US wages and incomes would collapse, virtually wiping out the 'middle class' in short order, and the consumption that goes along with having a thriving populous. In this regard, one must realize a 'middle class' can only survive in a dynamically expanding economic environment, like that found in China today, but you should know that greedy bankers have already pushed the process there into a surprisingly mature stage, where based on constraints produced by their sheer population size, and the world's inability to feed that machine from a resources perspective (think peak oil), 'global capitalism', whatever that means today, is staring straight down the barrel a gun destined to bring an end to it's long-term life-cycle. (i.e. think Millennium Cycle) Therein, without the ability to grow wages, tap existing wealth (think the housing bubble), and in the absence of tectonic innovation growth (think the tech boom), the US is bound to catch the flu, where it appears some parts of the world are well ahead in this respect. (i.e. Europe topped economically long ago when their populations outgrew productive capacity and the colonization life-cycle fully matured.)

Does this mean economic collapse is dead ahead? Absolutely not, not as long as society maintains faith in the current system, which it will as long as 'the middle class' is still enjoying three square meals a day. When this becomes increasingly difficult to do however, as is the case now because inflation keeps rising, mortgaging the kids to pay bills may become fashionable due to the 'crisis' that will develop in the States. Implicitly, you will know a 'currency / confidence crisis' is in full bloom when the USD plunges through 80 and doesn't look back. This is why we remain bullish on gold and silver bullion, because when people want out of fiat currencies, and as alluded to above, all fiat currencies are depreciating against tangibles, gold will rise across the full spectrum, but most importantly against the USD as it loses 'reserve currency' status. We think gold plotted against the USD still looks good as a 'buy' at present, even though traditional technical indicators are suggesting a substantial correction could ensue anytime now. (See Figure 1)

Figure 1

How substantial of a correction could gold experience if the record high speculative long position, held by Large Speculators against Commercials, is liquidated in historically characteristic fashion? You may remember a while back we first introduced the possibility gold may have to vex the $490 area (38% retrace off 1980 intra-day all time highs) before settling back to $450 to test the breakout above the $50 interval as per our Progressive Interval System (PI), and in this respect, our view on the subject remains unchanged. Furthermore, as we expect to see open interest (OI) in Comex metals continuing to set new highs in coming years, don't expect to see much of a pullback when prices head for support at $450, because one should expect to see precious metals investing of all kinds increasingly become a favored alternative to stocks, bonds, and real estate as the bull market in tangibles matures, where bullion, and it's surrogates like Comex gold and silver, will continue to shine for as long as this market remains solvent. (i.e. able to deliver the physical gold on demand.)

Attached is a gold plot that clearly shows the importance of the $50 progressions in gold's advance, where if history were to repeat compared to the jump over $400, one should expect to see prices fall all the way back to the $430 area potentially, just as $375 was seen last year after the complex had topped out. Further to this vein, it looks very much like gold stocks are set to top out again this year in November some time, suggestive a protracted correction should ensue afterward if history is any guide. (i.e. the last two years saw precious metals stocks put in interim tops at the end of November lasting four to six months.) In fact, it could be precious metals stocks, as measured by the Amex Gold Bugs Index (HUI) have already put in a top this year, potentially forming a 'triple top', which as you may know could be quite a sticky measure to get through in the absence of buoyant liquidity conditions. (See Figure 2)

Figure 2

That is to say, the theory the precious metals sector is so small, stock market participants will take it up anyway even if general liquidity conditions become strained, is about to be tested in my opinion. In this respect, one must remember gold bullion will likely act in stark contrast compared to paper promises during a liquidity crisis, where this morning for example, market participants are bidding the USD higher in a flight to safety, just as was the case yesterday with gold. (i.e. they are both being bid up in the global de-leveraging process currently underway.) Therein, we could show you several indicators that point to the probability precious metals stocks are a very risky bet right now, but the one that really hits home is the Golden Star Resources (GSS: AMEX & GSC: TSX) / HUI Ratio, which continues to work it's way lower, albeit at a slower pace of late. (See Figure 3)

Figure 3

The important thing to realize here is that since the inception of the bull market in metals stocks back in November of 2000, GSS has been the leader in the 'growth sub-sector' of the precious metals stocks universe, and that even though it's managements continue to prove themselves incompetent, if conditions were truly buoyant, this would not matter. In fact, if GSS were to begin out-performing it's counterparts anytime soon, such an advent would suggest very good things lie ahead for the sector, where we would have no reservations recommending other juniors and small cap opportunities because macro-conditions would be emitting good vibes. Here is a long-term plot of the GSS / HUI Ratio indicating if we do not get a bounce forthwith, a 100 percent retrace should be expected. (See Figure 4)

Figure 4

The implications associated with GSS's under-performance should not be taken lightly, as if there is a liquidity crunch going into Christmas this year, which much to the surprise of many could happen given the current backdrop (i.e. the Fed is no longer in control of market rates, something that will be much to the surprise of many a market maven), a 'Grand' scale crisis could be in the cards. Furthermore, one should notice that such an outcome would be more than a one-time hit on year-end bonuses for the brokers, and that more importantly this would send a lasting message regarding the future such that the Decennial Pattern, as measured by the Dow over the past 125 years, would be broken. There's another one of those considerations you should put in your pipe and puff on for a bit.

Further thoughts on the subject matter presented above can be obtained at Treasure Chests, as per below.

Good investing all.

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