Below is an extract from a commentary originally posted at www.speculative-investor.com on 30th March 2006.

The US stock market appears, on the surface, to have been quite firm over the past several months, but in real terms (that is, relative to gold) the market has been very weak. In fact, the following chart shows that the S&P500/gold ratio broke downward from a lengthy sideways consolidation during the final quarter of last year and is presently testing its February-2003 bottom.

A comparison of the above chart with a chart of the nominal S&P500 Index will highlight one of the major risks of betting against the stock market. The risk, for those who attempt to profit from the secular bear trend by taking-on positions that require a fall in nominal prices in order to be profitable, is that there will be sufficient inflation to prevent the market from falling by much in nominal dollar terms even while it tanks in real terms.

We have no doubt that the S&P500 Index is immersed in a secular bear market that will continue for another 5-15 years, but, as we keep emphasising, secular bear markets are about declining VALUATIONS; they do not necessarily involve declining prices. It is extremely likely that the price/earnings ratio of the S&P500 will drop to 10 or lower at some point over the next several years, but this fall in the P/E ratio could be driven more by a rise in earnings than a fall in prices. And if you think it is unlikely that the S&P500's earnings will rise by much over the next several years, consider that the composition of the senior stock indices will change. In particular, if commodities are in a secular bull market then 10 years from now oil and other commodity-related stocks -- the stocks of companies that are likely to experience very strong earnings growth for many years to come -- will probably make up 30%-40% of the market-cap-weighted S&P500 Index.

Our own expectations as to how far the S&P500's nominal value will fall over the next several years have certainly been dampened over the past 12 months by the amount of inflation that has occurred. For example, at this time last year we were expecting a test of the October-2002 lows by the final quarter of 2006, but we now expect this year's decline to end at, and the next intermediate-term advance to begin from, well above the October-2002 lows. Our thinking is that this year's decline will take the senior US stock indices down by 20%-30% from whatever peak they make over the coming weeks.