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Strange Bedfellows

Gold bugs may despise central bankers, but which among them would argue that central banking isn't actually bullish for the price of gold in the long run? While we're churning out aphorisms, I learned this holiday season that value costs money.

Gold market conditions thinned last week, after the prior week's assault on the $355 handle. They were relatively thin everywhere, at least until the final trading day of the year. Nevertheless, we saw the Euro and Swiss Franc accelerate to new three and four year highs, respectively during the remaining sessions of the year, and we saw new 35-month lows in the US dollar index. Even the Yen seemed to break out of a five-month downtrend against the greenback by Monday. We like to say gold predicted it all. It did you know, and we suspect it'll soon be predicting more of it to come.

Interestingly, during gold's pullback on Monday, mainstream's headlines read that gold was down due to profit taking and a small retreat in oil prices. This is a monumental shift from 'gold is down because it's dead!'

While most markets stayed thin in holiday trading, however, rumor mill conditions in the gold world thickened. Glossy eyed gold bulls ecstatic about gold's late season bull market signal and about being on the right side of the market heard Greenspan utter the word gold but three times. To them it was a superbowl pass and they ran the ball right past the end zone and onto the next field with the idea that key Fed officials have been signaling the coming of a reversal in more than 100 years of straight-line monetary debasement; that they plan to reinstate the gold cover clause, which served as a bridge to more soundless money under the Bretton Woods system.

The hope among these gold bulls is that it marks the beginning of a move back to a gold standard, as if, suddenly the Fed admitted that it had it all wrong. Haven't you guys been watching? They've wanted to move away from one since the Civil War.

Tea with Jim has turned into quite the party. However, we're sorry to say that we saw no hint of a move toward a gold cover clause in Greenspan's speech last week. There was an admission that a decade ago, central bankers agreed fiat currency was subject to excess.

  As recently as a decade ago, central bankers, having witnessed more than a half-century of chronic inflation, appeared to confirm that a fiat currency was inherently subject to excess - Alan Greenspan; Dec 19, 2002; FRB website.

However, this knowledge resulted in the New Economy, a counterfeit product of the real thing courtesy of an inflation induced monetary boom. Maybe Mr. Sinclair is right (The Gold Cover Clause). Maybe the Fed is going to lobby for a gold standard now at the same time it lobbies for expanding its open market operations mandate to include mortgage backed securities? Well, if so, I didn't see it in the speech myself. Wouldn't we have to see Greenspan admit that central bank policies since then have continued to "confirm that fiat currency was inherently subject to excess" before running with that ball? As far as I could tell, the speech was all about what a good job the Fed did during the nineties and that it still isn't possible to prevent bubbles.

Mr. Sinclair has worked for the IMF, and boasts lots of experience on such matters. But we have to differ with him on the reality of this speculation.

For the head banker to hint that banks are going to have to accumulate gold reserves at this point would be like committing suicide for a banking system that is allegedly short too much gold, or am I missing something? If Greenspan and Bernanke hinted at a move like this, either they aren't aware of any gold price suppression or figure it doesn't exist. For, can you see the contradiction between acknowledging a massive bullion bank short position and recommending a plan that will put a squeeze on it? Or are we to think that Greenspan is one of the good guys ready to punish his member banks for their profligate investment and inflation practices conducted under his very own reign? Maybe so. After all, he's presumably an objectivist. What's an objectivist doing running a central bank anyway, has anyone stopped to ask?

According to Mr. Sinclair, the genuinely excitable Chairman of Tan Range Explorations that has decided to take the gold bull market by the horns himself, the plan to implement a gold cover clause won't go into affect until the dollar falls by more than 30% by the trade weighted dollar index.

Now think about the effect on gold prices from the prospect of a collapsing dollar combined with an announcement that banks are going to have to buy gold later. Why would the Fed add such bearish impetus to an already limping banking system now? To fight deflation? Jim's wish effectively helps Greenspan et al promote their own deflation fallacy, because he suggests the Fed is deliberating dollar devaluation to fight it. Tit for tat. With due respect Jim, for all your experience, you may have been outfoxed by some of the shrewdest State propaganda since the third Reich.

Of course it would be shrewd for the Fed Chairman to publicly deny the likelihood of deflation, yet prompt a gold bull into promoting the Fed's utility in fighting it. Maybe I'm overestimating the Fed, but it's poetic at least. In the big scheme of things, a central bank and gold producer are, strangely, bedfellows, since after all, it's central bank policies that fuel the biggest bull markets in gold.

If we really wanted the nation's banks to accumulate gold reserves, the answer is simple, abolish the Fed. The effect on markets might be the same as hinting at the move to a gold cover clause. Either way, the Fed's survival depends on gold's demise rather than its resurrection. The bull market in gold is a market reaction to the poor monetary policies of the Fed. It's a tax on dollar holders. It's the hidden tax that inflation is rightly blamed for. It's not a tax the Fed wishes on its dollar-ridden global banking system. Gold investors despise the Fed, but deep in their hearts, many of them hope that its Chairman is still a gold bug, as he had once described himself. You see, he'd learnt way back then how to peddle hope. We've long given up on the idea of Greenspan the savior. You should too Jim. It doesn't add up anymore.

Gold is going higher because it's forecasting trouble for the dollar. The gold market is discounting dollar devaluation, but one that's initiated by the market, not the Fed as they would wish us to believe - if only to ward off a hard-landing for the currency by implying control.

It's Still A Bear Market on Wall Street
US Treasury bonds firmed up last week in the context of a fourth quarter correction. The chart bias turned bullish coincident with renewed bearish bias in the Dow chart on Friday, as the Dow bears pierced nearby bullish support at the Nov 13 low of 8298 intraday, which is the last highest low in the not quite three month countertrend bull leg that began on my birthday no less. Bulls were able to close the Dow 6 points above that level at 8304 nonetheless, and edged it back up to 8342 by Tuesday Dec 31st. It's true, they could be hanging on by their fingernails, but nonetheless, hanging on is what they're doing.

The bears are still in control of the primary and intermediate trends in Wall Street's stock market averages, but have let the bulls lead stock prices higher in a countertrend sequence since October, resulting in what was either a real reversal in the Nasdaq, or a fake one. That has yet to be determined. Speculative markets are prone to random volatility, however, which make chart analyses often less reliable.

Our read of the November breakout in the Nasdaq indicates a fresh wave of speculative froth at best, and without confirmation from any of the broader blue chip averages, we are skeptical it is going to hold up. In other words, we're confident it was a fake move, or bull trap.

A break down through 1319 for the Nasdaq composite, 8298 for the Dow Industrials, 872 for the S&P 500 index, and 465 for the NYSE composite would represent the surrender of the near-three month countertrend sequence by the bulls, which would confirm our hypothesis, and open up the possibility for new lows. Bulls might be satisfied if it were only going to be a test of recent lows, but the fact remains that the bears still control the main trends, and there has been little the bulls have done to alter that technical condition so far. Most of the averages barely made it back up to their 200-day moving averages despite the added Fed stimulus in November. Even the Nasdaq's would-be reversal didn't include a crossover to the bullish side of the 200-day moving average.

It's still a bear market, and so, investors should be open to the possibility of new lows in the averages. Bulls have factored an earnings recovery for the fourth quarter of some magnitude, but they fall short on premise as well as the realities evident almost everywhere but the housing and mining sectors. More importantly, they have yet to factor in a potential market driven rise in bond yields resulting from the "inflationary" factors that surface during any currency devaluation.

Perhaps one reason is because the Fed has recently promised us it will keep a lid on longer-term interest rates if it has to (Bernanke). Oh yeah, by the way, good luck doing that while the dollar's falling. The last time they did fix long term interest rates was during the fifties, after the prior secular bull market in bonds gave way to a thirty year bear market. Whatever the reasons then, a) it didn't work for long, and b) the dollar was on a fixed rate regime. That means today, it would work less long.

I wonder if, under such circumstances, Kudlow would be rooting for the Fed, free market enthusiast that he claims to be. It's just a passing thought at any rate. I know he supports the Treasury when it rigs bond market demand.

Outside of these policy machinations and fresh bear tracks on Wall Street, the bonds probably also saw a bid from additional bad economic news during the week as well as war rhetoric.

I'd like to offer some speculations.

The first regards US dollar rhetoric. When someone's got a lot of stock to get off, they hire a promoter to talk up a good story while exiting through the back door. It's no different in other markets. Any large owner of dollar reserves, whose aim is to reduce them in favor of at least a greater diversification of currency reserves, is going to turn up the volume on how great the dollar is. If Japan wanted to sell a portion of its gigantic dollar reserve, it wouldn't tell you. Its politicians would undoubtedly be waving the American flag on the one hand, while selling on the other. Of course, just because that logic is valid, it doesn't mean that if you hear the rhetoric, it isn't sincere. So our first speculation is that it isn't sincere, and thus, that the dollar will continue to fall.

Our second speculation involves the Loonie, and its implication for the momentum in gold prices. While the European currencies are off and running, the Loonie is threatening to fall to a new record low. The dollar index has continued to sink, but the weakness in the Loonie coupled with a consolidation in the Rand and renewed weakness in the Australian dollar are cause for concern if you're bearish on the dollar, as we are.

Without trying to figure out what exactly ails the Northern Peso in this editorial, our second speculation is that the Canadian dollar gets nailed soon. This is premised on its chart behavior, which has been conspicuously weak despite the broad weakness in the US dollar this year. In fact, it has been the weakest performing major market currency all year long, outside of the Latin American currencies. If the current activity results in new lows, the break down could send gold bulls a shock. In other words, a breakdown in the Loonie could be the curveball we've been worrying about, even if it were to be just a minor setback.

Our third speculation is that the Dow is going to 6000 in the first quarter, and that gold prices are going to surpass $400 somewhere in the first quarter, forecasting further trouble for the US dollar, and despite a weak Loonie.

Valuations Must Submit to Rising Prices, Rates
Our main argument for lower equity valuations is that a declining dollar will result in price increases for various factors of production, and ultimately, pressures for bond yields to rise. There are three main opposing variables to our case.

  • The first is the effect of the Fed's rhetoric about fixing long term yields
  • The second is the specter of an earnings recovery, and
  • The third is that the "odds" favor the bulls

Bulls would claim the mere fact that the bear market has lasted three back-to-back years (a post 1932 record) as indicating the decreased probability of further declines, and they would add to that the implications of a coming presidential cycle, as well as a whole whack of other superstitious mumbo jumbo, such as the fact that this bear market has been the deepest one on record since 1977. We have to congratulate CNBC on communicating these odds to investors. They did a poll after reporting on them, and 61% of respondents claimed to be bullish on equities for 2003. Sell!

We'll say one more thing to that. The nineties bull market was a market that established new bull market records, and we expect the bear market to also produce new bear market records before it's all over. But just in case those odds still hold today, in this new economy etc., we've worked out the following scenario. Dow 6000 in the first quarter, or lower, by way of a bear market capitulation/panic, followed by a sharp reversal and the onset of a bear market rally as we approach US election posturing.

Maybe the market even finishes up on the year, which would require only a 2500-point bounce into the end of 2003 for the Dow, off of the 6000 handle. This way, CNBC's viewers might be right, even if they sell before they are. The point being that our bearish scenario could still fit in with the alleged probabilities this way.

A meaningful rally off of these levels, however, would require actually improving earnings prospects. Moreover, the Fed would have no mandate to fix yields in the case of a recovery, so the earnings would have to be good enough that investors could tolerate buying stocks while yields are rising. This is the one place we could be wrong... that earnings come in surprisingly strong. Certainly, that would be a surprise.

We just don't see enough room to run from here for stocks, but that might be different at Dow 6000, once yields have had a chance to rise and investors have discounted that prospect, specifically its effect on stock valuations.

In light of developments in gold and oil prices during December we'd be looking for poor fourth quarter results from the banks, or at least poorer than currently anticipated, assuming that recent settlements have already been factored for the quarter. Undoubtedly we haven't heard the end of this kind of litigation as the Spitzer settlements open the door for investors to sick their own lawyers on the investment banks guiltiest of cheating their clients.

The future write-offs related to such settlements, foreign country debt fallouts, further stock market weakness, soaring gold & oil prices, and potentially rising interest rates are fertile ground for establishing a bearish argument for bank shares. I'm sure we've missed a few, but these are good enough for us to stay bearish at the moment.

Oil prices might be about to complete a major bottom. Note the 2-year head and shoulders bottom in the chart for Brent. The Brent chart formation is less bullish than the NYMEX Crude chart, but we couldn't get the right parameters for NY Crude. If the recent breakout holds, bulls will have reversed a two year bear market, confirmed the bull market signal in gold, and set oil markets up for a primary jaunt to the $60 range, perhaps even by next year if geopolitical tensions provide a catalyst. Yes, fourth quarter earnings better be good on Wall Street, indeed, or the bulls are going to simply give up trying to pick bottoms. And that's fertile ground for a real bottom.

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