With bearish headlines abounding, the volatility index (VIX) hitting levels not seen since the September 21, 2001 lows and indices hitting some longer term targets it should have come as no surprise to see the massive relief rally of July 24, 2002. This drop took the markets below their September 21, 2001 lows and had divided the S&P 500 in half, shaved 37% from the Dow Jones Industrials, lopped almost 77% off the NASDAQ and almost 48% from the TSX composite. Nothing was spared. The Dow Jones Transportation index had fallen 46% from its 1999 highs, the Amex Oil Index (XOI) was down 31% from its 2001 highs and the Philadelphia Gold and Silver Index (XAU) was down about 37% from its May 2002 highs. We suppose everything could be worse. The CBOE Internet Index (INX) is down 93% from its all-time highs.

But is the July 24, 2002 a one-day wonder, a temporary low or is it the big low everyone so desperately wants? We have noted before that once we enter the Kondratieff winter it is highly unlikely that this is the big low that everyone wants. By most measurements the market is still overvalued. Bear market lows are made with Price Earnings in the 8-12 range for the S&P 500. Long-term averages are around 15-17 and we are according to Ned Davis Research at the upper range of that level now. Some have shown, however, that we are still well above 20. While there is some argument that the market is now more fairly valued we are still a long way from traditional bear market lows.

More likely we have hit a temporary low that could last from anywhere from a few weeks to several weeks. Numerous indices and stocks had huge outside reversal days that could be construed as a technical key reversal day. Naturally of course going forward the lows made on July 24, 2002 must hold. If it is effectively a one-day wonder we will be seeing new lows probably no later then the first week of August. The 20th anniversary of the 1982 lows where the bull market of the 1980's and 1990's all began is on August 9. The beneficiary's of any near term strength will probably be the very beat up tech names. If buying choose carefully and do not hold for the long term.

A favourite expression we hear is "Is this it", "the bottom", "capitulation". What one has to keep in mind is that capitulation is a term more appropriate to a correction in a bull market not the end of a real bear market. October 19, 1987 was a financial panic/capitulation. January 14, 1990, that was also the start of the Gulf War, was a capitulation day within the context of a bull market correction. The same for October 8, 1998 at the height of the Asian/Russian financial crisis. In a real secular bear market you will get short term capitulations that may signal the end of a shorter term down move much like we saw last September 21, 2001 and quite possibly the low on July 24, 2002. But real long-term bear markets end quietly almost unnoticed like they did on that day in August 1982, December 9, 1974 and July 8, 1932. At those points interest in the market is almost zilch and a bull is nary to be found. We are nowhere near that point yet.

While the markets approached many of our recent targets of 7400 Dow Jones Industrials (low 7489) and S&P 500 at 770 (low 775.7) we are severely chastened by the crash/panic that occurred in the gold stocks. The easy explanation is that it is once again the manipulative work of the Federal Reserve (Fed) or the Plunge Protection Team (PPT) (the Exchange Stabilization Fund, an arm of the US Treasury) possibly trying to shore up potential problems at J.P. Morgan Chase. While that indeed may be part of the explanation as the US Dollar staged a probable overdue rally with intervention after hitting a high of $1.01 against the Euro the reactive sell off in gold and gold stocks is clearly beyond any expectations. Indeed the collapse in the gold stocks was more in keeping with gold at $285/$290 or lower.

On July 19 gold spiked over a small down trend line that had been in place since peaking near US$330 back in early June. While the stocks had lagged it gave few clues to the collapse that followed. On July 23, 2002 gold fell roughly $10 and again on July 26, 2002 another $7. At the time of writing it is possible that we will see a test down to between $290/$295 before this is finished but gold is slowly trying to recoup its losses and the stocks are coming back strongly. The US Dollar on the other hand during the same period had pushed the Euro back to $0.98 a mere 3% rise. Still this still leaves Gold at or above its longer term 200 day moving average, 40 week moving average and 23 month moving average. The US Dollar Index has currently considerable upside room to get back to the same averages.

Not so for the stocks that have plunged right through support zones beyond any expectations given the level of the US Dollar and Gold prices and certainly beyond what would have been called for. We suspect that margin calls, fund redemptions and hedge fund sales that were affecting the market also played a big role in the collapse of the gold stocks as well. Many of them are now clearly undervalued given the current levels of gold prices even if gold prices were to fall into the $290's. Still there is some risk of further losses until this washes over and gold crawls back over $315 once again. Above $325 a break out would occur that could take us quickly to $350. The drop in the stocks on July 26, 2002 brought the Philadelphia Gold & Silver Exchange (XAU) back to a trend line that dates from the 1999 lows but above 70 the index would regain its breakdown zone.

Some have called the recent upswing in gold stocks a bubble. We don't believe that to be the case as clearly there is a long-term inverse relation between the US Dollar and Gold. Gold stocks were merely responding to the rise in gold prices and reflecting the direct to their bottom line the rise in gold prices less adjustments for some rise in costs that are also in US$. Most measures of the Gold/XAU ratio and Gold less the XAU ratio were never at known extremes. The Gold/XAU ratio bottomed near 3.60 with a longer ten-year average near 4. The Gold less the XAU ratio is fairly valued at 220 and a longer ten -year average is near 250. The ratio reached roughly to 220. Extremes in the Gold/XAU ratio would be under 3.

In the Kondratieff winter, gold has clearly outperformed. The rationale for owning gold and gold stocks remains firmly in place. We summarize:

• Demand - While Gold demand abated as we went over $300 yearly demand/supply shortfalls are still 1500 tonnes per year or more. Some of this is made up by Central Bank Supply but with no new mines coming on stream and companies needing more time to reopen closed mines there is no foreseeable turnaround to annual shortages. Silver inventory supplies in the United States have run out and there has been no new production coming on stream in years. Silver demand remains very firm with a plethora of industrial uses.
• Short positions - The conservative estimated gold short position is in excess of 5000 tonnes and the more probable realistic short position ranges from 10000 to 15000 tonnes. Silver short positions are also quite large.
• War risk - The war on terrorism is an open ended long lasting affair. There remains a serious risk of a broader war in the Israel/Palestine conflict, or an outbreak between India/Pakistan and the probable invasion of Iraq and possibly even Iran.
• Country Debt collapse - Argentina collapsed and there is further risk in Brazil and having the contagion spread to other Latin American countries. Many African countries are perpetually bankrupt.
• Corporate corruption - Enron, Global Crossing, Tyco, WorldCom, Aldelphia, America Online and more. The sight of the arrest of the Rigas (Aldelphia) father and sons seemed to help the market on July 24. So where were the shackles and the orange jump suits? Now that would have left an impression. The SEC has decreed that over 900 companies CEO's and CFO's must certify their most recent filings by August 14, 2002 or risk jail terms. Failure for numerous companies to comply could abort any rally underway. There are also investigations into J.P. Morgan, Citigroup and Merrill Lynch over their dealings with Enron. J.P. Morgan is the $24 trillion derivative bank. The problems at Enron concerned the hiding of derivative deals. Even Bush and Cheney are under investigation for their nefarious dealings at Harken Energy and Halliburton. The White House is trying to stonewall the investigation and a lawsuit against Cheney. Something is rotten in America and to think they used to criticize Japan for effectively the same thing.
• Oil - We are running out of oil. Long-term shortages should begin to show up by the end of this decade. We have contended that the War on Terrorism and the probable invasion of Iraq is more about the oil then it is about terror or weapons of mass destruction. The USA consumes 25% of the world's oil and worldwide supplies are not secure. There has been no major find in years. Commencement of war with Iraq could spike oil prices over $40 and higher.
• Trade wars - America calls itself a free trader. You would never know it with the trade wars developing over lumber, steel and farm products. Trade wars, through the Smoot-Hawley Act of 1930 was a major contributor to the Great Depression.
• Trade deficit - The US trade deficit that recently hit record levels of $35 billion/month and is more than 4% of GDP is clearly unsustainable and cannot be financed from non-existent US savings.
• Debt - This is the real Achilles heel and we are only beginning to see its potential deflationary effects as corporations go bankrupt. Consumer bankruptcies are on a record pace and will rise as any recession or worse gets underway.

While gold stocks have suffered a sharp technical correction the fundamentals remain unchanged. Regaining above 70 on the XAU would be a positive development. A breakout over $325 for gold would launch a move to $350 or higher. As for the broader market the rapid rally following the lows of July 24, 2002 is never sustainable without at least some serious test of the lows. While some short-term relief may be in sight it is unlikely to be sustained for any period unless the apparent economic growth proves to be more sustainable. Some recent numbers indicate that may not be the case. The SEC compliance required of CEO's by August 14, 2002 could prove to be a watershed unless a vast majority complies. Irrespective given the high risks that remain out there it is unlikely that any real advance can get underway unless a more substantial period of basing and backing and filling is complete.

Possible dates for tops in the market given a short-term relief rally are August 14/15, or a psychological top on or near September 11. Worst case is that the rally we saw off the July 24, 2002 plunge impressive as it was, was it. Irrespective we see further lows ahead in the fall so short-term relief yes possible, long-term relief not even close.