Below is a commentary that originally appeared at Treasure Chests for the benefit of subscribers on Friday, March 6th, 2007.
Margin Debt - it's a portfolio killer - especially when combined with feelings of euphoria and complacency. This was the predominant condition in the stock market that allowed for this little crash, and what is most likely to come. Fear about the Yen Carry Trade being unwound sparked by the sell-off in Chinese stock markets Tuesday has set off ripples throughout the entire financial system that will in time culminate to produce a genuine financial calamity. So, as schooled the other day, one should have your portfolio positioned 'comfortably' for what looks to be a bumpy ride, meaning do not be greedy yourself and minimize the use of margin. In failing to do so, and assuming volatility continues to rise from here, which is a fair assessment given previous lessons in human behavior along side market dynamics, you run the risk of becoming 'disenchanted' with the investing game. And this would be unfortunate if your portfolio is centered the metals and energy because in time tremendous rewards will be harvested by the wise and patient investor.
Martin Armstrong's revenge - I could not think of a more appropriate title to characterize this write-up because whether by chance or not, the stock market did turn south with a vengeance right on the exact turn-day identified by his model. Of course the real neat part of the whole enchilada is the fact his model predicted this turn all the way back in 1999. And while this may not compare to Harry Dent's record, at the same time it's difficult not being impressed all things considered. Of course Mr. Armstrong also turned bullish on gold about the same time in 1999, so totaling things up in this respect, we must tip our hat to both of these guys for providing a great deal of visionary insight into the markets and cycles. What's more, this is also why a great deal of respect must be paid to the apparent 'chaos' in financial markets that was undoubtedly sparked at some level on Tuesday.
Along these lines, we would like to take this opportunity to introduce another lesser known, but still ingenious mind belonging to Benoît B. Mandelbrot, one of the men known for coining the term 'fractal' in 1975. For our purposes in defining use of the word fractal to describe price movements within emotionally charged financial markets, we would like to draw your attention to the fact in addition to qualifiers like 'break' and 'broken' within this context, perhaps the best definitional framework is derived within an understanding of chaos theory, which of course relates back to the above. Here, the idea is what is happening in the stock market (and other financial markets) is not 'normal', and because of un-natural interventions in what are understood to be freely flowing markets on the surface, unhealthy pressure builds up, and at intermittent times when underlying internals will allow, is released in what could be termed a 'normalization process'. Or in other words, the market attempts to go where it would already be if allowed to trade in an uninhibited manner.
Enter the banking and brokerage industry, which since the repeal of the Glass Steagall Act in 1999 have been working together with tacit complicity of the US 'establishment' (and globally) to artificially prop up its debt and equity markets. And in this respect they have done a miraculous job, not only in terms of supporting the broad measures of equity investments in the States, still considered to be center of the investment universe, but more, in also suppressing alternatives to these paper markets. The best example of this in my opinion is seen in gold's lack luster performance since 2001 when a derivatives based short squeeze commenced producing an approximate 300-percent gain into last year's highs. Here, and in terms of current fiat currency pricing, we consider gold's performance 'lack luster' not because it didn't match a comparable first wave run of 500-pecent seen back in the 70's when first allowed to trade 'freely' as the gold window was closed under Nixon's watch. Nope - that's not the benchmark I am using. I am simply looking at the fact a full three-quarters of the global hedge book held by producers has been closed out now, meaning the lion's share of non-official sector short squeezing fuel for the fire has been eliminated from the formula effectively. Of course if one includes naked shorts held by banks the aggregate situation is quite different, but getting these guys to cover is not so easy. When they do however, and in fact become net accumulators of gold due to pressure from citizenry, this is when one can look forward to currently unthinkable gains in the metals. In the meantime however, it appears we have not finished playing games yet, not until all the official price fixing has run its course, with another fractal or five thrown in along the way for good measure.
And here there are many possibilities in this regard. Of course the important thing to realize is pattern does not matter. Like the stock market's fate, it does not matter whether it's a smooth ride or a fractal. The important thing to recognize is the secular (long-term) trend in a market. And if one is participating, the idea is to remain 'comfortably' invested in allowing process to unfold, as one should be doing with respect to precious metals investments at present. Unfortunately for stock market investors however, the secular trend higher could be at an important milestone if the fractal break seen Tuesday was a warning shot across our collective bow. This is not the most likely outcome considering the larger inflation cycle still has a great deal further to run from a historical perspective, but never-the-less it is a possibility, where at a minimum one should at least be expecting additional cyclical (corrective) downside in the weeks and months ahead. To us, this is the most likely possibility considering price managers still have a few cards to play, not to mention Presidential Cycle considerations relating to the election in 2008.
So, what is really happening right now then if this break in the stock market has the potential to spill over into next year and spoil the party from a Presidential Cycle perspective? Well, for one thing, if this is in fact what could be defined as the next leg of the secular bear market in stocks that commenced in the year 2000, one where weakness would undoubtedly last into next year, then from a price management perspective, this 'managed adjustment' could turn out to be a 'mistake' for lack of a better term. Why a mistake? To understand this, one must view things from a price manager's perspective. Here, with central banks taking the lead, on Tuesday the Greenspan and China warnings were issued on a coordinated basis with the little green man actually in Japan to give the appearance the China action was sanction by the larger banking community, along with providing the message this action was definitely being 'managed' by Da Boyz. We know this because of the way Greenspan's nudge was toned down immediately once the stock market fell off a cliff. What's more, Greenspan, who does not mind being in the spotlight again, was brought into the picture because Chinese speculators were simply not getting previous hints to slow down, keeping pressure on commodities prices high, along with manufacturing an untenable bubble.
You see the idea here is with the election approaching next year, and the global economy being what it is today, if price managers are to attempt get those pesky commodity prices under control before things get out of hand, they could not wait any longer given time constraints. How would it look in November next year with crude at $100 and gold at $1500? Would that increase your desire to vote for incumbents? And given their previous failures to suppress commodities then, they had to bring in the 'big gun', Greenspan, to get the job done. Unfortunately however, up to this point he did get the job done regarding stocks and gold, with precious metals market easy for them to push around because it's so small, but not surprisingly to us, efforts to get commodities correcting in earnest have apparently failed again, at least until they step up price management efforts if they dare.
And this is the big question then, do they dare attempt hitting commodities again with the stock market in such a precarious position from a technical perspective? Especially knowing how dependent the economy is on asset prices, along with the risk perceptions a soft landing is no longer in the cards, which could cause an asset price meltdown to accelerate lower in fractal fashion. Based on the price action of the yield curve right now, where conditions remain quite flat, the market is giving the appearance a muted attempt is being made to fight the inflation boggy. Here short rates are not falling as fast as mortgage rates, which are being monetized aggressively due to a popped housing bubble. In essence then, this could be characterized as a frail attempt to attack commodity prices, but based on continued buoyancy in this regard, they are failing miserably. (See Figure 1)
And based on how commodity prices are shrugging off these attempts due to tight supplies in everything from base metals to the energies, either the gloves must come off in this regard, where nominal rates are actually allowed to rise, or market participants will see through this veiled attempt at responsibility on the part of price managers and give them a run for their money. And if it's not in the debt or stock markets because of existing support mechanisms, it would likely move over to the gold market, where a commercial (think the naked short positions banks and brokers hold) short squeeze could ensue. And you may remember, that's the message history is suggesting via these analog comparisons, where after some further downside (5 to 10%) in the stock market as we run into spring / summer, equities make a final abrupt (fractal) turn higher to complete a potential Grand Super Cycle Degree sequence, or higher, sometime between now and decade's end. In this respect, again we bow to Harry Dent and his insightful / visionary work concerning the impact of demographics on the financial markets.
Of course there are always things that can go wrong, even for our all-knowing price managers, which could cause the fractals lower in stocks to continue in spite of official policy. You may remember my comments made several times over the past few months regarding the Yen, which is now threatening to fly through the 200-day moving average sending the message leverage is being unwound 'big time'. And that this is a new trend conceivably taking years to transpire if history is a good guide. Here is a particularly poignant passage and chart relating to this thinking from a report published just last week, as follows:
"Speaking of the Japanese in this regard, now you know why one should practice a great deal of skepticism towards tightening talk coming out of Bank Of Japan (BOJ) officials, especially with Yen Gold at the highs signaling a 'need for speed' in monetary policy, not the opposite. Those pesky commodities are ratcheting higher however, notch by notch, as more and more of the phantom inflation created by these jokers finds its way into commodities prices. And as you know from last week, current circumstance associated with industrial metals and stocks in relation to gold are set to further expose the fraud central bankers are perpetuating on a predominantly unsuspecting population, where the yellow metal should begin to do some fairly serious ratcheting against pretty much everything that moves soon in discounting accelerating debasement agendas forthcoming. To think the opposite would conflict with the evidence, even if the Yen were to begin appreciating, which of course would have many of the unwary thinking the current batch of central bankers were actually serious about committing suicide.” (See Figure 2)
And in terms of the above understanding, nothing has changed in my opinion; where it's unlikely authorities wish to deal with another 'meltdown' going into next year. The only problem is in their drive to keep bubble land perpetually inflated, bankers and brokers had to find a new game last year to make up for the loss of growth in consumer debt, and they went to private equity deals as part of the leveraged buy-out craze, which are both 'time bombs' waiting to happen. Why? Because mentally challenged hedge fund managers took down a good chunk of the estimated $600 billion of these illiquid deals last year, and more every day, as greedy bankers continue to rotate credit growth requirements into their newest scam. At some point however, they will be forced to sell due to redemptions, but will be unable to facilitate the transactions.
These private equity deals are a new thing though, so they must be exciting so the morons that are snapping them up for now. One day however, and maybe sooner than most think knowing the chaotic nature of fractals, we will see a string of days like we saw Tuesday as the house of cards comes tumbling down due to margin calls, and these margin calls will naturally extend to hedge funds considering the substantial leverage employed in many of their financial dealings. Effectively then, this essentially means many of these illiquid private equity deals have been bought on margin. And in returning to the above then, what do you think is going to happen when these hedge fund unit holders want their money back? Do you think they may become slightly disenchanted with investing when they discover they have lost a great deal of money with no hope of recovering it? Do you think they may begin to see a pattern - one where bankers can't be trusted? Do you think they may attempt to flee the middleman after this seeking the safety of precious metals?
While this is a 'fair conclusion' in my eyes, if history is a goof guide, this will not take place until a good deal of damage in the larger equity complex has transpired. And as pointed out yesterday, this will not take place until fall / winter next year if what appears to be a similar sequence to that of the years 2000 takes place. Of course if price managers step in earlier this time around because of the economy's increased dependence on asset prices, a bottom could be seen earlier, perhaps at the characteristic turn time in May for precious metals, with a retest of the bottom during summer doldrums. Of course no matter what the final outcome in a game not unlike throwing horseshoes or hand grenades, given the upside potential in precious metals all things considered, we will be certainly be quick to accumulate more positions under such circumstances, where from a technical perspective the Amex Gold Bugs Index (HUI) could revisit 270 once again in forming a rare 'rectangle', or worst case in my opinion, test the large round number at 250 where strong / trend defining Fibonacci resonance related support is present.
While we are on a technical note, where I will in fact wrap things up here today with a few things to watch for in this regard, it should be noted price managers were able to knock silver down enough yesterday to effectively reverse the up-trend in the Silver / Gold Ratio, which as you know from our discussion last week signals recognition of potential for an economic slowdown on the part of investors. This, coupled with a noticeable widening in credit spreads, means stocks will most likely fall further in knocking down expectations of a soft landing this year. Naturally then, this suggests we should not be in a hurry to buy intermediate to long-term duration precious metals or energy positions, where given the current set-up in futures as an indication here this morning, Monday could be a very bad day in extending the current fractal. Here, it's important to realize that while short sales and high put / call ratios may characteristically buoy prices into options expiry in two weeks, rallies should be sold, with dips bought as we approach May. In this respect, we will be looking for a meaningful turn higher in the yield curve along the way to signal Feds are officially in panic mode, with absolute declines in not only nominal rates, but real rates to follow shortly afterward.
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