The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, September 18th, 2007.
That's the extent of leverage being thrown at the financial system in keeping the Western banking model (he set the stage for way back when) - and better known today as 'globalization' - afloat. If the bank run in England currently underway is any indication however, in spite of these efforts big changes are now at our doorstep. And if history is a good guide, even exploding derivatives growth and money supply will be unable to prevent the system from collapsing onto its own weight, even though increasing hyperinflation practices will be employed in an attempting to preserve current political regimes and power structures. Why is this the case? Because in the end change is inevitable, where those attempting to model themselves after J.P. Morgan (the bail out king) today will discover it's better to think in these terms at the beginning of a larger cycle (the Fed cycle began with its birth in 1913) than the end.
To this end, and in following Morgan's example, authorities are throwing everything and including the kitchen sink at attempting to keep bloated Western economies growing these days, including unprecedented bail outs of real estate speculators and loose-headed consumers attached to the subprime mess. And while the propaganda machine would like you to believe everything is under control, a quick look at the gold chart would tell you different. That's right - all you need do is look at the gold chart to know everything is not under control, including inflation practices. The implication here is the bailouts will just keep on coming as the crash in financials continues to take its toll. Somebody should have clued Greenspan into this brand of thinking long ago, no?
And as for the American consumer, well, he's not only up to his eyeballs in debt, he's also thrown the kitchen sink out the window as measured by consumption habits, debt thresholds, and just about any other measure of excess one cares to mention, which of course is not news to our regular readers. What is the significance of this? Above and beyond the truism one is suppose to refrain from doing so predicated on the saying, 'everything but the kitchen sink', the implication here is the consumer is broke, and that with credit facilities faltering now, the only way we can pay our bills in avoiding default is to print the money. It's either that or start saving to pay the debt back. Unfortunately this would crash our bubble economies, which is an outcome monetary authorities will attempt to avoid like the plague. So, they inflate. And they inflate with the same excess of consumers, which as alluded to above means hyperinflation, the Morgan legacy.
How can we be sure the above view is correct? For one thing, money is now being channeled into the system like never before. And based on the way Western banking model contagion is spreading throughout the global monetary system, where for example Britain has not had a bank run like this since the 19th century, this trend is here to stay for longer than most realize. (i.e. the contagion will continue to spread.) What's more, we will assume monetary debasement rates will need to be accelerated in paying for all the bailouts as well. And further to this, we will assume that Grand Cycle change is now upon the world, and that at the center of what is happening is not just the globalization trend exhausting itself; but also, exchange mechanisms are also entering a period of radical change as well, where as economies increasing regionalize, a breakdown in fiat currency based regimes calls for a return to more traditional customs in settling international accounts. Here we are referring to a reversal of Nixon closing the gold window if you will.
But why guess about all this? Why don't we take a look at the charts to aid us in discerning if this line of thinking is correct? And naturally at first then, we endeavor to capture the essence of the 'big picture' in this regard; as to do the opposite would be to start from the wrong end of the spectrum. In this regard, and in addition to focusing on the larger / simple relationships, we will also look back in time of course. First up to bat will be precious metals stocks, where the basic understanding here is if they can continue higher in price from here, breaking above historically important resistance (triple top), then something is happening that is big enough to demand our attention. Remember now, as mentioned just above, Britain, a staunch US economic ally in what we will term the Western banking model to keep things consistent, is at this very moment suffering from a bank run the likes of which has not been witnessed in over one hundred years. (See Figure 1)
Figure 1
So it should be no surprise then precious metals shares are doing well in this environment considering the increasing amounts of fiat digits floating around out there these days. And let's not kid ourselves. The US must be in recession already, and heading for a depression based on how fast economic conditions are deteriorating. For this reason alone then, (never mind the tight supplies) it should be no surprise gold has caught a bid, potentially heading to $1,000. Why would it go to $1,000 as it's next significant milestone? Well, for one thing, simply the attraction of the large round number will keep people buying because they know that once minor degree resistances at $730 and $850 are taken out, it will take a four-digit handle to cause a pause. What's more, and a point made last week regarding targets for the price of gold, a very strong Fibonacci resonance related projection signature seen here on the weekly chart from the Chart Room, is suggesting the truest measure in nature is pointing there as well. Thus, now that we have a known driver big enough to tell us monetary debasement agendas must accelerate into the future in bailing out the banks, the recipe is complete. Gold is heading to $1,000 if there's any justice in this world. (See Figure 2)
Figure 2
And although by no means should one expect the stock market to lay down and play dead during these inflationary times, at the same time, and as with previous inflationary episodes, don't expect stocks to go much higher until gold has had its way as per a crashing Dow / Gold Ratio. Here, and as you can see on the attached chart; that may be exactly what happens if current Fibonacci related support gives way. Does this mean stocks are done for good, all things considered? Definitely not in my view, where at some point monetary largesse not going into essentials (commodities, hard money alternatives, etc.) will undoubtedly find a home in stocks at opportune times, especially considering how hard the powers that be (bankers and brokers) continue working at padding their own pockets. That being said, this doesn't mean a little tree shaking is not due, where a meaningful drop through the large round number at 1400 should not be taken lightly. Notice how this assessment conforms with Dave's astute views on the subject, where he sees stocks breaking 1400 as we head into next year, possibly basing in the 1200 area before heading higher. (See Figure 3)
Figure 3
And then there is the US Dollar Index ($), which looks like its heading to 40 eventually. Of course if US monetary authorities only cut the Fed Funds Rate by a quarter today, the $ could rally back above 80 before it heads lower for real. If this transpires, and as discussed in more detail below, such a move would create a buying opportunity in precious metals markets this week that should be accumulated. Here, it must be recognized the Fed is caught between a rock and a hard place, where if they seriously pander the mob, the $ will crash. And if they don't its perceived equities will be taken down, which could cause enough people to sell US paper, possibly having the same effect. That is to say if the Fed doesn't spike the punch bowl with a half point cut in the Fed Funds Rate today, bringing some psychological relief to the consumer (the market has already dropped rates in reality), then expect stocks to sell off right away. And if they do pander the mob, while stocks may rally briefly, its also perceived this is already largely discounted in the market, meaning expect a fairly quick reversal as market rates could react negatively. This would have the effect of supporting the $, which is why this scenario remains probable despite the fact US financial institutions are likely crumbling in the background. (See Figure 4)
Figure 4
In this respect it wouldn't look good for gold to be going through the roof either, so expect the Fed to take another swipe at it today in attempting to drive it back below $700. Again, they could do this by only lowering the Fed Funds Rate by a quarter point, which is already baked in the cake (meaning the $ might rally in reaction), along with lowering the Discount Rate to its primary dealers a further half point. (i.e. which is suppose to show restraint in support of the $ while at the same time acknowledging the severity of the credit crisis.) If this were to formulate the fabric of a Fed policy change today, along with some clever (double speak) wording in the official policy statement, who knows, stocks might really like this and rally with the $ into month's end, as contemplated in our last meeting.
And as you know from further discussions last week, this could usher in the possibility of some serious potential weakness in stocks during the months of October and November in entering a possible 'panic cycle' often witnessed in years ending with '7', as was the case in 1987. Again however, if we sell off into month's end as with 1998, the lows in stocks could be witnessed in the first part of October. Here, one should notice the pattern so far this year matches that of '98 very closely. This makes sense from the perspective both '98 and this year are characterized by crises in the financial sector, with present circumstances being far worse however. That being said, both years are characterized with bailouts, and the monetary largesse that goes along with such activities, so either result would not be a surprise, especially a bullish resolution considering next year's election.
According to Dave however (as an extension of our discussion above), whom you may know has nailed the trade pattern in the SPX for quite some time now, a third possibility exists, one which is more consistent with the fact current circumstances are far worse than both 1987 or 1998, and for this reason heightened measures (printing money) associated with thwarting the potentially negative economic consequences associated with a loss of confidence will keep prices buoyant longer than we history students are considering. Moreover, this implies that even Dave's views may be too pessimistic regarding what all this monetary largesse will do to stock prices by Christmas. The CBOE Volatility Index (VIX) is the key variable to watch in this regard. No matter how you stack things up, it still needs to put in one more down-leg minimally, and if support at 20 doesn't hold, it's lookout above for stocks.
Accordingly then, and of course very consistent with our inflationary times, more upside still exists for all varieties of equities (excluding real estate and tech stocks as global bubbles cannot repeat within a generation), possibly new highs for the broad measures of stocks if the attached chart (see Figure1) of the SPX has any predictive value. The big question of course is just how much. In terms of the above precious metals charts (XAU and gold), what we will be watching for in days to come is whether breakouts above indicated long-term resistances will both transpire, and hold. And while I see no problem with the breakouts occurring, the holding (testing of the breakouts) may prove more challenging if our margin debt related observations from the other day prove accurate. Here, if this is the case, then what I would expect to see is a breakout very soon (this week), a run to new highs like in '87, and then the tests associated with equity complex weakness in October.
Just how bad things get in this regard will depend on seasonalities, put / call and short ratios, along with monetary debasement rates obviously, all of which remain support of prices at present. Here, I would not get seriously concerned about the possibility of more substantial losses in equities until one or more of the above variables tell us its time to do so. (For this reason we will not be offering any shorting ideas just yet.) At the same time, taking some short-term profits off the table at seasonal highs in a few weeks (1st week of October) would likely not be a bad idea as well, because if inflation appears bound for Pluto, market rates are likely to see past the current credit crunch scare eventually and take a stab at the stars as well. So you see, just how bad the correction in October gets will be determined by what happens over the next few weeks with respect to the above variables.
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Good investing all.
