Although I have made it a career mission to develop my own proficiency at recognizing mainly primary, but also intermediate market reversal points, I have usually found it wise to avoid timing their precise arrival. If only because I will happily admit that I don't know it all. On the other hand, it appears that we are so close to an impending gold market move, that I can smell it. In fact, the absence of any loud calls on the potentially bullish resolution in the long-term gold charts is perhaps confirmation itself. More importantly, however, is that the greatest likelihood of a major market catalyst lies between now and October. Allow me to qualify that call with two historical facts; I am notoriously early in my timing, but I am also often lucky in my timing.
Still, it is "remarkable" that on the eve of what is increasingly likely to beget the biggest bull market in gold the world has yet seen, that not a single market technician in television land has noticed the arguably long developing bottom in gold prices.
Ten Year Gold Prices (USD)
Adding insult to injury in the business of objective financial reporting, please have a look at the desperately awaited summer rally in the Dow so far, and tell me what is so darn good about it:
Five Year Dow Jones Industrial Average
Compare this rally to the last one in the last quarter of 1999, and especially to the rally that answered the late '98 sell off. You will start to get the impression that the market looks tired.
Nevertheless, the financial networks are quick to point out to the viewing public; one short-term bottom after another within the ranks of the thousands of stocks that make up a stock market whose primary bull trend ought to be in question. They are in complete denial of the potent reality of what are more likely to be longer-term reversal patterns than continuation patterns, in the primary trend of many of the stock market's more important sectors -- as equally oblivious, in fact, as they are to the discernible bottoming action in the primary trend of gold prices. This kind of loyal behavior to the preceding trend is very typical at important reversal points, but I dare say that it has never been this extreme. And as the stock market tries to recover its bullish case over the summer doldrums, participants in the gold market are watching the dollar lose its momentum, very closely.
Let's check out some of these "short-term" bottoms right now,
The Bank stocks would appear to have already had their run. This looks more like a primary top than a launching pad, wouldn't you agree?
The Biotech's made a valiant effort at new highs on the Greenspan tout, but that previous January move sure looks more like a blow-off now more than ever, or maybe I'm wrong.
The Chemicals look heavy, don't they? Or is the chemicals business just part of that old economy?
The Drug stocks are certainly trying to recover the strong five-year ascent that ended last summer. Of course the real value of this chart is in its explanation potential. Looking at the spectacular rise in fortunes for drug companies since 1994 then, we can guess what is really at the root of the entire US bull market. Just kidding.
The Retail index doesn't seem to show as much confidence in the consumer as the consumer has shown for the economy as of late.
Dead cat bounce in the five year Software index. This chart reflects the majority of technology stock charts today. In fact, it looks nearly identical to the NASDAQ chart, as you will see below.
Can you see any potential changes in the primary trend on the horizon by studying just these charts? I can. Of course, there are many more sectors and indices to look at, and feel free to do that at www.stockcharts.com (an excellent website for the intermediate chartist), but I think I captured a decent cross-section of the stock market with these. The rally in brokerage shares recently, in my humble opinion, is a bit nutty in light of the arguably late stage cycle that the equity markets appear to be in. In fact, it also appears odd that the gold bug Swiss firm, UBS, chose to jump into the big techno-game in the last inning, with their acquisition of PaineWebber, and when their own poorly performing investment thesis was about to finally prove right. Connect the dots and you have speculators imagining all sorts of strategic European alliances.
What the heck else are the Europeans going to do with their dollars, sell them? To whom? Maybe they will just buy some Treasury bonds. While everyone else is selling dollars? No way. UBS might as well buy up market share in the financial services business that they know so well. In fact, I find it interesting that General Electric is one of the two largest PaineWebber shareholders. Here is why.
Behold, the television cheerleading squad 'surprisingly' infers that this is to be followed by more such confirmation of the legitimacy of their institutions. Such bullish propaganda is likely to get GE top dollar for their stake. Is there a conflict here, or a plan? Don't you just love patriots like this? Meanwhile, the Europeans may in fact, quietly, start buying up America with their hung dollar position. Perhaps someday, the Banks of Asia can start buying up our real estate too.
Remarkable…
Remarkable is exactly what it is. "Remarkable" also happens to be the word used by Mr. Greenspan most frequently (I am estimating) in his public testimonies so far this month. It is also the word that most adequately describes the frequency of Mr. Greenspan's public appearances lately, which ratings must nearly rival "The Letterman Show" by now. Much of his recent talk contained pretty much the same old techno-spin, so I'll spare you the boring analysis1, but I will say this:
I learned a long time ago how to read between the lines. All you have to do is discern what hasn't been said. However, for this, you need to know the topic well.
Despite the clearly evident double (asset) bubbles in US stock and real estate markets -- and the even more eye-catching (and probably irreversible) imbalances in the country's national accounts, aggregate global credit position, and the now entrenched consumption/savings habits of its confident consumers -- it is perhaps worth noting that Mr. Greenspan's reference to these topics has diminished in frequency, markedly over the past few years. Instead, they have been replaced with ambiguous statements about the productivity debate and about observations as to where demand is relative to the nation's capacity to satisfy it. His newest theme revolves around the "remarkable" epiphany that there exists an entrenched long-term propensity for US consumers to import and for foreigners to invest in the United States. That, by the way, is where he should look for his productivity answer.
What in the heck did he think would happen? American consumers have had their global purchasing power inflated by a dollar biased global monetary policy, which has engendered not only a powerful spending incentive, but also a national "dependency" on foreign investment inflows. The inflation in the exchange rate of the international reserve currency has delivered not only favorable goods prices all over the world for consumers that have access to cheap dollars, but has also encouraged foreigners to keep their liquidity in Dollars, especially since there is such a conveniently developed financial market infrastructure in the United States. Hence, the obvious propensities that have resulted from financial market participants who have recognized this "bias," and moved to set up an international infrastructure to accommodate, or accentuate, it over the past two decades. I am glad that Mr. Greenspan has finally noticed the obviously resulting propensities. Truly remarkable!
On Moral Hazard
Mr. Greenspan also suggested that the public sector's role in preventing future crises should be limited, in order to avoid the risk of moral hazard in investment decisions (a paraphrase from the Financial Times - Gerald Baker). What about the cumulative moral hazard in monetary policy to date? Perhaps the Fed's role too, ought to be limited, for there seems to be plenty of it (moral hazard) around these days. The whole idea behind a gold standard is to allow the markets to more automatically adjust monetary policy, without the risk of moral hazard. On the Fed's role, then, it seems that the Internet/Tech bulls would agree with the gold bugs. Common ground?
Moreover, our Philosopher King said that, "Extensive efforts of recent years to bolster our international financial structure through enhanced regulatory supervision have too often proved ineffective. Fortunately, there are good reasons to believe that, properly structured, the markets themselves can provide the self-correcting discipline that is so necessary to financial stability." You know, if I didn't know any better, comments like that would otherwise give me a sense that our chief may be some kind of "closet gold bug." I just cannot help but think that this very intelligent man has a plan. Perhaps he has already considered the transition to a gold standard. If so, he must realize how devastating a blow it would deliver to the financial world today if he announced such a position. Perhaps the Washington Agreement was only the first step in many to come as he makes subtle changes to the international financial landscape. Nah, he couldn't be that smart.
Finally, in light of the visibly lessened reference to asset price valuations in his recent speeches, one would think that the issue has been at least philosophically resolved. Wrong again, for the discussion about the favorable structural shrinkage in equity "risk premiums," is largely based on assumptions about the Information Technology sector's contribution to making the earnings outlook more predictable, not less. If so, how does one reconcile that bullish view with the rising frequency in earnings surprises, good or bad? Furthermore, how does one reconcile this with Mr. Greenspan's increasing assertion that rapid economic change is really to blame for some of our recent dislocations and mounting income inequalities, which themselves are reflected in the rising call by the poor for a piece of this paper pie? If the market is saying that the Information Technology is supposed to reduce the risk of being wrong, through communications efficiencies, why do we have increasing dislocations in the economy?
Perhaps we shouldn't lose sight of the fact that while this technology revolution will undoubtedly help us better understand the past and the present, it is not likely to help us predict the future any better than we ever have. Perspective.
Gold Market Update
With the exception of the small sell off, forced by the recent spike in the Dollar last week, the gold market has been very quiet. The lack of any significant follow through investment demand on each rally is disappointing, but not surprising at the moment, in light of the religious long-term mantra that dominates the stock market world. For all of the noise (hope) about a new bull leg for stocks, however, the gold market isn't buying it. As Victor Niederhoffer likes to say, in the Education of a Speculator, markets like to play dead just before a big move. Maybe he's right. We will find out soon I suspect.
A good look at the more active days in the physical gold market, since the Washington Agreement one year ago, continues to reveal accumulation rather than distribution. Meanwhile, a long term chart still looks more like a bottom than anything else. Both of these observations are especially significant because the dollar has inflated substantially over the past few years.
Nine-Year Dollar Index
Of course, as a technician, you cannot call a bottom a bottom (in gold) until it is confirmed. A good trader, on the other hand, should reasonably make a whole lot more of a particular chart pattern as it is developing, owing to his or her gainful position watching the action unfold at the micro level.
So Why Now
Because, we are swiftly reaching the conclusion to a monetary experiment that started nearly thirty years ago. The conclusion is that freely floating exchange rates, in the form they (don't) work today, are incompatible with the ability of the free market price mechanism to properly allocate the world's scarce resources, because they distort trade, accentuate economic imbalances, and as a result, introduce enormous systemic risk into the financial infrastructure. Especially when the supply of the reserve currency is growing a good pace faster than the world economy. In short, they are not a stable platform of monetary "value" for Adam Smith's ideal vision of true capitalism to work. Don't believe me? It is less and less arguable that the sole reason for the existence of the massive global derivatives industry in the first place is to presumably hedge the risk of volatility away. Wait just a minute though; volatility isn't the only problem here. I am not merely suggesting that there is too much volatility, blah, blah, and blah.
What I am saying, is that free floating exchange rates, especially when anchored to another fiat currency, have become part of an ultimately unstable reflexive process that has helped accentuate enormous, and unfortunately, irreversible imbalances in the "Dollar" based global monetary experiment. The only peaceful resolution to this process now, is to find a way to keep it growing. However, I think that Wall Street is running out of bullish spin. I would like to conjecture what is likely going to happen and why we are at the dawn of this monetary revelation. That being said, the majority of economists will still not have this revelation until well after the fact.
The Capital Epicenter of the World
We have seen monetary inflations all over the globe turn into catastrophe one after the other this decade. Each catastrophe, from Mexico to Japan to Indonesia to Russia, had developed into further dollar denominated asset price inflations as global capital hastily fled these currencies and bullied its way into the great "island of prosperity," the US of A. Nothing reflects this fact better than the very visible speculative financial excess in both, the US economy and in US stock markets today. Since, however, we have already established that this excess exists, time and again in fact, I am not going to squander this space with conspicuous examples of what everyone already knows.
Few would argue that US finance is truly the epicenter of global finance. Some might argue my observation that it is also the case that the US dollar is at the center of global commerce, and further, that it is at the center of our entire global monetary system. Even more would argue that this has expressed itself in our every day walks of life. Yet, the evidence is compelling how a stock market, which dollar valuation has grown from a fraction of the size of the economy to nearly twice, in only about 15 years, is the simple result of a series of unstable reflexive processes that have evolved through a nearly failed monetary experiment.
One of the focal points that is now emerging in the investment business is the US trade account, which is interpreted to be the country's main Achilles heel (though I believe that the consumer actually deserves this title). Anyhow, I began wondering, as far back as last summer, when the market would begin to discount this imbalance. The markets answered quickly - trade is irrelevant for the moment because it represents only a fraction of the total foreign exchange transaction.
Consider the statement, "The 1.8% widening of the U.S. goods and services trade deficit in May to a new record $31.0 billion from an upward adjusted $30.5 billion in April, had little forex impact. But the data clearly show that the domestic demand did not suffer from rising oil prices and interest rate hikes." from Bridge News. Little impact? Obviously. The market confirms, not that this is still not the bad news, but that capital flows dominate the FX market today.
That point when capital inflows begin to slow is the point at which the market will begin to correct the tremendous imbalance in these accounts. On that note, the shine has already dulled for the stock market, and I guess that we'll have to wait and see how loyal our dollar holders are today when the US is faced with increasing political conflict, a new young president, and foreign investors that realize that the consumer is impotent (no pun intended). I have already demonstrated the existing incentive for today's "dollar holders" to wrangle political concessions from the United States, and therefore begin the process of a shift in global power2 . This power, that we have today, will not be given up lightly. In fact, depending on what concessions are made, it could cause domestic civil strife to arise.
In any case, the balance sheet position of the financial epicenter of the world is artificially inflated owing to two decades of monetary inflation, which final outcome is to have manifested itself in the most unreliable currency of all, the stock certificate.
Pffffftttttttttt The Bubble has Popped
The evidence is overwhelming that real business activity has taken backstage to the business of financial and real estate speculation. The new economy really isn't what most investors actually think it is. In fact, it is a delusion.
I know it is hard to believe, especially when otherwise credible people in the world of finance speak about it as if it were the Promised Land. The sad fact of the matter is that much of this economy is really a function of an unbridled monetary inflation, and credit expansion, rather than innovation. The thrust of technological development, it is my contention, has actually been a primary benefactor of these easy money policies, not a generator of the kind of real wealth investors think. For the business of technology is as uneconomic, in the aggregate and over the long run, as it ever was. Monetary inflation, on the other hand, is as economic as it ever was! And the result is as certain as it always has been.
Consider an additionally popular misconception. Anyone who actually thinks that a collapse in the United States financial system will only slightly impact the global economy does not understand the nature of today's new economy, period. They do not understand the impact of the wealth effect, or defect, on European or Japanese economies resulting from their holdings of dollars. They do not understand how a 50% loss in foreign investors' dollar holdings can amplify throughout their own, already fragile, economic recoveries. Maybe they just don't want to understand. That, sadly, is the most fitting explanation for the behavior in financial markets lately. As I have said before, the period of strongest denial is upon us in the stock market. It is that period where investors have had to make a choice between selling their losers and therefore throw in the towel, or strengthen their faith and rationalize their belief systems in order to hold for the long term. What's your guess?
Besides, throwing in the towel means that you know this was all bullshit, and it's time to end it. While that is almost easy to do for the average contrarian, it is almost impossible to do if you are an investment advisor who has forgotten to tell your clients to sell in April. The period of strongest denial is upon us.
Here is the Bottom Line
1. Overall, financial market liquidity has been showing strains since February 1999 through the stubborn upward pressure on long yields at the time, which happened to be coincidental with what may be the left shoulder on a massive Dow top.
2. The bullish psychology climaxed in December 1999, and cracked in January 2000.
3. The increasingly narrow bull market momentum finally climaxed in March, and cracked in April.
4. Market breadth has not deteriorated any further, but it has not recovered either.
5. Consumer spending momentum may have already shown some early signs of strain, reflecting a saturated spender.
6. The credit market dynamics that have fueled these monster imbalances have come to an abrupt halt. Let me explain.
One by one, the traditional sources of cheap credit for this paper mania have shut down. First, the yen carry trade, then the FED, then the gold carry trade, all in 1999. So far this year, the creative Euro carry trade, then the yield curve, and then the Government Sponsored Enterprises (Fannie Mae and Freddie Mac), have had their credit creating abilities shut down on them, so to speak. Now, all that is left for sources of ever more credit creation is the banking system, the finance companies, and the brokerage industry. Perhaps the brokerage industry should start snapping up these finance companies to create a synergy on the debt collection front (just kidding, I think). Anyhow, collapsing stock prices on a dearth of financial market liquidity will likely put an end to further credit creation, at least in its stimulative effects.
Therefore, the next bear leg in stock markets is just around the corner. It will send off primary sell signals to the hedge fund crowd and an army of global speculators, and it will be accompanied by a growing bearish consensus toward US financial markets, and perhaps will eventually lead to the revelation, and subsequent final conclusion, about the fiat monetary experiment. Of course, this could take years to enter the minds of our leaders, but I dare speculate that ultimate day to be the top in Gold prices, rather than the start…
The monetary policy debate is what the next bull market in Gold is going to be all about. I can see it coming. Maybe you can too.
Three Year NASDAQ
On the heels of the kind of massive credit creation seen by the banks and finance companies since the last FOMC3 , it is amazing how little bang there is in the stock market. Compare the momentum in the latest NASDAQ summer rally (above) to the momentum in previous rallies.
Conclusion
My hunch is that the tape will begin to boil in the bullion market before the third quarter ends, and the catalyst will indeed be Wall Street. The liquidity parameters are not accommodative enough to fuel another stock market leg, especially not a broad one. Never mind credit market spreads; the market action on the day of the addition of JDS Uniphase to the S&P 500 (July 26) should have exposed the dearth of liquidity accompanying the momentum-less stock market summer rally. Unless the bulls really take charge here, this could turn into an asset market sell off approaching the third quarter, which could conceivably affect capital flows, significantly, and hence, finally unravel the artificial Dollar exchange rate.
With Wall Street's traditional sources of credit slowly disappearing, and with a generally still strong bullish consensus toward the stock market, I think the Goldilocks theme will soon become fiction, again. Oh, the circle of life.
“To live in the presence of great truths and eternal laws, to be led by permanent ideals; that is what keeps a man patient when the world ignores him and calm and unspoiled when the world praises him. ” Balzac.
1. For an update on his productivity position, see A Nation of Story Tellers
2. See The Politics of the Dollar
3. The Credit Bubble Bulletin from Prudent Bear
