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| . | S&P | DJIA | NASDAQ | RUSSELL |
| HIGH | 1246 Aug 3 | 10698 Aug 3 | 2218 Aug 3 | 689 Aug 2 |
| LOW | 1205 Aug 26 | 10397 Aug 26 | 2122 Aug 26 | 649 Aug 26 |
| REBOUND HIGH | 1242 Sep 9 | 10683 Sep 12 | 2183 Sep 12 | 691 Sep 12 |
This is now an old and tired bull market that is coming off record bullish sentiment. The Warnings Department has suddenly become very strident. Base metal prices are plunging and the treasury curve has reversed to steepening.
Sector Comment: Our proprietary Bank Trading Guide climbed from 122 in June, 2003 to the high of 181 on June 1. On the week of August 18, the technical reversal provided the "sell" signal.
The Guide declined to 153 on August 26, from which it recovered to 158 on September 7. At 154 today, falling through 153 would extend the downtrend.
As concluded last week, it is appropriate to increase the pace of selling financials and when the trend extends sell more aggressively.
INTEREST RATES
The Long Bond has slumped from 118 1/2 on August 31 to 115 1/2 today.
While a brief pop is possible on weakening commodity prices, the message is that the treasury curve has reversed to steepening.
During the summer, our advice for investors was to sell the rallies and by September to be defensive. The 4 to 5 year term could be ideal for the post-boom contraction.
For traders, we hung on waiting for the 119 1/2, but that has now changed to selling the next pop.
Credit Spreads have narrowed a little, perhaps with positive vibes for the stock market likely to revive into mid-September.
The high-yield has come in from 337 bps on September 2 to 321 bps on September 12.
Breaking through 320 bps on August 30 resumed the widening trend and through 340 bps will extend it. Yesterday's number was 321 bps.
At times, spreads coordinate with our Bank Trading Guide and its breakdown number is 153.
The Dollar Index could drift down to the 85-86 window.
As we like to contemplate, the very worst thing that could happen to policymakers would be a firming dollar.
This is based upon the doctrinaire practice of depreciation, which has been the universal remedy for any official concern. So if depreciation is good, appreciation is bad - particularly if the world is massively short dollars and long highly inflated asset prices.
The problem, as any speculator knows, is that the debt stays when prices suddenly fail. Typically, this then urgently compels offside players to sell assets to cover debt that suddenly makes cash (dollars) more important than formerly hot stories.
On the dollar relative to currencies, our view is that as the majority of the global debt issued (there has been a debt bubble) has been underwritten in New York and payable in dollars.
This has also been the condition when sterling was the senior currency and London was the financial centre. Following previous great asset inflations, the problem became servicing debt into a firming senior currency.
After all, the majority of global debt during those melancholy contractions was obliged to be serviced in sterling. Selling other currencies or raw materials to meet those obligations tends to make the "owed" currency relentlessly strong.
In the 1550s, Thomas Gresham discussed this acute problem as financial agent and advisor to the government of Elizabeth I.
In yet another century, actually the 20th, Ludwig von Mises wrote a concise essay on the post-boom credit contraction - The Dearth Of Credit is below.
A low of around 85 for the dollar index has been possible in September. After that, the uptrend that started last December can resume.
The Canadian Dollar has been likely to firm as crude oil completes its seasonal high in early October and Natgas sets its high - perhaps in November.
After that, it could decline a little against generally weaker commodities and widening credit spreads.
COMMENTS FOR METAL AND ENERGY PRODUCERS
Energy Prices: As mentioned above, crude could set a critical high in early October. Typically, natural gas makes an important high late in the year.
The ChartWorks has been expecting the uraniums to outperform the oils and it has started already.
Base Metal Prices: We have been looking for base metal prices to conclude their cyclical peak as the stock market does.
A final leg up for both was possible into early September and metals have slumped this week. Indeed, the break amounts to 9% for our index in only 8 trading days, which is impressive. Within this, nickel plunged 11% as copper fell 6%.
Last week, we noted that one negative was that U.S. credit spreads had resumed widening and that the treasury curve was close to reversing to steepening. As it turns out, the latter started at the end of August.
It seems that the key signatures for the start of a cyclical bear market for base metals have been accomplished.
Golds: The August 17 edition of ChartWorks noted that on the expected weakening of the dollar index, gold could spike up. Also noted was the "For the market to remain healthy, prices cannot close below $438."
On August 18, it slipped below this and the low close was 430.3 on August 30. The recovery since has carried to today's 455.
The advice from this page on August 25 was "We wouldn't chase any [share] rallies, but would buy any selloffs.".
To get some variety into the phrasing, the message on September 1 was to "buy the dips." Bereft of innovation, the advice of September 8 was to "buy the dips."
This was based upon the real price (gold/commodities) rallying to 202, which was the breakout level. That week's observation was that the golds had performed immediately very well as our index rallied off a low of 183 in late September, 2000.
The attached chart shows the low for the HUI at 36 on November 4, 2000. Also note that this had almost doubled as the gold/commodities index made its impressive rise into February, 2001, well before the nominal price broke above 272.
Essentially, the critical decline in the real price began in 2003 and set up a huge double bottom with the low of 185 on June 1 ending the bear.
After setting an enthusiastic high in late 2003, both senior and exploration gold stocks began a cyclical bear market. For the seniors, this wasn't realized until they rolled over and died earlier this year.
As it is turning out, the senior golds (HUI) concluded the bear market in May, as did the exploration stocks (www.goldcolony.com has a good representative index of 50 stocks).
Last week's edition reviewed that on its bull market out of the Fall, 2000 low, the real price advanced 35% and on this cyclical bull market a 50% gain was possible.
The correlations may not be carved in stone, but if the HUI soared over 600% on a 35% increase in our gold/commodities index, what will it do on a 50% gain?
Even more - what will the exploration index do?
Senior golds could retreat as the stock market sells off. By November, investors should be fully invested.
Real Price: On the attached chart (bottom clip), note the huge double bottom and breakout above the resistance line at 200.
More specifically, the break above 202 was accomplished on September 8 and the high, so far, has been 210 yesterday.
Clearly, the low of 185 on June 1 set the end of the cyclical bear market and the recent breakout defines the beginning of a cyclical bull market. As concluded last week, the 50% gain would take the gold/commodities index to 278 in about two years.
Investment Demand: We rarely mention supply-demand stuff, but gold's physical off-take has been impressive. Moreover, financial conditions have now changed in a manner that in the past have been associated with an increase in investment demand.
The most timely one has been the treasury curve reversing from flattening with the business boom to steepening with the pending contraction.
The curve (from 10-year to 2-year) has steepened from 12 bps on August 29 to 33 bps today. While the relation is variable, often a turn to steepening anticipates a rally in gold by up to two weeks. Gold's low at 430.3 on August 30 was simultaneous.
An increase in investment demand should also show up with gold advancing against most currencies, not with the orthodox BS about "dollar down - gold up."
***
(Bottom Chart)
The full understanding of credit and its cycles has been provided by the Austrian School of Economics. Its leading exponent has been Ludwig von Mises and some of his comments bear witness to today's one-way excesses. It is imperative to have an understanding of credit that works in both financial and tangible asset booms.
"An increase in the quantity of money or fiduciary media is an indispensable condition of the emergence of a boom. The recurrence of boom periods, followed by periods of depression, is the unavoidable outcome of repeated attempts to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.
The breakdown appears as soon as the banks become frightened by the accelerated pace of the boom and begin to abstain from further credit expansion. The change in the banks' conduct does not create the crisis. It merely makes visible the havoc spread by the faults which business has committed in the boom period.
The dearth of credit which marks the crisis is caused not by contraction but by the abstention from further credit expansion. It hurts all enterprises - not only those which are doomed at any rate, but no less those whose business is sound and could flourish if appropriate credit were available. As the outstanding debts are not paid back, the banks lack the means to grant credits even to the most solid firms. The crisis becomes general and forces all branches of business and all firms to restrict their activities. But there is no means of avoiding these consequences of the preceding boom.
Prices of the factors of production - both material and human - have reached an excessive height in the boom period. They must come down before business can become profitable again. The recovery and return to "normalcy" can only begin when prices and wage rates are so low that a sufficient number of people assume that they will not drop still more."
The Austrians did not distinguish between financial and tangible asset booms, did not provide any examples or a forecasting model.
Bob Hoye
Institutional Advisors
E-mail bobhoye@institutionaladvisors.com
Website: www.institutionaladvisors.com
PIVOTAL EVENTS - SEP 15, 2005
Hoye Archives
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in this report are solely those of the author. The information
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