Stock Market Barometer: Find the cost of Freedom

Gold Price Today is lucky enough to offer our readers  a guest editorial from Stock Market Barometer. Please read on to find out why the stock market of today is not as robust as the mainstream media would have you believe.

• The US dollar is extremely oversold, and due for a reaction.
• What if we’ve seen so many distortions in the market that the recent Dow Theory buy signal is wrong?
• Gold’s current downward reaction has been shallow

“Never think that war, no matter how necessary, nor how justified, is not a crime:”
- Ernest Hemingway

This is an image that you are not supposed to see. Dead American soldiers are taken off a transport plane, in the middle of the night on the East Coast, and with no one around and no acknowledgement of the sacrifices made. The Bush administration prohibited the press from filming this even though the United States is a country that espouses freedom of the press, and the Obama administration isn’t any better. Sixty-six young American men died in Afghanistan this month and that is the deadliest month in the nine year long war. The idea is captured in the phrase “out of sight, out of mind”. The US government figures that if you can’t visualize the price you are paying to make war in Afghanistan, then you won’t mind paying it.

I came of age with the Viet Nam war, lived with the Brigate Rosse in Italy and Sendero Luminoso in Peru, survived terrorist attacks in Chile and I know that no good comes out of violence. The US invaded Iraq based on the lies of weapons of mass destruction and went to Afghanistan to defeat the Taliban. Now the press is trying to turn it into a modern day Holy War, a Crusade, but it’s just about money. The Catholic Church killed millions of Arabs, and later on millions of Indians in Latin America for money. The war in Afghanistan is more of the same. Drugs are big money and Afghanistan is all about drugs and to a lesser degree certain commodities. Drug cartels pay millions and millions of dollars a year to lobbyists so that drugs are not legalized in the United States, and who benefits from that? The war on drugs is just like any other war we’ve fought over the last three decades, expense and losing proposition!

Perhaps even more important than the expensive quest of nation building are the recent Fed mutterings regarding the need for more stimulus. Everyone from Bernanke on down are dropping subtle hints that something else may be needed a little further down the road. Bernanke spoke before Congress and said the Fed would study the possibility “just in case” and then on Thursday, James Bullard, the President of the St. Louis Fed came out and said that Fed policies were putting the US at risk of a Japanese style deflation. On Thursday the Fed’s Beige Book came out and said that the economy continued to be weak in June and July, laying the groundwork for the emission of more fiat currency before the end of this year. Why open the spigots after a three trillion dollar injection? The US has a US $13 trillion national debt and another US $50 trillion in unfunded liabilities. Illinois isn’t paying its debts and California, the world’s eighth largest economy, will be completely out of money by October. Meanwhile the economy continues to slow as the weak GDP numbers show, housing looks terrible with 1.6 million properties receiving foreclosure notices during the first six months of this year, and unemployment is a real problem.

So much debt and absolutely no way to pay it all off! The United States could default but that would make it a financial pariah for decades to come, so the only other navigable road is to print fiat currency until the cows come home. They’ve tried to go about it as if time were not of the essence but the grains of sand in the hourglass are running out and soon the Fed will be forced to call out the helicopters. The behavior of the U.S.  dollar is now reflecting the Fed actions that will be taking place in a couple of months. Huge increments of supply will be hitting the market in the Fall and the world’s markets will be in no position to absorb it all. In anticipation of the flood the dollar began to lose ground back in early June and has yet to pause to catch its breath.

It took the spot US Dollar Index six months to move from 74.23 to 88.71 for a gain of 14.48. In less than two months it gave back almost half of the gains! A 50% retracement would take the index down to 81.47 and Friday’s close was slightly above that at 81.52 while the intraday low was at 81.46. What’s more the dollar is fast approaching the 200-dma, it is extremely oversold, and it’s due for a reaction.

Given the Fed’s need to create fiat paper, I look for a first (three to four days) or second (seven to twelve days) degree reaction, and then a continuation of the move down. The real test will take place when the Index hits the old historical low at 80.16 (80.45 in the September US Dollar futures contract), and when that support is broken I expect the speed of the decline to increase. Once below 80.16 we’ll encounter additional layers of support at 77.02, 75.43, and 73.06 before we finally see a test of the all-time low of 70.70 posted back in April 2008.

I expect to see a test of the 2008 low sometime in early 2011 and as the dollar falls back below 80.16 this year, confidence in the US and its ability to deal with its obligations in a responsible manner will wane. Countries like China and Japan still hold large amounts of dollar denominated assets and they will finally be forced to look for other alternatives. These alternatives will include the Euro, gold, silver, certain strategic commodities, and companies that possess certain strategic reserves of minerals, oil and copper that are located in foreign countries.

Right now China is negotiating with Argentina for the purchase of companies that produce grains, iron ore, natural gas, and oil. Also, they have entered into similar agreements in Venezuela, Peru, Cuba, and Ecuador. The speed with which everyone exits the dollar will quicken as the year drags on, but it is worth remembering that for every loser there is a winner. Back in early June I recommended the Swiss Franc to my clients when it was trading around 85.50 and you can see what happened below:

On Friday the Franc broke out and closed at 96.00, a new closing high for this leg up and it won’t face any real resistance until it hits 98.71. I am looking for the Franc to reach par with the dollar before the summer ends.

The health of a country is almost always reflected in the value of its currency so you can assume a declining dollar means that trouble is on the way. So why has the Dow been rallying and why did we experience a Dow Theory buy signal earlier this week?

The answer is not as complicated as you might think. Like the dollar, the Dow is discounting a new deluge of liquidity even though the amount and timing is unknown to us. It is worth remembering that the Dow reflects the sum total of all things known for months into the future, and that is reflected in the price we see on the screen.

Before this week the Dow had made a series of three lower lows as well as three lower highs for a total of 1,643.69 points lost. The bear market rally from March 2009 to April 2010 recovered 61.8% of the initial leg down (October 2007 to March 2009) and I am interested to see if the pattern will repeat itself. In order for that to happen, the Dow would need to rally 1,015.80 points to reach the .618 retracement at 10,630.12. So far the intraday high has been 10,584.99, posted on the Thursday’s open and that was marginally above the intraday high from Tuesday.

What’s more the 50% retracement stands at 10,436.16 and we’ve yet to see any real separation from that level on a closing basis. The high close so far has been 10,537.69 on the 27^th and both Thursday as well as Friday saw lower closes as the Dow ended the week at 10,465.94. Were the Dow to fall back below the support/resistance from the 50% retracement at 10,436.16 early this coming week, I would consider it to be an interesting development.

The most interesting development occurred on Wednesday when both the Dow and the Transports closed above their respective June closing highs. This triggered a significant Dow Theory buy signal indicating that we are again off to the races and higher numbers.

What if we’ve seen so many distortions in the market that the recent Dow Theory buy signal is wrong?

In my last daily report I posited an interesting question. What if we’ve seen so many distortions in the market that the recent Dow Theory buy signal is wrong? On July 27^th we saw the Dow close above its June closing high and this was confirmed by the Transports that same day. That triggered a significant buy signal and smart investors should go long. It’s not unusual to see two or three days of weak or sideways action after such a move and that appears to be what is happening now. But what if the Fed, by printing so much money, has distorted the markets to such a degree that these signals now longer mean what they used to?

Richard Russell has said on more than one occasion that we are experiencing market conditions that no one has ever seen before. The Fed has been trying to maintain a bullish primary trend for a decade through the use of historically low interest rates and unparalleled expansion of the money supply.  I have to wonder how well Dow Theory, or any analytical tool for that matter, can predict under such conditions.

On Thursday and Friday we saw sideways movement with a failed attempt to move higher on Thursday and another failed attempt to move lower on Friday. The most probable outcome would be for the Dow to test good resistance at 10,817 and for a non-confirmation by one of the two major indexes to occur as that happens. I see little or no chance for the Dow to make a new bear market high, even with new liquidity flowing out into the market place. Don’t forget that each successive bail out has had a shorter shelf life and this one is already being priced in. I know the injection will be huge but I don’t think the results will be any different. The debt crisis will not be resolved by creating more debt. The debt crisis can only be resolved by writing off bad debt and there is absolutely no consensus for such action.

The market must sooner or later reflect the fact that no policy has been implemented to deal with rising debt and unemployment. As I said earlier, there is already a lot more debt than can ever be paid meaning that the counterparties to that debt will lose out. I saw a recent estimate that puts debt and derivatives at $1.4 quadrillion and I would surmise that 90% will end up being washed out. Eliminate 90% of the value of the Dow and that is a reasonable estimate of where it will end up.

One pleasant surprise this last week was gold. The yellow metal fell to test good support at 1,158.20 on three consecutive days and found willing buyers on each occasion. I did think that spot gold would fall as low as the strong support at 1,148.90, but it now appears that I may have been a bit pessimistic. Also, we had options expiration this week and that usually attributes to downward pressure on the price of gold. As you can see on the chart above, on a closing basis gold held above the previously mentioned support at 1,158.20 and then closed out the week at 1,180.90.

Gold’s current downward reaction has been shallow

Right now spot gold is 28 days off of the April 21^st high and I would look for a retest of the recent low on Monday or Tuesday, a possible but not probable lower low at 1,148.90, and then a short period of consolidation followed by a move higher.

Although gold has moved sideways out of its ascending trend, it has done nothing wrong. The current downward reaction has been shallow, approximately US $100.00, and has yet to seriously threaten the 200-dma. Note also how RSI, MACD and the histogram are all pointed up now and it looks like the challenge will be to move back above the 50-dma that stands at 1,211.57, and then above Fibonacci resistance at 1,219.20. This could take some time as gold balances the pressures of deflation against the Fed’s propensity to print. In the end the Fed will turn out to be gold’s biggest booster as it destroys the US dollar and creates the third phase of the great bull market for gold in the process. Many clients have written gold off, convinced it will fall down to 850.00 and they will realize when it’s too late just how wrong they were. By the time they figure it all out gold will have blown past resistance at 1,298.10 and will be well on its way to my projected top of 1,372.80.

Both silver and gold stocks continue to hold up reasonably well. The HUI has held stubbornly above strong support at 427.32 and closed out the week at 442.64. To date I have sold 35% of my portfolio and will sell another 15% into strength, hopefully this week, as I continue to liquidate gold stocks. I used part of the cash from the sale to buy gold at 1,159.00 and silver at 17.55.

With every day that passes I have a growing fear of paper assets and a greater respect for physical gold and silver. Therefore if I can trade paper for physical, I consider myself a lucky investor. My fear of paper is related to my fear that the market mechanism could collapse and that is a risk I am not willing to take. Of the two metals, I view silver as dirt cheap and with significant potential. Take a look at the daily chart below and then I will explain why:

Silver has been moving sideways since late March and rallied off of Wednesday’s lows to challenge strong resistance at 18.18; strong because both the 50-dma as well as Fibonacci resistance come in at the same exact number.

Finally it is worth remembering that gold has long since made new all-time highs while silver has yet to recover half of its 1980 all-time high. If I adjust silver’s 1980 high for inflation, one ounce should be at $172.00 and our current price is about 11% of that. Aside from that supply will continue to dwindle and once silver is recognized as money, the sky is the limit.

CONCLUSION

On Friday the FDIC took over another four banks, a total of eighteen since July 16^th, and there are several hundred more on the FDIC’s troubled bank list. The GDP grew by a less than expected 2.4% during the second quarter as a larger than expected trade deficit and a continued reduction in consumer spending weighed on the economy.

It would have been much lower but there was a jump in inventories and now businesses will be faced with the task of selling off the build-up; no easy feat since consumers are not in the mood to spend. Unfortunately we live in an economy that produces less and less and it is run by a government that is growing and consumes more and more as you can see below:

This consumption is crowding out mainstream America and that will lead to further increases in unemployment. Government creates waste whereas small and medium sized companies create jobs and consumption. If the trend is correct there is a lot more waste to come in our future.

In an effort to “paint the tape”, manipulation is now done out in the open. The fact that gold has been hit at 8:45 am EST every morning for weeks on end doesn’t even draw a comment. That someone buys the Dow during the last hour of close, when the charts indicate that selling is the wise choice, and the buying always begins in the S&P pit, likewise fails to elicit commentary from the supposed experts that talk incessantly on TV. The idiotic questioning regarding the possibility of a double dip, when there hasn’t been any real recovery to begin with, is an insult to any hardworking individual that has to try and balance a check book. Generally accepted accounting principles went out the window two years ago and most balance sheets of the government favorites (think GE, Citibank, Goldman, Bank of America, etc.) are nothing more than an exercise in fraudulent business practices. Rather than having a government that protects the interest of the general population, you have a government dedicated to the task of leaving the vast majority of Americans mired in poverty for decades to come. Anyone who expects the market to advance in such a convoluted and corrupt environment really has no idea as to what is going on around him.

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Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

August 2010

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Information in Gold Price Today is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Appropriate independent advice should be obtained before making any such decision.