McHugh On The Markets

The Federal Reserve is flooding the economy with liquidity. They do this when risks of market declines are at their highest. It looks like they've had enough of this equity market slide as they boosted M-3 another 19.1 billion this past week (a 10.36% annualized rate of growth). For the past two weeks, they have increased M-3 a whopping $73.2 billion (that's a 19.97 percent annualized growth rate). Over the past six weeks, M-3 is up $105.2 billion (a 9.59% rate of growth). Now does that sound like a Fed the least bit worried about inflation? The left hand grabs the eye with staged announcements of another inflation-fighting quarter point measured interest rate increase, even creates a little controversy with language changes to really steal our attention, while the right hand pumps and pumps and pumps like the black hole of deflation is knocking at the door. The Maestro is quite the magician. Good for Gold, bad for the Dollar.

M-3 can grow from two sources, the money multiplier (velocity of money from economic growth) and from the Fed literally printing the stuff. But regardless of how it grows, the Fed has absolute power over the quantity of money that sits in the economy at any given time. If there is too much, they pull it out by selling their inventory of U.S. Treasuries to investment banking houses in exchange for money (deposits at banks). If there is too little, they buy securities in exchange for money they print. They also can slow the velocity of money growth by changing margin and reserve requirements. So when we mention the Fed increased M-3, we are saying they allowed it or directly caused it, but the end result is an acceptable targeted level by the Fed, one way or the other.

The trade-weighted US Dollar is breaking south from an Ending Diagonal Triangle pattern (a.k.a. Rising Bearish Wedge) - a typical termination pattern - that formed Micro degree wave 5 of Minuette c of Minor 4 up. The Dollar should be on its way to a retest of its recent lows, a test of 80.00. The decline should proceed in five-wave, stair-step fashion, with the move from April 14th's 85.32 to April 22nd's 83.36 a Micro degree wave 1, and the current move up a Minor degree wave 2, eventually dropping to a primary degree wave (1) sustainable bottom, to be followed by a multi-month A-B-C corrective rally for Primary degree wave (2).

Gold is shown above, courtesy of www.stockcharts.com. We await a breakout in Gold either to the top boundary of the Rising Bearish Wedge, or to below the lower boundary of both the Rising Bearish Wedge and the long-term rising trend-channel. Rising Bearish Wedges tend to correct to the beginning of the pattern, which in this case is around 375ish. However, should the Fed continue to pump money into the system - which they are doing - then the correction in Gold could be quite shallow, take on the form of an Elliott Wave "flat" pattern, possibly the shape of a triangle with lots of overlapping waves - or delayed. Short-term, it is difficult to say whether Gold has topped or not. March 11th, 2005 may have been the top.

But there is room for Gold to rise to - and perhaps slightly above - the upper boundary of the Rising Bearish Wedge, to 460-465ish. Inside the Rising Bearish Wedge, Gold has recently formed a continuation Symmetrical Triangle Pattern, which increases the odds Gold will peak toward 465 before falling.

The HUI (shown at the top of the next page) is tracing out a classic Gartley pattern, with a downside target around the 150 area. However, ironically, this pattern is a Bullish pattern. What that means is, once prices correct to the 150 area, it is off to the races as a very nice Bull run begins again.

And using a third tool for the HUI, the Elliott Wave analysis, we see that waves iii through v should carry prices much lower to their wave C bottom. Where might C of 2 bottom? Based upon the Elliott Wave count, a 38.2 percent retrace of Intermediate degree wave 1's rally from 35.31 on November 16th, 2000 to 258.02 on January 6th, 2004 suggests a bottom for the current Intermediate degree wave 2 decline of 172.94 (almost got there). A 50 percent retrace takes prices to 146.67. Interestingly, should Minor degree C end up equal to Minor degree A, that would suggest a bottom of 154, very near the H&S and Gartley targets. After the carnage, we should be at the bottom of Minor degree C of 2, to be followed by a powerful rally for several months or even years, Intermediate degree wave 3, probably in response to more Dollar devaluation.

"For I know the plans I have for you, declares the Lord,
Plans for welfare and not for calamity to give you a future and a hope.
Then you will call upon Me and come and pray to Me
And I will listen to you.
And you will seek Me and find Me,
When you search for me with all of your heart.
And I will be found by you, declares the Lord,
And I will restore your fortunes."

Jeremiah 29:11-14

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Robert McHugh Ph.D. is President and CEO of Main Line Investors, Inc., a registered investment advisor in the Commonwealth of Pennsylvania, and can be reached at www.technicalindicatorindex.com. The statements, opinions and analyses presented in this newsletter are provided as a general information and education service only. Opinions, estimates and probabilities expressed herein constitute the judgment of the author as of the date indicated and are subject to change without notice. Nothing contained in this newsletter is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. Neither Main Line Investors, Inc. nor Robert D. McHugh, Jr., Ph.D. Editor shall be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided.