Global Meltdown Now

Sid Klein Global Strategy

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At 48.5%, scenario #1 calls for a deluge in January, as part of collapse toward Dow 9500 in the first quarter.

At 47.5%, scenario #2 calls for a drubbing through March, concluding in April in the upper 9000's.

At 4%, the bull scenario includes a reverse-shoulder-head-shoulder breakout and acceleration from levels just overhead (see charts). The Dow would trade essentially flat around 13,000 through the year.

Silver is putting in a time cycle low before month-end, while yearend selling by the commodity funds has already passed. Similarly, today is the last day of the year for share window dressing. Today may be the inflection point, where highs and lows in stocks and precious metals are made.

I did not believe that yearend would hold up the market this year, and so wrote that it was too ludicrous to imagine that everyone would sell on January 1st at the same time.

Well, there is no limit to human stupidity, it seems. Let the front-running begin!

The Dow had skyrocketed 500 points on news that the ECB would earmark funds for the European banks and, now, the Dow has marginally traversed the peak that followed that huge advance by a few points, as of now.

This month, the advance was on the strength of a 300-point move up in the Dow. The news was, basically, that there are fewer net dollars per group, the Sovereigns and the banks. The market learned that the ECB would lend to the banks (who already owe them), 487B Euros, to be part of the triangular resolution to the European debt crises.

Bottom line: the one trillion Euros available for sovereign and bank debt is cannibalized with each transaction for either group's balance sheet. The market has just rallied back 300 points, celebrating the discovery that what was celebrated wasn't as good as thought, when it had rallied 500 points.

To counter any short lived illogic with simplistic reasoning (a look at a Venn diagram?), in November, the market discounted more than what it got in December, thereby creating a condition for psychological whipsaw (See VIX chart), to usher in Wave-3. The secular bear market may resume at any time.

One of the several possible news events that could catalyze the psychological whipsaw would be the inclusion of Germany in the ratings agencies' downgrades. The DAX is sceptical (see chart), but the Dow might have some unwarranted German positivity built into its price.

Those forecasting "a yearend rally" were helped along with headlines about better than expected German fundamentals, as if this could minimize the risk of the Germans being added to the ratings agencies' list if downgrades, despite growing sovereign commitment to the Eurozone crisis.

The ratings considerations will contemplate the balance sheet, not the income statement, so inclusion of the Germans could also have a whipsaw effect on the market.

For efficiency, the commentary continues within the following annotated charts and concludes in the VIX section.

On the NASDAQ chart above, the "X" serves as "B". The "c" in the present moment concludes "C" of Wave-2.

The whipsaw effect discussed earlier could not be better set up than with the VIX all the way back at its neckline of 20.

With yearend approaching, no new news events would be forthcoming in the near term. So, with stocks buoyed on light volume, understandably, it was not a good environment for January put options, which are at the centre of the cash VIX's smash.

Serious contango in the VIX futures market suggests an expectation of higher VIX levels ahead. The indicator has been right on the other end of the market. Past discounts (backwardation in the VIX futures) correctly foretold of a bottom in the market following a hard smash.

If investors dump their near term puts but plan on buying near term puts soon, one would expect those investors would buy VIX futures contracts, like any long hedger in the commodity market would, when the investor knows that he/she will need the underlying physical commodity at a future date.

From the side of volatility, this is yet another key aspect that is consistent with a major decline in the near term, as part of the inception and acceleration of Wave-3 of this bear market's resumption, which began at the peak of what I had forecast, identified and described as the "1931- Peak."

The light volume time drift allowed the VIX to fall to a reading of 20. With the market trading on low volume and time passing, but with appetites among the hedgers no less, the result is contango in the VIX market, which is, in effect, a call on the January and 1st-quarter puts. This is extremely important! This is consistent with…

Typically, before a dramatic smash, the major players who will be offloading the market would have used this past quarter to establish delta hedges. This is supported by the facts above, and is consistent with a near term collapse toward 9,500. (In this scenario, much of the decline will have occurred in January.)

The role of delta hedges is that profits accumulate to a greater degree than the accumulated losses in the stocks being hedged, the faster that stocks drop.

No longer does an institution have to worry about breaking their own market; rather they now benefit from an accelerated conclusion of the equity collapse. Reiterating, everything is consistent with a crash now, as the condition is consistent with the ruling class being prepared to profit from and adapt to it.

While the cash VIX was down 43 at 20.75 on Friday, the January futures were up 60 and closed up at 25.70! The contango continues, including the April contract at 28.15. Does 20.75 seem realistic?

Japan is the only other asset class I deem appropriate for the long side of long/short trades in 2012, along with the precious metals and their equities, when appropriate.

As described weeks ago, the extremes of the Japanese market (based on the past quarter-century) tend to be the end of December, or, alternatively, at a price often not much different, mid-to-late March.

The best risk/reward route longer term is the use of small and mid-cap Japanese stocks. The rebuilding of Japan will occur domestically and, as history will hopefully write, "The Japanese used an unforeseen natural calamity as the source to a plan that took the country out of its quarter-century deflation."

Due to the severity of what I foresee for next year in the global markets, for official purposes, my bullishness should only be taken as part of a long short portfolio, or where it represents a portion designated for equities, which should already be a well discounted number.

With small stocks outperforming in the US in 2012, as well, we certainly see, longer term, small and mid-cap stocks as the best route toward optimization of any Japan-related strategy.

Once again: The best time to buy or sell Japan is at our yearend or, less often, theirs, in March. Historically, if and when March exceeds the previous level, it can be marginal break or, as is often the case, a failed attempt at a new high or new low.

This is my lead index right now for ANY global long/short trade. This trade (i.e. - Nikkei-Dow), put on today, will yield extremely high risk-adjusted returns through 2012. This trade is recommended at today's prices.

The Shanghai index is in a serious and ongoing decline, the worst of which will be over by their New Year.

Chinese market woes range from property leverage in certain areas, to slowing growth. Of course, I have been to Asia to experience what Westerners call deflating or depressed or slowing. Our circumstances have rarely been as lively.

However, everything is relative and the Shanghai's malaise speaks of Asian and global weakening. There will be great demand in one area, but that's Japan's domestic domain, as discussed above.

The Shanghai index is a long/short candidate versus Western markets later, particularly as 2012 enjoys a newly begun cycle of lower rates. (Chinese monetary policy shifted the night before New York exploded 500 points.)

We exited the silver call position with minor (~10%) losses, since which time I have believed that December 27 plus or minus a day would mark a cycle low! (This is part of the reason for the week-early report today.)

I could not understand how I had a major buy signal, while looking for the equity markets to collapse, given the co-directionality to-date.

I have been publishing SLV-DJX charts, which included two horizontal lines that indicated support levels, both of which have been broken. But, today, being stopped-out of that trade, one must wonder if the reason for being stopped-out was not because the co-directionality with the equity markets was getting too stretched, but perhaps even reversed at last!

This would have dramatic implications for asset allocation. The present level of the silver/Dow spread (basis the ETFs in the chart) suggests that we may be looking at a looming (now) meltdown in financial markets, where panic investment is into the precious metals, and NOT into the yield-less 10-year Treasury paper.

Silver is a screaming buy on my time cycle low, TODAY. Gold has caused enough oh-my-God-panic among the clued-out Westerners, who sell their gold to the insatiable Easterners. The latter are unencumbered by any thought that inflation and deflation still have something to do with anything.

As I have been writing for 10 years regarding this period, whether considering asset allocation, downgrades, ANYTHING, this is a balance sheet story, not any income statement diversion.

Anything corrective in gold would simply be trading in a very broad range for 6 months. This would allow for a collapse in global equity prices to take place, and the passage of time to offset the general market forces pressing on gold prices.

Once again, as I have so often since turning bullish at $280 in 2002, I am reminding that time replaces price.

The bears have expressed lunacy in their arguments, not exclusive of: Gold is a state of mind and, since it is so volatile, it is just another risk asset without any formula for valuing it unlike a fiat currency with a 2% yield….which is paper on paper.

Throughout time, people have turned to gold. Therefore, at least this "state of mind" has a track record. Meanwhile, isn't believing in 'paper', and the paper it's printed on, a "state of mind?"

SLV strategy: Apart from SKGS's unchanged asset allocation model (below), shorter term and position traders should consider March 2012 and January 2013 calls, nearer and farther out strikes, respectively.

The way to play the SLV cycle low is to simply go long this week versus the Dow (2nd chart on next page). Given my view that a meltdown is very possible now, this is the least stressful way to go about a long position.

As far as gold itself goes, the first observation and critical note is: what is the worst case? According to my Elliott Wave read of the charts, it would be entirely normal to decline to 140 on the GLD and still trade comfortably within bullish trends. I repeat, comfortably.

However, my own view is that gold has bottomed and that the correction of this cycle will be one that is more of time than price. This is what gold has repeatedly done over the past 10 years (I repeat, repeatedly).

My conclusion therefore, is that gold will trade within a wide and shrinking band between 150 and 180.

The Euro has been dangerously co-directional with the Dow, though recently, late year vagaries have caused a lag. In other words, the Dow will crash to catch down, while the Euro has yet to find its new baseline.

Many thought that the Euro could fall no further once "everyone" was so bearish, but currencies are well known for their pattern extensions during normal times…and these are not normal times.

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