I am truly amazed at how easily today’s politicians can go in front of the television cameras and lie through their teeth to the American public, and I am even more amazed at how eager the public is to hear the lies. I am convinced that they would rather hear a lie than the truth. They obviously don’t realize how dangerous that is, but I assure you they will. In fact that realization will hit them square in the teeth before this year is out. The word complacency doesn’t even begin to describe their attitude; it’s like their on one of Timothy Leary’s acid trips from which you never recovery. The US use to be a great nation because it had ordinary people who found ways to improve, to get things done, and to advance. It wasn’t perfect but the whole was better than the pieces that made it up, and people were willing to sacrifice today for a better tomorrow. Now we have developed into an instant gratification society that can’t even spell the word tomorrow and could care less about next year. The average American couldn’t be in a worse position to deal with a severe economic problem: negative savings, declining real wages, rising unemployment, rising prices, and poor government have all but insured disaster.

Friday saw the first significant victim as Indy Mac, a California savings bank, was closed down by Federal regulators. Think of it as the first little ripple in a cesspool with a huge tidal wave coming behind it. Then we have the Freddie Mac and Fannie Mae debacle where everybody is sitting on the edge of their seat waiting for Bernanke to announce that the Fed will bail it out. This will be no small feat as the tab will amount to a cool trillion dollars! So far there is no bail out but the Fed did say they’ll loan to the two entities upon request. I have been talking for months about possible bankruptcies and have compiled a list of good candidates:

• Citibank
• Ford
• General Motors
• Countrywide
• Merrill Lynch
• Bank of America
• Lehman Brothers
• Chrysler

And I would also like to give GE an honorable mention because they have so many derivatives floating around out there that I am sure they have no real clue as to their own financial status. Think of these companies as the very small tip of a very big iceberg.

The reality of what I am saying can be seen in the following three year weekly chart of the banking sector:

You cannot have a chart like this without some real carnage and we are about there. In case if you’re wondering, this is what a crash looks like and we’re not done yet. There will be some relief rallies along the way, but more waves of selling will follow just like night follows day.

Many folks mistakenly look at everything that’s come to pass and feel that is the reason the stock market is in decline. Big error! The market is not in decline because of everything that has happened; the market is in decline because of everything it sees in the future. By future, I mean six to twelve months down the road. The markets do not care one iota about the past. The stock market is a forward looking mechanism and what it sees coming down the road is not good. Ever since the October false

break high the Dow has headed south carving out a series of lower highs and lower lows. Actually the move down began with the July 14,021.95 top and it led to the first lower low in August followed by the previously mentioned false break top (a false break is where you see a spike in one direction followed by an immediate significant move in the other direction). The August low in the Dow was accompanied by a similar move in the Transportation Index, and this in turn was followed by divergence between the two Indexes as the Dow rallied into October and the Transports continued their decline from the July high. This divergence produced the first in what would be a series of non-confirmations between the two:

Once the October high was in for the Dow, it immediately rolled over and chased the Transports lower. Both indexes made lower lows in November, rallied slightly, and then made significantly lower lows in January. The January confirmed lows were quite significant in that they were below the 2007 lows and it triggered our first major bear market signal in four years.

Before continuing I want to summarize: the Dow made a July top confirmed by the Transports followed by an initial 9.5% drop. Then the Dow rallied to a false break top in October, unconfirmed by the Transports. This in turn was followed by the Dow making lower lows in November and January, both confirmed by the Transports, and the latter triggering the first major bear market signal in four years. Now I want to continue my explanation. From January the Dow experienced a reaction followed by an even lower low in March. That low was not confirmed by the Transportation Index and that became our second significant non-confirmation since the bull market came to an end. Once the Dow bottomed, both indexes turned higher with the Transports clearly leading the way up. So much so that the Transports actually made a new all-time closing high in June of this year and to complicate matters even more, it too was unconfirmed by the Dow by a wide margin. This was the third non-confirmation but not the end of the story. Once the Transports topped, the Dow turned down and recently closed below its March lows and continue to power lower. Meanwhile the Transports have yet to confirm, and if they don’t, it will be the fourth non-confirmation, and I don’t ever recall such a confusing and difficult situation in the twenty-five years I’ve been involved with the markets.

I normally don’t get into the why’s behind market events as I’ve always felt that explanation is better left for history books. I must admit though to being fascinated as to the “why” behind the three/four non-confirmations that current exist in the stock market. I have gone back seventy-five years and was unable to find a similar example. I think the reason is twofold:

• Never before have we seen so many distortions, intentional I might add, at work at the same time. The world’s central banks have gotten together and flooded the market with fiat currency in the effort to prevent a recession. Likewise the Fed has maintained interest rates at artificially low levels allowing inflation to eat away at your wealth. All of this in an effort to avoid what cannot be avoided, i.e. a downturn in the economy.
• Combine this with extraordinary demand for commodities which put pressure on transportation in spite of a slowing world economy, and you can see why transports have resisted a downward reaction. The demand in commodities is due largely to the fact that people are no longer willing to hold dollars specifically and fiat currency in general. The majority of individuals now prefer to hold something much more tangible in their hands.

This is all just an educated guess on my part, but I think time will prove me right.

So what do we have in store over the coming weeks and months? In a word, trouble. These non-confirmations brought about by distortions and increased demand for commodities will soon bring about a leveling of the playing field. The thieves you have been manipulating the markets for years will finally get what they deserve and those few speculators that were able to preserve their capital while making the correct investment will in the end win the day. I know it sounds egotistical to say this, but I know how it will all play out. My only question is timing. The Dow topped out in October at 14,164.53 (closing high) after rallying from the 2002 low of 7,286.27, i.e. a rally of 6,878.26 points. Slowly the Dow began to retrace the bull market gains and are about to approach a critical level. In any retracement of a bull/bear move, the critical moment is when you reach the 50% retracement and in this case it will be at 10,725.40. That’s the halfway point between the October 2007 high and the August 2002 lows, and any two consecutive closes below this support would imply that we will in fact test the 2002 lows. You don’t have to do the math to know that 7,286.27 is still a long ways from Friday’s close at 11,096. We’re now only 371 points from that crucial support and I am convinced we will test it in the coming days. Keep in mind that Friday’s intraday low of 10,963 was only 237 points away and that’s not even a good day’s work with recent volatility.

So it’s a given that we test crucial support, and then what? Well, one of two things happen: we close below it and crash now, or we rally for +/- 45 days and crash later. Since it seems to me that a test of this support will not be confirmed by the transports, my best guess is that we’ll bounce and see our first decent rally since late April. Since the early May lower high no rally has lasted more than three days and a 45 day reaction will bring out all the folks calling for a new bull market high and suck in the last dollar from the last widow out there. The reaction should end in early September and will be followed by a second test of 10,725.40 and a subsequent break below it. This in turn will lead to a crash in late October or early November. Either way you get a crash this year, it’s just a question of when. We should know the answer in a week or two. If I had to point my finger at just one causal thing I would point to the

Bush administration’s “strong dollar policy” reaffirmed just the other day by Treasury Secretary Paulson who I really dislike. If you can find snake oil salesman in the dictionary, his picture should serve as a definition. Did I say that I really, really, really dislike him!!! A 40% decline in the US Dollar Index over seven years is the culprit behind most of our problems today. Who will buy stocks or bonds in a currency that loses that much value? Right now the US dollar Index is on the verge of starting another leg down. Thursday and Friday saw the dollar break below the bottom band of its trend line that held since mid-March indicating that we are about to fall lower. My target for the coming decline is all the way down at 60.38. I bet that will surprise all those dollar bulls out there, and Mr. Paulson too!

On Friday we witnessed a rare event, sharp declines in the Dow, the dollar, and bonds and the latter was probably the hardest hit as the September bond fell a large 1.15 to

close out the week at 115.27, this after a brief test of significant resistance at 117.19 just twenty-four hours earlier. What’s more the close was back below the 200-dma which is above the 50-dma and that is bearish. Personally, I have been convinced that bonds are in a bear market that will last a decade or more and price is going a lot lower. There will be some lines in the sand and I have listed them below:

SUPPORT RESISTANCE

US BONDS 115.17 115.29

114.21 117.19

113.22

112.13

and the first real key will be string support at 112.13 which turned back the last decline in June. Two consecutive closes below this level will lead to a test of critical support at 105.04 (to give you some perspective, this is similar to the 10,725 level in the Dow). Eventually the bond will fall much lower.

Given everything I’ve said about the dollar in particular and US paper assets in general. I believe that commodities will continue to move higher. The US will print more while maintaining rates at current levels, although I still think lower rates are a real possibility. So it will be a case of too many dollars chasing too few goods and that will drive prices higher. Over the last six months we’ve seen selective corrections/reactions from specific commodities but nothing generalized and I suspect that trend will continue. Those of you who are waiting for a generalized commodity crash will have to wait a little longer. Oil, copper, grains, and the softs will continue to work their way higher with volatile reactions along the way. Just look at oil’s behavior this last week. In particular, oil broke out above $100.00 and since has experienced standard three/four day reactions with a few eight/nine day reactions mixed in. That was also the case just last week as August oil closed at 146.08 on July 3rd and then began a sharp, violent three day decline to close at 136.43 on July 8th. This of course ushered in the usual chorus of “a top is in” but the market being what it is immediately made fools out of the top callers registering a new all-time intraday high on Friday at 147.50. Take a look below:

I know oil is overbought as you can see in the daily chart but demand remains reasonable and a weakening US dollar will make it difficult for a sustained reaction. At best I think you’ll see a sideways movement such as the one that occurred in June allowing the overbought condition to be alleviated somewhat.

One of the things that tell me that all prices are headed higher is the behavior of gold. After gold topped out at 1,033.90 back in March, many people expected an unusually sharp and violent decline all the way down to 731 but it never materialized. Instead we saw a mild 15.5% correction that took gold’s price down to 846.40, marginally below the 850 historical high where gold broke out from back in December. When the initial bounce came, many resisted the temptation to get back into the market, feeling that a lower low was inevitable, and they were dead wrong. What they missed was gold’s tendency to follow strong rallies with milder than expected reaction. They also forgot that gold spent sixteen months building a huge base for the rally up to 1,033, a rally that took just seven months. Take a look at gold’s daily chart below:

You can see that we have posted a series of higher lows and higher highs and recently gold broke out above the upper band of the down ward sloping trend line that stretched back to the March top. That is quite bullish.

Gold is not going to put in a lower low and gold is not going to go away in May. What gold is going to do is rally. Thursday and Friday’s break out to the upside left what was strong resistance at 945.15 in the dust and implies a test of the critical resistance at 999.40 which turned back the last rally. I have posted what I consider to be significant Fibonacci numbers for both gold and silver below:

SUPPORT RESISTANCE

GOLD 945.15 967.70

924.60 999.40

902.10 1,077.60

1,148.70

SILVER 18.75 19.01

17.79 20.03

17.47 20.67

*These are based on August gold and September silver futures contracts

There will be strong reactions along the way but gold should not correct more than 4.5% over the immediate future and will challenge the 999.40 resistance without any significant setbacks. I am convinced that gold will reach a minimum price target of 1,372.80 with no more than two 7.5% reactions (eight to twelve days each) along the way.

Likewise I see a good future for silver, in fact better than gold because silver is the cheapest thing out there. On Friday the September silver rallied 60 cents to close at

18.92 and just under what will be good resistance at 19.01. The reason for the increase in gold and silver prices has a lot to do with problems in the market and I believe the rise is beginning to discount the closure of some important institutions like Citibank. The Fed will more than likely bail out Indy Mac, but I have to ask with what money? The FDIC really doesn’t have the funds, never did, and this is just the first shot across the bow. There will be dozens, maybe hundreds, of banks like Indy Mac that you’ve never heard of before, with tens of thousands of middle class investors left out in the street with no money, and no real assets to prop it up with. The world’s central banks are doing their collective best to suppress the price of gold and silver, in an effort to create the illusion that everything is alright, but they are failing. Silver’s P & F chart is pricing that in with a target at 23.00 and we may even see higher prices. As I’ve said before I am projecting gold at 1,711.00 by late April 2009 and that equates to a silver price close to 33.00.

In conclusion, this week will be quite interesting and I really want to see how the market reacts to the Indy Mac situation that was announced after Friday’s closing bell. I have been watching CNN and Bloomberg Sunday morning and they have carefully avoided any commentary. This should be the type of news that drives the Dow futures down 150 to 250 points before the open. Notice the emphasis on the word “should”. I have no don’t that the Fed will be intervening in the S & P pits but my hope is that they won’t. I would like to see a real spike down, with no interference, in order to get everybody over to the short side of the boat. That would mean a test of 10,725 sometime tomorrow and then you would have a chance for a reversal and the beginning of a decent rally. I will exit all of my short positions in the Dow, S & P, and NASDAQ if and when I see a 10,850 print in the September Dow. Why not wait for a 10,725 print? Someone a lot smarter than me once said that “the most expensive eighth’s in the market are the first eighth and last eighth of any move”. What he meant is that you never try to squeeze out the first or last cent in a move. On the other hand if I am wrong and there is no rally, I will simply sell the market short again on a close below 10,725 but I must first play the odds that favor a rally at 10,725. Anything else would go against my initial position and second guessing usually costs me money. If the Dow continues down through 10,725, then I suspect we’ll see the transports confirm somewhere later in the month and a crash will come after that. All in all, it’s shaping up to be a very interesting Monday.

ebo@dtanalysis.com

Dow Theory Analysis SAC

July 13, 2008

Here is an article by a Congressman that explains the problems we face better than I can:

Inflation: Ron Paul Explains How We Got Into This Mess

Bill BonnerProvided as a courtesy of Agora Publishing & The Daily Reckoning [Australia]Jul 10, 2008