It’s never dull in the markets, even when prices appear to be stuck in the mud. This week was no exception as the market searched for a bail out from Washington, got one that was less than expected, and then lost it before the ink could dry on that monster check. Life is like that sometimes, full of surprises. It seems that the deal can be boiled down to a debate over several key items:

• Paulson wants immunity from prosecution,
• The government is going to pay greatly inflated prices for worthless assets, thereby creating a fictitious market, so “Friends of Hank” are unduly rewarded,
• Paulson will be given complete control, i.e., more power than any one person has ever had. And
• The taxpayer gets stuck with all the liabilities while receiving none of the benefits.

This last item is particularly interesting in that the average American will get stuck with a US $750 billion bill, and yet it will not save a single house from going into default, with the possible exception of some of the large shareholders of major institutions like Goldman Sachs. Some of the proponents of the Paulson bailout actually had the nerve to say that the “assets” purchased at inflated values would someday be worth money, ten or twenty years from now. My experience tells me that something worth zero today will be worth zero in ten years. Try cashing in a Confederate dollar at your local supermarket!

The real deal breaker though is the fact that the general public is outraged that Paulson wants to give their tax dollars to his friends. Under normal circumstances, politicians wouldn’t pay much attention to what the public wants, but this is an election year and a lot is at stake. It takes a lot to get the American people outraged, and away from their reality TV, but Washington finally managed to strike a nerve. Both parties may learn the hard way that it’s best not to wake a sleeping giant. Unintended consequences can jump out and bite you on the rear end. A problem of this magnitude could spawn a third part that might actually tackle the real problems that face the US. The two party system has had a lock on power since the days of Teddy Roosevelt, but nothing like an economic disaster to shake things up.

Every time we’ve had a serious problem (Mexican crisis, Asian crisis, Russian crisis, the tech wreck, and 9/11 to mention a few), both parties have solved the problem by throwing money at it. A politicized version of shop until you drop, no pain involved, and the American people went along with it. They were told that if you simply trusted Washington, you wouldn’t have to have bad times, and they bought it. Anybody in business knows that bad times are a part of the business cycle, and that’s why you save, to survive the rainy days. Americans were actually discouraged from saving and told to consume using cheap credit. Greenspan, the genius that he is, actually told Americans that it was in their best interest to use adjustable rate mortgages when the prime rate was at historical lows. Under Greenspan the savings rate actually turned negative and stayed that way for years, while foreigners financed US consumption. Under Washington’s guidance, the largest debtor nation in the world not only borrowed money to finance its debt, but borrowed to consume at a greater rate. Meanwhile production left the US to the point that consumption now accounts for more that 75% of GDP. Am I the only one who sees a problem here? My grandfather never made it to third grade, but he knew that if you had to borrow in order to pay your debt, you were as good as out of business. The United States is about to go out of business.

I suppose I could find a way to support a US $700 billion bailout, even a less than good one, if I thought that was an accurate amount, but I don’t. In fact I am sure that is only a very small tip of a very large iceberg, and it would simply be better to wash it all out here and now. I have walked the earth long enough to know that, as hard as you try, you can’t ignore your problems in the hopes that they’ll simply go away. That mentality seems to act as fertilizer and they grow until they consume you. Americans need to do an about face right now and face their economic reality. This garbage about forming committees, avoiding and/or assigning blame, and searching for worthless solutions is a waste of time. Politicians will not solve the problem; they are the problem. Americans need to step up and take the power back that is rightfully theirs under the Constitution. You remember the Constitution, it’s that 240 year old document that lawmakers violate on a weekly bases. Our forefathers fought to protect that document and our present day politicians treat it like something less than toilet paper.

Somewhere along the line, somebody got the bright idea that you could postpone the day of reckoning indefinitely. I remember when I was in the university, young and still a full head of hair, and I was taking my first economics class as an undergraduate. They herded all into auditorium to watch a film. Some professor in some think tank came down a spiral staircase expounding why the US could never go broke. The gist was that we could sell bonds until the cows come home, because the richest nation in the world had the ability to tax. Modern day politicians did sell bonds until the cows came home, but never taxed the people to pay for it. Likewise they injected liquidity during recessionary times, but never withdrew that liquidity during the good times. It’s a policy of the good without the bad and the world just doesn’t work like that. Now we have to pay the piper for all the distortions created and it will be painful, but if it isn’t done now it will devastate what was once the greatest country in the world.

In the face of what’s coming the investor really doesn’t have a lot to choose from. He can stay in all cash, but even that isn’t as simple as it sounds. For almost a century the world has used the US dollar as its reserve currency, and that proved to be a sound bet for a long time. Enter the Bush administration and all of that begins to change (actually it began back with Clinton but Bush took it to a whole new level), and the dollar has lost against the world’s major currencies for almost nine years. In late 2007 the greenback fell to a new all-time low, as Greenspan tried to print his way out of every dilemma. That policy has driven the US Dollar Index down from the 2001 high of 121.00, down to the 2008 low of 70.75 with very few interruptions.

Seven months ago the US Dollar Index began to build a base and then in July it took off to the upside like a rocket. The old historic low was at 80.50, and it held in place for decades. This rally ran right up to that level and seems to have fizzled out. Since

then the December US Dollar Index has fallen back down marginally below good support at 76.49. Then the December US Dollar Index rallied three days to an intra-

                                                   SUPPORT               RESISTANCE

US DOLLAR                                 76.49                           77.24           
                                                       76.25                           77.53
                                                       75.44                           78.46

SWISS FRANC                             92.10                           92.40
                                                       91.30                           92.70
                                                       90.70                           93.60   

day high of 77.44 before losing ground on Friday. The December US Dollar ended the week at 77.04 and may trade in a range as it distributes before the next move down. It’s important to understand that the dollar rallied due to deflationary pressure. Income and employment began to decline and that caused a scramble for dollars to service what only can be described as staggering debt loads (most debt is denominated in US dollars). People took on large amounts of debt thinking that trees grow to the sky, and now they’ll learn the hard way that they don’t.

I believe that rally more than likely came to an end. With the amount of huge bailouts coming down the road, or in lieu of those massive bankruptcies, the dollar will be as desirable as leprosy. On the other hand, we all need some sort of paper currency to put into our pockets, and my choice was, is, and will be the Swiss Franc for the foreseeable future. No system is perfect, including the Swiss, but their business has been money for almost five hundred years, and I don’t see them ruining that. As the dollar rallied, the Franc underwent a correction, but recent turmoil in the financial markets seems to have lit a fire under the Franc. I have always looked at the Franc as an insurance policy. No matter what happens anywhere in the world, the Franc will react favorably. I know it’s a strange concept for Americans to think of holding some other currency, but they had better get used to it. In 2001 the US dollar was worth almost two Francs, while today it is approaching par for the second time.

Aside from buying the Swiss Franc, I believe that everyone should own gold. It is the only store of value that does well in both inflationary as well as deflationary times, and has stood the test of time. Since a retest of the US $252.50 all-time low in 2001, gold has traded as high as $1,033.90 earlier this year and finally taking out the old 1981 historical high of $850 by a wide margin. Now I am the first to admit that gold is not an easy market; in fact it is probably the most manipulated market in the world. I say that because it is the most watched indicator with respect to how things are going and, since we live in a world where bad news is not accepted, central banks waste huge sums of money trying to cap the price. In spite of having spent billions of dollars, the bull market remains intact and it’s a perfect example of how you cannot change the direction of the primary trend. As with any market, secondary reactions occur and they are often violent, but they are just that, secondary reactions. Movements in gold are further exaggerated, because it is the only market that can both rise and fall on fear, and that seems to increase volatility considerably.

I am convinced that some investors have been accumulating large amounts of gold for years, firm in the belief that major problems are coming and they want to protect their wealth. These same investors also are there to buy every significant dip, and we saw that just a couple of weeks ago, as the December gold futures contract tumbled from the 1,048.00 intraday high on March 17th to the September 8th intraday low of 739.80 and just above crucial Fibonacci support at 735.90. This correction was the steepest of the bull market and forced most investors to exit thinking the bull market in gold had finally run its route. Of course they were wrong. Gold has made a career of doing just that, making investors sell when they should buy and vice-versa. Once everyone was safely on the sidelines, the December gold immediately began to rally and Friday closed at 888.50 but traded as high as 920.10. Since the September bottom, gold has become extremely volatile and trades in huge ranges, and that included Friday’s 49 trading range.

                                                   SUPPORT               RESISTANCE

GOLD                                           885.60                          897.25           
                                                      875.45                          906.16
                                                      860.19                          914.68

SILVER                                         13.05                           13.89
                                                       12.65                           14.60
                                                       12.10                           15.08   

With respect what is going on here and now, we are dealing with the usual end of the month battle to keep price below a certain level; in this case 900. There is no significance to 900 other than psychological and maybe it’s tided to some options that will expire soon. It is worth remembering that Friday’s close is almost 150 off of the September low, and closer to the all-time high, than the September low. Yet in spite of the strong bounce, most investors are still waiting on the sidelines. Gold is not the only thing that has improved. December silver closed at 13.50 on Friday and that is a new closing high since its early September intraday low of 10.31. I actually think that silver looks better than gold right now, and it is undoubtedly the cheapest thing around.  With respect to the future, many readers have taken great pains in advising me to seek professional (psychiatric) help when it comes to my 1435 price target for this leg up.

Well, I am going to stick to my guns and insist that the December gold futures contract will trade above 1400 within the next six months, and maybe a lot higher. It just depends on how bad things get. You’ll note in the preceding Point & Figure chart, that I am not that far off from its bullish price target of 1300!

Finally, I am recommending the purchase of selective dividend paying gold/silver stocks in small amounts (notice the emphasis). They include Buenaventura, Gold Corp, Royal Gold, Golden Star, and Silver Wheaton. I exited most 65% of my stocks

before we hit the March high and did so because I saw a difficult path for miners. My reasoning was based on the following:

• Energy costs account for close to 30% of all costs and they were on the rise,
• Labor costs would increase as demand for metals increased,
• Environmental issues would increase costs, and
• The declining Dow would pull gold stocks down with it.

With respect to the first two, deflation has reduced energy costs and will force labor to curtail demands for higher wages, as more people enter the ranks of the unemployed. With respect to the declining Dow, it has already punished gold stocks and I no longer see a lot of downside risk. Finally with respect to environment issues, they will always exist, but a worldwide recession will permit somewhat more tolerance.

Finally, we come to the Dow. I believe that most investors should sell the Dow short, but there seems to be a stigma with respect to short sales. Many assume that risk multiplies exponentially when you sell short, but I couldn’t disagree more. As long as you’re prudent, and as long as the primary trend is down, there is no more risk than when you go long a stock in a bull market. It’s just the other side of the same coin! I

have been saying for almost a year that the Dow has topped and we were going to head a lot lower than just about anyone could imagine; first to 11,750, then to 10,725, and finally to a minimum of 9,913 (and maybe as low as 9,005) on this leg down. So far we have fulfilled the first two acts to the play, but lack the final episode. To date nothing has happened to change my mind.

As the Dow moved down, making a series of lower lows and lower highs along the way, most of the major indexes followed suit, all except one. The Transportation Index refused to fall and even made a new all-time high in May as the Dow fell. The

Transports even held up in spite of the fact that the Baltic Dry Index (not shown) fell by more than 50% over the last four months. The Transports resisted every move to the downside, until now that is. Slowly the Transportation Index has carved out a series of lower lows as it works its way toward a test of the July lows. I suppose some sort of stop-gap deal will be passed and we’ll see a small reaction as a result, but the trend is down, and we have yet to see the worst.

On September 17th the December Dow futures contract closed at 10,664 and more than 60 points below the crucial 10,725 support. It is crucial because that marks the halfway point between the October 2007 all-time high and the 2002 closing low. A violation of the “50% Principal” implies a run back down to the 2002 low is now in the cards, unless of course you have a false break. Volume and breath indicate that we did not experience a false break and the news related rally that followed the 10,664 close was quite narrow, and I would like to highlight that on the whole Lowry’s selling pressure actually rose last week while buying pressure declined. That is not what makes a bottom!

Conclusion

It is a lot easier to make a deal with the devil than it is to change the primary trend of the market. I am adamant in insisting that we have a long ways to go before we see a bottom. A bailout that defrauds taxpayers while favoring a select few is just what the doctor ordered to drive the market down to such a bottom. The Fed had one last bullet in the chamber and chose to waste it on the “Friends of Hank” instead of trying to do something that would have helped the average American. I don’t know how the American people will react to the bailout or if they realize just how badly they’ve been deceived by their politicians, but they’ll figure it out shortly. You can outlaw short selling (the list was increased from 700 to 920 companies), and you can outlaw gold (it will happen soon), but you cannot proscribe the primary trend of the market. It will overpower the Fed and the Treasury, and it will eventually vanquish all lies and liars. You will see that I am right before Christmas. 

ebo@dtanalysis.com
Dow Theory Analysis SAC
Sept. 27, 2008