We have entered what should prove to be the most difficult time in several generations. The excesses of the last thirty years are finally coming home to roost and no one is prepared, and politicians are in denial. Two days ago the Senate passed a modified version of the same bill the House rejected. The modifications appear to be superficial and designed specifically to win certain votes that were not there the first time around. It now appears that the House will support the bill passed by the Senate and pass a “bill that will protect the tax payer”. Nothing could be further from the truth. The tax payer will never receive anything back, no houses will be saved, and will soon realize that this is just the beginning, and not the hoped for end to the credit crisis. Most of the money from the bailout will go to overseas institutions in return for their silence. You see they were defrauded; Brazil’s President Lula and Russia’s Putin as much as said so this week. Think of these payments, as close to face value, as hush money. The United States has a dirty little secret: it has defrauded the rest of the world by selling them trillions of dollars of worthless paper for decades. Paulson and Greenspan were a couple of the chief architects, and that’s why Paulson was so anxious to get the money with no strings attached. Don’t forget that he was with Goldman Sach’s for years, and Goldman was a major player in the derivatives market, along with GE and a host of others. His old company, along with what I like to refer to as “Friends of Hank”, will be among the select few in the US to receive a bailout.

So that’s what all the fuss is about; we bailout foreigners and Paulson’s friends. Meanwhile production plummets and the job loss totaled 165,000, the biggest loss in five years. Nothing in the bailout will change that. The US lives on credit, produces nothing, and therefore lives well beyond its means. Credit became restricted late last year, consumers began to cut back in November 2007, and that cutback has now pro-

duced a worldwide recession. Domestically auto and housing sales have fallen through the floor, and I suspect that Americans are now trying to save, which will only serve to exacerbate the current crisis.

Back in September of last year, I wrote an article entitled “Bernanke and the Fed” in which I talked about all the problems I saw coming down the road, and stated that the government was ignoring the real problem and using inadequate solutions. In response to that article I received the following comment from a young lady by the name of Catherine Austin Fitts in which she stated:

“There is an assumption in most market commentaries that the sub-prime mortgage problem relates to borrowers without the income capacity to carry the mortgage and collateral properties declining in value. That is entirely too optimistic. The question that needs to be asked is – What are the number of sub-prime and total US mortgages outstanding, including those represented by securities owned by global investors, and do that many real properties and borrowers exist? I believe that the answer is no, that the implied collateral and the actual collateral in both numbers of property and value differ significantly.”

“It is one thing to pump up the value of something that is dropping in value. The harder challenge is pumping up the value of nothing, while generating the cash to service debt created with fraudulent collateral and straw buyers. That requires growing the game, and it would appear the game has stalled. Indeed, the only way to keep such a game from unwinding is to pump in new government guarantees, which is what the US Administration proposes to do now.”

She wrote this on September 4, 2007 and clearly recognized the game for what it was – a huge fraud. The government has indeed increased the size and weight of each subsequent guarantee and each subsequent guarantee has had less affect than its predecessor. With each guarantee came the promise that the problem wasn’t serious, and said guarantee would provide the final solution. Now we come to the new last bailout, a US $700 billion bailout that is the largest in history and should save the economy. Many congressmen and senators are “hopeful” it will solve the problem and are content to let Paulson make the “guarantees”. These same congressmen and senators are blind to the truth, but will more than likely use the same logic on the next bailout proposed in a month or two. These bailouts are coming with increased frequency and for larger amounts; the next will easily exceed one trillion dollars and it too will solve nothing.

Here’s some reality. The New York State Housing Authority can’t sell their bonds and California needs US $7 billion in emergency financing or else. California is one of the largest economies in the world, larger than most countries. Then there’s Michigan, a bankrupt State for many years. Meanwhile the banks absolutely refuse to loan to each other, just like in 1907. You remember 1907; I’ve been talking about the Great Crash of 1907 for a year, and now you are going to get a chance to live it! The futures market has now priced in a 50 bases point cut in the prime rate, but it will not make any difference. The folks who need money can’t qualify and the folks who can qualify don’t want the money. Unemployment is rising sharply while wages are declining even faster. We have entered a deflationary period that is now feeding on itself. I have lived through this in Peru (1989-1990) and it is not a pretty sight. The difference is that the United States, specifically Paulson and Greenspan, sold more than US $600 trillion in derivatives to the rest of the world. That’s a lot of derivatives considering that the world economy is only worth about one/eighth of that. Now all of that will come back to haunt both gentlemen and the world will finally recognize their actions for what they are; criminal, bordering on evil. Throughout the course of history it would be difficult to find two other people who have done so much damage to one nation.

So here we are on Friday, October 3rd and it is just announced that the Congress of the United States has just approved the bill authorized by the Senate. What’s more, it was approved by a wide margin under the guise that it would be “good for America”. In an effort to sing the bull to sleep, there has been a big shift in emphasis from a “Wall Street bailout” to “what is good for America”. It’s the same bill, with some frills, but a big change in how it is sold to the people. That is typical of the Bush Administration! At 1 pm EST the Dow was at the highs of the day at 10,796 and the Transports were at 4,366 as they began to pull away from their respective January closing low of 4,140.29. Then came the Congressional vote, followed shortly thereafter by the only vote that really counts, the markets! The Dow began to sell off as soon as it became apparent that the bill would pass. One attempt to rally it occurred around 3:15 pm EST and it was immediately met by renewed selling. When

it was all said and done, the December Dow finished down 193 points at 10,364, a new closing low for the entire leg down.

Now here is where it really gets interesting. For more than nine months the Dow has carved out a series of lower lows, while the Transportation Index had the bad taste to diverge. At one point in late May, it even pushed its way to a new all-time high, while the Dow lingered more than 1,000 points below its October 2007 high. Since then the Transports have given up ground grudgingly. Just two short weeks ago the Transports were trading above 5,200 and some Dow Theorists were wondering if we would see a new bull market. That was two weeks ago and a lot has changed since then. I pointed

out to anyone who would listen that the divergence wouldn’t hold, using the Baltic Dry index as justification, and stated that the Transports would in fact break down. Today that tree finally bore fruit! The transportation Index fell 42.63 points to end the session at 4,134.55 and six points below the January closing low. This is the long awaited reconfirmation of the bear market signal given by the two indexes ten months ago. What’s more, this is a sobering prediction of awful, horrific, and dreadful things to come. All of the banshees and poltergeist stuck in closets or hiding under beds are about to be released upon an unsuspecting world. In short, what has happened is nothing compared to what will happen in the coming weeks!!

The decline in the Dow is all part of a much larger process called deflation. Deflation occurs when you have declining growth along with declining prices. Right now you have declining commodities prices as well as falling paper assets, with one exception, the US dollar. Many analysts have mistakenly taken dollar strength as an indication

that things are about to get better in America, but nothing could be further from the truth. The dollar is exhibiting strength for one reason and one reason only: most debt is in dollars and with incomes declining and unemployment on the rise, everybody is scrambling to serve debt. Here’s a short story to demonstrate my point. I live in an area dominated by agriculture (cotton, grains, vegetables, and fruits), fish meal production, commerce, steel production, and natural gas production. Cash has always been abundant, but recently I’ve noticed that more than one ATM machine has lacked liquidity, and it’s in all banks (foreign as well as domestic). Things like that catch my attention, so I went out of my way to stop and see a fellow I know who’s the general manager of the big branch about 50 km away. I asked him how things were going, i.e. if liquidity was a problem. He told me that cotton and fishing were a disaster, agriculture and commerce were on the decline, and only natural gas was holding up. He blamed the situation on the US, but said it had bottomed and things were about to get better. I just listened. I didn’t have the heart to tell him what I thought was going to happen, and he wouldn’t have believed me anyway.

If I lack liquidity in a little area in some corner of the end of the world, imagine what’s going on on Wall Street, or London, or Hong Kong… People are starving for credit and there isn’t any. If you have money you’re scared to death to loan it out because the collateral you receive can’t be sold if the need arises. The same thing happened in 1907 when more than 5,000 banks closed their doors and Wall Street was brought to its knees. There is one major difference between now and 1907: back then the US was a creditor nation on a gold standard and now it is the largest debtor nation with a fiat currency backed by a hope and a prayer. Can you see a little problem here? The markets certainly see a problem and today they spoke up loud and clear, but almost no one is listening. In order to understand the situation, you need to block out the voices of Bloomberg and CNN (the mute button is a wonderful invention), and actually think about what is going on. Thinking is a lost art in today’s America; everybody is more than happy to delegate the thought process to someone else. That way you don’t have to accept responsibility for the consequences. The United States used to produce some truly great thinkers, but for the life of me I can’t name one new face in the last twenty years. We much prefer to admire the Jack Welsh’s, Alan Greenspan’s, and Hank Paulson’s holding them up as heroes, when they really defrauded us. They’re long on skill with the numbers and derivatives, but very short on truth.

So we have the US dollar in the rise indicating that it is the place to be, but not so fast. If you look at the daily chart of the spot US Dollar Index above, you’ll see that it rallied back up to the old historical low at 80.50 (red-green horizontal line) for the second time. Historical numbers, especially ones that held for decades, almost always offer considerable support/resistance, and I suspect this will be the case. I would be a

little surprised if the greenback was able to rally much beyond this point. If the dollar can make it past the old low, then I look for a top at 83.15. It would also not surprise me if the US Dollar Index pulled back here and then made a third test of the 80.50 resistance, before finally turning back down.

Right about now it would be worth remembering that a reaction does not indicate real strength or allow for assumptions that the worst is over. Even the Titanic had a few shining moments before it sank. What it does indicate is that we had a momentary surge in demand brought about by folks who are on the wrong side of loans. Let’s go back to my friend who manages the bank I visited. He said that there was a visible pullback in a number of important sectors, but what he fails to grasp is the timing of the pullback. As I drive down the expressway, I can see that they have planted two or three times the acres that were utilized just two years ago. Maybe even more! Also, these same fields are filled with new tractors financed by my friend at the bank. The fish meal plants have so much inventory built up that they have to stack it in fields on pallets, and cotton growers did not bother to harvest the entire crop. What I am trying to say is that everyone got caught expanding production, based on the hope that demand would grow to the sky, and now they’re caught with their pants down. They’re asking for extensions on their lines of credit and refinancing on loans that can’t be paid, and it is putting a strain on the financial system here, and in Brazil, and in Russia, … There are a lot of countries like Peru, exporters of raw materials and/or

semi-finished goods, caught in the same bind and the best way to understand their plight is to look at the weekly chart of the Baltic Dry Index above. You can see a stunning drop from the 11,750 all-time high just five short months ago, to Friday’s close at 3,002! That’s tough to swallow and extremely difficult to manage financially. I want you to take a good long look at this chart because I think the Dow will look the same in a couple of months.

So the dollar will top and then go on to make a lower low; it’s just a question of time. Likewise the Dow is now headed lower, a lot lower. Recently the December Dow fu-

closed below what I consider to be critical support at 10,725, critical because it involves the “50% Principal”.[1] The 50% Principal states that when a primary reaction retraces more than 50% of the previous move, you stand a very good chance of retracing the entire move. If I apply this to the recent trends in the Dow, I can see that the Dow rallied from the 2002 closing low of 7,286.27 to the 2007 all-time closing high of 14,164.53. A 50% retracement of this move takes you down to 10,725.40. We closed below that level on September 17th and again on September 29th but some Dow Theorists looked at it as one-day wonders. Well, they don’t have to look anymore because on October 2nd and 3rd the Dow made consecutive closes below the critical 10,725 level, and the Dow made a new low for the move down confirmed by the Transports.

To summarize both the Dow and Transports broke down in November, the Dow then broke to a lower low in January confirmed by the Transports, and now the same thing has happened in October, reconfirming the initial January bear market signal. So unless you need a truck load of bricks to fall on you, the markets are signaling that they are headed lower; initially to 9,913 and then 9,063, but eventually down to the 2002 low of 7,286 and I believe lower. This is a process that will take time, it took nine months just to get a reconfirmation, but damage will be done over the next six weeks, before this leg down bottoms out. Secondary reactions will occur and they will be violent, giving hope the market has bottomed and things will get better, but the reality is that we’ll go much lower, lower than just about anyone can imagine, before it’s all said and done. For possible bottoms, we can look at the coming support levels offered by the entire range of the twenty-five year bull market (July 1982 to October 2007). They are as follows:

Notice how I highlighted the 50% retracement of the entire bull market. I have no doubt that we’ll see a test of that level, maybe as early as late this year, and that we’ll eventually break below it, just like we broke below the 10,725 level two weeks ago. My estimation for a final bottom would have to be the 618 retracement at 5,890.

For those of you who think stocks are cheap, think again. One month ago the PER for the Dow was at 100 and now I am sure that its somewhere close to infinity since most companies are reporting losses. The PER for the Transportation index is at 23 and the dividend yield is at 1.6% according to Bloomberg, so we don’t find any bargains there either. Before we see a bottom, yields will rise to 6% or higher and the PER will fall down to 5 or 6. Then you can start to search for bargains, but not until then.

I see only one alternative when it comes to protecting your wealth, and that road leads to gold. I know that during a depression, and that’s where we’re headed, everything loses value at first. The first thing to recover will be gold because it, like the cockroach, has stood the test of time. Gold is the world’s “problem” barometer and when things get bad, or threaten to, gold rises in price. Over the last twenty years there has been a concerted effort to suppress the price of gold in order to create the illusion that we live in a problem free world. The wheels are now coming off of that illusion, everybody sees it live on CNN, and gold will respond to the threat as it always has and suppression be damned. The bear market in gold came to an end in 1999,

bottoming at $252.50 an ounce and that bottom saw a retest in 2001. Since then gold has steadily rallied, as you can see on the weekly chart above. Earlier this year the spot gold topped at $1,033.90, marginally above strong resistance at 999.50. It didn’t stay there for long beginning a retreat that took it all the way down to an intraday low of 739.80, a 38% correction and the largest since the bull market began seven years ago. Most folk’s, myself included, were looking for a much shallower correction and the depth of the drop forced many investors to abandon positions, just when they should have been buying.

The correction was so strong that few bought on the way up as gold raced from 739.80 to more than 920.00 in less than ten sessions. When they finally jumped in, gold did an about face and drove them to the wall yet again, as it fell back to Friday’s close at 833.20. That’s gold and that’s deflation! Using the December gold futures contract as our model, and using only closing prices, it rallied $163.50 from the 745.50 low. A 50% retracement of that rise would imply an $81.75 drop to $827.50. So far we have held that on a closing bases and as long as we do, I have to view gold in a positive light. If the December gold contract closes more than marginally below 827.50, then I would have to assume that we’ll retest the $736.50 support level. More important than a retest is the message that such a retest would send. If we were to fall all the way back down to 736.50, it would be an indication that deflationary pressures are stronger than even I anticipated. That would not be a pleasant revelation. On the other hand, if gold can work its way back above the 889.50 resistance level, and stay there for three sessions, it would indicate that we are shaping up for a third test of strong resistance at 999.50. Personally, I have to believe that’s what will happen, unless the market tells me otherwise.

Finally a word about gold stocks. I sold out most of my portfolio several weeks before the HUI topped earlier this year and had the good sense to avoid since then. Not happy to leave a sleeping dog lay; I broke down and bought 10% back last week. Wrong thing to do! I forgot that a low tide will strand all boats. This week the market reminded me ever so gently that I am not nearly as smart as I would like to believe, and clocked the HUI for almost a 19% loss. Take a look:

I have decided that if the HUI closes below 255 (red-green horizontal line) I will not only sell the 10% position, but all of what was left from before (BVN, GG, SLW, and RGLD) and find something better to do with my money. No point in living with a mistake.

In conclusion, I want to leave you with a look into what the future has in store for you. You need to understand just who you are dealing with. The Bush Administration is corrupt and works by instilling fear; the more afraid you are, the more willing you are to give up your rights under the US Constitution:

“The only way they can pass this bill is by creating and sustaining a panic atmosphere. That atmosphere is not justified. Many of us were told in private conversations that if we voted against this bill on Monday, the sky would fall, the market would drop 2000 to 3000 points the first day, another couple thousand points the second day, and a few members were even told there would be Martial Law in America if we voted no. That’s what I call fear mongering… The only way to pass a bad bill – keep the panic pressure on”.

Rep. Brad Sherman

Democrat, California

It is nice to see that someone still has a brain in Congress. What most of you don’t realize is that is precisely what the Bush Administration wants, i.e. to suspend the rule of law (US Constitution) and govern by Presidential decree. Imagine this: American troops in American streets pointing guns at American citizens! Bush and Co. feel only then will they be able to cover their tracks and avoid prosecution. No need for elections with Martial Law, and no need to face justice. Better yet, you can persecute anyone who speaks up and in the name of the law. That’s the end game and they are willing to sacrifice America and Americans to do it. It starts with little things like changing the rules (eliminating short selling and confiscating gold) and then blossoms, taking on a life of its own. Before you know it 240 years of sacrifice are up the stack. One thing Bush failed to consider though is that the problem has now spread worldwide, and he can’t legislate or declare martial law on the world. He’ll learn that the hard way. The rest of the world will not sit still for it either. If a banker in a town that 99.99% of humanity can’t find on a map knows the US is at fault, imagine what powerful people in China and Europe think and feel? Imagine what these powerful people will do to protect their own interests? Before we hit bottom, it will become very complicated and very dangerous.

ebo@dtanalysis.com

Dow Theory Analysis SAC

October 4, 2008

[1] The “50% Principal” is not my creation and I never said it was. I have always viewed it as part of Dow Theory. Here's an article regarding the origins of the 50% principle, I'll include a passage: "Apparently, the “50% Principle” was instead introduced by E. George Schaefer, who published a newsletter in the middle years of the last century by the name of Dow Theory Trader." Here is the link:

http://www.marketwatch.com/news/story/50-percent-retracement-principle/story.aspx?guid=%7BDD4FB34C-1D39-4A01-AA23-7101C95F60E3%7D

There are also vague references to 50% retracements in The Dow Theory by Robert Rhea. If in fact it belongs to Richard Russell, I stand corrected and he should get the credit instead of Schaefer or Rhea.