Taylor On US Markets & Gold
BULLISH MARKETS
Commodities - In closing at 249.12 for the week, the CRB has now broken out
above a powerful upward channel that started during the April-May 2002 time frame. As such it is well above its moving averages, all of which are
rising. The 20-day moving average is 244.72. The 50-day moving average is
239.72 and the 200-day moving average is 224.59. This is clearly a powerful
bull market. The Rogers Raw Materials Index Fund, to which we currently
allocate 8% of our Model Portfolio is also in a similar trend. Clearly, investors are switching out of paper or financial assets which are proving to be a most inopportune place to park ones savings and into "things" which unlike paper do contain intrinsic value.
As the Kondratieff winter deepens, we are not sure that commodity markets
will retain their strength but for now they along with gold (which is more than a commodity - it is money) are perhaps the best performing markets in
the world. Factors favoring strong commodity prices are a weakening dollar
and a reallocation of wealth to China, where that underdeveloped country is
growing at a startling pace. Incidentally, Frank Holmes explains the enormous powerful forces that underlying this demand for commodities that
is coming from China in our interview with him to be published toward the
end of next week. Franks family of funds includes the China Regional
Opportunity Fund (USCOX) is active.
We expect the dollar to continue to weaken and that China will continue to
grow more at least over the near term. However, on the negative side, we
share Ian Gordon's view that when the depression reaches its greatest
depths of despair, global demand will be so weak that we will witness price
weakness in the commodity markets too.
Gold - The noble metal is also in a very strong bull market and for some of the same reasons
that commodities are rising. At its $369.30 close on Friday, gold has now
closed at a higher week ending price for six weeks in a row. Gold is
significantly above all its moving averages all of which are rising. The
20-day moving average is at $364.32. The 50-day moving average is at
$351.02 and the 200-day moving average is at $325.24.
But the difference between gold and most other commodities is that gold is
money. It is only to a minor degree, a commodity. As Dr. Larry Parks pints
out, that mere fact that there is a 40 year above ground supply of gold is
evidence that it is money. People hoard it for that purpose. Even jewelry
in most parts of the world, where they buy 18k or higher gold jewelry, it
is a quasi monetary metal. By comparison, most commodities, silver included, have much smaller supplies above ground because they are constantly being consumed for industrial purposes whereas gold is hoarded and used as a store of value and sometimes - when no one will accept paper money as a medium of exchange. In contrast to gold, most other metals (silver included) have less than a one-year above ground supply. That is because relative to gold, which is highly portable, these other metals are not nearly as attractive as a monetary metal as is gold. They are thus used mostly for industrial purposes.
So, when the depths of the Kondratieff winter are reached, how much demand will there be for industrial metals? That is the $64 trillion dollar
question. I share Ian's view that at some point over the next few years, a
plummeting economy will erase the positive forces that are now leading to a
general commodity bull market. By contrast, since gold contains all the best characteristics of money (store of value, portability, exchangeability and durability) that is what people will demand for what meager goods and
services are being exchanged.
I hope I am wrong about this view because it paints a dire picture of life
ahead of us that is almost unthinkable to those of us who have grown up in
a prosperous western world. It is somewhat easier for my 78 year old
parents to fathom. They did suffer through the Great Depression. They had
to give up their dream of graduating from High School in order to till the
fields so that their families would have enough to eat. And it is more
thinkable for folks like our Jewish friends who suffered at the hands of
Hitler in World War II to understand. But a picture of abject poverty and
civil unrest, which begets dictatorial government is far more common in
history than the easy, prosperous and free life that God has given the
western world in recent decades.
Silver - The silver markets are about as ambivalent as I am about their
prospects. Like me, it seems to be having a difficult time making up its
mind whether it will take on a larger monetary role or whether it will
remain more of an industrial metal. This past week, silver took a sharp
dive downward to $4.62 to meet but not decline below its 200-day moving
average. Silver remains bullish but certainly is not displaying the
strength of gold.
U.S. Treasury Markets have continued to defy the experts. But that should
not be a surprise. Why? Because most experts do not have a big, long term
picture of where our economy has come from and thus where it may be headed. In projecting the future, economists never go back to the Great Depression and before. The assumption under which they operate is entirely false. It is that we are now smarter than we were in the 1930's so that such an event can never happen again. And so, despite the fact that twelve successive rate cuts have failed to reverse the bear market and are obviously failing to lead to a robust economic recovery - if indeed we are having a recovery at all - fails to alert them to the fact that monetary and fiscal policy are impotent to avoid a deflationary depression like that of the 1930's or worse.
And so, even Bill Gross at Pimco has assumed the Fed could generate inflation by printing money. Aside from commodity inflation, which may be
caused more because of long term shortages and demand from China than
monetary policy, there are no signs of any inflation on the horizon to lessen the pain of our economy that is being chocked to death by trillions of dollars of debt. The inability to stimulate higher prices is clearly evidenced by a U.S. Treasury bond market that remains in bullish territory. Were there some evidence of inflation, the 30-year bond, which would be the most sensitive to inflation, would certainly start to sink and rates begin to rise. But in fact, the 30-year bond remains most bullish of all Treasury durations. Thirty-year rates remain well below long term resistance levels that extend back to 1995 and not too far from the bottom support line of the current declining wedge formation. Should rates decline below those key levels, we could see U.S. Treasuries rates make new lows.
Indeed, if the Fed does as it says it will do, that is to inflate by buying long term bonds, we could see another leg up in the long term bond market. This would be especially true if as we expect, the economy continues not to respond to simulative monetary and fiscal policy. Eventually though we do
expect even the Treasury rates to begin to rise and to do so dramatically
as the dollar continues to decline. At some point in time, we expect to see
a mass exodus out of the dollar, which will trigger much higher interest
rates. And as that happens, we expect to see the housing markets in the
U.S. decline very sharply.
BEARISH MARKETS
Federal National Mortgage (FNM) - Markets discount the future, so perhaps
the weakness in this stock, which represents owners in the Federally backed
mortgage-banking institution known as Fannie Mae, is telling us something.
This institution was implemented for the purpose of fueling the housing
bubble. It trades on the NYSE. It closed at $63.10 on Friday, which compares to its 200-day moving average of $69.81. The stock is now only
about $2.50 from its October 2002 low. If it falls below that level, we could see a major decline in this stock, which could be foretelling of a major decline in the housing sector, which along with the dollar has been the last major bubble to burst.
Real Estate iShares (IYR) - This real estate trust index, which trades on
the AMEX, has a chart that also looks something like the FNM chart. The
stock closed on Friday at $74.10, which compares to its 200-day moving
average of $77.57. It is below all of the moving averages, all of which are
declining. Perhaps this is more evidence that the real estate markets
(including housing) is getting ready for a tumble.
Equity Markets - The S&P 500 as well as the Dow are well below short and
Long-term moving averages, all of which are declining. The key to watch now
is the October lows. Should they be violated, as I expect they will, we could see the capitulation phase of this bear market finally get under way.
Remember when a year or two ago, when after a couple of triple digit down
days in a row, main stream folks on CNBC were asking "are we there yet?"
Have we experienced capitulation yet? Like the annoying kids in the TV ad,
these people did not have a clue that we had not even come close to any
true capitulation. Most of them are not old enough to have lived through a
capitulation market. As a 55-year old, I clearly remember the 1970's
through the early 1980's when non one wanted to own stocks. That's when you know you have experienced capitulation. When we actually have suffered
through capitulation of the equity market, there will not be enough people
around who care enough to talk about capitulation. And when you find it
hard to find anyone who believes stocks are a good investment and when the
disfavor of equities makes it possible to buy high quality blue chip stocks
at P/E multiples of under 10 and providing dividend yields in the 5% to 10%
range, stocks may then be worth buying. Then we will have experienced
capitulation in the equities markets, but not until then.
We are still very, very far - in terms of market declines, from capitulation. The latest "Barron's statistics reveals equity markets remain largely overvalued and as my good friend Chuck Cohen points out, bullish sentiment for equities remains high. Just the opposite as in the gold markets. The P/E ratio for the S&P 500 at the end of this week was a still very high 27.62% times. That equates to an Earnings Yield of 3.62% . By comparison, the 10-Year Treasury yield is 3.93%. Using the O'Higgins Model, which adds $0.30% to the Treasury yield would give us a yield of 4.23% compared to the S&P 500 earnings yield of 3.62% so that stock returns as measured by the S&P 500 remain clearly inferior to stocks.
The U.S. Dollar - The most important market of all, given its status as the
world's reserve currency is the U.S. Dollar. Now that the world is seeing it for the phony it is, investors are opting on of it for other currencies as well as gold and commodities. Can the new Treasury Secretary find some
gold to sell to pound the gold market down so as to lift the dollar higher?
Perhaps in the short term that may be possible. Whether our policy makers
will want to do that is an entirely different question since the unspoken
realization among our policy makers now is that the dollar must decline in
value if there is any hope of avoiding a deflationary collapse of our economy and our monetary system.
When we interviewed people like David Tice, Ian Gordon and Dr. Ravi Batra
back in 1999, they each suggested that the real collapse in our economy
would likely become obvious with a plunging dollar. These gentlemen have
understood that the dollar was hugely overvalued and that at some time, the
market for the Greenback would return to reality. So far we have seen a
fairly orderly decline in the dollar and we hope the decline remains orderly. But in fact, it is my view that there are some potential events on the horizon that could lead to a panic in the financial markets that in turn could lead to a panic out of the dollar.
The Potential for a Collapsing Dollar
Richard Russell has provided his subscribers with some very good reasons to
anticipate a major decline in stocks - the capitulation phase of the bear
market may be very near. (Let me suggest once again that you consider
taking out a subscription to Richard's letter, which is both a monthly and
daily service. Go to www.dowtheory to subscribe). When confidence in our
stock market is shaken to its core, I would expect the dollar will also be
shaken to its core. But what might lead the market to its next and most
dramatic decline yet in this bull market?
In my view the most likely dynamic that will lead to a plunging stock market are earnings disappointments. Not only is business lackluster, but one factor that is bound to dramatically lead to lower earnings will be the expensing of pension funds. In fact it is in the pension fund area where some of the most obvious fiat currency dollar lies are now exposed.
February 10, 2003
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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