A Big, Powerful Bear Market Rally. Is it for Suckers?

Wow! What a display of firepower, not only in Iraq, but also on the floor of the NYSE where U.S. equities posted their biggest weekly gain since October 1982 when by some accounts, the greatest bull market in history began. But this latest move does not look like the start of a secular bull market. I say that not only because Stocks remain hugely overvalued (With a PE of around 30 times, they remain at levels even in excess of most market tops), but also because of the violent and dramatic rise. Richard Russell (www.dowtheoryletters.com.) pointed out in his 3/21/03 missive that corrections against the primary trend typically are explosive and almost always make up previous losses in a very short period of time. For example, on January 13th, the Dow closed at 8786. Over a two month period, March 11th to be exact, it had fallen 1262 points to 7524. In just 8 trading days, by March 21, 2003, the Dow had gained 997 points or 79% of what it took two months to lose.

So we think this rally has "bear market rally" written all over it. The shorts had the bejeebers scared out of them, so as they cover their short positions, a rally is ignited. Then, the majority of people, who allow emotions rather than reality guide their actions, pile back into the market out of ignorance, and a belief that they are about to miss the next great bull market. Without an historical perspective, they do not know that bull markets begin when stocks are cheap. Nor do they understand that secular bull markets are not a perpetual event.

Trading Secondary Trends is not Easy

One very wealthy subscriber contacted me late Friday to lament his inability to trade out of gold and into equities on what was indeed a very perceptive educated hunch he mentioned to me a couple of weeks ago about the gold share and gold markets. This man who is a physician is simply too busy to trade the market, though I have no doubt if he were to do so he would be as good as anyone there is. He is an exceptionally bright and talented man.

If you have the time or inclination to trade, you can do that. There are newsletter services that provide trading advice for people who want to try to get in and out of the markets on an ongoing basis. But that is simply not the approach of this newsletter.

I tried to explain my investment modus operandi in my March 2003 monthly issue. I am looking at a very, very long-term perspective. How Long? How about 10 to 15 year cycles within the larger 60 or 70 year cycles? Or, how about catching the primary trend of a market, which as Richard Russell points out is the major requirement for making money in the long run. Trying to make money by trading secondary trends within the primary trends is not easy. It is easy with 20/20 hindsight vision. Russell argues and I agree, that for most people it is simply better to be on the right side of a primary trend and then compounding your profits year after year. And if you are on the right side of the primary trend, then you will avoid those devastating losses over the longer term.

One more piece of advice. If you are troubled by temporary losses suffered by secondary trends within the primary trend, then go ahead and trade if you think you can do better that way. But if you get too emotional about sustaining losses during major reversals, then you had better turn your portfolio over to a professional manager or buy treasuries and gold and forget riskier investments. Investing always involves risk. In my view you can do best by paying little attention to the noise of day-to-day market moves and even the longer term secondary moves and by staying invested on the right side of the primary trend. Of course that isn't as easy as it sounds. How do you know the primary trend is not being reversed? For that we need to take a longer term perspective and rely on some market veterans for help. I continue to place a great deal of confidence in Richard Russell who's knowledge and experience with the Dow Theory is second to none among the living. For a still longer term perspective, I continue to believe my friend Ian Gordon understanding and guidance within the Kondratieff cycle framework is useful as is David Tice and his associates like Marshall Auerback and Doug Noland.

Having reiterated my confidence in the primary trend, I will admit to having personally taken a bit of the cash out of my TD Waterhouse account to buy the Nasdaq 100 Index, symbol QQQ last week upon Richard Russell's advice. Richard noted several technical reasons why we could be in for a major secondary trend within the longer term bear market. So I took a small percentage of my portfolio and bought the QQQ's on Wednesday at $26.60. Add another 3 cents per share for in and out commissions and my "all in cost" is $26.66. The QQQ's closed at $27.17 for a 1.9% gain. Not bad I suppose for just three trading days. But until Friday afternoon, this position had been "under water" most of the time. It took the highly emotional rise on Friday, which resulted totally from our military conquest in Iraq to put my trade in the money. By Monday, who knows what will happen? A problem over the weekend along the way in Iraq or God forbid, a terrorist incident in the U.S. and the rise in equities last week could reverse so fast it would make your head swim, especially given the fact that we remain in a bear market. All I am saying is trading is not easy.

Given my inclination toward fundamental analysis rather than technical analysis, picking the longer-term trend, by tuning out the noise between major secular shifts makes more sense for me. So that is what this newsletter will continue to try to do. If you want someone to help you trade, then I respectfully suggest you find someone who is skilled at that trade and who has that as their newsletter's mission.

On the other hand, markets can do anything in the short term. And while they eventually return to equilibrium, you can go broke waiting for that to happen. I would not be surprised if the current rally in stocks lasted for several weeks if not several months, if a new positive reality is created out of Iraq. Remember how long the phony "new paradigm" combined with mucho liquidity drove stocks to dizzying heights without any evidence of realty? Even Richard Russell said today that he thinks it is possible that we could see the market rise very substantially within this primary bear market, even possibly rising to new highs before resuming its downward path toward an ultimate Dow bottom somewhere below 5000. But the facts remain, stocks are GROSSLEY overvalued and they must come back down before we begin a brand new bull market. They could go either way. But if you want to play this bear market rally, a purchase of the QQQ (Nasdaq 100) or the SPY (S&P 500) or the Dow Industrials (DIA), go ahead. But remember we are in a primary bear market so chances are very, very good that we could see a nasty resumption to the downside at any time.

Has Anything Really Changed Since Lasts Week?

When I set aside the emotions of this past week, and when I ask myself what has changed, I can only conclude that very little if anything has changed since the depressed mood of last weekend. True the first couple days of the War in Iraq seem to be going well. But clearly there are some big picture economic and geopolitical forces on the landscape that I believe do not favor the U.S. economy and the world's reserve currency even if things go well militarily in Iraq for America.

Destroyed Alliances? Will there be economic repercussions against the U.S. from France, Germany, Russia, China and other major powers following the war? Even as I write this, I see news scrolling at the bottom of my television screen to the effect that France and Germany will not support a U.N. resolution that would allow Britain and the U.S. to lead Iraq after the war.

Increased problems in the Islamic World? We noted that during the early hours of the war, there were anti-American riots in Jordan and Egypt. Will the U.S. who with some justification is seen as the Great Satin (given massive immorality) not create more rather than less international strife, which in turn would have dire economic consequences.

Pricing Power - Corporations continue to have great difficulty in passing along costs because of huge excesses that were created by the excessive monetary creation during this Kondratieff cycle and especially as a result of the gold rigged strong dollar policy of the Clinton Administration. Without pricing power, companies are not likely to begin massive capital expenditures that could kick start the economy, which leaves the burden on the a very tired and overextended consumer who, because of job losses is displaying an increasing loss of confidence.

The U.S. Current Account deficit has now reached 5.2% of GDP. Ordinarily, 5% is considered a problem. And now with massive U.S. deficits and a move to keep the dollar strong and our huge overseas spending for Iraq, this deficit might get bigger still.

At some point, the U.S. dollar is going to get hit very, very hard. This week's emotional rise in the dollar and equity markets may indeed prove to have been a brief respite for America and her markets. And here is where we think the ill feelings between the U.S. and other countries like France, Germany, Russia, etc. could begin to come into play against the dollar. With the U.S. really not having much to offer the rest world any loner in terms of real wealth producing production, and with declining profit margins to back up that statement, why would countries want to continue holding dollars? We note with great interest an article in the Wall Street Journal last week that PEMEX, the Mexican state owned oil company will not start to ½ o the dollars the receive for the sale of oil for other currencies.

On the economic front, the U.S. economy remains weak. Stephen Roach, Morgan Stanley's chief economist says he and his colleagues are anticipating what he terms "stall speed growth." In other words, there is a minimal speed at which the economy must grow if it is to remain in flight. The Morgan Stanley economists are expecting zero growth this quarter which comes on the heels of a tepid 1.2% during quarter one of this year and 1.4% during the prior quarter. In addition to the factors noted above, Roach is especially worried because even as the U.S. entered this recessionary or sub-par growth period, the inflation rate was uncharacteristically low. And since recessions or even "stall speed" growth rates are deflationary, and since virtually no pent up demand exists to pull us out of this funk (autos and housing) as usually happens, Roach worries that we are indeed vulnerable to a Japan like deflation.

GOLD

Bombs Away on Gold

The picture above shows gold getting hit very hard, especially on news that the U.S. was heading into Iraq. Funny how this pattern stopped for a short while when we were without a Treasury Secretary. Funny how the price of gold began to rise when no one was in charge of the Exchange Stabalization Fund but how the very first day the new Treasury Secretary took office, gold was once again trashed in New York.

As in the Gulf war, gold once again rose before war broke out and then even as the U.S. got ready to invade, and before any knowledge of success got under way, the price of gold collapsed. Does that make any sense? If a potential conflict was the reason for the rise in price to begin with, then how could the engagement or even the mere rumor of engagement, reverse the price especially on a rumor before the outcome could be known?

I suspect the reason the price of gold was rising and the dollar falling had more to do with economic reasons, which in turn may have made the invasion of Iraq all the more urgent from the U.S. point of view. What may indeed be at the heart of the real reason or at least one major reason for the U.S. invasion of Iraq is the need for the U.S. to retain the dollar as a reserve currency if it is to remain the world's leading super power.

I don't have the time or space to pass on all my thoughts which raced through my head as I did my bicycle reading this morning, but let me summarize my views on this issue and then provide a link to you on an lengthy essay on this topic, so that if you are interested, you can dig into this topic on your own.

And the Greenback?

The Dollar as a Reserve Currency Underpins like never before, the claim against global wealth by the United States. There is no price in the world of greater importance than the dollar because the dollar is used as a medium of exchange for virtually all international trade. What happens when the dollar loses value? The U.S. banks, which dominate the global scene suddenly become significantly smaller and less capable of gaining world wealth by creating money from the issuance of debt. In essence, they lose their monopoly power in the world to create money and lend it out to the world as the dollar buys far less. That in turn means the U.S. shrinks as a global superpower because its ability to buy assets around the world, to dominate the geo-political landscape and finance and thus flex its military muscle around the world also declines in relation to the dollar's declining value.

Big the U.S. has a big fundamental problem. It no longer has a healthy and strong economy. The U.S. as the world's largest debtor nation by far. Given our huge trade and current account deficits (now 5.2% of GDP), our reliance on savings from foreigners, and the demolition of any serious mining, manufacturing and agriculture industries here at home, what does America really have to justify a strong dollar, especially now that Alan Greenspan's "new economy" has been exposed for the fake it is. Without a fundamental reason for the dollar's strength, what are our politicians, who are owned by our bankers and large corporate interests to do? Thanks to people like Bill Murphy and Reginald Howe, and the others who support their efforts to find out why the gold markets have acted so strangely over the last number of years, there is no doubt that the Clinton strong dollar policy was built upon a) the manipulation of the gold price and b) the big new economy lie. Had our policy makers allowed the price of gold to rise to is equilibrium price, estimated by the genius work of Frank Venerosos to be around $600/oz., the dollar never would have become so dominant nor the financial bubbles so enormous, nor the likes of Bob Rubin and Jon Corizine so filthy rich.

Gold Manipulation May No Longer be Possible or Effective. Bill Murphy has pointed out that it is likely the ability to retain a strong dollar and hence the dollar as the world's reserve currency by manipulating the gold may now be diminished by the fact that ½ of our gold reserves may have already been dishorded. Also, the dollar has been coming under pressure because of a growing desire on the part of many nations, most notably the likes of China and Russia, not to mention the demand for oil sales to be paid in Euros rather than dollars. Those two factors have limited the ability of our policy makers to underwrite a strong dollar by simply trashing the price of gold as they did in the second half of the 1990's. So now, another "fix" has had to be created in an effort to try to defend the dollar.

In the short run, the invasion of Iraq may continue to look good for American markets. But over the longer term, if its effect to prop up an already extremely overvalued dollar, it will only serve to worsen the disequilibria that has been leading to a global deflationary market meltdown. We think the argument by James Sinclair and Stephen Roach of Morgan Stanley, that an overvalued dollar is one of the keys to the global economic malaise is exactly right. In the longer term this policy is suicidal for the U.S. and one also wonders if the resentment against the U.S. by France and Germany and to a lesser extent by all of Europe for using its mighty military to prop up the dollar, not to mention resentment from the Islamic world, might not ultimately inflame foreigners against the U.S. and actually make them more determined to use the euro or gold as a medium of exchange so that ironically the end result may be the weakening rather than the strengthening of the dollar.

Deficits & Gold

Geopolitical problems resulting from the war in Iraq and mounting problems for the U.S. as evidenced by the twin deficits (Federal and Current Accounts) figure to be very positive for gold over the longer term. Here is what Richard Russell said about the deficits and gold this past Friday.

" What this whole deficit situation does provide, I believe, is a golden opportunity to accumulate gold and gold shares. The future of paper money can be seen clearly in the mounting deficits that are building around the world. Gold is out of favor now, the gold stocks are scraping the bottom, while confidence (or is it fear) of the US is on a "high" - and a violent bear market correction has taken over Wall Street."

March 25, 2003

Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
http://www.miningstocks.com