The Dollar and Bonds The bullish trend in the bond market was broken last week and the dollar continued to show short-term strength.

This past week the dollar displayed more strength while the U.S. Treasury market suffered one of its worst setbacks in quite some time. In other words, both the dollar and interest rates rose last week, which suggests investors think we are heading into a period of rising economic fortunes. Not agreeing with that forecast, your editor is watching interest rates and the dollar very carefully for a clue as to WHY rates are rising. If the dollar declines and bonds decline (interest rates rise) together, that would suggest foreign capital is leaving the U.S. And if interest rates are rising due to an exodus of foreign capital from the U.S., rather than because of increased competition for capital resulting from a growing economy, we could the be facing the worst of both worlds, namely declining income to service a rising debt service requirement. But such is the stuff from which Kondratieff winters are created.

Yet, with the Fed talking about buying long term treasuries, the bond bull may have another leg or two to run on, though from a technical point of view, last week's sharp rise in rates that took us above a short term trend line suggests we may also have witnessed the end of the bond bull market. The day massive amounts of foreign capital leaves the U.S. is the day everyone will become familiar with the term "Kondratieff winter" or something akin to it. America has become addicted to foreign capital. The addict will die (so to speak) when foreign a foreign capital flight leads to a dramatic reversal of interest rates, which in turn would be expected to put an end to the housing orgy. The decline would likely then feed on itself such that corporate bonds become an absolute disaster as corporate default begets still more corporate defaults. That too is the stuff from which Kondratieff winters are made.

Last week's rise in interest rates happened for "good" reasons, namely that Americans believe in their economy. If rising equity markets and a rising dollar market are accurately predicting the long term future, our Kondartieff winter forecast could be thrown out the door. We wish we could believe the rosy picture the equity markets have been giving us. Unfortunately the dollar and equities remain in a secular bear market that appears to have a long, long way yet to run. The upward moves for both the dollar and equities are well within bear market norms. The big question is whether or not the bull market in bonds is and the bigger question in our minds is why it is over. Time will tell on both scores.

Inflationists like Larry Kudlow applaud higher commodity prices as well as higher gold prices at this time as evidence deflationary pressures are abating. With all due respect to Mr. Kudlow, we think he doesn't understand that higher raw materials prices are DEFLATIONARY for America because, given the U.S. policy of ridding itself of mining, agriculture and manufacturing, rising raw materials prices simply push costs of production higher overall in our economy and reduce profit margins accordingly still beyond their existing pitiful levels. And it is collapsing profit margins that are creating most of the damage in our economy. Likewise, Larry thinks of gold as a commodity rather than money. He does not understand that gold will ultimately rise when commodity prices decline, simply because gold will be demanded as money in place of paper money.

The Equity Markets - Although stocks were lower last week, various moving averages say the bear market rally is till in play. However, a host of bullish sentiment indicators, overvalued equity prices and the refusal of the Transportation Index to confirm new highs in the Dow suggest this bear market rally may soon come to an end. What we suspect could trigger a return of the equity markets back to their primary secular bear trend are poor earnings reports. One reason I believe earnings will be disappointing is that CEO's are expressing such a gloomy outlook for their companies. The ratio of dollar equity sales compared to dollar equity purchases by insiders has been $4.10 for every $1.00 purchased (according to Richard Russell, "Richard’s Remarks" dated 6/28/03)

The equity markets remain in a secular bear market. Our best advice is to stay out. But if you must play this market, do with the S&P 500 Index, or QQQ's or Dow index, but put a close stop under these investments because when this market turns back down, it may do so with little warning. BE VERY CAREFUL if you are on the long side of equities!

FIGHTING DEFLATION - A Short Term Rush leads to Long Term Death

There is no denying that the huge infusion of monetary narcotics pumped into the economic veins of America by our banking system over the past number of months is bringing about some short term results that gladden the hearts of politicians, bankers, pimps and prostitutes as well as unsuspectingly naive average good hard working people who, unlike the above named, actually earn a living by creating wealth. Doug Noland, writing for the Prudent Bear (www.prudentbear.com) summarized economic news of this past week as follows:

Trouble with paying so much attention to daily, weekly, monthly or even in some instances annual market and economic data, is that we fail to see the longer term picture as to where the economy is going. I am 100% with Richard Russell in believing that what we really have to do is focus on the primary trends of markets and not day-to-day or even year-to-year gyrations. What we try to do in J Taylor's Gold & Technology Stocks is focus the longer-term fundamentals of the economy as well as individual companies. Richard Russell points out that most people become wealthy not by trying to put everything they have into what we like to call "10 baggers," but by properly identifying the primary trend of the markets, investing in those trends and then compounding earnings. And staying away from the really big losses is an important part of the strategy of accumulating wealth slowly.

In looking at the long term, and I mean very long term trend of the markets, let me remind you once again that money magically created out of thin air is not wealth. Especially since Nixon detached the dollar from the discipline of gold, America has been creating money (and debt because without gold, money=debt) at a pace far more rapidly than real wealth in America has grown. In other words, the ability to service a rising debt levels from cash flow has been decreasing very substantially. I am convinced we are getting near the end of this game.

Fiat or debt money is in fact nothing more than a claim against the future wealth of a nation. It is not in itself wealth. When a fractional reserve monetary system like ours expands far more rapidly than economic growth, and when that takes place over long periods of time, one way or another, the economic well being of a nation must decline. Short-term charades can work for the benefit of the above noted illicit members of society in the short run by deceiving and keeping average citizens off balance. So the proclamations of a reviving economy are serving to suck people back into the market because for the benefit of the ruling elite. With people living busy lives, they do not have the ability to see the longer term picture. They rely on the "easy" news presented to them on television so they miss the big picture.

But this time, its Different! No Need to Worry. Oh Yeh?

When one reminds the establishment elite that what they are doing is taking advantage of the general populace to get rich and grab political power, the usual refrain and the one we hear now is that "this time it is different." Don't you believe it! The laws of economics and the laws of man's relationship to man (And as a Christian, I believe man' relationship to God as well) are just as real as the physical laws observed by natural science and everyday life. They NEVER change! The only thing that really changes from one major economic cycle to another is the ingenious manner in which humankind attempts to deceive himself and others into believing that this time it is different and that therefore, we don't need to pay attention to what led to past problems.

Why the Next Depression May be Worse than the 1930's

During the work day, your editor normally keeps CNBC on but muted during the day. Most of the time all you get on this channel is meaningless chatter about how "prosperity is right around the corner." We used to occasionally catch our good friend David Tice, on the tube. But recently, about all CNBC brings you are raving equity bulls. However, at one point this past week when I happened to glance up at the TV above my desk I spotted the above chart. I immediately turned up the volume to listen to listen to what Charles Minter, manager of the Comstock Capital fund had to say about debt and the U.S. economy. In the mean time a phone call distracted me away from his message, but I heard enough to prompt me to go to www.comstockfunds.com to catch more of this brave man's message.

Greenspan Is In A Bind--Deflation Will Be Final Result
25 basis points, 50 basis points, or No Change -SAME RESULT

"There is almost unanimous agreement in the investment community that "deflation" is either no risk at all, or at the worst, a very insignificant risk. Obviously, our regular viewers do not include us in that camp. We believe that all the ingredients are in place to support the deflationary environment we envision. These ingredients include the bursting of the financial bubble (with extreme stock valuations) accompanied with record amount of debt and close to a record of excess capacity. These similarities to the Great Depression in the 1930's and Japan after 1989 are striking. We also have twin deficits that are approaching $1 trillion, and a very low savings rate. "First of all, we have just burst the largest financial bubble of all time in the first quarter of 2000. We have used many examples to show just how ludicrous the financial bubble was in the late 1990's in our "special report" on the left side of our home page. We will go through more examples now just to make sure you don't forget what happened, since the savers (who are breaking even in real terms now in money market funds) are jumping back into stocks. If the Fed lowers rates by 50 basis points tomorrow they could start losing money in some of these funds if the funds don't lower their expense ratio.

We point this out to also remind the participants in this latest "mini bubble" just how absurd valuation levels reached. The NASDAQ was trading at 245 times earnings at the peak and the S&P 500 was trading at over 35 times earnings. The NASDAQ P/E is now trading at infinity since there are more losses than gains in the Composite, and the S&P 500 is still over 30 times earnings. The valuation levels of the other two bubbles that led to deflation were high but not nearly as outrageous as ours. The peak P/E in the bubble of 1929 was a shockingly high level, at the time, of 21 times earnings. The P/E of the Nikkei 225 average in Japan at its peak in 1989 was about 70 times earnings, but you have to take into account that the accounting in Japan is much more conservative than in the U.S. It is true that the Japanese real estate bubble was worse than the real estate extremes we are experiencing in the U.S. now, but since real estate is just about the only asset that creditors are willing to use as collateral for loans, we expect any reversal in prices to be the catalyst for the deflation we envision.

"Other examples of extremes during the late '90s bubble were Lucent at the peak trading at a capitalization level of $264 billion and $64 per share now trading at $1.88 and under $8 billion of market capitalization. Ciena traded at a cap level of $171 billion and $151/share and now trades at $5 with just over $2 billion of market cap. In the "special report" we have other even more extreme examples.

"The debt levels reached in 1929 of 270% relative to GDP were considered outrageous at the time and we are sure no one believed they would ever be exceeded again. Well take a guess where we are today? The debt to GDP actually is now at 300% of GDP! The debt in Japan (which was mostly government debt) was over 130% of GDP and has expanded substantially since the peak. The government debt in the U.S. is still only about 70% of GDP, but if we continue running the budget deficits we are running now this could explode along with the private debt.

"The bubbles in Japan and in the U.S. in the late 1990's allowed corporations to use inexpensive financing and leverage to expand capacity almost beyond belief (especially in high tech). This capacity build up is the main factor forestalling capital expenditures and causing virtually no pricing power in the corporate sector. The figures weren't available in 1929, but the concept of "pushing on a string" is the common denominator of the first two deflations and we believe that we are headed into the same dilemma. This is the concept of pushing money into the banking system but not being able to continue pushing the reserves out into the system as loans. The steep decline in the money velocities (GDP/Money Supply) of M-2 and M-3 are indications of future problems in stimulating the economy with growth in the money supply.

"Greenspan claims to be little concerned about deflation, but it is odd that he refused to use the word until the reporters pressed him into using it. And now he uses it in every speech, with the caveat that there is a low probability of falling into the abyss of deflation. With all the ingredients to the recipe for deflation in place today, we would contend that there is a lot higher probability of deflation than Greenspan is admitting to, and he is also very much worried that monetary policy will not work. Remember, there are two sides to this coin if he continues to lower rates below 1%. We have already discussed the first problem of driving money market funds out of business, but the people who are living off of fixed income investments will continue to see a drain on their income no matter which duration of rates are lowered. This is not inflationary!"

One point of disagreement I have with what was said above is that I do not believe the bubble of the late 1990's has yet been burst to any great degree. We have seen some of the air come out of the equity bubble. But with equity prices remaining even more expensive than at the time of the 1929 crash, stocks are very, very expensive and thus in general should be avoided. Based on current earnings, in general stocks should decline another 66% or so to bring them in line with historical bear market bottom valuations. Besides, as Stephen Roach of Morgan Stanley recently pointed out, the equity bubble moved into the housing bubble which in turn has traveled into a bond bubble. Overall, very little of our collective asset bubbles, which have been blown up by an excessive creation of money and debt, have a long way to go before the collapse.

The following chart displays the velocity of the U.S. dollar using two measures of money, namely M-2 and M-3.

You can rest your bottom dollar on the fact that the above picture is implanted securely in Greenspan's mind and it must be scaring the bajeebers out of him. Why he has not talked about monetary velocity? I suppose it is the same reason he tries so hard to avoid the "D" word by talking about declining rates of inflation. In fact, Greenspan must try to convinced everyone that deflation is highly unlikely because if everyone believed as I do that it is inevitable, people would immediately begin selling their homes, stocks and bonds and parking the proceeds in gold and cash. That action would then be self-fulfilling prophecy. The economic collapse will happen any way. But by spinning the "everything is under control" line, the game of musical chairs can last a while longer though of course the economic dislocations become ever more pronounced.

So, Mr. Greenspan can huff and puff and blow the monetary bubble up higher for a while, but if pricing power is so poor that business profits continue to decline so that borrowing makes no economic sense, or so that companies are not credit worthy, then the attempt to inflate the economy with easy money gimmicks are sure to fail. I was not aware of the major slowdown in the velocity of money displayed above, but now that I see it, I am convinced even more that Ian Gordon's Kondratieff winter is barreling our way. The slowdown in the turnover of money is a powerful deflationary dynamic. The Fed must be scared silly over this evidence which explains why the are talking about extraordinary measures. I think they know we are in trouble but for reasons noted above they are trying their best to act calm.

GOLD

The early stages of a bear market are just the opposite. Most people in the equity markets these days believe stocks are bound to come back. Out of fear they may miss the next move, they jump back into the market as soon as the equity prices show signs of life. That, along with short covering, explains why some of the most powerful market rallies take place in the early stages of a bear market.

An encouraging note I just picked up form Richard Russell in today's "Richard's Remarks" was that the "commercials" have reduced their short positions from 146,075 contracts to 136,408 contracts. At the same time, they increased their long positions from 51,869 contracts to 59,389 contracts.

The commercials are among others, the bullion banks who have been an accomplice to the gold price rigging scheme of our policy makers. The commercials are usually, though not always right, so it worth watching their behavior. This latest report suggests they are becoming a tad less bearish on gold.

GATA's Mike Bolser sums up the near term fundamental case for gold as well as anyone when he noted the following at www.lemetropolecafe.com yesterday:

"One can speculate that the Eastern pole of the multi-polar world has taken a temporary respite from its dollar selling to permit its de facto leader, Vladimir Putin, time to tidy up some UK energy business [Gazprom pipeline] before dollar selling and Euro buying begins in earnest after the holiday week. We can expect the dollar to resume its downward track. BTW the end-of-year regression target for the dollar is 77 and the Euro is 1.28…"

"With the bond market under clear stress and continued weakness, the future for Treasury bonds is down also. Where will the mountains of cash go that come out of the bond market? Into topped equities? Into topped real estate?

"Some of it will find the gold shares and the yellow metal. It won't take much of that to break the gold cartel for good.

Also providing some good insight into gold's near term prospects at GATA's web site from a technical perspective was my good friend Chuck Cohen. Chuck sent the following messages to Bill Murphy which were posted on the GATA sight.

Bill
"Just noticed that the AAII latest figures was 71% bulls and 10% bears equaling the top at the beginning of 2000 which was the highest since 1987. So this and the Investors Intelligence numbers are similar. My take is that we are seeing the last painting due to the end of a record quarter and perhaps it will extend to the first few days of July. Then if these historic figures are any guide, we should see the bottom drop out. "I believe that gold has weakened due to the rally in the dollar, but the shares are a better predictor of the future since they have less manipulation in them. The interesting point should be what will happen to gold as the market becomes liquidated.

All I can say is the fundamentals are in play for gold in the longer term if not in the immediate term. My friends are suggesting both short term and long, gold is looking very strong.

June 30, 2003

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