Taylor On The Markets & Gold
Jay Taylor
Financial Markets
Why are stocks performing so poorly when all the economic news and most of the earnings news is so much better than expected? Interesting how the
talking heads address this issue. Larry Kudlow simply assumes the market
has it wrong. That's different than his appraisal of the markets when they
were heading higher. He reminded us then that the market is a great
discounting mechanism that was forecasting economic growth and a tremendous growth in earnings. Larry was right then. So why should he give up on the notion that the market might be predicting an economic decline and declining earnings going forward?
Could it be that Larry is simply talking his book? Could it be that he is
simply allowing wishful thinking to get in the way of an objective view of
the markets? Jim Rogers once suggested to me that I stop picking on Larry
Kudlow. He asked me, "Don't you know he is on CNBC only for the ratings?
Stop wasting so much time worrying about him."
I think Jim Rogers is right on that score and I also think some soul
searching on the part of your editor and everyone who invests is always a
good idea. Being human, we can all fall into the trap of wishing something
to be true, and then take a position based on our wishes and desires rather
than on an objective view of the situation at hand. Indeed, the plummeting
gold price and even more drastic decline in gold shares over the past few
weeks has prompted me to ask myself if I'm not perhaps talking my book too
much. I believe we should always try to see the markets (and life in
general) as they really are, not as we want them to be. Regarding gold, I
continue to believe we are in a bull market as discussed below.
Is the Secular Bear Market Back in Control?
Richard Russell (www.dowtheoryletters.com) talked last week about how
badly the market internals have been breaking down. He noted that each day
over the past few trading sessions, the number of new lows has been
surpassing the number of new highs at an accelerating pace. Richard's
observation is consistent with a dramatic breakdown in the 35 sectors that
we follow. In our study, we also include the Dow Industrial Average as well
as the S&P 500 and the NASDAQ.
So every week we review 35 sector charts and the charts for three major
averages, and the picture as of the close of business on May 7, 2004 wasn't
pretty. Of the 35 sectors, we found only one chart that was bullish and
that was for the pharmaceutical sector. The Pharmaceutical Index, which
trades on the AMEX ($DRG), stood at 336.89, which placed it above its
20-day moving average (333.68), its 50-day moving average (332.26), and its
200-day moving average (327.01). Apparently, fund managers are moving into
the pharmaceuticals as a defensive move against an equity market that seems to be about ready to destruct in a major way.
Not only was there only one sector chart that was bullish, the magnitude of
bearishness has risen dramatically from a minus 58 reading last week to a
minus 82 for the week ending May 7, 2004. The maximum possible bearish
reading is minus 114 (38 charts, all of which are trading at below their
200-day moving average). Of the 34 bearish sectors, 14 were significantly
bearish (below all the moving averages), and 17 were moderately bearish
(below their 20-day and 50-day moving averages, but not below their 200-day moving averages). The bearish magnitude was -82 out of a maximum possible -114. That compares with a bearish magnitude of -58 last week when we still have 5 bullish sectors and 10 rather than 14 significantly bearish sectors. It would seem very possible that we are on the verge of a major plunge downward now in the equity markets. The Bear may indeed be ready to take control of what we think will be an awful bear market of epic proportions that began in 2000 or, by Richard Russell's appraisal, during 1999.
Since we began tabulating the weekly sector charts provided by
www.decisionpoint.com back on March 19, here is a composite picture of the
38 charts (35 sectors and 3 major indexes) that we monitor at the end of
each week.
We suspect the volatility displayed in this chart is a characteristic of an
equity market in the process of topping out. As the topping process takes
place, small changes in price can quickly move a chart above or below its
moving averages. Indeed, there are a few sectors, which with a small move
upward could quickly turn them bullish. The Consumer Index, Computer
Software Index, Natural Gas, and the Oil Index are all moderately bearish
and could quickly rally back toward a bullish posture. But by far, the
charts we view showed a very dramatic plunge over the past two weeks,
either toward or markedly below the 200-day moving average.
What Might Be Happening?
If the market looks forward, what might this sudden breakdown be telling
us? In time, we will find out, but as I looked at some of key sector
charts, one thought that came to me is that the markets may indeed be
forecasting a breakdown of consumer demand. And some of the major consumer sector charts are breaking down rather badly, including two of the most important ones, namely autos and housing.
Let's talk about autos first. Remember how following 9/11, the markets took
a dramatic plunge downward, and the economic picture looked very, very
bleak. The auto companies, encouraged by a Fed that said it would pump as
much money into the economy as necessary to avoid going into a depression,
began to offer zero-interest rate loans. From that time on, we have had a
huge boom, not only in regular-sized cars, but also with larger
gas-guzzling vehicles.
As far as I know there is no Auto Index chart that we can follow. But take
a look at this chart of General Motors, which we might use as a proxy for
what is left of the American automobile industry. Clearly GM's shares are
in a bearish mode.
The Banking and Financial Sector
Morgan Stanley's lead economist, Stephen Roach, has been pointing out these risks for quite some time. And in light of the increasing role played by
the Chinese economy, not only in the U.S. but also in Asia and to a lesser
extent in Europe, the changes in China may indeed be about to trigger the
inevitable plunge into the Kondratieff winter. And if that is true, the
banking and financial sector will not be able to print their way out of
this mess either. In fact, they will be at the very heart of the
deflationary collapse because through the creation of fiat money, they have
created huge liabilities which when they default, will cause these
institutions to collapse to a fraction of their current size, so that
ultimately they will represent much less than the 22% of the S&P 500 that
they currently comprise.
But given its current size relative to the S&P 500, the financial sector
represents a huge part of our economy. Given our fiat money regime, these
institutions-having a license to create money out of thin air-have grown in
size at the expense of the productive sectors of our economy. This is
exactly what our current ruling elite have designed for themselves by
eliminating gold as money. The bankers and the ruling elite who they are in
bed with have managed to carve out a very significant portion of our
economy for themselves. For that reason alone, as well as with respect to
questions about derivatives and financial security, it is proper to take a
look at the charts of the financial sector to see what they might be
telling us. Here again, the picture is not very rosy. The broader based
index of financial institutions, known as the Financial iShares (IYF)
traded on the Amex, broke below their 200-day moving average last week. And interestingly, the chart for the bluest chip bank in America, JPMorgan
Chase, has plummeted downward way below its 200-day moving average. Keep in mind that this entity, which along with Barrick Gold is the defendant in
the Blanchard anti-gold manipulation case, is also the world's leading writer of derivative business.
Interest rates are of course at the heart of the financial sector's
problems. The $64 trillion question is whether interest rates will rise
moderately or to levels viewed as extreme, relative to our recent
experience. I think another question of even more importance is "WHY"
interest rates might rise. Could they rise because our economy is so good
and getting better? That would be the most positive reason for interest
rates to rise. But what I suspect is that interest rates may also be on the
rise because of problems beginning to arise in China and a simple
reluctance on the part of that country and many others to continue
increasing their dollar exposure as a reserve currency.
Clearly, interest rates have broken through recent resistance levels. Rates
on the 10-Year Treasury, from which mortgages are priced, are off to the
races. The 30-year and 5-year charts look very much the same. But what
surprised me was the sudden and dramatic rise in the 3-month T-Bill yield,
which as can be seen above, rose through the 200-day moving average like a
hot knife through butter. The Fed has little control over longer-term
rates. It has more control over short-term rates. Either it has lost that
control or-as it would have us believe-it is in the process of changing
toward a less accommodative monetary policy. However, in reading an
excellent essay written by money manager Adrian Van Eck, it sounds like all
hell is about to break out from China and as a result, China may now be
pulling away from its status as a major creditor to the U.S. If so, that,
as well an improving business climate, may explain why interest rates are
surging. And if they continue to surge, the Kondratieff winter may indeed
now be upon us.
Bob Hoye, who writes the very expensive "Pivotal Events" letter for
institutional clients, made the following points on May 7 that I think are very much worth repeating:
- "This has been the biggest and most reckless 'carry' trade since the 1720 bubble when the Bank of England was not allowed to raise the discount rate above 5% when rates for stock speculation reached 10% per month."
- Referring to the equity markets he said, "The main trend is now down and our case has been that the third year out from the bubble would show a cyclical recovery in business with a cyclical bull for the stock market. Both would be within the typically long, but variable, post-bubble contraction. To be blunt, the 'waterfall' will confirm the resumption of the secular bear market. In looking at metal prices and credit spreads, Mr. Market says it is a bear already."
- "The markets are now in the early stages of a severe liquidity crisis."
Richard Russell frequently says that in a bear market, everyone loses
money. The winners are those who lose the least. That's what happens in a bear market. What happens if this is not just any normal bear market of epic proportions akin to that of the 1930s or worse, as your editor believes is likely?
GOLD
Gold works perfectly well as both a deflation hedge and an inflation hedge
because gold is not a commodity-much as Andy Smith and the rest of the
establishment who push gold as jewelry want you to think it is. Gold is
money, as GoldCorp declares on its corporate literature. Ultimately, when
the financial system implodes and when people will no longer accept fiat
money because it has become worthless, but will demand gold for
transactions, that hard lesson will be learned. But for now, the official
propaganda of the American empire is that gold is, like any other
commodity, doomed to decline when the economy cools.
GOLD SUMMARY FROM GATA'S BILL MURPHY
Bill Murphy has graciously agreed to make himself available for a summary
of the gold markets at the end of each week for the benefit of our
subscribers. The best thing to do is to subscribe to Bill's excellent
service, which brings you a host of essays and factual material on the
economy as well as gold and silver markets on a daily basis. Go to
www.lemetropolecafe.com to sign up for this very reasonably priced service.
But here were some of the points Bill made last week relating to the most
brutal decline since the bull market in gold began back in 2002.
- The decline was orchestrated by the Gold Cartel. We started to see the
propaganda campaign against gold and gold speculators two or three weeks
ago when the Financial Times started to print anti-gold stories. The usual
suspects, namely Goldman Sachs and J.P. Morgan, have recently been bombing the markets. The combination of their heavy-handed trading tactics combined with intervention in the paper markets scared speculators from being long to neutral or short.
- The irony is that you could write a scenario right today to easily justify gold rising to $500/oz. For example, oil is approaching $40 per barrel. Cotton was up the limit on Friday. Soybeans are going through the roof. The geopolitical situation for the U.S. is in complete disarray as a result of the scandals in Iraq. In other words, you could make a much better case for gold to be at $500/oz. today with all these other events than at $379. But the Cartel is obviously doing all they can to affect the psychological behavior of the markets.
- But the Cartel is petrified because of the bond markets. They know what a
rising gold market could do to set off derivatives in the bond market at
which point things could get out of control. So they continue to do everything possible to restrain the price of gold. They (the Cartel) made a
calculation. They know what was coming with rising interest rates so they
are going to get everyone's mind off of what is happening. Gold is a
barometer of what is happening. So with the price of gold falling, they will say, "Look, there is no inflation, look at the gold market." And so people should stay calm and stay in the bond market-in other words, to keep people in the fiat currency system rather than to opt out of fake money (dollars) into real money (gold), because then the establishment loses political and economic control over the masses.
- If things were so good, why didn't the U.S. raise interest rates like England and New Zealand did? The reason is that things are not so good. The
Fed is afraid to raise rates. So the bond market is collapsing. $40 oil and gold is going straight down! Give me a break!
- I asked Bill what he thought the mechanics of the gold manipulators was,
now that interest rates remain so low: "Do you think the gold covered by
Barrick and other major mining companies may now be heading back on to the
markets after briefly being parked in the central banks? Barrick alone
reduced its hedge book from 24 million ounces to 15 million ounces over the
past couple of years." Bill said it is hard to say. Whether the bullion
banks are returning it to the central banks or continuing to use it to bomb
the markets, I don't know. There are always ways for these, the richest and
most powerful people in the world in the Cartel, to come up with more gold
or use more derivatives in the over-the-counter market to turn things. And
since this group has such influence on the press to combine with their
insider positions in the markets, they have everyone at the margins in the
gold markets getting out. The obvious result is the slam in the gold price
we have seen in the last few days. And so with price action making market
commentary, this thing feeds on itself on the downside.
- But here is an important point. This is what I heard yesterday and
reported at www.lemetropolecafe: the cash market as opposed to the paper
market (which is ruled by the Cartel) is very dry. According to John
Brimelow, who quoted a Reuter's reporter, "The physical market has been
quite good for the last couple of months. It is actually quite hard to get
gold bars in places like India and Dubai. Refineries are working flat out!"
Now that's not a market that should be collapsing! All the basic
fundamentals are positive. Bill said on a fundamental basis, you couldn't
draw up a more bullish scenario than you have right now. But that is
exactly why there is the intense propaganda campaign against gold. The
establishment assaults gold and silver to bury it so you turn all the
commentary negative and drive the speculators. Evidence is that the
speculators are getting shorter and shorter, even as the fundamentals are
getting more and more bullish. So we are being set up for one of the big
bullish runs of all time for gold. But in the meantime, it is painful.
As we were getting ready to wrap up our conversation, I reminded Bill that
this is an old story. I first met Bill when gold was at its bottom of around $255, when he and Frank Veneroso went to speak at a conference in
Montreal back in 1997 or '98. I proudly count myself as one of Bill's
biggest fans since that time when he was beginning to plan the
establishment of GATA. Bill agreed with me that we are winning the war
against the manipulators. And on an optimistic note, he noted that he
thinks that by the end of 2004, people who don't get shaken out of the gold
and gold share markets here will be very happy campers by that time. If you
have your position of the physical bullion and the shares, and avoid
getting into margin problems-if you trade that way-you should be very happy
by the end of the year.
Finally, before we finished, I asked Bill if there were any other thoughts
to leave for our subscribers before we said goodbye. Bill had a few
additional comments. He talked about how Greenspan was warning about metals prices declining because of the Chinese slowdown. And yet an "in the field" contact for GATA in China said the notion that things are slowing down in China is utter nonsense. This guy who was with one of the biggest metals companies in all of China said this company was planning to double their copper production in the years to come, and that things are booming. He said that people who are paying attention to Wall Street on this ought to
think twice.
I'm not sure I am as skeptical about a decline in China as Bill suggests.
But then I am a deflationist, and I think Bill, like most gold advocates,
is more of an inflationist. I truly expect commodities to tank, but for
gold to rise dramatically in terms of real purchasing power, vis-à-vis
paper money and other commodities, as the Kondratieff winter takes hold.
And because gold actually does better in a deflationary depression than in
an inflationary environment, the turn of events in China is seen as being
very bullish for gold in the long run, if not in the short term.
More in tune with my thinking along those lines is Bob Hoye, who also
believes we are heading for a major deflationary event as financial bubbles
burst. In his May 7 issue, Hoye said the following:
"The financial markets have only just discovered that leveraged money is
not really liquidity and, although the change has been violent, it is not
yet acute enough to mark the end of the crisis.
"Typically, in such a consequent 'flight to quality,' is to the best
liquidity, which has always been Treasury Bills or the equivalent in the
senior currency and to gold.
"As mentioned above, steepening of the Treasury curve and widening of
credit spreads has been on schedule and is now sensational. These are the
features of the post-bubble contraction that have been accompanied by
increasing investment demand and an improving trend for gold's real price.
"As evidenced by the alarming widening of spreads for Turkey, Brazil, and
the U.S. ten-year swap, the turmoil is global. In which case, where will
prudent money find security and liquidity? In yen? In euro? In sterling?
Quite simply, these are not big enough currencies nor do they have money
market instruments with the liquidity of U.S. bills or gold."
Hoye also shares your editor's view that silver will not do as well during
a deflationary crisis as will gold. In fact, he is now downright bearish on
silver, stating that his target for the gold-silver ratio is 110 vs. 67.76
now, and a low ratio of 50 on June 2. Simply put, Hoye sees silver as a
commodity and not as money. I am more sympathetic with my good friend Dave Morgan on arguments for silver as money, but I am also sympathetic with Hoye's view which, until more recently, was also the view taken by Ian
Gordon on the silver/gold controversy. In any event, Hoye believes we are
nearing the end of carnage in gold and that the yellow metal will continue
to gain vis-à-vis silver. We shall see.
I would also like to give one more quote from Hoye's "Pivotal Events"
column of this past Friday, with respect to gold and gold shares.
"Gold Shares: Core positions from the seniors to exploration companies
should be maintained. Considerable amounts of money have been raised for
exploration, and the management and geological skills of many companies are
outstanding. This will result in some discoveries which, even in a dull
gold market, can result in a market play."
To that I say "Amen," because even in the 20-year bear market in gold, we
have seen many discoveries and many exciting times in the gold markets.
However, I would also say that if the gold markets turn out to be dull, we
will have a much harder time making the kind of money we made in the past
couple of years. Although the last few weeks have been the toughest in
quite some time for us gold bulls, when we take a good look at the longer
term picture as we see in the chart below, what this decline seems to be
suggesting is that what we are now in is a serious correction, but that the
long-term bull market for gold remains very much in place.
May 10, 2004
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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