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:
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.
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