Deflation Signals Are Getting Stronger

The very core of our Model Portfolio strategy is based on the premise that we are nearing the end of the 60- to 70-year Kondratieff cycle, and as a result, deflationary forces of over-indebtedness will overtake all attempts by politicians and bankers to inflate us into prosperity. At the very core of our deflationary belief is the rapidly escalating rise in debt relative to national income. The notion that nations can defy the laws of economics through their printing presses is absurd to the core. The need on the part of U.S. monetary officials to print more and more money in an effort to stave off deflation demonstrates the folly of that view. This is so because in a fiat currency system, debt is the raw material from which money is manufactured. And so any attempt to overcome the deflationary tendencies of debt will ultimately increase, not decrease, debt. Because this concept is so important, we have chosen to publish the chart on your left once again. Note the direction of debt in America (now $37 trillion) compared to GDP (income). Every time Alan Greenspan and Ben Bernanke at the Federal Reserve fire up their helicopter money printing machines, the red line grows steeper and steeper, while the blue line continues in its very modest linear direction.

The enormous growth in debt relative to income in itself is deflationary. In fact, as Ian Gordon has pointed out in his work on the Kondratieff cycle, the reason deflation and not inflation is the outcome of enormous growth in printing press money in the Kodnratieff winters is because a threshold of debt is reached in which debt becomes so burdensome and onerous that any attempts to inflate away the debt problem can no longer work-not unlike an aircraft that is trying to lift more weight off the ground than it is capable of lifting.

So what are some of the growing signs that deflation is winning the day?

• An enormously bearish stock market picture - Despite the most stimulative fiscal and monetary policy in history, U.S. equities have not even come close to their all-time highs reached in 2000. This is exactly what Ian Gordon predicted when we first interviewed him in 1999. The top of the market that would soon approach would not be equaled again in his lifetime. (Ian was then about 57 years old). With the next leg down in the equity market (which we believe will see the Dow and gold reach parity before the bottom), we think deflationary pressures will become ever more obvious.



• Price inflation in the U.S. - While I believe inflation is much higher than the government claims it to be, it is continuing on a long-term downtrend from its highs that were reached at the peak of the Kondratieff summer, which ended in 1980. Unlike that period of time, major disinflation in manufacturing and finance exist which, for the time being, are enabling Americans to buy the appearance of prosperity for a while longer, when in fact they are digesting ever more lethal does of debt. As the number of Americans unable to meet their debt obligations begins to grow exponentially, it is my view that we will be in the unfortunate position of seeing prices of everything, (perhaps even commodities) drop much more dramatically than even during the 1930s.



• Bond rates decline even as oil prices surge - The bond market, which is comprised of the most sophisticated investors in the world, is taking interest rates to lower and lower levels, even as a key component of inflation-namely oil and gas prices-rise. What this suggests to me is that powerful deflationary forces such as global competition in manufacturing, services, and finance are overwhelming inflationary forces in key commodities.



• Retail stocks are starting to decline markedly - The consumer represents about 70% of the American economy. The entire world, to a greater or lesser extent depend on the U.S. consumer to keep digging himself into debt in order to buy the goods and services that keep the rest of the world's economies growing. Retails stocks and recent consumer behavior and attitudes suggest this mania may be coming to an end. If so we may well start to see the unwinding implosion of the great American debt devil that ushers in the Kondratieff winter freeze up.



• Tepid growth in the U.S. Money Supply - There have been some major declines in the M-3 measure of money growth which may or may not be indicating we are nearing the tipping point. Certainly measures of money are getting more and more complicated and with the involvement of the government support in the mortgage industry, M-3 may not be telling us as much as it did at one time. I prefer to watch global U.S. dollar liquidity which at this time is still growing at an amazingly high rate of around 20% per annum. Yet what I find amazing is that despite this growth, except for some commodity prices, inflation in the U.S. continues to rend lower from its 1980 double digit highs. In fact, this is the measure I am watching most closely because as during the Asian deflationary crisis, this measure of liquidity actually turned negative 5% at one point. As the great debt bubble begins to lose its air, we will see an actually decline in the money supply not only M-3 but more importantly in global U.S. dollar liquidity at which time, I expect the dollar will actually gain value, at least in terms of what it will buy within the U.S.

• Signs of Commodity Price Declines? - There may even be signs that commodity prices have peaked. Indeed the CRB has been in decline since April of this year. And my friend Chuck Cohen sent the following email message to me: "Jay: Have you seen the grains recently? Also, look at rice and lumber. I think that copper could be next. The oil frenzy appears to be masking the general weakness in commodities. Chuck

As for now, commodity inflation, especially in the energy sector remains a reality which is why we continue to owns some energy stocks and the energy heavy Rogers Raw Materials Index Fund. By the way, one stock I think you should really keep your eyes on is International TME (OTBBB- ITME), for reasons noted in our Corporate News & Views below. In anticipation of continued commodity inflation until such as a time that deflationary forces overwhelm continuing attempts to inflate the currency.

As I have said before, 2004 is a year of corrections in the markets. We expect a resumption of the major market trends which are: bear market in stocks, bear market in the dollar (relative to gold) and a bull market in gold to continue starting in 2005 with a resumption of those trends becoming more obvious before the end of 2004.

TRADER ROG'S CORNER

GOLD IS CRAWLING, WHILE THE DOW IS DANCING

As we report in after the daily and weekly gold closing, Crude Oil is over $48.50 and headed for $50.00 resistance again; the Dow is up about 35 points; the NASDAQ is virtually flat at 2 points; and all this while CNBC is reporting on the coming debacle at Fannie Mae. The news alleges these executives manipulated the numbers to pump their bonuses. I would expect this to get much worse, then be smoothed over to the best of the authorities' ability, as we approach an election and some very fragile markets. Fannie Mae took a big stock hit Wednesday when the mess became apparent, but the controllers are working overtime to smother the problem. If Fannie Mae hits the dumpster, everything else goes with it. As they say, "It's too big to fail."

Gold began with a nice little rally this morning, and then the PPT jumped on it, giving gold lovers a major rise in blood pressure. Still, as I busily draw on my weekly good chart, I see a major continuation triangle with its extended apex closing about November 1, 2004. This scenario fits nicely with our expectations as the price bars have got to jump over the top or slide under it before November 1. Since we are quickly running out of month, and next week traders will be balancing books for month end, I would suggest our big event will now hit in October.

Within this much longer triangle is another rising up channel beginning last June. This channel is fairly wide, about 12-15 points top to bottom and moving along with a good upward slope. With a Bollinger Bands overlay, this channel shows quite graphically that gold is rallying to the top band and continues to want to stay that way. So, in spite of the PPT's best efforts, gold marches up with each slapdown. I suspect the PPT is permitting this gradual slope to makes things gradual for everybody. They cannot risk a gap open break away, as it could easily get out of control and then we all have some really big trouble.

So the gold traders and investors should keep calm, keep invested, and stay out of gold futures to control risk. For those who know this futures game, I would suggest you be very careful. Should gold hit a big rally break, and they try to smother it, an over correction could easily run the stops, and the contract holders would be in a real pickle and unable to escape.

With the smothers being put on gold, it likes to sit, resist, jump over, but generally hang around $408.50. Our weekly close today is in this neighborhood, stopping at $409.70. Next week should not be a real terrific metals week as the monthly book re-balancing has just 4 days left. Expect choppy, non-directive action and more waiting.

However, beginning with October 4, we could finally see some excitement. It's still hard to tell for sure, but gold appears to be in a three-wave beginning. If true, this is the big one we have been waiting for. Three waves are the big moves traders love to jump on.

Our next group of overhead resistance points in order are: $415, $424-425, and $429-main overhead resistance. After three closes over $429, we head for $450, $475, $502, and $514. Our $502.00 is the primary stopping point, but if broken, we go to $514 next.

I expect things to really slow in the rally as we approach $502. Profiteers will be aching to exit, and the gold futures option holders had better be thinking of selling positions around $480. If you try to ride to 502, you may not be able to get out fast enough.

Next week we begin to see more quarterly corporate reports. Many of these reporting corporate officers would rather be on vacation or disappear than sit in front of the cameras and shareholders tap dancing around their lousy numbers, which are surely coming. Soon the Dow and Nazz will be smothered, while gold and silver are doing the dancing. Keep your dancing shoes on, as you cannot dance at this metals party if you are out of the market. Keep invested. Keep the faith. Your turn is coming.

The Dow Jones Industrial Average has tried to break through overhead resistance three times since it started its toppy two-step, downward slide. Technical analysis says an upward breakthrough usually occurs on the third or fourth try. Well, guess what; we've seen three failed tries on a downward sloping chart. Can it break through on the fourth? I say no. Three strikes and you are out.

The eminent Dow theorist, Richard Russell, was wondering out loud this week as to why the Dow and Transports have diverged for over seven months. He said he had not ever witnessed this phenomenon. One of his readers suggested the transport guys were busy hauling in goodies from Asia and exporting empty containers. I would add the railroads are short of cars as the increased need was not expected, and it takes some time to build new rolling stock. Further, in Canada, the railroads are overwhelmed by hauling raw materials to the Western ports for shipment to China at a very accelerated pace. Ports are backed up for weeks. Their next big problem will be harvest hauling next month, with not nearly enough rail cars to go around, carrying time valued cargo-food products.

I would suggest that rare, seven month divergence is a product of the Plunge Protection Team diving into the S&P's at propitious moments, slamming any sell off. Chicago pit traders are seething, as the "normal" flow of bid/ask has been severely interrupted. Logic has not prevailed, and it's costing the locals some real bucks. Buying a nice chunk of S&P's in the face of an imminent failure has helped the Dow turn around, base and return to small rallies, saving the day. But only temporarily.

Gold has experienced just the opposite. Whenever the U.S. dollar acts terminal and gold rises over the "permitted amount," the PPT hammers the market with gold sell-offs, creating a gold trading range, and avoiding a ten or twenty point gold rally runaway. To complete the scam, the U.S. dollar has been protected by Asia's buying T-Bills and Bonds in huge volumes. Our printing press directors in Washington are helping this game along as well.

There you have it: Prop the S&P's and Dow, sell the gold, and prop the dollar. This fiscal foolishness is winding the economic coil ever tighter, and merely postponing the final day of reckoning. That big day, I would suggest, is coming sooner rather than later.

We have long lists of reasons as to why an implosion is imminent. One that reared its ugly head this week was Fannie Mae. Bad news about creative numbers, coupled with a shaky real estate market, scared some into a sell-off. This baby is so large it probably exceeds the total annual GDP of most nations in the world. The WSJ reported smarter consumers smell a top, and are exiting their McMansions for something reasonable, paid for, and located in more conservative living areas.

The bond traders didn't cooperate either, as they went opposite the conventional thinking, and traded toward higher interest rates. Keep in mind the bond traders and currency traders not only understand where things are going, but they trade in that direction and ignore the herd. These sectors will be the major factor in fixing this major market mal-adjustment. No PPT help is possible here.

So what happens next? Dow and NASDAQ go down, bonds go up in price and down in yield, real estate cracks, and the sheeple just stand there waiting to commit fiscal suicide, going over the cliff in one large herd. This waiting and standing there, doing nothing in the face of disaster, is creating the large market pause (inside trading days) we see today. This ends very soon, just as a market mistake dumps over the markets, creates a cascade of selling, and panicking the sheeple to run over the selling cliff.

Buy gold, gold stocks, and options, get out of debt, and sell the Dow and NASDAQ. If you are stuck in a retirement plan and cannot exit, try to buy some put options or leaps to offset the losses that are certainly coming your way. Until Next Friday Until next time, this is Trader Rog.

NOTE: Traders Tracks, which lays out Trader Rog's top trading picks are outlined toward the end of this weekly message.

September 27, 2004

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