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Fool's Market

March 10, 2005

Something about the markets has been worrying me at a subconscious level over the past few weeks. There are too many "obvious" signals being given - of which the following are but a few:

  • Dow Theory gave a buy signal with transports reaching an all time high
  • Commodities and oil look like they are going into orbit
  • Virtually unanimous bearishness against the US Dollar
  • Virtual unanimity that price inflation is going to start spiralling out of control

Yesterday I had a meeting with a brilliant man - an old friend who is a genius at product marketing and brand images. At 67 he is retired and is bored. His wife has to restrain herself from committing murder. He is thinking about buying two computers (why two?) and putting $1 million into the markets to "trade". His objective? Make a turn of $500 a day. "I'll buy in the morning at $1.12 and sell in the afternoon at $1.15. I'm not greedy, but there's always a few cents in it during the day"

BB: "Hey Mike. What will you do if the price falls by 3 cents?" Mike: "Well, then. I'll hold another day and wait for it to rise again" BB: "And if it doesn't?" Mike: "Well then I'll sell out at a loss. I can't expect to make a turn on every deal"

As I said before. As a brand image guru, Mike is a genius. I would probably go so far as to say that he's the best I've ever come across in that particular field. Put a 2B pencil in this guy's hand and he transmogrifies into a supernatural human being. Sort of like Clark Kent turns into Superman. In 25 years of working with him I have never once seen him make a mistake in his area of expertise. He just "tunes in" to the consumer market, and with a few strokes of the pencil solves problems that no one else can.

When you try to talk to him about things like Front Page and Page Maker he just shakes his head and clucks. "C'mon Brian, you can't expect a computer to think creatively. The guys that rely on this fancy technology are just masking their lack of talent. Give me a 50 cent pencil and I'll show you how it's done". And then, infuriatingly, he proceeds to prove his point.

I have a client that has a brand image problem that we've been grappling with for five years and, yesterday, in desperation I turned to Mike for help. In five minutes flat over a cup of coffee he cut through all the crap and gave me the answer; and his answer "feels" right. You know how there are some things that you just know are right. Well, Mike's answer yesterday was one of those.

But there's a potential problem lurking in the minds of people who are too successful. They get to thinking that they are invincible. Mike just can't get his head around the fact that the $1.12 share might fall by 3 cents. After all, in 25 years he's rarely seen his portfolio drop seriously in value. And on the rare occasion when it did, he just held on and it came right. Why would he be wrong in year 26?

But, if all the Mikes in the world were joined end to end in the stock markets, would they ALL be right and would they ALL make money by trading in a manner that he seems to think is a natural phenomenon? He genuinely thinks Page Maker and Front Page are used by creative people who are challenged in the talent department, but he is happy to embrace the concept that all he needs to make money on the markets is a computer with a trading system. I guess with two computers he reckons he will halve his risks. Go figure.

So, getting back to what has been worrying me. With all the market's signals and trends stacking neatly together, and with geniuses like Buffett and Gross leading the way, all we have to do is follow them blindly into the sunset and live happily ever after? Sorry sport, unlike Mike's answer to me yesterday, that conclusion just doesn't "feel" right.

A couple of weeks ago I changed mental gears and I started to put my mind into Devil's Advocate overdrive. And guess what? I am seeing some very worrying "non confirmations".

Here's one (charts courtesy of

Note how the Bank Index itself rose to a new high, but the PMO is showing "falling tops"

There are a couple of sectors that do not show this type of non confirmation but, by and large, most of them do.

Take the transports as an example:

The trannies have reached an all time high, but the PMO turned down from a double top? Whoa! Let's stop and look a bit more closely here.

S&P large Caps show the same non confirmation as the banks

As does the DJIA

As does the S&P Small Caps

But the chart that really caught my attention is this one:

The problem with this chart is not "technical". It has to do with bank profitability. If 3 month money is costing the banks close on 3%, and there is so much cash around that the banks have to compete to lend it by reducing their lend rates, what is going to happen to their profits?

But the first chart above showed banks as strong. (except for the PMO)

Really? Let's look a bit more closely - but from a greater distance to give some perspective.

What do you know? A "rising wedge" AND a "falling PMO"

So, if you were a bank, what would you do?

Well, I would get a bit more selective about the quality of my loan book, and I might start to raise rates on more risky loans. But absolutely the last thing I would do is drop my long lending rates any further.

So, as a guide, let's look at the long dated (30 year) yields.

Oops! Is that a "falling wedge" I'm seeing?

Now, what if the market - which is a super efficient machine designed to part us from our money - is just setting us up for a fall? Is this possible?

Absolutely it's possible. In fact, given the evidence above, I would venture to say that it's probable.

If yields (and long lending rates start to rise) this will have several probable consequences on a technical level:

  • It would probably validate all the "non confirmations" and cause the Dow Theory buy signal and all other similar buy signals to be proven as "false breakouts"
  • It would probably cause the US Dollar to bounce up from the support level of 80
  • A bounce up by the US Dollar from current levels would be very important according to the following chart
  • It would cause the PMO to bounce up from what could turn out to be a 17 year "double bottom"
  • It would penetrate a 3 year down trend line to the upside
  • It would yield a target of 90-100

But, c'mon Brian. "Everybody" - even Buffett - is unanimously agreed that the dollar has nowhere to go but down.

Yup! And on that response, I rest my case.

The markets are not designed for people like Mike to live out their dreams. Simply put, it's just not that easy.

And right about now, I reckon the market is about to teach us some powerfully important lessons about who is REALLY in charge around here.

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