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Global Market Outlook

Equities Poised for Crash; Commodities Outlook Mixed

October 13, 1998

The outlook for U.S. and world equities was firmly bearish last week and we expect it to remain so for the balance of the year.

Commodities, however, are sending mixed signals, with some sectors still firmly entrenched in long-standing bearish trends, while others appear to be on the verge of beginning new bull markets. Due to the precarious state of domestic and global economic affairs, as well as the rapid spread of deflation, every market sector covered in GMO should be seen as tenuous at best. Entering long positions in those commodities that appear to have bottomed should be delayed until further confirmation is given by the markets.


U.S. equities markets entered the initial stages of what we consider to be a crash last week. While not reflected in the Dow Jones Industrials, other stock market indices showed tremendous weakness and experienced profound losses, while several important technical indicators were at levels seen only in times of severe sell-offs.

In a week that saw panic selling in the bond market and dollar index, all the major U.S. stock indices, with the exception of the Dow Jones Industrials, were off significantly from last week, including the NASDAQ, the S&P 500, the Russell 2000, the Value Line composite, and the Wilshire 5000.

Even more interesting was some of the internal action on the Dow Jones Industrial Average last week in what appeared to be a clear case of intervention on the part of "investment pools." Action on the Dow as measured by its Oct. 7 intraday chart showed what appeared clearly to be a classic case of investment "pool buying," where a cadre of high-powered investors attempt to influence or provide an artificial support to the market. This was evident from the smooth and powerful impulsive waves whenever the market tried to climb. But whenever the Dow tried to fall it was met with immediate and constant resistance as reflected by the extremely rippled look and shallow slope of its corrective (descending) waves. Meanwhile, the NASDAQ was slowly and steadily eroding over the course of the week along with, but to a lesser degree, the S&P 500. This highly unusual divergence of market indexes occurs only before significant downward moves in the broad market. Based on this occurrence alone we would be justified in expecting a market crash sometime this month.

Undoubtedly, there are those on Wall Street who, in their unbounded arrogance believe they can actually control and manipulate the market through such maneuvers as buying up index futures, or through large stock buy-backs on the part of major companies. Though such tactics do often have a temporary ameliorating effect (though "white wash" would be a more appropriate description), in the end they can do nothing to halt the ineluctable forces of the free market. In fact, any attempts at controlling the free market can only be made within the confines of the free market itself and under the principles which govern it (i.e., even if attempts are made at controlling the market they can ONLY be made by playing under the rules of the market—thus, the free market actually controls those who to try to control it). A beautiful pictorial example of this occurred last week under the circumstances mentioned above. Obvious attempts on the part of large, powerful investment pools were being made at halting the Dow's short-term decline. But all the while, a triangle pattern was being formed on the Dow's five-day chart. While the conspirators were trying to prevent an outright collapse of the Dow, they were actually guaranteeing its eventual demise and even exacerbating it by creating a massive price congestion of pent up "energy" waiting to escape (e.g., the triangle formation). So in the end, the market always has the last laugh over those who would control it.

More of the same type of action that characterized Wednesday was witness on the Thursday, Oct. 8 trading session. Every measure of internal strength showed a market in retreat and most of the stock indexes were down significantly. The Dow fell 274 points before staging a dramatic turnaround and finally close down only 10 points. Many traders were fooled by this action, especially as it was accompanied by some of the heaviest trading volume in Wall Street history. Ordinarily this would have been a buy signal and perhaps a sign the bottom was in place, but for those who closely follow the market it clearly wasn't anything of the sort; rather, it proved to be a confirmation of the major bear trend underway. This was ascertained by noting that the massive increase in volume began in only the first few hours of trade when the Dow was falling and before the Dow began its comeback; thus, it could not properly be considered a buy signal.

The Dow Jones Transportation index also served to confirm the major bear trend underway, falling more than 200 points over a two-day period last week, and finishing the week down a total of 176 points from last week (a considerable percentage for the Transports). This provided a Dow Theory divergence and pointed to yet lower numbers ahead for the Dow Industrials.

The Dow Jones Industrials chart has formed a rather large and uneven contracting, or symmetrical, triangle pattern with prices fast approaching the apex of the triangle. More often that not, symmetrical triangles are continuation patterns in which prices continue in the direction they were heading before the triangle formed (in this case, downward). But occasionally they may be considered reversal patterns. The question is, which type of pattern is this particular triangle—a continuation or a reversal formation?

The answer to this can be found in the pages of Technical Analysis and Stock Market Profits, a master work by the grandfather of classical technical analysis, Richard Schabacker. Writes Schabacker: "In the main, the most helpful indications [for determining the direction prices will head after breaking out of a symmetrical triangle] are generally those dealing with fundamentals, or at least with aspects not immediately present in the technical formation itself. How are earnings? What are the future prospects? What surprise news is possible in the stock [or stock index]? What is the future for general business? Is the technical position of other stocks, and of the general market itself, strong or weak? Such pertinent questions, while not all fundamental by any means, often give the correct answer to our technical problem as to whether a Symmetrical Triangle in process of formation is going to turn out to be a real reversal of technical trend, or merely a continuation formation (a temporary halt or congestion leading to a strong resumption of the previous trend)."

The answer to each of these questions makes abundantly clear the general outlook for the stock market and the business sector. The outlook is nothing short of dreadful, and most stocks are still tremendously overvalued and must return to more realistic levels before the "correction" can be considered over. That could take a while.

Asia & Russia

Meanwhile, in Japan the Nikkei index is performing exactly as we forecast in last week's GMO. Just today (Oct. 5) the Nikkei registered its lowest level in 12 years. It currently rests below the critical 13000 level. If Nikkei cannot find support above 13000 in the next few days then watch out below. Our forecast of a Nikkei 10000 before the end of the year may come true sooner than we think.

Again, we reiterate the urgency of Japan's predicament: As the veritable "hub" of the global economy, how this country fares economically will greatly impact the health of the entire global economy. With the Nikkei pointing downward and with the recession in Japan deepening into a depression, we expect to see general worldwide recessionary/depressionary conditions developing to a noticeable degree by the end of the year. This, of course, includes the United States.

Hong Kong's Hang Seng index has been in a consolidation period that can best be described as a "rectangle" formation under classical technical analysis. This pattern portends a sharp move to either the upside or downside upon completion. Its measuring implications are found by multiplying the number of times the line on the chart touches the upper and lower boundaries of the rectangle by the number of points between the support and resistance line that form the rectangle. That number is then added to the price level on the stock index at the time of the breakout from the rectangle. In this case, we can probably expect a sharp move of a few hundred points. Judging from its general trend and from recent market action we would expect this ultimate breakout to be to the downside. Thus, we predict a continuation of the bear trend for this index. Also, a larger head and shoulders continuation pattern seems to be in place which further presages a continuation of the falling trend this index has seen since 1997.

No need exists to comment in depth on Russia's stock market outlook. In a nutshell, the outlook is bleak. No sign exists on the immediate horizon that the bottom has been seen in its stock market, and until it is, the downtrend is firmly in place. Social, political, military and economic conditions in Russia can be expected to continue to deteriorate until its bear market is halted. Unfortunately, however, the ongoing bear market will only serve to exacerbate the breakdown in each of these aforementioned areas thereby compounding the country's problems.


For the first time since 1980, things are finally starting to look positive for the overall commodities sector. It may still be premature to say this, but we believe that the overall commodity sector, as measured by the CRB index, has nearly completed its long-term correction. Technically, commodities could begin a new leg of the bull market any time they want to—all the technical requirements for a correction have been completed.

The CRB spot commodities index monthly chart shows a nearly 62% correction from 1996 highs alone. A head and shoulders pattern that formed between 1994 and 1997 broke below the neckline and appears to have run its course.

Also, the Elliott Wave count from the 1996 "head" to the present numbers five complete waves, with waves one and three being approximately equal. Thus, from all technical measures, the minimum requirements for a bear market completion have been fulfilled.

Even more promising is the potential "V-bottom" shaping up on the CRB index daily chart, which provides further evidence of a major bottom already in place. An argument could also be made that this pattern is part of a larger head and shoulders reversal formation. In short, things haven't looked this good for the commodities sector in years. Keep your eyes glued to the CRB index in the coming weeks for further confirmation of a bottom.

And precious metals are facing a critical test—if gold cannot overcome overhead resistance at $300-$304/oz., little if any hope remains for a new bull market.


The long-standing "falling wedge" technical pattern we have pointed out on the 30-year U.S. T-bond's chart for the past several weeks finally broke to the upside just as we predicted. Bond yields are rising while prices are collapsing, thus ending the fabulous bull market in bonds for U.S. investors.

Look for a continuation of the falling trend over the next few weeks as bonds cease to become an international "safe haven" from collapsing equities markets. The Japanese, who are among the largest holders of Treasury bonds, have begun the long-awaited sell-off of their U.S. bond holdings and this does not bode well for the bond outlook. With the collapse of bonds and the U.S. dollar index, that leaves only gold as the last potential safe haven for world investors. If the gold market doesn't hold up in the face of this worldwide financial collapse, we know of nothing that will.

The candlestick chart for T-bonds looks particularly vicious. A breakaway gap formation has appeared on the chart which points to much lower prices in the near term. Immediate overhead resistance for the collapsing bond market is between 130 and 131. The next level of support comes between 124 and 126-08.


The downward trend in the U.S. dollar is accelerating and we expect the collapse in the dollar index to intensify in the coming weeks. Prices on the dollar index have been vacillating in a narrow range of late, but this should be viewed as nothing more than a consolidation phase that will shortly be resolved in a continuation of the newly established bearish trend. At the same time, a chart pattern that could be perceived as an obtuse "falling wedge"—a bullish pattern—appears to be forming in the candlestick chart of the dollar's future index. As well, a bullish "harami" candlestick pattern has formed on the chart, so these two factors could be pointing to a short upward rally before the overall falling trend re-commences. But any rally in this index will probably not last more than a couple of days before bearish sentiment once again asserts itself.

Eurodollar futures (basis March) on the CME have shown a slow, steady progression over the past couple of months and are in a bullish uptrend. The Eurodollar chart has given the bullish "all clear" signal for traders who want to go long.

Incidentally, Bert Dohmen, in the October of his excellent Wellington Letter made the following observation concerning the dollar's demise in connection with the upcoming introduction of the Euro:

The long-term chart of the U.S. dollar shows a wedge formation from which the chart broke to the downside. That is technically very negative behavior. This could suggest the start of a longer term top in the U.S. dollar. That would have the same important repercussions on many markets.

Note that…a long-term sell signal on the U.S. Dollar Index [has just been given]. These signals do not easily reverse. As you can see, over the past seven years those signals have been very important.

First of all we should ask what could cause such a sudden turn in the U.S. dollar. After discarding many of the commonly-given reasons, I can only conclude that the start of the European Monetary Union on January 1st next year could be the cause. The member countries, and all major corporations in the Union, will start using the EMU as their currency for contractual purposes and transacting business. Today, much of this business is probably done in U.S. dollars. In other words, the dollar's role in world financial trade would be diminished. There would be less demand for dollars, which would cause its value to weaken.

We completely agree with Dohmen's analysis and we have predicted for over a year now that the introduction of the Euro would, in fact, signify the end of the sovereignty of the U.S. Dollar among world currencies. Interesting times lie ahead.

The Canadian dollar appears to have made a "V-bottom" right in line with the overall CRB commodities index chart. This is unsurprising as Canada's dollar is commodity-based. Intermediate support is at 65.5 on the Canadian dollar index, so watch this level closely to see if it holds. Otherwise, things appear to be looking good for this extremely oversold currency.

Another currency that may have bottomed is the Japanese Yen, which shows a pattern on its chart similar to a V-bottom but less pronounced. The Yen appears to be consolidating right now, but as long as 72 holds as chart support, watch for higher levels ahead in the coming months. An upside penetration of 80 will give a strong buy signal.

Energy complex

The chart for crude oil (West Texas Intermediate) shows a clearly defined "head and shoulders" top that formed between 1995 and the present. Only in the past year has the pattern's neckline been broken. The oil complex has experienced a rally of late after several months of falling prices but we do not expect this bullish trend to last long.

For now, we are bearish-to-neutral this market.


Has the bottom finally been reached in gold's 19-year-old bear market?

Our answer to that question is that it is too early to tell but it is beginning to look like a possibility. The gold market is showing unmistakable signs of a turnaround that could witness in the coming weeks a bullish move to levels unseen since 1997.

From a technical standpoint, gold still needs a decisive close above $300/oz. to turn the trend from bearish to bullish, and it needs a close above the $312-$315/oz. level to signal the beginning of a major upward trend. Those levels, however, are well within reach and could be attained within the next two weeks. A penetration of these critical resistance levels will provide investors with a major buying signal.

Also from a technical perspective, gold's MACD indicator is on the verge of registering an important buy signal (though it hasn't quite given that signal yet). Also, gold's recent trip to $280/oz. did not witness any follow-through, which technically constitutes a strong sign that the downtrend—at least for now—may have ended.

From a fundamental standpoint, gold is definitely in the driver's seat as a form of monetary exchange. As currencies, bond markets, and stock market indices around the world collapse in a massive deflationary depression, gold stands above every other form of money as being free from the underlying fundamental weakness that currently plagues global markets. It is, after all, the only form of money that is not simultaneously someone else's liability. In short, gold is debt free and immune from crises in confidence, which is precisely the fundamental cause of the economic contagion presently enveloping the globe.

Gold's comeback from an atrocious-looking technical outlook began last month when gold futures registered what is known in Japanese candlestick parlance as a "harami" pattern on its candlestick chart. That bullish chart pattern, which formed at the bottom of a steep decline from a "contracting triangle" formation, signaled the beginning of an impressive (not to mention shocking) rise to its current levels, where it is testing the all-important $300/oz. mark. Indeed, gold must be given credit for bucking the bearish trend that has plagued it for the past year and for proving the gold bears (including us) wrong. While it still isn't official, gold does appear on the verge of registering a clear bullish buy signal. A decisive break above the $312-$315/oz. resistance level will give this signal. Otherwise, we could be witnessing another wave of falling prices.

Also, several leading gold mining stocks have registered bullish chart formations that could presage a larger upmove in the gold market as mining stocks often serve as proxies for the larger market. The XAU index, which measures the strength of the mining sector, is also beginning to look bullish.

Silver, however, is not looking quite so lustrous. The white metal has been in a downward spiral for several weeks now with no letup in sight.

Recent support at $5.00/oz. was broken and it is now headed full steam for $4.60/oz. or lower. Silver should stay under intense selling pressure throughout October and November but we believe a turnaround may be in store by year's end.

Silver's fundamental picture, in contrast to its recent technical outlook, holds promise. Silver dealers report record sells, especially to wholesalers, in the form of major buy programs. Widespread fear over the coming Year 2000 computing crisis (Y2K) is spurring a tremendous demand for silver non-numismatic coins (mainly in the form of Morgan silver dollars and U.S. 90% bullion coins) among the buying public in the face of large silver stock drawdowns, shrinking supply and falling prices—an remarkably rare set of economic conditions, to be sure. Many silver dealers anticipate that 1999 will see tremendous erosion in silver supplies accompanied by climbing prices as demand increases in the face of shrinking supply.

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy.  The forecasts are made using a unique proprietary blend of analytical methods involving cycles, internal momentum and moving average systems, as well as investor sentiment.  He is also the author of numerous books, including “2014: America’s Date With Destiny.” You can view all of Clif's books here. For more information visit

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