Gold Fax Letter

August 10, 1997


"We do not now know, nor do I suspect can anyone know, whether current developments are part of a once or twice in a century phenomenon that will carry productivity trends nationally and globally to a new higher track, or whether we are merely observing some unusual variations within the context of an otherwise generally conventional business cycle expansion. The recent improvement in productivity could be just transitory, an artifact of a temporary surge in demand and output growth."
Alan Greenspan, Humphrey-Hawkins Testimony, July 1997

Despite the "New Era" euphoria which followed Chairman Greenspan's recent testimony, there is nothing to suggest that he has signed on to the ad astra per aspera or brave new world scenarios. This political nostrum of the Rubin/Clinton presidency, that we have achieved permanent prosperity and with the complete absence of inflation, permanent steady growth and full employment, is of course the mantra of Wall Steet and the armies of new investors who have mortgaged their homes and budgets in order to fling money at mutual funds. Very soon, no one over 35 years of age will have to work since they can easily live off their investments!

The euphoria of a stock market bubble does not consist merely in rising prices, which in any event we have had for 15, 17, or 22 years depending upon your preferred starting point. The essential element of any investment mania is the mindset which drives it, which is always and everywhere a combination of greed and a belief in the inevitability of wealth for those who believe. This mindset has only seen its public celebration and nearly universal acceptance within the past six to twelve months, and especially since the failed bear move of February to March of this year.

In my community I am approached by people who have never invested in the stock market, good people with modest and hard-earned savings who tell me proudly how they have made 10% on their mutual fund investments in the last 3 months and how it will help them meet retirement and other future goals. I have learned not to caution that what goes up can go down, since the look in their eyes is that of the religious convert.

A friend in Hawaii told me of his neighborhood's block party which featured a mock hanging of Chairman Greenspan in the wake of this "irrational exuberance" speech. His neighbors had, many of them, increased the mortgages on their homes in order to get rich in stocks and mutual funds. They most certainly did not want anyone to spoil the party.

This is the stuff of fin de siecle and millennial mania. We used to chuckle to hear of people walking away from their property in the years just before 1000 AD in the imminent expectation of the Second Coming of Christ. Now we have great numbers of people mortgaging their equity in home (and even autos, I am told) to invest at the top of a great bull market with the expectation of eternal and fabulous wealth.

Recently I received an urgent Email message from the organizer of a section for an important economics conference to be held in Canada next year. This section is to discuss the business cycle and longer economic cycles. The organizer was unable to line up any speakers or posters and had received much negative comment from academic and business economists to the effect that "that stuff is dead and buried."

Likewise, an important university-based Internet site devoted to the study of economic long waves has recently degenerated into an exchange of increasingly fractious messages as to whether the stock market will or will not go up forever.

If one reads Chairman Greenspan's recent comments carefully and quietly one finds that he has not bought the new paradigm. Clearly he does not wish to be hung, in effigy or otherwise, and so he chooses his words carefully, but even in the snippet above he says it is an open case whether we are in one of those few exceptions to the business cycle, wherein extraordinary productivity gains postpone the cycle's course, or whether we are merely at that stage before the takeoff in growth and inflation.

Have floating interest rates, unpegged foreign exchange rates, free capital flows, just-in-time inventory management, out-sourcing, timid labor captains, derivatives hedging, aggressive marketing, and a Pentium ™ computer on or under every desk permanently changed the way that human beings conduct their affairs and turned economic development upside down? Or are we merely seeing the economic and business response to the demands of the long decline from the hyper-growth and inflation years of the 1970's? And seeing it in its last efflorescence and triumph at that?

There is no doubt that each of these factors from interest rates to personal computers has enabled the dominant world economies to weather the disinflationary down wave of the economic cycle whose peak was in the mid 1970's. Instead of a synchronized worldwide collapse, as in the 1930's, both the US and the world economy saw the rolling recessions (or depressions, depending upon geography and life position), and the relative freedom of capital and of innovation in technology and finance cushioned the decline so deftly that many (again depending upon locale and economic position) failed to realize what had happened.

And yet if you were in agriculture in 1982-86 or in the "oil patch" earlier, or in real estate nearly everywhere from time to time, there was no doubt in your mind that times had changed, and not for the better. And if you are a union-organized worker or a middle class householder in the West, you are laughing to keep from crying when you hear about the amazing new prosperous era of permanent wealth and no inflation.

There is so little knowledge of the very fact of economic and business cycles or of where the world economy might now be within them, that even amongst those with the education and professional experience to gauge them correctly, there is a complete void of understanding. Nearly everyone with an interest in economic long waves (all twelve of them!) feels that we are at the verge of a deflationary economic collapse which will rival if not surpass that of the 1930's. Partly this reflects the somewhat muted down cycle discussed above, and partly it reflects the overwhelming influence of several very influential investment gurus whose professional careers have largely rested upon the notion that the US economy has reach its pinnacle, starting from its birth in the 18th century, and that it is destined to crash and burn.

Thus we have the linearist millennial hyper-optimists on the one hand, who see us on the road to Nirvana, and the crash and burn cycle school on the other who feel the Dow Jones Industrial Average will revert to triple (or double!) digits as the US economy dissolves.

And in the middle we have Chairman Greenspan and other members of the Federal Reserve Board whose recent comments all point to the reality of the situation, namely that we are at the trough of the growth without inflation cycle. As the economy continues to expand, as it is clearly doing—and expand nearly synchronously worldwide for the first time since the 1970's—we will see increases in prices of most things, from labor wages and benefits to raw and semi-finished materials to end products.

In short, in looking for historical parallels we are not in the early or late 1920's nor in the 1970's. We are in the mid 1940's. We are at the end of the disinflationary adjustment wave of the long economic cycle.

What are the tell-tale signs? One is the recent nearly universal fear that disinflation will turn to deflation. Those who have been through the down cycle think it will get worse and that the current improvement is transitory. I am always reminded of my grandfather who sailed through the bond bull market of the depression and up to 1946 and who always looked for the return of the depression, no matter how good things got to be.

In point of fact, the stock market crash which everyone expects ended in 1980, or, if you wish to quibble, in 1982. Look at an inflation-adjusted Dow Jones chart or a Dow to gold ratio chart if you doubt what was called the "invisible crash."

In point of fact, commodity prices bottomed at nearly identical levels ("double bottom") in 1986 and 1992.

In point of fact, interest rates bottomed at the short end in 1992 and at the long end in 1993.

In point of fact, the economy bottomed in 1992.

In point of fact, the "War" ended—the Cold War with its fallout in Russia and Germany—in 1991-1997.

We are at that point, in the US and in most of the world, where most of the problems of the prior cycle have been solved and where average citizens are weary of sacrifice for the common good and ready to share in the prosperity. We are at that period, as in 1945-46, when Churchill was rejected by British voters and returning US troops and the quiescent unions insisted upon their fair share.

What we can expect in the times ahead is actually quite clear: rising interest rates and prices of goods and real estate—which will shock the just-in-time inventoryists to their core—and a "period of re-adjustment" in the equity markets wherein in they learn to live with rising rates and prices once more. Given the prevailing sentiment which is expecting the opposite, the equity markets could experience a correction in time approaching that from 1946 to 1949/50. This will be as much due to unpreparedness for change as it will be due to gradually rising interest rates. No one will be prepared for rising demand for all manner of basic materials.


Last week I read a comment by a respected economist and bond market player that the US debt markets would for the first time in living memory see a yield curve inversion caused not by Federal Reserve actions but by the supreme confidence which the bond market has in the Fed's commitment to stamp out inflation completely EVEN AS M3 IS EXPLODING!!!!! I should point out that the spread between fed funds and the 30 year bond was only about 80 basis points at the moment. Friends and colleagues who would never be caught dead with a bond in their portfolios were rushing to load up as prices soared.

This week we have seen the beginning of this scenario of mine in real world events. From a technical perspective, the US long bond completed its correction upward of the bear market move of early 1996 off the double top with 1993. This correction ran in two waves from the July 1996 peak of nearly 7.25% to almost identical correction lows of 6.3%. Based upon standard technical projection techniques we can expect at least a test of the 8.1% level, corresponding to near par on the CBOT T Bond contract. The primary government dealers got stuck with (the last?) T bond at the auction on Thursday and were forced to unload it into a wary market. From Monday to Friday the long bond rate traveled from a low of 6.274 to a high of 6.666, corresponding to a CBOT Tbond range of 116-31/32 to 112-8/32! This is no bounce off the ceiling. This is akin to the chandelier falling to the ballroom floor.

And look at the no-brainer one way stock market. Despite waning momentum and many tell-tale signs of a top to those with eyes to see, the market groaned on up until the key reversal in most indices and derivatives on Thursday and the breakaway gap down on Friday. Some very large institutional players bought all the way down on Thursday and are still hemorrhaging badly, so I would expect a blitz on Globex on Sunday in an attempt to get a better exit price or even to attack the breakaway gap. The big boys and the "Dippies"—the bargain hunters who know no fear of a bear market-- will be in there with wallets bulging, buying with both hands.

But many simple trend-following measures, such as the adaptive or variable moving average—pioneered by Tushar Chande and Perry Kaufman among others—have turned down for the first time since April. And for the first time also, the closing price came below such averages. In addition, all manner of timing indicators from Fibonacci cycles with 1994 and 1996 bottoms to MACD's and conventional cycles say it's done for a while.

From the time of Jesse Livermore through that of Ralph Nelson Elliott, trading wisdom insists that major bull moves consist of "three pushes to the top." At this time we can identify three large pushes since the late 1994 lows of approximately equal traverse in the popular averages. The first, from late 1994 to February 1996 was approximately 13 months, the second from July 1996 to February 1997 was approximately 8 months, and the third, from April 1997 to this week was nearly 5 months, numbers which bring joy to Fibonacci enthusiasts. Even if you are not one, you will appreciate the speeding up or acceleration in this rocketing market. Add to that the measuring gap in the middle of the last thrust (in June) and you have the makings of a top as I warned last time out.

If this primitive wave analysis is correct, we could have a correction of the whole bull market from 1994 if not from much earlier. This fits with the long wave fundamental analysis ("funnymental", as Ed Seykota calls it) of section one which suggests we might be in a 1946-1950 phase of the long cycles.

And even lowly gold, which has nearly achieved its bathroom plumbing fixture destiny as foreseen by Lenin, and which is scorned by central bankers and beneath contempt or comment from everyone else, arose from the depths this week. Is it possible that the ultimate reserve asset, the floating paper issued by the US Treasury denominated in a currency which floats at the pleasure of the market, may have some competition? Not for the new breed of central bankers for whom rate of return exceeds all other considerations.

Nevertheless there were rumors from usually good sources both that it was George Soros and his Quantum Fund which bought the Australia Reserve Bank's hoard and was lifting his "Chinese hedge", but also that Goldman Sachs purchased up to 15,000 gold contracts on the Comex. (To be sure, others maintain that it was Korea or Russia which bought the RBA's gold.) The Philadelphia Gold & Silver Stock Index ( XAU) has meanwhile rocketed 20% since the RBA massacre.

If both my long and short range analysis is correct, we may at last be seeing the turn in the cycle. Now that the stock market has seen the best it can see on the horizon, we may be in one of those times when money comes out of over-valued equities and seeks out undervalued real estate and other physical assets. This is the great cycle of American wealth, from stocks to real estate and back again. You will note that the new tax bill favors long term holders of stocks and even has some interesting new real estate provisions for the first time in a long time. Is this merely a coincidence, or do most congressmen still have their ears, and wallets, bent by their local bankers?

Is it different this time? Has history, economics, and business—to say nothing of civilization—become linear and steadily progressive now and forevermore, or are we still subject to cycles in all things human as we have always been? I say cycles, which hopefully continue with an upward bias over long periods of time. Stay tuned.

GOLD FAXLETTER © 1997 IS PUBLISHED BY TENORIO RESEARCH & TRADING, DR. THOMAS DRAKE, EDITOR, 3 HAWTHORNE CIRCLE, SANTA FE, NM 87501. FAX: (505)989-3351. ANNUALSUBSCRIPTION: $250 for all Letters, Interim Bulletins, and all special reports.

Pure gold is so soft that a strong man can squeeze it and shape it.