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'Hill Cows' And Other Myths

December 21, 2005

When my children were small, I used to tease them, a lot. Now they're all grown up and I still like to tease them. I guess old habits die hard. In order to pull their leg, I often took advantage of the fact that they possessed a blind faith with respect to anything I would say or do. If I said it, it had to be true. My favorite deceptions of all time always had something to do with cows. Don't ask me why, because I really don't have a clue. Maybe it has something to do with the fact that they just stand there all day long and chew their cud. Just a thought! During their formative years we lived on a farm where the surrounding land was quite hilly. One day I was feeling particularly mischievous and I called my son over to my side. "Stretch" (that's his nickname for which he's never forgiven me) I said "I want you to take a good look at those cows grazing in the field below. Do you notice anything different about those particular cows?" He studied the situation for a moment and admitted that he'd drawn a blank. "Well son, if you take a good, long look at them, you'll notice that their legs are shorter on one side of their body as compared to the other side." I didn't want to give him a chance to think about it so I continued "and that's because they are a rare breed of cow called 'hill cows'." Now that really caught his attention! "They are bred to live in mountainous territory similar to what you see around our house. A normal cow would topple over in a landscape like this, but not these babies. Most people, even farmers, don't know that such animals exist." With that last remark, I had him hook, line, and sinker!

I guess I had a cruel streak somewhere deep down, because I couldn't let it go at that. Some months later, I told him about "chocolate cows" and the truth about the top secret Nestles cows. "You see, as WW II broke out, the Swiss became worried about some on their important industries, and one of their biggest companies, Nestle, was extremely worried about a recent discovery. It seems in the late 30's they had developed a way to have cows produce chocolate milk straight from the udder." Genetic engineering at its best! "Anyway" I continued "they were worried the German's would invade Switzerland and help themselves to all the Nestles chocolate cows." I then went on to explain that the Swiss decided the best way to protect their discovery was to ship said cows to the US until the hostilities had terminated. And that is precisely what happened. In late 1940, plane loads of genetically altered "chocolate" cows arrived from Switzerland and they remained in the States until 1946. Upon their return, a grateful Swiss nation divulged the secret to the Hershey's company in the US and now Americans have chocolate cows as well. Great stuff, eh?

Good story, but what the hell does all this have to do with the stock market? Well, my children would eventually catch on. We lived in a farming community and their friends would delicately explain to them that their father was a few bricks shy of a full load. In today's world, the attitude of the average American, and in particular the average investor, is quite similar to the attitude my ten year old son possessed way back when. It's the attitude of blind faith, which sometimes flies in the face of reality. The only difference is that my son "grew up" and investors never quite seem to make that transition. As a group, they are content to live in the reality carved out by CNN and never dare to question the existence of the financial equivalent of hill cows. Here are just a few of the myths being fed to the public:

  • The economy is sound 
  • We live in a truly democratic society 
  • Debt is not an issue 
  • The war in Iraq is necessary and justifiable 
  • The US is too big to go broke 
  • There's no inflation 

And this one is my personal favorite:

  • This time it's different 

I could go on and on, but I think you get the idea. I guess we believe these things because it's a lot easier than trying to deal with the reality.

Some myths are acceptable, even admirable. Santa Claus always struck me as a truly wonderful and worthwhile myth. The Easter Bunny is also a good myth, but seems to have lost credibility over the last two or three decades. Others are regional, like Bigfoot, and really have little redeeming social value. Others are purely negative in their connotation and destructive in their nature. That's where the Federal Reserve fits in. The Fed policy, through the promotion of several self-serving 'myths', contains the seeds of the very economic destruction that its foundation was supposedly designed to prevent. The Fed came about as a result of the 1907 Depression which almost destroyed the U.S. financial system were it not for the efforts of one man, J. P. Morgan.

Over the last thirty years, I've lived all over the world: the U.S., Asia, Middle East, Europe, and Latin America. And I've learned one thing, religious and political beliefs aside, all human beings react in more or less the same fashion. Why is that you might ask? It's really quite simple. All human beings are driven by emotions, some more than others, and you can't escape it. Love and hate, greed and fear, hope and despair: these emotions have driven human beings (and financial markets) for thousands of years. That's why most people buy tops and sell bottoms, and that's why history seems to repeat itself. Man, in the final analysis, always falls back to his emotions and that, in turn, produces what appear to be cycles. I believe in cycles, I just don't believe you can time them to a certain amount of weeks, months, or years.

Complicated stuff these human beings! Take today for instance. We have the most powerful nation in the world, the United States, heading down a path toward self-destruction and doing it with blinders on. How will that end? There are no mysteries here, folks. It will end like it always has because human beings are going to react just as they always have when the proverbial feces hits the fan. The only thing to add is that technology, along with the unprecedented distortions that currently exist, will make it worse than anything currently imagined.

When all the problems finally float to the top, and our politicians act surprised, there will be a rush to do two things: avoid blame on the one hand, and assign blame on the other hand. It's unfortunate that this will be the case, i.e., the very people who created the myths responsible for the problems we now face will try to put themselves into a position of assigning blame. In my opinion, the assignation of blame has become the American way! It's much easier than recognizing the source of the problem and applying the appropriate solution. This time around though, I predict the outcome will be different. The very people responsible for all the problems we face will actually pay the price - you and I. That's right folks, we did it. You don't have to go any further than your mirror in order to find the ones responsible for the problems that we're about to confront. We wanted pork because it was easier than tightening our belt, and the folks running the show gave us pork by the truckloads.

How can this be, you might ask? Human nature being what it is, we took the easy way out. We decided to vote for people who told us exactly what we wanted to hear. How else can you explain George Bush? They told us that we could print all the money we want and never suffer any adverse effects, and they told us we could go as far into debt as we wanted and nothing would happen. From an intellectual standpoint, "chocolate cows" make more sense! My grandfather never made it past the second grade and couldn't read or write when he migrated to the U.S., but he wouldn't have bought these arguments for all the spaghetti in the world. Yet, we're infinitely better educated than he was, and we still fell for it like a ton of bricks. He knew that "cash was king" and he reminded me of that every chance he could. I can still hear him telling me in his thick Italian accent to "never go into debt". He built a small empire in the furniture and hardware business based on that concept. Pretty sharp for someone who never made it through grade school?

In conclusion, I see a severe storm warning and that warning is in the form of the greatest barometer of all, i.e., the price of gold. Against all odds, and most predictions, the price of gold closed at US$ 530.40 on Friday, December 9th. We could correct tomorrow, or we may just keep going. I don't know and neither does anyone else. The thing is, the warning flags are flying and no one is paying any attention. Think of it as the financial version of Katrina! When it was over, New Orleans was a ghost town. The difference is that this particular storm will engulf the entire country and leave no one unscathed. The type of social unrest that you saw in such a civilized country as France some weeks back will be the rule rather than the exception. The rule of law, and the Constitution, will be set aside and replaced by a rule of one. There will be curfews and you'll need a permit to cross a State or County line. Armed soldiers will be everywhere and they'll enter your house and confiscate property with impunity. It will be a sad state of affairs. I know, because I've lived it before.


Before we look at the individual markets, let's see where we were on January 1, 2005 a where we are now. It's always good to know where you've been in relation to where you are today. It makes projections of the future a tad easier:

market commentary Orlandini

Commodities have been the clear winners. Gold, silver, and oil have lapped the field while the bonds finished in last place and the DJIA wasn't much better.


Through out the year, the market has been highlighted by some strange events. Take the DJIA for instance, the top thirty stocks have a PER that has been fluctuating between 17 and 21. Clearly oversold by historical standards and yet we manage to maintain that level. The average dividend paid has hovered around 1.7%; again, historically very low. Another piece of trivia for your scrapbook: throughout the year the average real savings rate has been declining and recently fell below zero. I'm not old enough to have experienced the Depression, but I don't remember a negative rate of real savings in my life time. Finally, we come to the coup de grace. In Dow Theory parlance it's called "non-confirmation" and it's really quite interesting to study.

A non-confirmation occurs when the either the DJIA, or the Dow Jones Transportation Average, makes a new high (or low) and the other fails to do so. If you look at the chart of the Transportation Average below, you'll see that it broke above its March highs in late October and, until recently, has continued to rise. The S & P 500 was even stronger, breaking above its March highs in early August. To date, seven weeks later with respect to the Transports, the DJIA has yet to confirm. Given the high PER and miniscule dividend currently being paid, I really don't see how it can confirm. There are numerous proponents of the "this time it's different" crowd who feel otherwise. They hang there hat on the argument that the market, better yet the world, is flooded with liquidity. Quite true, but someone has to want that liquidity and I don't see corporations standing in line to borrow money. Likewise, consumers and home buyers are pulling in their horns. In short, you can print money until the cows come home (no pun intended) but if no one wants it, it won't make a bit of difference.

Dow Jones Chart

Finally, observe that the last new high in the Transportation Index was in itself unconfirmed by RSI and MACD. Too, I can't help but mention that the Transports are trading close to 30% above the 200-w.m.a. and that is astounding. If that were gold, everybody and their brother would be selling it short. Isn't it strange how perspectives can change from one market to another? In closing, it is my opinion that we are currently at unsustainable levels in all three of the above mentioned averages and the fall from grace will occur sooner rather than later. A confirmation of that would occur with a close below 10,486 in the March DJIA futures contract.

US Dollar

I want you to pay particular attention to what I have to say about the U.S. dollar and where it will trade from here on out. When the US Dollar Index failed to make a new low back in March of this year, I took that as a sign that we were going to begin a Bear Market rally that would take us up to 92.00 and maybe even 96.00. That wasn't a very popular stance at the time because everybody, and I mean everybody, was short the dollar. Well I'm sure you're sick of hearing this by now, but "everybody" is almost always wrong. Sure enough, in October the Dollar Index hit 92.00. We actually managed to close marginally above 92.00 on two separate non-consecutive occasions. Please note the italicized word non-consecutive in the last sentence, because it is quite important and it's the building block for just about everything I'm going to say from here on out.

When you rally, and it usually doesn't matter if it's a secondary Bear market rally or a primary Bull Market rally, you always pay particular attention to how a stock, Index, or Average behaves when it reaches major points of resistance. With respect to the U.S. Dollar Index, 92.00 was and continues to be a major point of resistance. Therefore, when we hit 92.00 in October, I was glued to my screen looking for an indication of the next move, i.e., either a continuation on up to 96.00 or a top and a trip down to the old lows of 81.00. Day after day for weeks, we hovered around 92.00, almost always closing below that number. Finally we did manage to close marginally above it in mid-November, but the next day it fell back below it. When looking for signs of a continuation in a move, you always want consecutive closes above the pivot point. Myself, I like to see three consecutive closes above a target in order to have a real comfort level. That never happened, although we did manage another marginal close above 92.00 a week or so later. Again, it failed and we headed down. At that point, I covered my long positions and took a seat on the sidelines waiting for clarification.

A look below at the weekly chart of the U.S. Dollar Index also shows us a couple of other very interesting observations:

When the Index broke to new highs in October, the RSI, MACD, and the stochastics all failed to confirm. Combine all of this with the fact that just about everybody is now bullish the dollar, and you don't have to hit me over the head with a shovel in order to get me to see that the worm has turned. In short, the dollar has topped and 92.00 was a bridge too far.

On Monday, I advised my clients that I had actually gotten off the fence and had gone short the U.S. Dollar Index with a small position. Again, please pay attention to the italicized word small. I didn't jump in with both feet because I want to see confirmation. For me, confirmation involves a close below 89.03 and I won't go off the deep end until I see two to three consecutive closes below that number. Something tells though that I won't have to wait too long. On Friday, the MARCH US$ INDEX closed at 89.54 and that's below the level that we broke out from. Not a bullish omen if you ask me. Finally, the dollar is still quite overbought and I wouldn't be surprised to see a test of the 50-w.m.a. (87.12) before to long.

What could support the dollar and make me cover my short position? I believe it hasn't been so much a case of a dollar rally as it's been a case of a Euro decline. Things aren't going too well in Europe as politically they drift more to the right and economically they stagnate at a faster pace than the U.S. Over the short run, the Euro has appeared less desirable than the dollar and that's been the key to this rally. A move back above 91.02, on a closing basis, would be an indication that I'm wrong and we're going to at least test the 92.00 level again. Honestly, I don't think that's in the cards any more.


The picture here is a bit murkier as compared to the dollar. A look at the Weekly Bond chart below doesn't shed a lot of light but there are certain clues that we can pick up:

Enrico Orlandini bonds chart

The bonds rallied nicely form the June 2004 low to the June 2005 highs. An attempt in September to make a higher high failed and we can spot a rather grotesque head-and-shoulders formation with a sharply ascending neckline. We are now trading below that neckline and that's usually bearish. Since the June top, we've made a series of lower highs and lower lows. Also bearish! A glance at RSI and the Stochastics paints a neutral picture while MACD is only slightly oversold. No help there.

Just this week, the Fed came out and changed the wording in their statement to imply that further rate hikes may not be necessary and this supposedly will change the course of mankind (not really, I'm being facetious). The bond rallied, but in my opinion not like they should have. Personally, I think smart money took this as an opportunity to exit long positions, i.e., they sold the good news. This coming week's action should be the key although it's always difficult to tell during the holidays. In short, this picture is a clear as mud! In spite of that, I believe that we are distributing here and eventually we will fall down through the 200-w.m.a. at 110.08, and then test support at 109.04. With that in mind, I took a small short position in bonds a week ago and will stay that way unless I see a close above 113.12. It is my opinion that interest rates will have to rise in order to compensate for the price inflation which appears to be breaking out. Recent resurgences in grains, cotton, and lumber give some credence to the concept of price inflation that was lacking before. That doesn't mean the economy is gaining strength, because it isn't. Stagflation is the name of this game as far as I can tell.


I took my profits on Thursday night and exited my long position in the oil futures contracts. I really felt that the lack of follow through on Wednesday and Thursday was crucial. The rally stopped right where you would have expected it to stop, i.e. 61.80, if we are to turn down. Tuesday's high just happened to be 61.90. A look at a six-month Daily Chart of Oil allows us to focus on several interesting points:

Orlandini Oil chart

There isn't really too much for the bulls to hang their hat on here. We are neither oversold nor overbought at this point in time (not shown). Also we have spent three and a half months tracing out a series of lower highs and lower lows. Not at all bullish! Finally, on Friday we fell like a stone down through the 60.00 area where the break-out occurred just days before. We ended the week at 58.06. I suspect that, at the very least, we'll see a retest of good support at 55.70. In the meantime, I am quite bullish on oil but sitting on the sidelines looking for the fog to lift.


If you want the real truth behind the Bull Market in gold, take a look at the monthly chart below (November is not yet included):

Gold price chart

In any dictionary, in any language, when you go to look up the definition of "bull market", this chart should be included. It is unrelenting, unyielding, and persistent (yes, I know I'm being repetitive). If November and December were included in the above chart, you would note that we've recently broken above the 1987 highs and the gold price is now well above the 14 month moving average. Without a doubt, we are extremely overbought.

For months, I had been calling for a 489.00 top. When we hit 489.00, I modified my projections to include a 512.00 top. I also said that three consecutive closes above 512.00 would indicate to me that gold is reacting to very serious problems that it sees in the almost immediate future. That's happened, and I stick by my forecast: something is seriously wrong and we're about to get our comeuppance.

Gold reached an intraday high of 544.50 on December 12th and then began to decline, hard. Four days later, on December 16th, we saw a 496.20 intraday print, followed by a ten dollar rally and a close of 505.90. Everyone and their brother is now calling for a top and a subsequent significant correction to as low as 465.00, depending on the analyst. Remember what I told you about "everybody". I don't think this time will be any different. It is my belief that we'll see one of two scenarios: the 496.20 bottom was the end of a four day countertrend move down and now we'll see a resumption of the upward movement, or well see a low of 485.00 over the next week or so and then a resumption of the move up. Either way, we work off an overbought condition and surprise the Bears yet again.


This is a much tougher nut to crack as the big boys play some serious games with silver. It's not for the faint of heart. Even so, a look at the following Monthly Chart of silver paints a similar picture:

silver price chart

Again, the months of November and December aren't included or you would see the 934.50 top registered on December 12th. Shortly there after, I advised my clients that I covered 75% of my long silver future contracts. I commented that I could see a low of 800.00 when I looked at the chart. I am the first to admit that I don't have a good comfort level with silver and that's part of the reason I balk so easily. Silver can head south so easily that it is frightening.

In spite of my fears, I am still quite bullish on silver. Unlike previous rallies, I will sit tight on a position, wait for a resumption of the primary trend up, and buy some more. The key support levels to watch are 865.10, 856.60, 847.00, 819.70, and finally 792.60. My bet for a bottom would be 819.70 (basis the February contract). I realize that's a long way down from 934.50 but you have to realize that silver is a very volatile market; day in and day out, perhaps the most volatile of all the futures markets. Get use to it, because it won't get any easier.

Gold Stocks

For the most part, the HUI hasn't been a willing participant of the decline off the highs in gold. I suspect that a correction in the HUI could take us to a low of 245.00, which is where we broke out from. As all of you know by now, I have carefully avoided the purchase of juniors for well over a year. I prefer the Blue Chips. I did so because I was looking for two things in a stock: a decent balance sheet and dividend potential. A stock like Goldcorp. (GG) gives me the best of both worlds with eleven straight monthly dividend checks and a share price appreciation in access of 50%. Given what I've observed with companies like Samex, Golden Star, and others, I see no reason to change my position. I am 85% invested in Buenaventura, Coeur D'Alene, Goldcorp, Glamis, Newmont, and Royal Gold and will stay that way. While most of you insist in trading the 'tops' and 'bottoms', I demure. I will ride out any and all corrections just as I have for the last year and a half.

Enrico Orlandini

Website : Dow Theory Analysis

Dow Theory Analysis S.A.C.

Lima, Peru

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