first majestic silver

Not Happy

April 6, 2005

The proportion of mind space that this analyst has been paying to the US markets (which he typically only does in his spare time) is growing to become uncomfortably high. In itself, this is typically a sign that there may be significant changes afoot.

On March 10th 2005, I published an article on Gold Eagle entitled "Fool's Market".

Some weekly charts were presented, and the following represents a side by side comparison of some of those charts (courtesy Decisionpoint.com).

The most important conclusions to be drawn are as follows:

  • The bank index has given a serious "sell" signal, with 90 as the next support level
  • The PMO Oscillator on the Transports has given a "sell" signal from a high double top
  • The S&P Large Cap Index is resting on support of its 43 week Moving Average, having broken below its now downward pointing 17 week moving average

Within the banking sector, the one counter that I monitor from time to time is JP Morgan - for the primary reason that it is the "king" of derivatives.

Here is its ultra long term chart (courtesy bigcharts.com):

Over the past few months the OBV shows clear signs of selling pressure, and the chart has given the following "sell" signals:

  • Broke below its 48 month MA
  • Parabolic SAR gone negative
  • OBV uptrend line broken to the downside
  • MACD broke into negative territory

The reader's attention is drawn to the series of steeply declining red dots that commenced in 2000, and culminated in early 2004. (This series might best be described as "leg 1" of a Primary Bear Movement).

The steeply rising series of red dots from 2004 to two months ago, might be described as a "reaction" within a Primary Bear Market.

If these two descriptions are accurate, then the falling red dots of the past two or three months might represent the beginning of "leg 2" of the Primary Bear Market. If so, this is potentially very serious indeed. You see, leg 1 is quantifiable (very roughly) at 65-30 = $35.

Leg 2 (if indeed it is leg 2) could culminate anywhere between $20 and $10

I am not prepared to make this call yet because the picture is "too neat", and because the implications are too dramatic. But warning bells are starting to ring again.

A similar chart of Fannie Mae shows the following:

Although this chart looks particularly weak, it also looks particularly oversold, and may be ready for a bounce.

Further, the chart of Freddie Mac looks reasonable, but with some signs of selling pressure on the OBV, and an MACD sell signal having been recently given.

A really worrying chart is that of Walmart

Note how it has broken down from a triangle of indecision that has taken four years to complete, and note also how the breakdown took the price below its 48 month MA. Under normal circumstances, this would not necessarily be a cause for major concern, given that his happened 5 times since 2001 without a subsequent problem.

However, this time is certainly different because the 48 month MA is now no longer pointing up. (In fact it is now pointing downwards)

What does all this mean?

Well, if the backbone of the finance industry (in particular JPM) is looking very unhappy, and the largest player (ie the backbone) of the retail industry, is giving sell signals, there is cause for some real concern here.

To be fair, other important sectors - notably oil and housing - are not yet showing signs of weakening:

But to be equally objective, both of the above charts are looking seriously overbought.

About the only long term chart that I could find that is looking strong and is not (yet) showing signs of weakness, was the monthly Transportation Chart

But even here a pessimist might argue that the Transports are now bouncing down from a double top.

Finally, there was the "sensitised" P&F chart that I discovered two weeks ago (published earlier this week on Gold Eagle) of the ratio of gold to silver - which led to the conclusion that the markets are (as opposed to may be) at the edge of a period of unusual volatility.

Turning now to the Oil price.

What very few people are focussing on is that the primary limitation to increasing supply to the markets is not how much oil is "pumped", but how much oil is "refined".

Over the past couple of decades, insufficient refinery capacity has been added to PROCESS the current levels of demand - regardless of how much oil is pumped.

For the sake of argument, let us assume that China finds it impossible to satisfy her need for oil. What do we think will be the likely impact on her economy?

The following chart (Source: http://au.finance.yahoo.com/q?s=^SSEC&d=c&k=c1&p=m50,m200&t=my&l=on&z=m&q=l ), shows that (unlike the US market) the Chinese market has been pointing consistently down since mid 2001 - ie The US market has been benefiting at the expense of the Chinese market.

This begs the question: "what will happen to the Chinese market if the US market turns down seriously from this point?"

$100 oil is "unanimous" is it?

Well, how about something far worse than oil at $100 a barrel? How about oil at $30 a barrel, flowing from a collapse in industrial demand?

Note that the current move in oil started at $30, and note that the PMO is now at a "double top" level.

I am not seriously "calling" for such an outcome, but I am trained to consider ALL possibilities, and this is a possibility that is not only finite, it is reasonable. The ultimate reason that there is insufficient refinery capacity is that the builders of refineries - who absolutely know and understand how much oil there will be available to refine over the next (say) twenty years - concluded that there would be no purpose to be served in building refineries which could not be kept fully occupied for lack of supply.

So, if there is insufficient oil available, then it does not matter what price oil rises to, because industrial production will be experiencing a downward pressure through resource constraints.

And if production falls, volumes of products that find their way TO the markets will fall.

Who will be the beneficiaries of this state of affairs?

The charts are telling me that if oil (and consumer product) prices rise, the main beneficiaries of this (from a MARGIN perspective) will be the transport companies who will be in a position to blackmail the markets.

On the other hand, the charts are also telling me that the retailers may not have the pricing power to compensate for the twin pressures of rising costs and falling volumes of supply. i.e. Their profits will fall, regardless of "demand".

Ultimately, this is why we have our Insurance Policy in gold and gold shares. The Establishment Elite have been focussing for hundreds of years on the demand side of the equation, and have built "bullet proof" systems for stimulating consumer (and/or capital spending driven) demand.

But they have failed - miserably - to pay sufficient attention to the "supply" side of the equation.

They had the opportunity - with the Kyoto Protocols - to move to stimulate the development of substitute technologies, but they chose to fixate on oil and to "democratise" the Middle East instead, as well as drill for oil in Alaska.

That was a BIG (and unforgivable) mistake, flowing from which there will be serious consequences that may even lead to economic dislocation.

Summary and Conclusions

Where does this leave us?

  • The Markets are looking very unhappy, and there are technical arguments to support the conclusions that we may be facing a period of unusual volatility
  • The Chinese equity market has been telling us for some years that the US equity market rally was not destined to benefit the Rest of the World, and was merely therefore "technical" in nature.
  • The unanimity of commentators that oil may be headed for $100 a barrel, has a built in assumption that "ceteris will remain paribus" (that all things will remain equal); and the absence of refinery capacity is screaming at us that ceteris will most certainly NOT be paribus. In particular, if demand for oil cannot be met, industrial activity may (probably will) slow down which, in turn, will have SERIOUS flow on (economic multiplier) effects. In short, if you take $1 out of the economy at the source, it reduces GDP at the coal face by a multiple thereof. (This analyst has published previous articles on this subject in Gold Eagle that "prove" the argument that oil ultimately drives the world economy.)

Although gold is looking technically extremely overbought on the long term charts (and its PMO appears to be giving a sell signal), it is this analysts (personal and unsubstantiable) view that we might be entering a phase of financial history where previously proven "trading" techniques may no longer apply.

I apologise to readers for sounding so negative at this stage and, hopefully, I will turn out to be wrong.

Unfortunately, I believe I am looking at a confluence of events - backed up by some financial modelling spreadsheets which cannot be put into the public domain - which leave me little room for doubt that a slowdown in economic activity at this point may have some catastrophic consequences.

When all is said and done, it is "small business" that drives the economy at the margin, and the financial models show that an important segment of small business will not cope well with a downturn in the current economic environment.

I'm therefore sticking with my precious metals insurance policies, and the question that remains unanswered is:

How quickly can we bring
oil substitute technologies to market?

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