first majestic silver

Taylor on us Markets & Gold

June 18, 2002

Lets Get this Capitulation Thing Over with so the Bull Will Return

Weeks after the U.S. market topped out in March of 2000, the talking heads on CNBC frequently talked about CAPITULATION. It was obvious the perma-bulls on that network, who had never experienced capitulation in the stock market heard that they had to go through that before the bull could resume his upward thrust to 30000 on the Dow? Or was that 100000? And whenever you had a down day or two, you would hear the talking heads rush out to say something like, we must be near the bottom. Then they would give all sorts of reasons to believe the worst was over and happy days were just around the corner. So keep on pumping your 401-K money into stocks because in the long run you can't lose in the stock market.

Well as someone who lived through the last bear market in stocks as well as a 21-year bear market in gold, I can tell you that in this market downturn, we have not begun to see anything close to a true market capitulation. Capitulation of the bulls means that everyone who was bullish has given up that belief. They have thrown their hands up in the air in despair and have acknowledged the bears were right in fact right. And as for stocks, their emotions will tell them they never want to own them again. And on the way to this emotional state of despair, most investors will have had to call their brokers and issues a mandate to "get me out at any price. I don't care what you get for my shares. Just sell, sell, sell! I never want to own stocks again! THAT IS WHAT CAPITUALTION IN THE STOCK MAREKT IS AND WE HAVE NOT EVEN COME CLOSE TO AN EMOTIONAL STATE LIKE THAT IN THIS MARKET DOWNTURN. Which leads me to agree with Richard Russell that we are most likely still in a very early stage of a bear market in stocks.

As a 55-year old man, I have witnessed capitulation in the stock market that culminated during the 1981-82 bear market. Likewise, I have witnessed it in the gold market, especially during the late 1990's when the U.S. Treasury and the crony capitalist friends of our Government trashed the gold price and became rich in the process. I know what capitulation feels like because I have been there and done that! The vast majority of investors and fund managers these days have never experienced capitulation. I believe they are about to get a man sized does of that old time religion.

Another mark of capitulation having taken place is that so much selling has taken place that once again very high quality companies can be purchased at truly bargain basement prices. Remember how when the tech lost 30% or 40% from their peaks how people tried to sell them on the notion that they were cheap! Well they were still very expensive because they had no earnings. What makes a stock cheap is its earnings in relation to its price. In our book and at market bottoms, the strongest and best companies in America usually sell at PE ratios in the 5 to 10 range and pay dividends in the 5% to 10% range. When our Dow stocks reach those depressed levels, we might start to get interested in big cap stocks. Until then, we will stay on the sidelines or better yet short the market via the Prudent Bear Fund. In fact, we are looking forward to a true market bottom when PE ratios are so, so low because that is when historically real bull markets start. However, don't hold your breath because we think we are still very early in this primary bear market for stocks. We could be looking at 5 to 10 years or longer before big cap stocks in American stocks suitable for purchase. By that time, all those pretty faces on CNBC will have found something else to do like drive a cab or worse.

How do I know we are so far yet from a market bottom? Because stocks are still so expensive. Rather than a PE ratio of 5 or 10 times, the S&P 500 is still selling at about 44 times earnings. That equates into a still paltry earnings yield 2.32%. And while 10-year Treasury yields have come down, as of the close of business on Friday, it still provided a yield of 4.80%. If you add AAA corporate yields, you are comfortably above 5% which his more than twice the returns provided by the S&P 500. Historically, buying stocks when they are so much more expensive that bonds has not been a good long term strategy.

Why such complacency?

Why are stocks remaining so grossly overvalued? Indeed, the veteran analyst Richard Russell has repeatedly expressed amazement at the stubborn refusal on the part of investors to throw in the towel, even though stocks are now in their third annual decline and the stock market has shaved off $5 TRILLION of value. Richard who is in his 70's and as smart and observant as any analyst alive, says he has never seen anything like the complacency on the part of investors in America. It is astounding to him that the Dow has hung up as well as it has.

I think a hint at the reason the masses of people have remained complacent about the market can be gleaned from the following comments of our friend Bill Murphy, who writing for www.lemetropolecafe commented about Fridays action in the gold, dollar and stock markets as follows:

"The stock market was crashing, the dollar was tagged and gold was flying. All of a sudden (at exactly the same time) gold sank, the dollar rebounded and the stock market staged a fierce rally. You would have to be brain dead not to see the market intervention, engineered by the Working Group on Financial Markets.

"The NASDOG even closed higher after foreign stock markets were trashed due to the poor U.S. economic news. Once again, the stock market was not allowed to tank two days in a row, the goons capped gold's upside. What are they doing to our country? All the PPT keeps doing is prolonging the inevitable and increasing the moral hazard risk of the investing public. The public won't know what hit them when the "S" hits the fan."

There have been repeated reports from floor traders, ever since the near total meltdown of the equity markets in 1987, that major broker/dealer firms (The same ones named as defendants in Reginald Howe's anti gold price fixing case) have stepped into the market in just a nick of time to keep the market from plunging over Niagara Falls. Just as "melt down" first appears as handwriting on the wall, suddenly out of now where steps amazing buying in the futures markets to stave off disaster. And with disaster having been prevented time and time again the fear of God has been removed from the market. Lacking fear, the current market decline is taking much longer than in prior super bear markets.

The Mood Now Seems to Be Changing

Timely market intervention that has keep the market from plunging quickly to the depths of despair has helped keep people bullish for a much longer period of time than would other wise be the case. However, the primary bear market that we are in has been slow and relentless, like a Chinese water torture. It seems now that investors are finally becoming demoralized. At least that is the sense I get in talking to New Yorkers. Only a few weeks ago, these same people would treat your editor with utter contempt when I said sell stocks and buy gold. That mood is changing now. Now I get a mood like "you know, you just might be right." Still that is a long ways from capitulation. When the bear market has done his maximum damage there will be no ambivalence. "Get me out of stocks. I never want to own them again." That combined with amazing values (Earnings yields) is what I look forward to. Then I can once again become a card carrying "good American" instead of a person who is looked at as being un-American because I don't buy the lies being told by our self serving establishment.


During the bull market, analysts spoke of how higher stock prices were predicting a booming economy. Why is it now that when stocks are in decline those same people are no longer suggesting that the stock market has predictive power? Rather now they are suggesting that the stock market should be going up because of historical data indicating the economy has been improving. As Richard Russell proclaimed last week, "…the market doesn't give a hoot in hell about yesterday's economic statistics and reports, the market is only interested in what lies ahead in the way of economic, social and political conditions. And I can tell you that this market DOES NOT LIKE WHAT IT SEES AHEAD."

In deed, we think a lower stock market is even more ominous given that an unprecedented number of rate cuts have not only failed to fuel higher stock prices, but in fact after the Fed began easing, stock prices are DOWN 20%. As Barron's pointed out last week, in the past a mere 18 months after Fed easing, stocks are usually UP 20%. THE ONLY OTHER TIME THIS KIND OF THING HAS HAPPENED WAS DURING THE GREAT DEPRESSION!

We Told You So

Notwithstanding what CNBC and highly paid analysts like Abby Joseph Cohen have been telling investors, subscribers to J Taylor's Gold & Technology Stocks are not surprised. Ian Gordon, David Tice Dr. Ravi Batra, Congressman Ron Paul, M.D., Dr. Larry Parks, your's truly and others have warned our subscribers that the U.S. was approaching a period of time when excessive money creation would inevitably lead to an economic and market disaster. That disaster is now in the early stages of unfolding.

Ian Gordon, who is the foremost student of the Kondratieff Cycles warned us in 1999 that we were quickly approaching a period of time he labeled the Kondratieff Winter. This is the last of four seasons in the 60 to 70 year Kondratieff cycle in which debt that has built up from the start of the cycle must be repudiated, because it has grown exponentially to such an extent that it can no longer be paid. It is the unraveling of this debt that leads to massive bankruptcies, unprecedented levels of unemployment and depression.

There is a general belief that all Greenspan needs to do is print enough money so that he can inflate the debt away. But this is not possible because in a fractional reserve banking system like the one we have, money is manufactured from debt. But debt is the problem because its exponential growth results in the suffocation of the demand side of the economy as income is siphoned off from the economy to repay principle and interest. So the cure is worse than the disease. It is like a heroin addict reducing withdrawal pains by taking higher an higher doses of heroin at ever more frequent intervals. Eventually the patient dies as the life support systems are destroyed. The life support system of business depends on sales. But when income levels are snuffed out by ever increasing interest and principle payments, a threshold of lethality is met in the economy at which point the economy collapses. I believe the U.S. is at or very nearly at that point. And what could tip us over the edge could be the outflow of investment dollars into the U.S. that allowed us to live beyond our means all through the 1990s.

Why would that happen? The reason is the reason foreign money came into the U.S. in the first place - for high returns - is now fading out of sight. Take a way the $1.3 billion per day investment fix from foreigners that the U.S. economy has become addicted to and watch interest rates rise. If you think we have trouble meeting our debt obligations now, watch what happens when rising interest rates cause stock prices to plunge, people to spend less and debtors to begin defaulting at accelerated rates.


In our 1999 interview with Ian Gordon he suggested that the last Kondratieff Winter, which began with the 1929 stock market crash and ended in 1949, was repeating itself with great accuracy. And as I look at the current economic landscape, I have to agree. Consider the similarities now with 1929.

  • A major decline in stock prices. (Nasdaq, S&P, Dow show yet to drop)
  • The printing of more money (lowering of interest rates) is failing to revive stock prices.
  • The printing of more money is failing to stimulate the economy.
  • We see a beggar thy neighbor foreign currency de-valuation policy on the part of most nations hoping that a lower currency will allow them to sell into the U.S.
  • We have the spectacle of rising trade barriers, this time fueled by the United States in the areas of agriculture and steel.
  • We have a U.S. dollar that is grossly overvalued just as the pound sterling was overvalued during the 1930's.
  • You have a gold market that was being rigged in order to maintain an overvalued pound sterling. Now we have a gold market that is being rigged in order to maintain a phony overvaluation of the dollar.
  • We have excess supplies of all kinds of goods and services.
  • We have excessive debt loads that are strangling the demand side of the economy.

The problem in one word is DEBT. Notwithstanding what the Keynesians and Monetarists have told college kids since the 1930's, there is a limit of debt which a nation can endure. I fear the United States is approaching its debt threshold of lethality.

The Macro Economic Picture Remains Bleak

We have too much supply of everything imaginable as a result of the excessive money creation and globalization of the 1990's. At the same time we are faced with declining demand as debt servicing requirements is subtracting income out of the demand side of the economy. The result? Revenues are falling short of expectations and profit margins are plunging. And guess what. So are profits. This is not a very good picture for a stock market that continues to sell at historically high P/E multiples.

With profits declining or remaining at best lackluster, we cannot expect the capital goods sector to begin to grow anywhere fast enough to revive the high tech bubble economy any time soon. And with companies having cut every where possible, the only place left for CEO's to cut is labor. So as Stephen Roach of Morgan Stanley has been suggesting, the next shoe to drop may well be consumer spending as wages and jobs come under pressure. Plunging consumer confidence (from a 96.9 reading in May to 90.8 in June) represented the largest decline since a 9.7 point fall in September 2001. This could be the start a decline in the consumer sector. As in the stock market, the continued refrain that "prosperity is right around the corner" along with job losses and pay cuts may be wearing thin on an American consumer that has for quite some time been spending more than he earns.

And with return on investment now nearly what it was cracked up to be by the "New Economy" fantasies of the 1990's, foreigners are beginning to take their savings out of the U.S. which is resulting in downward pressure on the dollar. The virtuous cycle that worked in favor of the U.S. during the 1990's is now suddenly working against us. This is why we think the dollar and stock prices are headed much, much lower. And this is why our Model Portfolio, which is up 53.96% so far this year, is positioned to benefit from:

  • Declining Stock prices. (The Prudent Bear Fund)
  • A declining dollar. (The Prudent Safe Harbor Fund)
  • A rising gold price (Gold Shares)
  • Rising Commodity prices (vis-à-vis the dollar) -Jim Rogers Raw Materials Fund.
  • Tech companies that can produce ESSENTIAL good and services at lower and lower costs. So we think companies like Itronics, which is reducing the cost of food production and McKenzie Bay, which is on the cusp of reducing the cost of energy, are the only kind of technology companies we wish to own.

The $330 level is indeed representing at least a temporary resistance level for gold. However, the action this past week was very encouraging for bulls and I think very constructive from a technical view-point. Spot gold closed at $319 in New York and as such, remains slightly above its 22-year down trend line and above both the 50-day moving average of $310.85 and the 200-day moving average of $290.78.

From a fundamental viewpoint, the dollar continued to weaken last week despite yen intervention. The dollar closed at 110.80. We think the dollar is likely to continue to decline in value because we believe the U.S. economy will continue to disappoint as it did last week when May retail sales fell 0.4%. Evidence that Ian Gordon's Kondratieff winter continues to play out was also seen in a decline of 0.2% in the Producer Price Index. During the past year, the PPI is down from 142.4 to 138.8 or 2.5%. That's DEFLATION, in DISINFLATION! And that is exactly what Ian Gordon has been warning us about. And this is why Alan Greenspan has been warning about a lack of pricing power. And this is why we think Morgan Stanley's economist, Stephen Roach is quite right to be concerned that continued decline in corporate profits may well lead to the next shoe dropping, that shoe being the consumer. Wage pressure is bound to build as corporations continue to face going out of business pressures due to plummeting profitability. As far as demand for capital spending, forget about that if corporate profits continue to decline.

And even if we are fortunate enough to see some growth in corporate profits and in the economy in general, can there be any doubt that the U.S. stock market and investment returns in general will remain far below past expectations for many years to come? And if lofty returns are not available any longer in the U.S. why would foreigners continue to pump the $1.3 billion per day they earn from their trade surplus with the U.S. back into the U.S. in the form of investments?

So we find it difficult to think the dollar can remain strong as the New Economy myths and the myths of a strong dollar are exposed for the frauds they were are espoused to the world. This should lead to a weaker dollar which in turn should be bullish for gold.

A Short Term Bullish Indicator for Gold

I tend to take a long term view on gold as well as other markets. So, normally I don't spend a lot of time thinking about short-term technical indicators. However, my good friend Chuck Cohen has brought to my attention the Hulbert Financial Digest's gold sentiment index, which appears to be very bullish at the moment from a contrarian viewpoint.

As of This past Tuesday, the index posted a reading of 29.2%. This latest reading, which reflects gold timers' opinions as of the close of business this past Tuesday, means that the average gold timer tracked by Hulbert, is allocating more than 70% of his portfolio to cash.

The index had risen to 45.3% in early June as gold rallied to near $330 - a level not seen in years. But in the face of gold's correction over recent days, gold timers quickly pulled back. In fact, the Hulbert gold sentiment index is now back to where it stood in mid-May, well before the latest leg of gold's bull market.

Why is this high cash/gold ratio so bullish?

First, with gold timers so quick to retreat it suggests that they don't believe we are really in a bull market. Thus they have significant resources which can be redeployed in gold purchases upon a sentiment change. This is an emotion common to the early stages of a bull market and is in direct contrast to what we are seeing in the stock market which is at the end of a long bull market.

Mark Hulbert noted that his gold index is now no higher than it was a month ago when gold was more than $12 lower in price. And even more bullish is the fact that as gold has risen, signs of extreme bullishness are no where to be found. Back in January when gold rose above $300, gold timers went wild, sending the index to 90%, more than three times its current reading. So even when gold approached $330, sentiment was only about ½ where it was back in January. All this according to Mark Hulbert suggests that "the contrarian foundation of gold's bull market remains as strong as ever."

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