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Why Hasn't "IT" Happened Yet?

September 19, 2006

To listen to the Bears over the past few years, you would have thought we would all be in breadlines and soup kitchens by now. So far, all of the ranting about doom and gloom sounds more like the boy who cried wolf than accurate forecasting. But I do believe that when IT happens, things are going to get much worse than anyone can imagine. Even though the markets, at their lows in March of 2003 had lost over $6 trillion of value; that was not IT.

What is IT? Why hasn't IT happened and When will it happen?

IT is a major financial melt down followed by an economic contraction. IT is sudden and sharp downward spiral that takes everything down with it. IT will be started by a catalyst, a spark that will get everybody's attention. But IT is already built into the system, like a bunch of oily rags, all in a pile just waiting for internal combustion or a match or a spark to ignite IT. Some of the candidates for the catalyst include the following:

  • Crash of the Dollar
  • Stock Market Crash
  • Derivative meltdown at a major bank
  • Nuclear terrorist attack
  • Major terrorist attack on the US ( Bio or Chemical)
  • Major Corporate Debt Default
  • Major Municipal or State Default
  • Foreign Dumping or simply a refusal to continue buying US Treasuries

These are the matches. By themselves, most can be easily weathered. But when combined with the poor underlying fundamentals of the economy and stock market, such as $800Billion Trade and $600 Billion budget deficits, sitting on top a mountain of unfunded pension and medical liabilities; then IT can turn into an inferno.

Below are some of the oily rags just waiting to ignite.

  • Massive amounts of derivatives ($90 + Trillion)
  • Over valuation of the Dollar
  • Overvalued stock Mrket (19 times last 12 months earnings is overvaluation)
  • Massive build up of debt
  • Record Low % cash levels in mutual funds
  • Massive build up of personal debt
  • Under-funded pensions (Gov. & Private)
  • Housing bubble ?
  • Deflation or Inflation
  • Municipal and State deficits

But one thing for sure, IT will not happen as every body expects. Some are waiting to see the writing on the wall, Most want to see the fire before they will believe there is danger. Things haven't really changed that much over the past 3 years. Investor attitudes are much too complacent. They see nothing to worry about. Yet Liabilities have been outpacing income for sixl years: Since Year 2000, income growth has slowed while expenses have continued to accelerate.

So why hasn't IT happened yet? Thus far the Fed has succeeded in playing Fire Chief and kept pouring liquidity into the system. But the Fed CAN NOT keep the money and credit spigots wide open indefinitely: After all, is that not the definition of inflation? All they are doing is delaying the inevitable, not curing it. Adding liquidity is only making our future economic problems worse. It's the same as adding tons of kindling in time of drought. Excessive liquidity was the main cause of the 90's Bubble in the first place and for that matter, every other bubble throughout history. The Crash in 1987 came as a shocker: But Fire Chief Greenspan and his liquidity hose were on the phone to the banks and brokers offering unlimited credit to any institution that needed it. He saved a melt down with five minuets to spare. The downturn in 1997 was again saved by Allan and his liquidity hose. In 1998, the Long Term Capital Management debacle caught everyone flat-footed; once again along came the Fed to the rescue.. Then came Y2K and the Fed just automatically turned on the printing presses to prevent any problems. All of these problems had similar characteristics - they were sudden and solved by the Fed with increased liquidity. Along comes 9/11 and Greenspan once again took out his liquidity hose and drove interest rates down to 1%. But this time liquidity was not enough, it required two G.W. Income Tax cuts to halt the recession and get the economy rolling again. Only this time the 1% interest rates fuelled the biggest real estate boom in history.

This chart below, although not fully up to date, shows that the fabled liquidity that Wall Street crows about doesn't exist. This chart is a comparison of M2 (liquid money) to the NYSE capitalization. (If the Nasdaq's capitalization were included the chart would look even worse.) Liquidity bottomed out in the 1st quarter of Year 2000. It is only slightly higher today, but not enough to make a case for a long lasting bull run based on liquidity.

In fact, the Fed's solutions have once again driven stock prices to levels of irrational exuberance,. Too much liquidity has destroyed the allocation function of interest rates. Corporations and individuals have taken on unmanageable debt loads. Excessive liquidity drove the housing bubble. Too much liquidity must eventually weaken the Dollar forcing the FED to raise interest rates much higher. Adding more liquidity won't solve any of these problems; it just exacerbates them by delaying the inevitable, and quite possibly will make matters worse. It is taking ever increasing amounts of money and credit just to hold on to where we are.

When will IT happen? IT is beginning to happen all around us. The "oily rags" are there for everybody to see. Debt continues to pile up. The market is still over valued. The Dollar is just barely holding on. No, these aren't things that have "always been going on" as some pyromaniacs on Wall Street would have you believe. No, they haven't happened yet, but we are getting close. The potential for a stock market crash is always there with a market so overextended. The amount of Derivatives outstanding are growing ever larger, now totaling more than $95 trillion, according to the Comptroller of Currency. The total of derivatives is 8 times bigger than the entire US GDP. How risky is that?

What are the odds of any one of the catalysts happening? I don't know it varies. I put the odds of a nuclear war very low, but rising. I imagine the North Koreans or Iran might think differently. The odds of a derivative meltdown taking down a major bank are much higher. Barings Bank's failure and Long Term Capital's failure have shown us that derivatives can cause a financial disaster over night. The top banks are playing with matches, big matches, and there is almost no Federal regulation on derivatives. Warren Buffett referred to derivatives as financial time bombs. The odds are that the catalyst will come from the credit markets. Maybe one foreign bank will start to dump US bonds. Which would cause US long term interest rates to spike up and the Dollar to crash Could this happen? Could this have a domino effect? Japan with its 40% savings rate, has been the biggest buyer of our bonds both public and private, now looks like it's finally starting to come out of its 14 year recession: If it hasn't, it will, sooner rather than later, and then they will need some if not most of their savings to invest in their own economy: There stock market is deeply undervalued when compared to ours. Not if but when will they start selling its massive holdings of Treasuries?

Anyone of the above could lead to a market decline/crash. Long term rates look like they may start climbing again should inflation numbers force the FED to resume increasing rates.. And the stock market is once again attempting to climb a wall of worry and break out to new all time highs. Could that be the trigger; the Big Hook that I have been looking for, for almost two years? Yet each time the market looked like it was ready to break out it sold off.


If there is any doubt that the world's investment community is suffering from irrational exuberance, just look at the German and French Stock Markets; in the face of 12% unemployment rates and less than 1% growth rates to look forward to which they consider to be good, unemployment rates can only get worse and yet their Markets were making new five year highs, all in the face of Paris burning from two solid week of Muslim rioting.

There is certainly enough smoke to know there are still problems with stock and bond markets all over the world. Anyone who is tired of hearing about all of the dire predictions from the bears should be doubly careful since some of the most die hard Bears have finally tossed in the towel and turned bullish: When the last Bear turns bullish or neutral, watch out below. Anyone that is waiting for IT to arrive before they act is playing a dangerous game. Now is the time to act to protect your assets. If you wait for IT to be obvious, it will be too late as you get trampled in the mad rush for the exits.


For those of you who do not know how to handle the coming bear markets and insist on always being fully invested rest easy. There is still one ongoing bull market that is still in its infancy and yet most bulls are ready to throw in the towel, GOLD. My opinions are always forward looking usually projecting three to six months out. So if you have heeded my past musings you have been selling you stocks and bonds into rallies and you have cashed in your speculative real estate over the last year or so. At the same time you should have established a program of scaling into Gold and Silver with your ever increasing cash reserves. buying Gold and Silver Bullion and gold and silver stocks or what might be even better buying any one of the well known Precious Metals Funds that are out there and stop worrying. It's my estimation that You will more than double your money at a minimum, somewhere over the next two to five years.


For all those that have now been gripped by fear that Gold has by breaking below 600/oz entered a new Bear market of its own, STAY CALM. I have been warning you that when ever you have an Elliott wave Extension and that extension occurs as part of a fifth wave blow off; which is exactly what happened; that extension is always Doubly retraced pulling back to the beginning of the extension which according to my interpretation of Elliott wave is $540.. Now if the bullish sentiment percentage drops to below 15% as Gold approaches $540 in my opinion it would then be time to back up the truck and load up with Gold and Gold stocks. Now $540 /oz is not some kind of written in stone magic number. My down side support and thus the area of accumulation should be a $50 range bracketing $540 or $515 to $565:. Which, is a typical Fibonacci, Elliott Wave 50 to 62% retrenchment of the 2001 to 2006 first Wave of the Bull Market So Start scaling into gold as we approach that range.

As far as silver is concerned, there is a strong probability that silver will out perform gold.

Personally I prefer Gold because apart from all the fundamentals it is the only real money and I'm willing to pay a small premium for insurance; but take your pick.

Real Profits occur to those who at crucial times have the courage to stand alone.



Aubie Baltin CFA, CTA, CFP, Phd. (retired)
Palm Beach Gardens, FL
[email protected]


September 19, 2006

The above is my personal opinion, and in no way be deemed investment advice to buy or sell anything. It is submitted purely for informational purposes, based upon my understanding of the markets.

The term “carat” comes from “carob seed,” which was standard for weighing small quantities in the Middle East.
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