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April 20, 2008

Pivotal Events
by Bob Hoye

The following is part of Pivotal Events that was published for our subscribers Thursday, April 17, 2008

SIGNS OF THE TIMES:

Last Year:

"65% of Companies Have Exceeded Analyst Expectations"

"Chairman Bernanke has succeeded; the economy has been positioned on a sustainable track for manageable expansion: A Goldilocks scenario that is neither too hot nor too cold."

- Financial Post, April 25, 2007
- The rave was from Mike Thomson at Thomson Financial

Obviously, neither Thomson, nor Goldilocks had a forecast on the yield curve, which recorded the seismic reversal by the end of May.

"It's the best of all worlds. Global growth is strong and the dollar is weak."

- Wall Street Journal, April 27, 2007
- Chief Market Strategist at Bank of America

* * * * *

This Year:

"Downturn Creates Best Value Since '02"

"It's the time to play offence rather than defense; it is the best value that I have seen worldwide since 2002."

- Financial Post, April 10, 2008

"The miss is shocking, but we are not going to change our strategy because of a one-time miss."

- Financial Times, April 11, 2008
-- CEO at GE

* * * * *

Tales From The Crypt:

"Bull movements continue with prices at new highs for the year. Some 50 per cent of the loss with the autumn break has been restored."

- The Economist, April 5, 1930

"Market is highly irregular, but the trend continues upward under the force of investment trust buying and pool activity."

- The Economist, April 19, 1930

* * * * *

Stock Markets: Last week we reviewed the path out of the January panic, with the test of that low set with the Beat Stearns Panic. On the 55-day plunge into late January, our expectation was for a rebound in stocks and commodities out to March-April. In the stock markets a rebound retracing some 50% of the loss provided the estimate on the price levels that were possible.

This has been working out, and considering the relations, this would be accompanied by a weaker dollar. Tuesday's ChartWorks wrapped up two determinants that have been reliable at a number of important lows for the dollar index. One was on dynamics with the decline becoming severe enough to register a "Downside Capitulation" on our proprietary model. That occurred in late March, and as noted the condition of impetuous selling can last for a few weeks. The other stalwart has been the "Sequential Buy" pattern and that completed at the end of last week.

These two indicators have been reliable at a number of important lows for the DX and both investors and traders should be positioning for the reversal. As we so often enjoy the observation - a firming dollar in the midst of a fully blown credit market will be a nightmare for the orthodox world of policymaking and investing.

Sector Comment: In early March, our proprietary Bank Trading Guide reached a high with a high RSI and typically bank indexes set an important high about three weeks later. The key high for the BKX was set at 85 on April 1 and the initial break was to 75 on Monday, from which there has been some recovery.

The timing from the Guide has been interesting as the slump in bank stocks came in at the right time, but was not anticipated by the usual curve steepening or spread widening.

Banking conditions remain precarious and the popular notion that the Bear crisis was the worst that current strategists had seen and therefore "the worst is over" is not adequately researched. When participating in great financial manias and their consequent contractions it has been prudent to have a working knowledge of all of them, and to avoid positioning based upon personal revelations.

Action in the curve and spreads, which had been benign following the last crisis have shown a slight deterioration since last Wednesday. Traditional corporate spreads (BBB) have widened from 206 bps to 214 bps and the whole curve from bonds to bills has steepened from 294 bps to 335 bps. Admittedly this is not big action, but for new readers our model expected the credit markets to reverse from boom conditions to contraction by last June - and this worked out.

As we have been noting, the last two crises were not accompanied by any widening of money market spreads. We thought this could be due to the funds being injected by distraught policymakers. However, we have thought that money market desks could not be isolated from credit distress forever. Also, there is a seasonal tendency for spreads to reverse to widening in May.

There has been some change as libor, over bills, has widened from 193 on April 1 to 241 and the yield ratio on bills to commercial paper has widened from 198 to 241. The last time money market spreads widened was in July and it became dramatic with the August crisis.

It is worth recalling that central bankers have little, if any, influence on spreads and the curve.

Continue to avoid banks and financials.

Base metal prices were also likely to rally to a seasonal high around now. On the mining stocks a couple of weeks ago we mentioned that upside resistance might be found at around 860. The index (SPTMN) spent a week there and yesterday surged to 886, where it is approaching an overbought sufficient to limit the rally.

This is accomplished within the window of seasonal strength and at the point where the dollar could recover.

Our policy on this sector is to buy on seasonal weakness late in the year and to sell on seasonal excitement around now.

INTEREST RATES

The Long Bond: Last Thursday we thought the bond rally could end near 121 and it got to a little over 120 on Monday. Then in as many days, it gave up three points, which is a fast hit. Our case has been that the bond had become just another asset class to be bid up on arbitrary notions. Lately it has been the "flight to quality" story, which is so much nonsense.

Now, with rampant "inflation" becoming the focus the bond has dropped. We don't care much about the reason for the plunge - just that at some time it breaks the spell of ramping the bond up for absurd reasons.

In the face of "inflation", some have thought that the Fed ramping down short rates has been absurd policy. Not so - short dated market rates of interest always plunge during a post-bubble contraction, and the senior central bank has little alternative but to follow.

This is why a relentlessly steepening curve is also a post-bubble feature. Bill rates decline as corporate rates soar, and eventually bond revulsion encompasses long-dated treasuries.

Credit spreads and the curve have been discussed above.

Gold Sector: Last week we reviewed the standard that jewellery consumption makes up a huge portion of gold's demand. That is the case during a boom and during the consequent contraction such demand will plunge. This will be disquieting to orthodox analysts who have become overly reliant upon gossip about monsoons, what is going on in Middle East souks and what benighted central banks may be selling. The latter, of course, seems no longer a source of fascination.

In every contraction the real price of gold has increased as most investment alternatives and the price of most goods and services fall relative to gold.

The transition from the first to the second paragraph has been gradually occurring - especially against most stocks and corporate bonds. Since the low of 143 a year ago in May, our gold/commodities index recovered to 227 with the crisis in January. With the rebound in commodities and spirits since, gold's real price has slipped to around 205. This will likely resume the uptrend as the current rush to commodities expires over the next few weeks.

This, as well as a firming dollar will discourage orthodox gold bugs. Tuesday's ChartWorks is calling for a tradable rally for the dollar index and a tradable decline in gold's nominal price.

Precious metals had been expected to rally into March, and our work on the silver/gold ratio noted the high RSI reached in early March. Typically some two months later gold stocks would likely be down by around 20%, or more.

The HUI set its high at 519 in mid March and the initial slump took the index down to 418 in early April. That was a quick 19% and our advice was that after a test of the high, a more prolonged decline was possible. So far the rebound has made it to 476, which is a 57% retracement. This seems adequate and it should soon roll over on a tradable decline.

Our advice has been to lighten up on the seniors, and to use the HGD to make some money on the correction in gold stocks. As silver could decline relative to gold, we have been playing the short side of the big silver stocks.

CRUDE OIL
BIG BULL MARKETS SINCE 1913
(DEFLATED BY PPI)

• The table compares all of the big bull markets over the past 100 years. It does not attempt to analyse the technical or timing dynamics, but establishes perspective.

• At +623%, this bull market has racked up the biggest gain, which is outstanding compared to the previous best at +464% made on the sensational high in 1980.

• Over the past year, similar extraordinary gains, for example, were recorded by wheat, copper, lead and nickel.

• Often crude oil can make an important seasonal high in March. If this doesn't work out there are examples of an even bigger seasonal high in May.

Bob Hoye
Institutional Advisors

The opinions in this report are solely those of the author. The information herein was obtained from various sources; however we do not guarantee its accuracy or completeness. This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each securitys price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance.

Neither the information nor any opinion expressed constitutes an offer to buy or sell any securities or options or futures contracts. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities such as ADRs, whose values are influenced by the currency of the underlying security, effectively assume currency risk.

Moreover, from time to time, members of the Institutional Advisors team may be long or short positions discussed in our publications.

Copyright © 2003-2009 Bob Hoye

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