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January 04, 2009

A Most Horrible Year - Could It Get Worse?
by David Chapman

We suppose we could have premised this as "Annus Horibilis" but we weren't sure whether the Queen would approve. We also couldn't help but notice a John Mauldin missive that also used the same title "2008: Annus Horibilis, RIP" John Maudlin January 2, 2009. What can I say? We are all thinking the same thing.

We were also going to take another week off before returning but couldn't resist the temptation of sitting down at the computer and viewing the carnage of 2008 once again. As well just thinking about it more gives greater insight as to what we missed and hopefully help us do better in the future. It is not easy being a forecaster because your record is hanging out there for everyone to see.

But one thing we couldn't help but notice was the forecast of mainstream economists. According to Bloomberg based on strategists polled they expected the S&P 500 to be at 1,637 at year end 2009 (The 'permabear' keeps on growling in 2009 - Boyd Erman, Taking Stock, Globe and Mail January 3, 2009). Oops they were off a little. It ended at 903 off about 45 per cent.

We printed the table below in our previous issue but thought we should up date it to encompass the entire year. We expanded it a bit to show a few select foreign markets as well. Not included below is the best performing stock market index last year. Unbelievable but true it was Caracas SMI Index in Venezuela (yes the Venezuela of Hugo Chavez). It was down only 7.4%. That of course was in the local currency.

The winners?

• * Includes price gains plus coupon
• ** Average yield of auctions. Investors may receive considerably less - Source: Bank of Canada
• *** Average annual rate of inflation - Source: Bank of Canada

The winner of the past year was holding 5-10 year bonds. The huge bond rally over the past few months made holding these instruments a huge winner. While one would have felt warm and fuzzy sitting in T Bills this past year we are not really surprised that despite the volatility holding the yellow metal, gold came out ahead of T Bills. Over the past 10 years the best place to have been was in Gold stocks as measured by the Gold Bugs Index (HUI). Following close behind was Oil and Gold. Naturally being in commodities this past decade has paid off as even the CRB Commodity Index is up 90% over the past decade. The clear winners over the past decade - being in gold, silver and gold and silver stocks with a big honourable mention to 5-10 year bonds.

The proof as they say is in the results. Going forward we continue to believe these are the places one has to be. The recent correction in commodities far from being the end of the commodity boom is we believe merely a sharp correction (crash?) within the context of a long term bull market that still has several years to run. Naturally though the sector is not for the faint hearted and yes timing is everything.

Certainly not the place to be over the past decade was in stocks in general. They entered a period of a long term bear market with the market top in 2000 and this bear market has many years to run irrespective of periods of rebounds. While we are quite sure that we will see a rebound in the early part of 2009 or the latter part of this year ultimately we don't expect it to hold.

One major loser over the past few years has been the TSX Venture Exchange. But the poor performance of the CDNX belies the fact that this is really a place for speculators. There are periods where the venture exchange stocks can be extremely rewarding. One just has to remember to take their profits and not continue to admire the story.

As we head into 2009 we can't help but note that speculators in the CDNX stocks may have a far better year. Our chart below of the TSX: CDNX ratio shows that we have now broken down from a very steep uptrend favouring the TSX over the CDNX. It was indeed a breakaway gap this past week and we are now below the 13 week MA. We may have some more chopping around to do to form a better top but the tide will now switch to favour the junior penny stocks that dominate the CDNX. We will create a junior mining portfolio next week with our issue of StockPicks.

But overall the results of 2008 were pretty bad particularly if you were in conventional stocks. The reality, however, was that there little place to hide and portfolio managers everywhere are gasping for excuses as to why they had such a lousy year.

As we enter 2009 the bad news has been relentless. Despite the backdrop of bad news including the ISM Index reported this past week at 32.4 the fifth consecutive monthly decline in manufacturing activity. This was a 3.8 per cent decline from the November number. This coming week we get the employment numbers with non-farm payroll expected to show a decline of 475 thousand jobs in December. The unemployment rate is expected to rise to 7 per cent.

Despite the relentless march to lower interest rates longer dated bonds were hit hard this past week. Ten year Treasury Notes rose to 2.46 per cent from 2.16 per cent the previous week and 2.13 per cent the previous week. Could interest rates already be reflecting the massive monetary stimulus we have seen over the past few months? The unbelievable growth in money stock over the past several months we have never before seen. Here is the chart of M1 money stock. Note the spike that also came during the recession of 2001-2002. That one was small compared to what we have recently witnessed.

The question is being asked of course will it have any impact. Well maybe not. We couldn't help but notice the M1 Money Multiplier has now dropped below 1. Can't say we have ever seen that before. This chart would seem be suggesting that the monetary authorities (Bernanke) has lost control of things. This represents the velocity of money. You can print $10 of money and then the velocity of that money supply is how that money circulates over time. The more it circulates the more positive effect it has on the economy. But now with the M1 money multiplier falling below 1 you are now actually getting less for each new dollar. Since all money is just debt this means that the impact of creating new debt is now having little or no impact. Maybe that is why interest rates are rising in response because the debt is rising and the economic impact of all that debt is having less and less impact. You are just going to have piles of debt needing to be financed while economic growth is stagnant or falling.

We can't help but notice that everyone it seems is being bailed out or crying to be bailed out. Billions have already been blown bailing out the banks and now the auto companies. The US States are now in serious trouble and looking for a $ Trillion bailout themselves. With everyone wanting, needing money and the money supply growing in leaps and bounds and the velocity or circulation of that money sinking like a stone it is merely a question of time before the world begins to revolt at having to lend the US so much money. Once again could the sudden jump in interest rates this past week be suddenly realizing that and predicting further rises in interest rates ahead?

As we go into 2009 we are also entering a dark hour with once again war breaking out in the Mid-East. Curiously we are in the period of the 60th anniversary of the partioning of Israel and recognition by the United Nations. Actually the partition of Israel or Palestine as it was actually called at the time was approved by the UN General Assembly on November 29, 1947. The plan was to terminate the British Palestinian mandate by August 1, 1948. The first hostilities broke out in December 1947. So this is actually the 61st anniversary of the partitioning and war. We note that 60 years is the master cycle of time and 61 would correspond with the Fibonacci 61.8.

Given that this conflict remains unresolved after 61 years and is entering a new ugly phase we can only note that this dark period could get even darker as protests take place around the world risking the potential for clashes in Western cities of supporters on both sides or clashes with the authorities. Given other hot spots of the unresolved conflict in Iraq, things are heating up along the Pakistan/India border over the Mumbai attack, the cutting off of gas to the Ukraine from Russia, the ongoing tension on the borders of Georgia and Russia, and once again hearing accusations of Iran getting near to the creation of a nuclear bomb we are surely facing a bleak geo-political future. Put this against the back drop of bleak economic numbers we can only hold our breath as we go forward.

But despite all the bad news that doesn't mean that the market can't go up in the coming months. With the tax loss season out of the way and much of the economic news discounted only the geo-political events could be a major derailleur of the markets. We can't help but note that the cycles are favourable as we go into 2009.

Our first chart is the 60 year cycle of 1947-1949. In looking at these cycles we don't look at the absolutes but instead focus on highs and lows and direction. We note our low in late November 1948 with a peak coming on January 7. January 6 is an important yearly inflection point and we often see market direction turns around this time. The other inflection point is six months later on July 6. Following this peak the market moved into a February low before rebounding once again. The market then collapsed into the final June 1949 low which incidentally was the final low before we began the great bull market that ran into the mid 1960's.

Of course this time around our low was seen on November 20. But once again we are rising into the period of January 6 and we have a war theme in Israel/Palestine in the background. Nonetheless we note the February and June lows and we certainly expect this market will need some work before we can find our legs to put in a more sustained rebound.

We should note that this period is not the only 61st anniversary of the Israel/Palestine problem it is the 62nd anniversary of the partioning of India and Pakistan. A war broke out between India and Pakistan that lasted into 1949. Then as now one of the issues was Kashmir. And here we are once again with India and Pakistan potentially on the brink of war and Kashmir once again in the mix. Even as things change things also never change.

Our second chart is the 70 year cycle. We have noted before how this decade has followed the 1930's. We had a financial panic in 1937-1938 and flash forward to 2007-2008 we had another financial panic. One hundred years earlier in 1907 we also had a financial panic. We can't help but also note that 1837 also saw a financial panic. In 1938 the financial panic bottomed on March 31. We then rallied into mid April before falling once again into a low late May two months from the first good low. If we are facing a similar move this time just shift the months so we could expect a peak in mid January followed by another plunge to the downside that takes us into late February for a low. A better rally then could get under way from there.

If we shift forward to late 1938 and early 1939 we note that we made a peak in November 8 months from the March 1938 lows. A lower peak was seen on our turn dates on January 5 then a plunge into late January before recovering once again for a March peak and a huge plunge into April. There could be some inversions at work here but our November low could still be met with a first week of January peak then a plunge into late January before we regroup once again. Our final low would then be made in April as was the 1939 cycle. This period was also a dark period for the world as we were building up for the events that would become WW2. We also note that the period 1936-1939 was in Palestine known as the Great Arab Revolt. This uprising was viciously put down by the British resulting in the fracture of the Palestinian leadership from which they never really recovered.

Our third cycle we wanted to look at was the half 60 year cycle or 30 year cycle through 1977-1979. We can't help but note that like both 1937 and 2007 we saw a financial panic as the market collapsed from a peak that was actually made in September 1976 to a major low in late February 1978. But our focus goes over to 1978-1979 where once again we note an important November low. This time it was made on November 14 very close to our current November 20 low. This time thought the rally carried right through to a peak on January 26 before it was met with selling and an important February low. A rally followed into April and then another pullback that bottomed in late May. The market then began a rally that last into October 1979.

Important wars and other geopolitical happenstances were also occurring during this period. In 1978 a secular government was overthrown in Afghanistan by communist insurgents and in 1979 a revolutionary movement in Iran overthrew the Shah of Iran. Both resulted in prolonged wars. In the first case a 1979 invasion of Afghanistan by the Soviet Union and in Iran besides the seizure of the American embassy in 1980 Iraq invaded Iran. IN both cases the two separate wars did not end until 1988. The Russian/Afghanistan war saw the emergence of the Taliban and in the Iran/Iraq conflict led indirectly to the first Gulf War in 1990.

In looking at these past cycles and seeing us against the backdrop of war once again in the Mid East between Israel and Palestine and the threat of war between India and Pakistan we can't help but think that these cycles could once again play out for us. This week brings us January 6 and a key inflection point. We are rising into that level. Our other key dates seem to centre around possibly mid January and the end of January. An up January would bode well for the year irrespective of all the bad news in the background.

Once we get out of January themes centred around lows in February and possible lows in late May or certainly by June. Mid April could see either a peak or an important low. If a peak then our focus would go for lows in late May or June. No matter whether our final lows were in April or May/June we seem to get good rebounds that take us into October/November. Investors will have to be wary and willing to trade a bit if they want to be successful this year but odds seem to be supportive for a rebound of some substance in 2009. As to 2010 well that is another story.

2008 was really annus horibilis. So could it get much worse? Our cycles seem to suggest despite all the bad news in the background we do have some potential for at least some light and this year could be somewhat better even if we go through some series of ups and downs especially in the first six months.

Note: Chart created using Omega TradeStation. Chart data supplied by Dial Data.

DavidChapman.com
Technical Scoop

Charts and technical commentary by:
David Chapman of Union Securities Ltd.,
69 Yonge Street, Suite 600,
Toronto, Ontario, M5E 1K3
(416) 604-0533
(416) 604-0557 (fax)
1-888-298-7405 (toll free)

David Chapman is a director of Bullion Management Services the manager of the Millennium BullionFund www.bmsinc.ca

Note: The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete.

The information in this report is drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does Union Securities Ltd. assume any responsibility or liability. Estimates and projections contained herein are Union's own or obtained from our consultants. This report is not to be construed as an offer to sell or the solicitation of an offer to buy any securities and is intended for distribution only in those jurisdictions where Union Securities Ltd. is registered as an advisor or a dealer in securities. This research material is approved by Union Securities (International) Ltd. which is authorized and regulated by the Financial Services Authority for the conduct of investment business in the U.K. The investments or investment services, which are the subject of this research material are not available for private customers as defined by the Financial Services Authority. Union Securities Ltd. is a controlling shareholder of Union Securities (International) Ltd. and the latter acts as an introducing broker to the former. This report is not intended for, nor should it be distributed to, any persons residing in the USA. The inventories of Union Securities Ltd., Union Securities (International) Ltd. their affiliated companies and the holdings of their respective directors and officers and companies with which they are associated have, or may have, a position or holding in, or may affect transactions in the investments concerned, or related investments. Union Securities Ltd. is a member of the Canadian Investment Protection Fund and the Investment Dealers Association of Canada. Union Securities (International) Ltd. is authorized and regulated by the Financial Services Authority of the U.K.

Copyright © 2002-2009 David Chapman

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