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June 02, 2005

A Cycles Study
by Captain Hook

Several key cycle related factors are all playing on the trade in one way or another right now, as this new age of 'perfect' information the internet provides to the multitudes of market participants exerts its influence on price patterns. To be more specific, and as an example of this, one would think the market is currently factoring in what is termed 'seasonal weakness' (the shortest duration cycle), which is that period of time between May and October, where from a historical annualized perspective returns have proven hardest to come by. May has been a relatively strong month this year, which is opposite to the traditional pattern seen below. Because of this, one would expect to see relatively weak conditions develop soon and persist into July, which is normally the big bounce month after a slow May.

Such an outcome could spell trouble for the rest of the year, where the pattern from 2002 (weakness into July and October) should be expected. Away from purely cycle based considerations, if hedge funds and our bubbles start blowing up for real right now, and monetary authorities hesitate to provide an accommodative posture because they are worried about crashing the Dollar so soon after the Presidential election (debasing the currency prematurely in terms of the next election), all equity groups could indeed get hit very hard in 2005, and into 2006. (See Figure 1)

Figure 1

As you can see above, what appears to happen more often than not each year is knowledgeable market participants who know stocks are a function of money flow "sell in May and go away", because they realize summer is fast approaching (think holidays), and this normally means slower trade. Furthermore, you may have noticed, September, not October (crash month), is traditionally the worst month of the year for stocks on average, meaning after the summer doldrums have passed, it takes a spell to get people back in a positive frame of mind. There are numerous reasons why this occurs ranging from credit demand to momentum related considerations, but for the purposes of this study, it is sufficient to know that more and more market participants are aware of 'seasonal weakness', and are thus likely prepared for it. Of course this does not mean it will not happen because the causes of this phenomenon will exert their influence yet again this year.

It's important to note the same can be said for higher degree cycles, like the next one we will discuss (in order of magnitude), the Presidential Cycle, but that as we work our way up in degree, fewer and fewer participants will be aware of these phenomena, or even acknowledge their influence if known. Of course this will do nothing but increase the probability they will have a more 'natural effect' on the trade, where wider degrees of timing accuracy apply due to scale considerations, along with the influence of other factors.

A good example of what we mean in this regard can be gleaned by comparing the 4-year Presidential Cycle of Roosevelt and Truman (R&T) between 1944 to 1948 with that of George Bush Jr.'s first term as measured by the performance of the S&P 500 (SPX), where both played out as one would have expected in retrospect. In this first panel below, you can see the initial two years of the R&T term was not 'normal' (usually weak due to reduced fiscal spending), where because the influence of secular scale stimulus provided by the War (anticipation of the 'baby boom' and rebuilding was so great), stocks were going higher during this period no matter what else was happening in lower degree cycles, with World War II being the single strongest dose of economic stimulus every engineered by man. Partially due to future discounting, and because actual pressure in the pipe was already exploding as a result of the monetary inflation necessary to feed the war machine, a US modeled credit creation machine was able to plant its roots deep in the global economy (US Dollar becomes world's reserve currency), enslaving the conquered as part of the 'to the victor goes the spoils' tradition. Therein, much of Europe and Japan were 'blown-up' and in need of rebuilding, which in the end, is why wars are waged. (See Figure 2)

Figure 2

Today however, now that all those babies have been born, cities rebuilt, and growth prospects associated with these phenomena now spent (this refers to naturally accelerating money supply multipliers most importantly), we see that Bush's last term was what is considered 'picture perfect' in that government spending was attuned to provide relative strength in the economy and stock markets coincident with the timing of the election, and that is exactly what happened. (See Figure 3)

Figure 3

Nowadays, stimulus associated with the Presidential Cycle usually begins to kick in during the second year of a term because the economy (think global) has grown so big it takes more effort (think ever increasing amounts of fiat currency and credit) to get things moving in their desired directions on cue. Further to this, and assuming incumbents want buoyant economic conditions come election time again, given today's very large and mature global economy, an environment where we would need 'the paddles' to revive growth if a recession were to hit, one should expect to see the next four years play out much like the preceding term. Therein, one should expect to see both fiscal and Fed induced stimulus efforts begin as early as this year, which is earlier than was witnessed in the last term (in the second year), and increase in intensity as the third year of the term is upon us because there is an approximate one year lag between when stimulus is provided and when its effect is actually seen in the economy. Coincidentally, the precious metals sector should anticipate the inflationary effects of this phenomenon with gold stocks beginning to outperform in dramatic fashion sometime later this year as well if we are correct in our assumptions, as the paper proxies will move first due to speculative sensitivity. If this does not occur, as there is very little margin for error in this regard given the bubbles that exist within global economies these days, all bets associated with another relatively 'normal' Presidential Cycle will be off, where chances the next President of the United States will be a woman, Hillary Clinton, would be improved considerably.

The effects of stimulus associated with the Presidential Cycle were clearly dominant over the first 4-year cycle of the new millennium, increasing the probability 2005 should be a relatively weak year economically, along with the stock markets as a result of high growth expectations present in current prices. Interestingly, and in spite of increasing stimulus associated with the next Presidential Cycle instituted later this year, 2006 could still be a particularly 'poor' year in stocks and economically if the Decennial Pattern keeps conditions more buoyant this year than would otherwise be the case. Of course, by definition, both of the first two years of a new Presidential Cycle are expected to be slow, but based on this cycle related overlap, next year could be particularly bad. This means the absence of effective Presidential Cycle related stimulus meets head on with the expiration of Decennial Pattern strength, possibly making for a 'double trouble' scenario in 2006. (See Figure 4)

Figure 4

Continuing down the road, one should note the current Presidential Cycle falls in the second half of the decade, having a historical tendency to be particularly bad in the seventh year. This is good reason for Republicans not get their hopes too high for 2008, and another factor pointing toward an early initiation of Presidential Cycle related stimulus this time around. One must realize, if recession were to take hold of the economy right now, and careens out of the control of authorities, where there stimulative efforts are met with a yawn on the part of an aging population, things could get very ugly very quickly out there. In fact, it is our opinion that if the economy is not kept afloat this year (continuously stimulated), because there are too many bubbles floating around to think otherwise, traditional weakness in 2007 (see below) will likely guarantee hard economic times that last far longer into the future, where it could be argued the much anticipated visible effects of the Kondratieff Winter will be upon us.

This would involve a grand scale deflation lasting until 2020 at a minimum. And it could last much longer in total if we are currently ending a Grand Super Cycle Degree event, or a Millennial Degree wave, which is most likely given the totality of current circumstances. 2005 will definitely be a pivotal year in terms of telegraphing expectations for the future because the fifth year of any decade in over one hundred years has never produced a negative return for the Dow. Will 2005 be the year this trend is broken, further evidencing grand scale forces are at work? If so, suspicions regarding 'grand cycle' considerations in this regard will be substantially fortified. (See Figure 5)

Figure 5

Returning to the here and now, and as mentioned in our opening remarks, the fact stocks have moved up rapidly in May of this year is at odds with the traditional 'seasonal' pattern, and suggestive the summer rally some are looking for is most likely not going to happen. Further to this, and as outlined throughout our look at larger degree cycle forces applying pressure to the economy and markets as we move forward, its very important momentum is not lost this year, or any year for now on, because once the various interrelated bubbles floating around begin to burst, uncontrollable deflationary forces would most likely grip price trends, Presidential Cycle or not. If this were to occur, trading patterns in 2005 could end up looking like that of 2000, meaning stocks would finish with negative annual returns. If ever one needed to see a 'big' signal to warn them out of the stock market, this would have to be it, as again, the fifth year of a decade has not produced a negative return in over one hundred years.

The single biggest factor to keep your eye on over coming months is the precious metals sector, where as mentioned above, shares should both lead and outperform the metals if broad based price inflationary conditions are to be expected moving forward. If the gold price continues to trade well against a growing kaleidoscope fiat species, but precious metals shares continue to lag, and especially if this condition does not change before year-end, expect to see a deflationary sequence grip the global economy, as sacred time relationships in this regard will have been transgressed. Of course we are referring to key cycle related considerations in the precious metals sector that require monitoring, a source of regular discussion for us at Treasure Chests.

Special Acknowledgement: All charts provided courtesy of The Chart Store.

Good investing all.

Captain Hook
TreasureChests.info

Treasure Chests is a market timing service specializing in value-based position trading in the precious metals and equity markets with an orientation geared to identifying intermediate-term swing trading opportunities. Specific opportunities are identified utilizing a combination of fundamental, technical, and inter-market analysis. This style of investing has proven very successful for wealthy and sophisticated investors, as it reduces risk and enhances returns when the methodology is applied effectively. Those interested in discovering more about how the strategies described above can enhance your wealth should visit our web site at Treasure Chests.

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Information and analysis above are derived from sources and utilizing methods believed reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Comments within the text should not be construed as specific recommendations to buy or sell securities. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities. We are not registered brokers or advisors. Certain statements included herein may constitute "forward-looking statements" with the meaning of certain securities legislative measures. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the above mentioned companies, and / or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Do your own due diligence.

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