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May 19, 2006

Is the Bear Back?
by David Chapman

The sharp drop seen in the market over the past week or so doesn't seem to have phased investors much. Since the drop has gotten underway we have actually seen the Markets advisors bullish sentiment www.investorsintelligence.com rise not fall, as one would expect. Grant you the reading was 46.3%, which is just above the normal reading of 45%. But we are still down from the recent peak of 53.2%. These were not near real highs that we have seen in the past of nearly 60% but still they were good readings. A week ago the bullish sentiment was 44.3% and the week before that it was 43.9%. Bearish sentiment on the other hand was 25.3% down from previous readings. Maybe the drop in the latter part of this week will change their tune a bit in the next release.

And that is consistent with what we keep hearing that this is just a correction. Don't worry we should find a bottom soon and the market will continue its climb up the "wall of worry". Naturally of course it is "sell in May and go away" and it is May. Much of the selling of course has been coming from "hot money" such as hedge funds.

The flight from the commodity driven sectors has been particularly swift where the Gold Bugs Index (HUI) has fallen around 20% plus in just over a week. Oil stocks and the metals stocks have also been hit. Indeed the drop in the HUI has left it currently at levels last seen when gold prices were closer to $560 rather the current $660 - $680. We may have fallen about $60 - $80 from the recent highs in gold but we are well above the levels seen back in March. But the stocks obviously think gold is going to fall further. And indeed it may given the 50-day moving average for gold is currently around $615. That area could easily be a magnet.

Other base metal commodity prices dropped swiftly as well including copper and zinc. But the question investors should be asking themselves is "are the economies of China and India and other Asian countries that are largely driving this commodity boom about to come to a screeching halt"? Well the answer there is no. And why because they are just beginning to see the possibilities for hundreds of millions to be pulled out of poverty or marginal living and attain middle class status. That process is not going to stop. If there is something to be bearish about it is to see if there is anything that might stop that process. That one thing could be a housing slowdown in both the US and Asia that would clearly put a dent in demand.

These shakedowns have not been unusual since the bull market in precious metals got underway in 2001. One only has to look at the Gold Bugs Index back in 2004 to realize that the shakedown thus far here is tame compared to a few sharp drops we saw back then. At one point the HUI fell almost 32% in only 6 weeks. We have fallen 20% in only two weeks. A key moving average that one should watch is the 40-week and that is currently near 285. Since our big decade long rally in precious metals and precious metals stocks got underway we have seen three previous corrections of some magnitude and each of them tested the 40 week moving average, dipped under it for short periods or stayed under it for several weeks as we saw in 2004 and 2005. But in every case we recovered and moved to new highs.

In that respect it is worthwhile to show our chart of the XAU (Philadelphia Gold and Silver Index) and note once again how since the 2001 lows we appear to be making lows roughly every 12-16 months. By that measurement with the last lows seen in May 2005 an important low could be seen anywhere from May - September 2006. Since this drop has just gotten underway odds do not favour it making its significant low now. Instead we may go through a few months of chopping around until we make our final low. We went back and checked from the November 1995 lows to see if we could find lows roughly 12-16 months apart as well. Not quite perfect but we found some in a series of 15, 11, 15 and 18 months to the 2001 lows.

Those lows were in the context of a secular bear market in gold and gold stocks but since the 2001 lows we have moved into a secular bull market in gold and gold stocks. Even as things change some things remain the same. When this correction is over we will go to higher price. We continue to see $850, $1000 and higher for gold coming. As for the XAU how deep could this correction go? We appear to have moved into a phase for this bull market once we moved above the 2004 lows. The 2004 highs came in around 120. The parallel line that corresponds best with those highs currently comes in around 125. At current levels of around 140 that is roughly another 15-20 points to test the 2004 highs. Right now though we are extremely oversold and a rebound could occur at any moment.

While our optimism continues for the precious metals sector we are considerably less optimistic for the broader market particularly as measured by the Dow Jones Industrials, S&P 500, NASDAQ and excluding the TSX gold, energy and possibly metals other sectors will suffer. We have often noted the consistency of the 4-year cycle. Since 1932 we have seen significant lows in 1932, 1938 (extension), 1942, 1946, 1949 (short one), 1953, 1957, 1962 (extension with an interim low in 1960), 1966, 1970, 1974, 1978, 1982, 1987 (extension), 1990 (short one), 1994, 1998 and 2002.

This means the next one is due this year 2006 but if it turns into an extension it may not occur until 2007-2008. Major 18-year cycle lows were seen in 1932, 1949-1953, 1970-1974, and 1987-1990. Again if the 18 year cycle is occurring in this period it could range anywhere from 2002-2011. The Kondratieff Wave cycle last bottomed in 1949 pointing to the period 2000-2014 for the next bottom. Some analysts believe 1942 should be the bottom of the cycle pointing to the period 1992-2007. So there is considerable crossover in these cycles occurring during the first decade of new millennium. (For a complete analysis of cycles read Stock Market Timing - Cycles and Patterns in the Indices - Raymond Merriman). Mr Merriman also acknowledges possible evidence of 72-year cycles (4*18) and a 90-year cycle (5*18). There is of course insufficient evidence on these very long cycles to say with any degree of certainty of their repetition. But if they exist we are once again in the period of these long cycles that could stretch out to 2022.

A few charts are worth looking at with regard to these cycles. The bulls dream is that this current market has a shallow correction (10-15% tops) and then rebounds to new highs into 2007. This would be the 1936-1937 pattern (70 years) where the market fell 13% following a top in April 1936. But the drop was all over in a month and recovery took the market to new highs in March 1937. Of course what followed was almost as devastating as the collapse 1929-1932. The market fell for a year bottoming in April 1938 losing 50% along the way.

The bull's nightmare is the 1946 pattern (60 years) where a top was seen in May 1946 and we collapsed 25% bottoming in October 1946. The market never really recovered after that and for the next three years we chopped around before making the final bottom in 1949. Other cycles to watch are the 100-year cycle where the market fell into July 1906 before a shallow recovery into the fall then a drop started that became known as the panic of 1907with the market losing 45%. 90 years ago (1916) the market also held in and finished with a strong year-end rally but 1917 brought another sharp collapse after the US entered the war. Today war is threatened with Iran and if real hostilities broke out that would sink the market.

The bulls other nightmare is the Tokyo Nikkei Dow cycle of the 1990's. Here we made a top in June 1996 then proceeded to fall a sharp 43% into 1998. After nearly recouping all of the losses into 2000 the Nikkei began its final descent collapsing 63% into the lows of 2003. Our corresponding cycle periods we noted above fall neatly into the potential for a Nikkei Dow style flame out over the next several years because so many down cycles are coming together at the same time. As for the current Nikkei we can clearly see that we have broken the downtrend lines from the 1990 highs. While we may have hit temporary top as well in the Nikkei we believe the Nikkei is now beginning a new long-term bull market. The US's down cycle is still to come.

This cycle analysis does fly, however, in the face of many analysts who believe we have entered a new long-term bull market. As well there are many who believe this current drop is temporary. If the 1936-1937 scenario plays itself out they could very well be right. But longer cycles do not favour that outcome so we have to be aware that rallies could be short lived. The current breakdown was reversing today off of the 40 week moving average a significant support zone.

And we may be bouncing of what may be a huge ascending wedge triangle dating from the lows of March 2003. If that pattern is correct and it is broken to the downside just under 1260 then we will at minimum return to the lows of 2003. Another key area is currently at 1225, which defines the support of the bull up from 2004. This will be the last point of no return and ensure that the bear market, which began in 2000, is officially back.

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 © 2002-2008 David Chapman

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