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December 03, 2007

Catch-22
by Captain Hook

The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, November 11th, 2007.

What can I tell you, but I told you so. Finally, Europeans are waking up to the fact cake eaters on Wall Street intend to devalue their way out of their problems, as forecast here on these pages recently. This is because it's really beginning to hurt, and it now appears the US intends to make the currency trade a one way event in postponing any pain like the stock market. The only problem with this brand of thinking, if you can call what price managers are doing these days thinking, is a good old-fashioned currency crisis, which should go a long ways in waking up slumbering societies around the world in turn, along with keeping gold in the forefront. This should become even more apparent today with Bernanke speaking, where already yesterday a panicky Fed was pandering the mob by hinting at lower rates.

This is where it might get interesting however. What if the warning put out by Chinese officials yesterday regarding plans to diversify its currency was legitimate? This would mean that on top of China not only reducing its support of US debt markets recently, it might even become a net seller just when their support is most needed - when it's become fashionable to bail out of the dollar ($). So, what could actually happen here, and if not for this reason for others, is in spite of the US being in recession (oops - I forgot we aren't suppose to mention that word), interest rates could be forced higher unless domestic monetary authorities increasingly monetize the bond market with nobody catching on. I say 'nobody catching on' because if market participants see this happening, which would mean the US is still debasing its currency faster than its major trading partners, such a condition set would likely cause the $ to fall further. This in turn would put yet more pressure on long-term interest rates in the States to rise due accelerating price increases, which is the necessary result of hyperinflation, where either way you care to rationalize it, administered rates will need to rise at some point as well.

And this would be no problem if equities were rising. The only problem is this is not the case, and things might get a whole lot worse in this respect in short order as well because not only is the pain being caused by rapid currency fluctuations beginning to take its toll on global equity markets, the world is in jeopardy of catching a cold due to the US sneezing. Let's just pause a moment here and take stock of what changes have occurred over the past few days that are hinting the global economy is about to contract (see that - I didn't use the 'r' word). Let's see now, it appears the Canadian Dollar (C$) may have reversed lower yesterday, suggestive demand for energy and raw materials is set to contract. In keeping in line with a currency them, and as suggested the other day (see Figure 7), it also appears the Yen is set to reverse higher with a closing basis double top breakout, implying demand for hot carry trade money is drying up. Oh - and let's not forget about a rising yield curve, which is set to confirm economic Armageddon with any more strength past this point. (See Figure 1)

Figure 1

On the credit front it should be remembered that if history is a good guide, the very survival of the current credit cycle is at stake here, and that if margin debt trends are any indication (see Figure 4), a meaningful downturn (the big one) is due presently. Add to this the fact Asian stock markets appear to have topped, along with the Baltic Freight Index (BDI), and it doesn't take much imagination to figure out the global economy is cooling, at a minimum. Of course what will be most scary if it transpires this month is if record high short positions and index related put / call ratios are unable to keep US stocks markets buoyed as we head into options expiry next week. To be fair in this regard it should be noted put / call ratios have been falling with prices of late, meaning either the bears are bushed and / or the bulls are buying the dip. More than this though, if US stocks were to finish below options related floor pricing this cycle (November), such an outcome would suggest that growth metrics are so weak the currency wars going on are devastating the global economy. This would be a very powerful deflation signal, and validate the message being emitted in this chart, that being the echo-bubble bounce for stocks is done. (See Figure 2)

Figure 2

Source: The Chart Store

So it appears both the Fed and global economy are caught in a 'Catch-22' situation, where we are damned if we do, and damned if we don't on multiple fronts. In the case of US interest rates for example, if Bernanke intimates he is in favor of a strong $ policy at the moment in front of Congress today, it should become evident to all just what I am referring to here, because although the $ may rally, both stocks and the economy will take a header. Again however, let's not forget it's a lose / lose situation, where if the $ is allowed to fall commodity prices will continue to explode higher, which would be alright except it appears related stocks, which is where everybody who saves has their money these days, have stopped rising. This means most people will not benefit from more inflation, especially considering only the top 20-percent of income earners in the US have any money in the stock market to speak of. Nope - rising prices will do nothing for most people but place an increasing burden on them, which is deflationary ultimately. Thus, one must be careful with the above signals being thrown off at the moment, where apparently even a more optimistic result would only involve buying more time if this plot is an indication. (See Figure 3)

Figure 3

Source: The Chart Store

As for precious metals, if they are the inverse of the $, although there could be a bounce at any time, make no mistake about it - the world has no alternative but to continue bailing out the US consumer for as long as possible. This is because when the music finally does stop, meaning the global trade mechanism which has been sponsored by ever increasing quantities of fiat currencies finally feels the weight of water, the prognosis is not a pleasant one, that being deflation. So, although you may hear some complaining by those on the receiving end of a crashing $ now, I can assure this chatter would stop abruptly if global stock markets appear destined for a slide, which happens to be the case at the moment. This means that in terms of our Catch-22 predicament discussed above, when put to the test based on historical precedent one would be wise to bet on a falling $, and of course the $'s antithesis, which is gold.

If you ever need reassurance in this regard, just go to this link and look at Figure 3, where Dave readily shows you why the $ has a long way to slide.

With that, and because I am feeling a touch under the weather, this will conclude today's commentary. I will attempt to be back again tomorrow however because you should see a straightforward count on the S&P 500 so that you all know why it could go straight down from here. Remember, because of the impossible situation social planners had built for themselves in the 30's after the crash comparable to the imbroglio we live in today, stocks proceeded to decline 50-percent from a similar point compared to present circumstances, which is why Figures 2 and 3 above display these similarities so well.

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And if you have any questions, comments, or criticisms regarding the above, please feel free to drop us a line. We very much enjoy hearing from you on these matters, although we may not be able to respond back directly, so please do not be disappointed if this is the case.

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.

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