Stock Market Update, Gold Break Out and T-Bills

By: Daniel Smolski | Mon, Jan 26, 2009
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Just a few days into the administration and we are already starting to see cracks in the walls. Rumors have been surfacing Obama's much heralded stimulus package will not pass in congress as many republicans, including John McCain promise to be "faithful opposition party members." The opposition is unfortunately not against the spending but rather, against not enough spending. There are demands to make Bush's tax cuts permanent while democrats instead want to shift the tax burden onto the "rich." It was expected that Obama will enter politics with so much tailwind behind him, that he would be able to pass any bill in the first months in office. However, whether this stimulus bill is passed or not it conveys a well known problem that the legislative system is simply too slow. Once a stimulus package is approved, it will realistically take another year for shovels to hit the ground. There is an unfortunate lag that always occurs and tax dollars end up being spent when the economy is already, naturally, transitioning out of the trough and into an upswing. The money ends up, essentially, being spent needlessly but in today's world every tool, available to us, is being brought out to save the day.

The guessing game continues with how to resolve the banking fiasco. Henry Paulson's auctions have saved us from a financial meltdown but have done nothing to increase the flow of liquidity in the system. The Fed's attempt at direct cash injections into banks has simply ensured executive's bonuses and provided banks with cash to acquire one another. The most recent, "Obama solution" (originally actually touted by Paulson), has now been to create an aggregator bank, dividing banks into "good" and "bad" banks. This approach was initially employed in Sweden as the Securum model with great success. The crisis in the early 1990s in Sweden was of similar nature, based on a real estate bubble that brought the banking system to its knees. The government moved in and pumped cash into banks that were deemed to have temporary liquidity issues and completely took over a couple of them. It thus provided creditors with a blanket guarantee but shareholders were wiped out. The government was then able to sell the nationalized assets years later. In the end, the government actually turned a profit from the whole process. The difference today is our administration has, so far, indicated that it is in favor of shareholders and thus the prospect of us ever seeing our money is heading, ever closer, to nada. Had the government taken control in exchange for emergency aid, taxpayers would be in a much more secure position. Do not get me wrong, the argument here is for the worst of two evils. I believe no business should ever be state owned and run but in this case, it looks like the taxpayers are simply getting the absolute worst end of the deal.

Even the proposition of such a holding company conveys that it is a desperate attempt to keep the system rolling. The establishment of a shell where taxpayers are not aware of what they are on the hook for or what they own is shameful. Level 3 assets should have been illegal to begin with and it is a disgrace that the SEC simply ignored their growth. These assets have no market and thus cannot be valued, it is a game of don't ask, don't tell. We are now at the point where a decision must be made because as long as theses toxic assets remain on the balance sheets of banks, the banks will remain technically bankrupt. A certain level of confidence must be restored and perhaps this new aggregate bank will provide the hope that markets need.

Whether or not this Swedish invention works in America is yet to be seen but the creation of such a holding bank could provide the catalyst for a more sustained rally that we are expecting. It is finally an initiation of a model that does have some history of success and whether or not it works, it may provide us with the confidence boost we are looking for.

The gyration continues as the markets consolidate with a downward bias. We still would not be surprised to see the market break below its recent support and hit November lows. The retest will provide us with ample opportunity to add to positions. Such a low would establish a launching pad that will take us up to 10,000. It is possible that the indices are already forming a bottom here and will just move up. The markets in Europe have been performing notably weaker as the UK , Germany and France have already tested November lows. Asian markets have been mixed but overall, have been holding up relatively well. We have, thus far, not seen any material break downs and this bodes well, as weaker economies would be leading the decline if one was imminent. Going forward, if this recent support ends up being the bottom, we will simply maintain our current positions and ride the markets up. Surprises, however, have all been to the downside this past year and we are ready to extend our positions in gold, airlines or purchase SSO if the market does retest.

Some may be hoping this is it for the decline but we must keep in mind that the longer and deeper this current correction gets, the larger the rally will be. If we simply head higher from here, we could top off under 10,000 in a couple months. If we add to the declines and form a double bottom at 7500, I would expect the rally to go through 10,000 in the spring. It will not only lead to greater profits in our current long positions but will also provide a higher price from which to establish short positions. A further decline here will benefit us both in going long and in going short. The more pain we experience here, the greater will be the reward in the future.

The excitement of late has been in the precious metals arena with the gold price exploding $40 on Friday and breaking out. With the increase, we have officially formed an upside breakout, gold appears to have freed itself of the shackles of the downtrend line. It has been stuck in a rut of lower highs since July and some new life has finally been brought into gold. Going forward we would not be surprised with a retest of the breakout but $1000+gold is in the cards for 2009.

One area of concern is relative strength in gold shares. Gold stocks always lead any bull run in gold and although they have been picking up steam the past few months, they are still considerably below the historic average. This is mainly due to the extreme selling pressures of the past few months but strength needs to pickup to convince us this is the beginning of something bigger. We are very excited by the developments the past few days and continue to maintain our positions in gold stocks. We will continue to monitor the progress.

Gold stocks have been one of the leading sectors in the stock market, in terms of relative strength, as the general indices enter a large consolidation phase. Their performance bodes extremely well going forward. We believe the precious metals stocks will be one of the leaders going into 2010. Physical gold and gold stocks are to be cornerstone of any portfolio for 2009, both for the potential of capital gains and for capital preservation during these trying times.

We continue to believe that, in this era of bubble creation, treasury bills are the final balloon to pop. They have broken down out of a head and shoulder pattern and it is expected they will inevitably reach their 50-day MVA. As some stability is found in the markets, investors will increasingly refuse to accept zero percent yields and move their money into asset classes that provide more opportunity. The endless saga of money creation will eventually come home to roost. Zero returns will sooner or later, result in zero interest at an upcoming government t-bill auction. We continue to maintain our position in TBT, that is now firmly in the black. It is a great long-term holding that should provide us a great return in 2009.

The markets of late have not provided us with much excitement, as they continue their grind east. The coming days should provide us with information on whether this market is going to test the November lows or whether a bottom has already been established. My belief is that further declines are still to be had and if they are in the cards, we will be waiting to deploy cash in appropriate sectors. Timing the market is never easy, as people often act too quickly for reasons of greed or too late, for reasons of fear. Patience is a virtue and we believe, the next few days will continue to be reserved for patience. We will let this market play out and see what it brings us. We never attempt to force anything by deploying cash, unless it has met our parameters. It is however a very exciting moment as if a decline comes and we are able to establish new positions, the upcoming months should provide us with double digit gains. There is a lot to look forward to in the coming weeks and we will continue to keep our subscribers up to date.

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Author: Daniel Smolski

Daniel Smolski
Smolski Investment Newsletter

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