The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, May 25th, 2010.
I've either heard or read just about every explanation for why the stock market could plunge dramatically moving forward, and I would like to offer mine now, now that it appears the fundamentals associated with our political economy are finally aligned to sponsor such an occurrence. To get things rolling in this regard, everybody should read Jim Kunstler's latest, where he offers a few thought provoking ideas of why things are likely moving in this direction. And more so, please take the time to review Martin Armstrong's latest (you need a great deal of RAM to read the entire article) as well, where as usual he does an exquisite job of explaining why 'we the people', have finally had enough, and are now doing something about it. For my part, what I would like to do is add additional perspective you should know about, things to watch in the stock market that would confirm stocks could be in serious trouble moving forward, as well as my thoughts on why unfolding events are pointing to the likelihood man is at a profound turning point, far more profound than any other previously. That is to say hydrocarbon man, and modern technology man, and stock market mania man are all about to get a rude awakening in what can be termed an X-wave, that being a confluence of events that brings the collective race back to a lost appreciation of Mother Nature, and that reminds those who have forgotten to love their fellow man this is a far better practice than self-indulgence, deceit, or any of the seven deadly sins.
Now I could have just as easily entitled this piece X-wave consternation, or X-wave contagion, or even X-wave crash since that's what the stock, bond (credit), and commodity markets are in the process of doing, collectively in the process of what will undoubtedly foment into a full fledged deflation scare. You will remember from our thoughts on this subject presented last week we are in the process of watching for the official signal that such an outcome should be expected sooner than later. The reason this is coming down sooner rather than later should not be surprising in knowing Obama is likely the most self-serving leader of the US (and its empire) ever, guilty of each and every one of the seven deadly sins in spades, which then explains his policy and behavior. The botched handling of the BP oil spill in the gulf is easily one of the better examples in this regard, where unwittingly he has put the entire economy in jeopardy by potentially triggering unforeseen spillover effects. One that not many see is the slowing of southern economies could at the margin be sufficient to tip the aggregate credit cycle into meaningful decline once again, if not on a stand alone basis, just in time for the contagion from Europe to start making it's way over to markets on this side of the pond that have been rebubblized over the past year.
And that process will accelerate if Germany pulls the plug on the euro, where not only would this force austerity measures on reluctant PIIGS (et al) in the eurozone, again, this would also quickly travel worldwide, officially bringing in credit crunch contagion on a secular basis renewed. How would we know a trend has been established in this regard? Beyond knowing both Alt-A loans and commercial real estate are in the process of hitting the fan this year, again, as discussed last week (see attached above) technical evidence of this will be official with a monthly breakout of the Dow / TSX (TSE) Ratio (see Figure 2), where as stated in the annotations of the attached figure we can see that unbeknownst to the masses, a deflation signal is about to triggered with the Canadian markets finally feeling the pinch of the credit crunch. Up until now, because of delusional credit binging and belief on the part of foreign investors Canada was insulated from such contagion, Canucks (and investors) have been enjoying a false sense of security. That should change this year however, with a recently topped real estate market also putting in a generational high here as well.
With Memorial Day weekend to end the month, getting a sell signal from the Dow / TSX Ratio might prove challenging as stocks tend to rise into long weekends (because only the bulls go to work making the job easy for price managers), especially with stocks oversold on a short-tem basis and the influence of open interest put / call ratios weak. Still however, further evidence the secular credit crunch cycle has returned is naturally showing up in the financials, where understandably investors are hesitant to deploy funds given financial institutions on both sides of the pond are looking shaky. What's more, from a technical perspective, it's not difficult envisioning a rounding top being put in the Philadelphia Bank Index (BKX) / S&P 500 (SPX) Ratio here, not with the Gold / Silver Ratio apparently comfortably perched above the 65 mark. Certainly yesterday's losses, the first in 10 Monday's, and plunging stock index futures this morning confirm this view, given the pattern change is suggestive of a rebound throughout the remainder of the week possibly.
The real test will come starting tomorrow with Treasury auctions renewing, where previously, when stocks were not so oversold on a short-term basis, they would routinely weaken to help the bid in the bond market. And with a chain reaction from Europe possible at any time that could reveal the fragility in North American sectors, anything could happen with so many unprepared for another meltdown in both stock and credit markets, so stocks will need all the help they can get. As it stands right now, don't expect much of a bounce moving into week's end even though it's not only a long weekend, but also month end as well. Past this it will be difficult for the bureaucracy's price managers to keep things glued together as summer swings into gear with volumes already low. And by deep summer, if not sooner, at some point the bureaucracy's price managers will be the buyers of last resort, where for one reason or another, whether it be investor and / or speculator exhaustion, generating volume on the buy side should prove difficult, which will exacerbate volatility. So, although we may not witness a crash this week, typical seasonal weakness will play heavy on stocks in July, and then in the fall once again as well.
Along these lines, it's important to note that a consensus of the public has had it with our self-serving bureaucracy, as evidenced in last week's elections, and will undoubtedly be giving all varieties of government agencies a 'good look' in coming days, along with issuing more than a few pink slips along the way. You know this is coming when even the blue bloods within the governing structure (financial) begin expressing concerns government has gotten too big for their britches. What's more, the big message as far as investors are concerned is their will be NO MORE BAILOUTS for Wall Street, which needless to say will make it interesting the next time stocks begin to really tank. This would cause money supply growth rate measures to also tank even more, where they are already in trouble because the public has been all borrowed out for some time. The thing to watch for here is the monetary base, where if it breaks below moving average support, look out below.
In knowing this is now a possibility naturally the next big question is 'how would such a development affect precious metals?' The answer to this question is not easy, however with new mine supply unable to keep up with demamd, along with existing stock piles so low, it's difficult seeing much difficulty for gold moving forward as well, especially since it will likely need to be revalued one day to literally save what is left of the larger financial system. And while more aggressive aspirations for gold might be misplaced in the shorter-term, longer-term one should definitely remain bullish given the positive fundamentals discussed above. Technically however it's time for some cycle-based (time-line related) weakness, with the shares in the lead, as they should be negatively affected by a rout in the broad measures of stocks. (See Figure 1)
Assuming stocks do not fall off a proverbial cliff however, which unfortunately may occur because everybody is already in the pool and needs to come out, the technicals for the Amex Gold Bugs Index (HUI) don't look that bad, as can be seen above. So for now, we will assume precious metals shares are in for a typical correction, one lasting three to six months, with prices falling somewhere between 20 to 30%. Now gold shouldn't fall that much, however with the forecast for precious metals shares being mixed over the next six-months due to a May high likely in place (tops in May characteristically see bottoms in October / November), it may prove wise not to expect much. And certainly would not sell any gold (or silver), but take profits from short selling to accumulate more bullion on the cheap whenever possible, like this week. Of course prices could get better, so you might wish to wait and see if the channel that has been supporting HUI trade, or the sinusoidal in the Philadelphia Gold and Silver Index (XAU) pictured below fail, which would usher in some real bargains. (See Figure 2)
If I were to base my opinion on whether this correction will be significant or not using one chart, if it were the monthly Gold / CRB Ratio pictured below, unfortunately the viewpoint would need to be quite negative considering gold is set to underperform commodities for some time. Now this wouldn't be so bad if commodities were expected to be buoyant moving forward, but as you know with respect to the message being thrown off by the likely breakout in the Dow / TSX Ratio featured above, this is not the prognosis for commodities, which is a problem for gold. So, all in all, and no matter what my opinion is, the bottom line is gold and it's related equities should be viewed as being vulnerable over the next six-months, so don't be sticking your neck out in any wild trades, at a minimum. Strategic accumulation of physical bullion you can comfortably afford is fine, but no hair-brained speculations are allowed in knowing this - OK? (See Figure 3)
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