Harry Houdini - Seasonal Patterns -- And Liar's Loans Toxic Waste
Below is a commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, June 26th, 2007.
Market pundits are coming out of the woodwork prognosticating financial markets are in real trouble now because the subprime mess will spread to other markets, and a 'blood bath' will occur in everything from commercial loans to the stock market. And then select others more conservatively espouse, while they are open to such possibilities given global imbalances / bubbles are undoubtedly stretched, it's not over until the fat lady sings, but that at a minimum we should count on increased volatility in the days ahead. And with this assessment we can agree, where you know from reading these pages in past weeks and months we have been on this page for quite some time. What's more, and as you may have discerned, we are not in the business of fear mongering or sensationalism, but instead attempting to provide a realistic appraisal of anticipated market movements based in proven analytical techniques and methodologies. Of course given just how strange things have become over the past few years some of our accountings may appear to border on sensationalism, and for this we apologize and beg your understanding, as it's almost impossible to talk about the 'big picture' without conjuring up an image of Armageddon, if not now, in the days to come.
So, the question then begs, 'is the subprime mess the iceberg tip sensationalists claim it is, destined to spread to other markets, and a threat to the stability of the financial system at this very moment?' While there will undoubtedly be 'hell to pay' in unwinding excesses associated the housing bubble, a primary beneficiary of the larger credit bubble all along, in my mind the answer to this question is 'no', not yet, although I do think authorities will allow a certain degree of fear with respect to worsening possibilities grow before stepping in to support market(s) volatility. Why would they do this? Two reasons pop into my head right away in answering this question. The first is price managers are in the business of selling disaster insurance, and with things having gone so well of late, a little rain during summer has typically been very good for the bottom line(s) of brokers and banks by Christmas because sales remain brisk with increasingly large rocks held over people's heads. What's more, it should be noted this same logic applies to politicians justifying their existence, meaning it makes it appear we need them to solve the very problems they themselves sponsor. And the second reason is of course the need for these same people to knock down commodity prices in an attempt to hide the very inflation they themselves create. Fortunately for investors attempting to protect themselves from these characters, I'm happy to point out they are not having much success in this regard anymore because in order to accomplish a real breakdown in commodities they would have allow stocks and bonds to go along for the ride, and we can't have that now can we - not with our asset dependent economy these days. More on this below.
A side effect they may not be counting on however that if the subprime market is to receive less attention from speculative capital flows in the future as a result of the current turmoil, not to mention the four letter word 'risk' might actually return to vocabularies in financial circles, Da Boys will need to find new target markets to rotate into. Given this profile, precious metals have got to be at least within the realm of possibilities, even for the mentally challenged. Add to this understanding the hypothesis financial authorities will likely wish to see the M's growing again as 2008 (think Presidential Election) rolls around, where a bit of a crisis now will provide justification for doing so, and in my mind we have a recipe for precious metals to find a lasting bid once again at a time of year noted for producing such bottoms, that being in June / July.
Does this mean we see smooth sailing ahead for precious metals from lows seen in coming weeks? Definitely not - as stated above we see increasing volatility entering the picture, which means precious metals will likely see increasing volatility as well, however the bias should be to the upside. That being said, one should prepare for such developments mentally ahead of time, endeavoring to not become depressed every time your portfolio takes a hit. And we may get some practice in this regard as the days turn into July, where a continued slide in the Gold / TNX Ratio looks set to produce a sector bottom similar to that witness in the summer of 2002, that being a spike low which is tested later on in fall. Our thinking is being shaped in this regard based on the fact monetary authorities are not stepping in on the monetization front just yet in support of increasingly stressed debt markets. As mentioned above, they need to break commodities down now in order to justify a re-liquification program in the Fall aimed at smoothing out the economy come election time next year. Thus, we are looking for a spike lower in the Gold / TNX Ratio in coming weeks as we head closer to equity options expiry on the third Friday of July, where authorities know the very high put / call ratios will have a stabilizing effect on stock market prices. Here, we would expect to see the TNX top out in a week or two coincident to bottoms in both gold and stocks at this time. (See Figure 1)
And as with our ongoing discussion on fundamentals associated with precious metals, knowing what is happening to gold then is largely a function of understanding what our wonderful price fixing social elite (think bankers and politicos) are up to, which as mentioned, is centered on attempting to push prices down at present, with the attack theoretically suppose to trigger selling in equities across the board. Oh, but don't touch the precious stock or bond market bubbles however, at least not on a lasting basis, as buoyancy here is needed to maintain the liquidity nexus. Go ahead a kill those pesky commodities though, because rising input prices just adds more pressure to our 'inflation measures', which will eventually cause multiple contractions in stocks if interest rates rise on a lasting basis. And we wouldn't want that, now would we. We can't have stocks and bonds heading lower because the economy depends on these asset bubbles. Here, inflation bulls hope they don't make any big mistakes in the price management department, but unfortunately they usually do, as was the case in 1929, 1987, and any other comparison similar to our current situation.
That being said, for now when you see authorities talking tough on inflation however, one must assume such attacks are designed to mislead and paint false pictures, where again, authorities need to shake investors out of their commodity positions within what could be termed an 'opportunity window' before such policy must be reversed. Key here is crude oil (and gasoline as far as the consumer is concerned), where it's becoming increasingly difficult to suppress prices all the time due to natural forces associated with supply constraints. This means that in order to have a lasting effect on price, demand would have to curtail in meaningful fashion, which would involve slowing down the economy. And you know what that would mean. Of course you should understand this does not mean authorities will not take increasingly aggressive 'pot shots' at commodities in the near-term considering we are still within what could be termed an 'opportunity window' from a Presidential Cycle perspective. Every word of the Fed's statement this week will be scrutinized in this respect considering the dollar ($) is trying to roll over again. And for the Chinese too, they are worried their stock market(s) might crash just prior the Olympics next year if allowed to run unchecked now. So, here too expect Chinese authorities to become increasingly hawkish until they feel enough air has come out the balloon factory over there.
Circling back around yet again however, because pressure in our asset economy's pipe cannot be allowed to escape in any appreciable degree, as explained last week, like Harry Houdini, who is perhaps the most famous illusionist ever known, even though US monetary authorities are cutting back in money supply growth of the very visible M's, as with all good magicians, such antics are designed to distract your attention from where the trick is being perpetuated, in this case involving the Treasury making up for what the Fed is holding back. Like Houdini then, who was a master prestidigitator, US monetary authorities are hoping observers focus on the M's, which are languishing, to show they are exercising fiscal restraint, supposedly providing investors with confidence in the bond market, not to mention the dollar ($). Of course one would have to be an idiot in coming to such a conclusion in watching the stock market continually pop back up like a breach ball held under water every time an attack on commodity prices is manufactured, but of course this is what our wonderful government assumes you are - an idiot.
That being said, and as per our accounting above, from a technical perspective it also appears officials are not quite finished with these concerted attacks for the year yet (seasonal lows occur this time of year because authorities need to support a slowing economy through summer months), with one more push higher in long rates (TNX) to be expected in finishing off a typical double bottom in bonds usually seen in July. This is the low that's suppose to last all year, so from this perspective it's understandable if this sequence is extended into July considering real fundamentals supporting the 25-year bull market in bonds are visibly deteriorating in the eyes of more and more investors now, even the Neocon types that have been ignoring general price gains up until more recently. This means if yields rise one more time in July, as mentioned gold should be hit again as well, where as pointed out several weeks ago now in our discussion concerning the Gold / TNX Ratio, the metal of kings should see an ultimate (intra-day) low for the current corrective sequence in the $635 area, possibly even as low as $625, at the extreme. Not surprisingly, this analysis matches ultimate (upper) channel based support seen here on the weekly plot featured in the Chart Room, where such a move would also send indicators down to denoted supports as well.
Furthermore, and as implied in our note on the attached directly above concerning what happens every time the 50-weeks moving average is penetrated, it appears authorities intend to break gold down in July using rising 10-Year rates as the trigger, undoubtedly hoping this causes a channel break, and subsequent fall down into the $550 area, the channel bottom. And they may be successful in this regard, who knows, where if Dave is right about the TNX heading to 6-percent, this would mean Fibonacci related support on the Gold / TNX Ratio at 11ish would not hold, and considerably lower prices could ensue. How do we know this attack will come as we move into July? Because we know that they know high open interest put / call ratios (along with short positions) will support stocks as expiry approaches on the third Friday of the month, where they would only attempt such a feat (think Houdini) in knowing they can engineer a short squeeze higher in their precious stock markets easily at this time of month once support is provided for the bond market. Moreover, it should be noted the bond market normally finds support in summer and fall due to sluggish seasonal consumption / investment constraints, a topic discussed further just below.
In the meantime however, authorities allow prices to fall under such circumstances to provide the illusion they have lost control of the situation, and that bonds are under attack for real, causing many to run for the hills, and especially away from commodities, which of course is the primary objective of the larger exercise this time of year. As mentioned above however, in a perfect world this should be the last attack by authorities in this regard, not that volatility will leave the markets afterward given they will go from fighting the influence of past inflation on prices to accelerating new inflation growth to combat not only the slowing they themselves have manufactured, but also the natural slowing in spending hot weather brings this time of year. So you see this is why gold bottoms in summer, because seasonal patterns suggest monetary authorities have a bias to inflate into winter in order to get the larger machine working again, where consumption / investment trends need the support our inflated system demands. In a perfect world then, gold should find support fairly soon, if not in accordance with the scenario outline above, perhaps at initial larger degree Fibonacci resonance related support in the $610 range seen below. (See Figure 2)
What if the world is not perfect however, meaning this view proves to be incorrect? What if the liar's loans mess that is bound to blow up at some point does so soon? And what if the Yen were to start rising because market rates in Japan are dragged higher within the larger equation? And what about US trade related sanctions against China - what if Chinese authorities attempt to flex their muscles by continuing to shed US Treasuries? These are legitimate risks that could counter anticipated outcomes, not that we were expecting a clear bottom in the precious metals sector until fall anyway, as mentioned many times on these pages previously in connection with the comparison to the 70's experience. (See Figure 4) Moreover, such a view would certainly be consistent with Dave's very capable technical appraisal of the stock market utilizing proven Elliott Wave Theory (EWT) and Bollinger Band (BB) methodologies in arriving at a view of probable outcomes for the equity complex into fall.
And as you know from our previous discussions on this subject, it's the threat of a system wide credit crunch that will likely spark some degree of hyperinflation in the larger (global) economy eventually, where of course it could be argued we are essentially already getting there when all the various sources of monetary largesse are added together. You see in dividing them into separate sources, the various entities that comprise the Working Group On Financial Markets can continue to borrow from Houdini in terms of attempting to conceal the true degree of system debasement that now extends far beyond simply accounting for currency growth rates. Again, and as per our example above, these characters assume the market is stupid, or as corrupt as they are at a minimum, and will not recognize the totality of credit creation associated with the Working Group's collective efforts, much of which is ignored anyway with increasingly lax reporting standards. Here, we simply have to look at prices for evidence in this regard, where for example it appears the Baltic Freight Index (BDI) may be taking off once again, implying the inflation boggy is alive and well. Moreover, all we need is a little buoyancy in precious metals shares to return to the tape and a 'buy signal' for the sector would be triggered. This is of course what price managers are fighting at present, where you can expect more of the same until macro conditions switch over to the spending related seasonal softening discussed above.
Then, it should be understood price managers will actually have a vested interest in ensuring macro-conditions do not soften excessively through the fall, where if enough downward pressure on prices develops, we should expect to see growth rates in the very visible M's begin accelerating higher once again, if not so much in the more narrow measures in attempting to protect the $, in monetization measures most assuredly. Adding to the degree of certainty we should expect a strong inflation cycle to make its presence known sooner rather than later as well is the observation on top of derivatives related trouble associated with a residential real estate bubble threatening to go completely toxic given the opportunity, we still have generally rising open interest put / call ratios on US equity indexes. This means any degree of acceleration in monetary debasement rates enacted to compensate for softening economic conditions should bring dramatic price reactions higher if more recent history is a good guide. What's more, it's the knowledge that such supportive measures will surely be intensified if need be given Presidential Cycle considerations (talking in US-centric terms) that has us convinced larger cycle measures associated with gold's bull market are set to be unleashed relatively soon, meaning as far as portfolio planning considerations are concerned, while short-term trading practices might prove difficult in coming weeks, certainly placement of intermediate to long-term funds is likely to be looked back on as having been well positioned in current proximities.
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