A Lot of Technical Damage Friday: Is a Depression Coming?

By: Robert McHugh | Sun, Mar 9, 2008
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This week saw a new all-time low in the Dollar, new all-time highs in Gold and Oil, but the damage continues in stocks. There was a lot of technical damage done to stock averages Friday. We got confirmation of 18 month, very Bearish Head & Shoulders tops patterns in several indices, as prices completed their right shoulders and fell decisively below necklines. These patterns are huge, and the downside targets are 20 percent below where we stand now in several averages. In other words, these patterns are calling for a stock market crash. These patterns are saying that the Bear Market is nowhere near over.

We also got half of a Dow Theory re-confirmation of the Bear Market, as the Dow Industrials closed below their January lows. We now await the same action from the Trannies for downside confirmation. If we do not get the confirmation, that means there is hope for Bulls, but no Bull market signal.

Further, prices fell decisively below the bottom boundary of a 26 year rising trend-channel from 1982, as pointed out by Peter Eliades this week (www.stockcycles.com).We show that chart in our weekend newsletters to subscribers. This could be suggesting that the current Bear market is the big one, one of major Supercycle degree, the fulfillment of the Kondratieff winter cycle technical folks have been watching for, for a decade. It suggests we may be headed for a depression, not just a recession.

If we are headed for a depression, then raise cash. Raise it. Hold it. Go to our conservative portfolio button at the home page and study this portfolio. In depressions, cash is king. Lending is coming to a screeching halt. You cannot rely upon lines of credit as banks are cutting them as fast as they can. We have a credit crunch just getting started. Most of the mistakes of the 1930s are being repeated by the current crop of Master Planners. Raise cash. Do it now. The focus of government is on the money center banks, not on the consumer. They are worried about replacing written off loans with Fed liquidity infusions rather than getting liquidity into the hands of households. Big mistake. The money that is causing hyperinflation and a rising cost of living is going to evaporate as it arrives at money center banks. It will not be used to lend to consumers, but to replace losses by banks. If they took that money and tax-rebated it into the hands of households, bad debts would disappear from bank balance sheets and consumers would be empowered to clean up their financial positions, which helps banks, helps the housing market, helps the securities market, helps the credit insurers, and boosts the economy as spending increases, jobs increase, and tax revenues increase. But this is a Bear market, and in Bear markets our fearless leaders screw up. Bad things happen. Things go big-time wrong. The solution is in front of them, but they won't do it. Yes handing out big money, hundreds of thousands of dollars to each household, is hyperinflationary, but what they are doing now is also hyperinfaltionary, except what they do now will be ineffective. Getting money into households, big money, a rebate of their past 20 years of taxes, will provide trickle up benefits for that same hyperinflation. Then once things are cleaned up, we need to dump the Fed, and have the Treasury issue our currency, as they once did before the Fed existed, before 1913, backed by gold and silver. But it won't happen, so raise cash. This is wisdom.

We continue to monitor the monster shown on the chart below for the Dollar -- it tells you all you need to know about what the Fed has been doing with M-3, and what it is going to have to do with it in the future:

The situation has deteriorated as we see a decisive break below the Dollar's neckline. The Dollar could drop faster than perhaps anyone thought. The pattern is a Head and Shoulders top. These patterns are highly reliable. It is now a "confirmed" pattern, meaning prices dropped decisively below the neckline, below 80.00. This means the probability of the minimum target of 40.00ish being hit is great. With the Dollar dropping to 72.46 Friday, we continue to see a high risk situation develop of a devaluation of the dollar all the way down to 40.00. Not all at once, but over the course of several years. Perhaps all at once, should the government elect to flat-out issue an edict that a dollar is now worth 50 cents. Would they? Maybe, but without telling us. Why? It is a way to repudiate half of all the debt in the United States. Why would they want to do that? Perhaps if a recession became a depression, or the risk thereof. Perhaps if Housing was to absolutely dive into the tank. It would be a way to relieve mortgage holders of a huge chunk of their obligations in lieu of mass foreclosures, and bailout financial institutions holding substantial portfolios of mortgage backed securities. A massive print and hand out of money to every household to bail out the economy, would be the most efficacious approach to devalue the dollar, in this author's opinion. The Dollar has been devalued by 40 percent over the past five years!!!!!. This is why you feel like you are struggling financially. The cost of living has doubled over the past five years.

The pattern is ominous as far as its size, its timeframe, and as far as its downside implications. This pattern is textbook. No flaws. This is right in line with the Fed's decision to hide M-3, enabling them to hyper-inflate the economy with too much money for secret purposes (The Working Group's minutes are secret, their market buying intervention activities are secret, the quantity of M-3 being created is secret, where the money goes is secret). Any auditor worth his salt will tell you that secrecy breeds mischief, often with dire consequences. The founding fathers established accountability in our constitution, and the Federal Reserve and the Working Group (a.k.a. Plunge Protection Team) are violating that spirit. Congress needs to get real tough with this institution and group. The problem is, the focus has been on the money center banks, and not American households.

When the Master Planners devalued the dollar over the past five years, they raised the cost of living for everyone. The Middle Class is getting annihilated from this silent event. Incomes are not keeping up. This was done because this administration "equates stock market success with economic success and has directed their efforts to drive up equities at literally any cost," to quote a subscriber. That policy is pure fallacy as mild market declines are proven to be beneficial to Middle Class investors who use the safe, time-tested investing strategy of Dollar Cost Averaging (occurring in 401(k)'s for example), where occasional mild stock market declines can actually accelerate wealth generation. All this administration has accomplished is to ensure that Wall Street Banking Firms continue to make huge profits. This is not to bash Republicans, as this was not the case under Republican Ronald Reagan. However, because of this past policy, we now are not getting a mild decline, but perhaps the big one.

There is a key difference between the inflation of the past eight years and the inflation that must occur now. Before, it was unnecessary for our economy, for households' survival. It was unnecessary inflation that created bubbles that are now bursting, all so profits could be maximized on Wall Street. Now, inflation is absolutely necessary to prevent a severe recession, and perhaps depression that would crush Main Street. Serious threats are present that could change our American way of life. The middle class is at risk of being wiped out. Bank solvency is at risk as loan collateral values plunge. Bank solvency is at risk should their securities relying upon credit insurance be downgraded, requiring mark-to-market write downs that threaten capital, which affects permissible lending. Derivatives such as credit default swaps and other esoteric instruments are at risk of a meltdown. Step one should be to strengthen the credit insurers balance sheets, to make sure they do not lose their AAA rating. If they do, we could be looking a bank risk-based capital crisis, and weakening inability to lend. This would contract the credit function at exactly the wrong time, thrusting the economy into a depression. While steps have been taken to support the monline insurers, it may not be enough, should things spiral down, as we suspect they will.

If the Master Planners are going to trash the dollar anyway, why not hand the bulk of increasing money supply directly to each household. Why not send a check for $300,000 to every household. Now that is a real bailout, it would be effective, and we'd end up in the same place, a dollar valued in the 40's, but with a much stronger economy and a rejuvenated consumer, able and ready to spend. Wall Street would benefit with a "trickle up" benefit, rather than this administration's preference, to hand money to Wall Street and hope for a "trickle down" benefit. The Tax rebate program just passed is peanuts, is about one mortgage payment for each household, and will have negligible impact.

Unless the average American's finances are repaired, anything tried will fail, any more inflation generated will only make matters worse. The Master Planners have gone beyond the point where traditional Fed actions will work. A drastic change in macroeconomic thinking is necessary, starting with honest disclosure of how bad things really are.

Because the American household's finances are not being aided, banks are cutting back on lending, which is causing a contractionary credit crunch, which is further destroying economic prospects, and ergo the American household. It means more losses for banks. Any bailout must start with households, be aggressive, and happen soon. Once the American household is properly bailed out of its debts, a new currency with a gold and silver backing, as the Constitution of the United States requires, as written by our wise and noble founding fathers, should be the next step.

Get everyone out of their fiat debts by issuing enough fiat money to accomplish that, a one-time event, then get back to a gold and silver backed monetary unit, and dump the Fed. The Fed caused this mess with its hidden hyperinflation over the past decade, creating bubbles that are now bursting. Now they aggravate a terrible situation by putting pressure on banks to slow down lending, further exacerbating the credit crunch. They are slow to lower rates, reactive rather than proactive, as the Fed Funds rate now sits 130 basis points above the one month Treasury rate. Use them to get money into the hands of every household then bid them good riddance.

For the individual, defense includes raising cash, holding some gold, maybe some gold stocks, some Treasuries, but mostly cash. Our subscribers have access to the conservative portfolio model we developed back in October 2007. It has performed admirably during this Bear market.

As for one defense mechanism, Gold finished the Minor degree wave 3 of Intermediate degree 1 up on May 12th at $730.40, and has decisively surpassed that level, a Bullish breakout. It closed December over $800 an ounce for the first time ever. Gold is rising sharply once again, hitting a new all time high this week of 995.20. We now believe it could hit 1,300 by late 2008. Before that, there will be corrections, buying opportunities. Gold recently corrected, but is rising again.

Gold's Minor degree wave 4 was a Symmetrical Triangle, a consolidation pattern of the Minor degree wave 3 rally that started back in 2001 and extended into the May 12th, 2006 top. Waves a through e within wave 4 are complete. A break above $730 confirmed that the triangle is complete, and wave 5 up is underway. Wave fives typically extend with precious metals, so for wave 5, $1,300 is likely for Gold in 2008. Minuette wave i up of 5 up has not yet completed. Gold revealed itself to be forming a Symmetrical Wave 4 pattern, a five wave pattern of three waves each, that started at the $848 top on November 7th. This pattern is complete, is textbook, is Micro wave 4, and Gold has predictably broken out higher from this pattern, wave 5 of i up. See chart of this Symmetrical Triangle at the bottom of the next page. Wave fives extend in precious metals, are the longest waves.

Silver's performance is lagging Gold's since Silver has industrial use, and the stock market's drop is forecasting a slowing economy, which suggests industrial demand for silver may slow. However, Silver also has monetary value, so its downside has been limited. Silver finished its Minor degree wave 1 up. Wave 2-down formed an a-b-c flat, with a truncated wave c-down. A decisive breakout above 15 confirmed that wave 3 up of 5 up is underway. Waves i up and ii down finished, and wave iii up of 3 of 5 has started, off to the races toward $25, hitting 21.32 Thursday. Wave fives typically extend in precious metals, a solid reason Silver should be headed for $25. Precious metals are loving the hyperinflation, and the probability that more will be needed to bail out this economy.

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Robert McHugh

Author: Robert McHugh

Robert D. McHugh, Jr. Ph.D.
Main Line Investors, Inc.

Robert McHugh

Robert McHugh Ph.D. is President and CEO of Main Line Investors, Inc., a registered investment advisor in the Commonwealth of Pennsylvania, and can be reached at www.technicalindicatorindex.com. The statements, opinions and analyses presented in this newsletter are provided as a general information and education service only. Opinions, estimates and probabilities expressed herein constitute the judgment of the author as of the date indicated and are subject to change without notice. Nothing contained in this newsletter is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. Neither Main Line Investors, Inc. nor Robert D. McHugh, Jr., Ph.D. Editor shall be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided.

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