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June 04, 2008

Pivotal Events
by Bob Hoye

The following is part of Pivotal Events that was published for our subscribers Thursday, May 29, 2008.

SIGNS OF THE TIMES:

Last Year:

"Half the world is going through an industrial revolution compared to that of the U S in the 1890s. This will create demand for metal products like nothing the world has seen in the past century. We are just two years into a super-cycle of globalized demand. The underlying fundamentals are locked in."

- Mitchell Hooke, Minerals Council Of Australia,
in the Turkish Press, June 5, 2007

This reminds of the certainties about soaring copper prices when the mania in stocks and commodities blew out. In 1873 The Economist dryly reported:

"By articles in newspapers, reviews and magazines all sorts and conditions of men were induced to interest themselves in copper. It was shown by figures and arguments, apparently conclusive, and presented with great ability . . . that the world's [supply] of copper would be so much reduced that famine prices must prevail. The confidence in the future was strong enough to cause a further advance of 25 per cent, which was more than lost in the sequel, furnishing a fresh illustration of the rapid action of high prices in these days in bringing forward supplies from every quarter of the globe." The emphasis was The Economist's.

* * * * *

This Year:

"Is The Financial Earthquake Over?

"U S policymakers deserve the Nobel Prize for applied economics. The policy response to financial asset deflation was not only extremely fast, but extremely well coordinated. The second-round effects of asset deflation have been contained."

- Business Times, Singapore, Investment Round Table, May 15, 2008

We had two models that expected the stock market to decline into January, and as it completed we noted that the count of the 55-trading-day plunge in the Nasdaq was a pattern that often ended bull markets. Also, the plunge seemed to fit with accumulating dislocations in the credit markets.

Nevertheless, the advice on January 21 was to cover shorts and to position for an intermediate rally that could be hit by further discoveries of liquidity disasters. Overall, we noted that the revival could eventually become good enough to prompt a round of "self-congratulations" amongst the interventionist community.

The quote from the "Round Table" will likely deserve a special place in a growing list of clangers.

* * * * *

Stock Markets: We used two models on the rebound out to late spring. One was the 1930 example of the first bounce out of 55-day plunge. Yes, that one was drastic but we were interested in timing, which ran into April. The other example dealt with the longer-term, with the 5-year bull market out to the spring of 1937. This has been discussed a few times, and of interest is that copper and lead both set big cyclical highs in March of 1937. Tin, wheat and zinc set theirs in April, while corn continued up until June.

Ross reviewed the 1937 chart in Monday's piece. This rebound fits that model with remarkable fidelity - as well as to the 1973 example, which was a violent year for commodities.

On the longer-term the five-year bull market will be completed with the failure of this rebound which has been following the two key examples. The technical pattern on the near term is also working out. That's with hitting the upper standard deviation band and then falling into a weekly outside reversal. This pattern is, or should be, compelling persuasion to be positioned for a cyclical bear market.

Sector Comment: On the banks (BKX), last week's view was that the big rally out of the January trashing had made the big 50% retracement to 98. This has been followed by a series of declining highs with the breakdown below support at 74 being anticipated by the decline in the worst of the sub-prime making new lows. This threat would become acute when the higher-ranked issues broke down.

This week both the AAA and AA (sub-prime) took the fateful dive, which has been the precursor to each noteworthy drop in the stock markets since last spring.

Quite likely traditional corporate spreads will soon follow, which will pressure lending agencies again. Because credit doesn't abide interventionist notions that economies are national and can be "managed" changes in spreads will hit most banks around the world.

In the meantime, the teeter-totter action with banks and senior indexes on one side, and the resource sector on the other side continues to entertain. Today it is resource down and the rest up.

This has happened a couple of times in the last few months and it shouldn't be called rotation. Perhaps opportunism is one term, but it may not last.

Each crisis since last July has been quite democratic in taking most sectors down, and it's worth adding that Monday's ChartWorks with the 1973 and 1937 patterns are based upon the senior stock index.

Credit Spreads were likely to narrow into May and set up another go at the seasonal reversal that signaled the problems that appeared last summer.

Last week, we noted that weakening of the worst of the sub-prime was anticipating widening for traditional corporates. That melancholy trend continued, but the BBB bond spread narrowed from 210 bps in April to 177 bps on May 20 (We've called this some kind of a "negative divergence). Now it is out to 193 bps and is deteriorating along with the higher-ranked sub-prime.

This is the pattern that has anticipated each of the crises since last spring.

The first dramatic revelation was the first Bear Sterns disaster announced last year in early June when we were in London addressing the Halkin Financial Conference. Bob will be in London addressing a Halkin Dinner on June 11, and will be unable to write that week's Pivotal Events, but Levente and Ross will be on deck.

Stock Market: Negative Divergence

Note the divergence going into the October high.
Note the divergence with the recent high.

Charts above were featured in The Chart Store's (http://www.thechartstore.com) Weekly Chart Blog for the week ending May 23, 2008 and permission was obtained to reproduce them here.

"This oil squeeze may be permanent."

- National Post, May 5, 2008

"One thing is for certain: prices will continue to rise . . . traditional criteria of supply and demand don't apply."

- Secretary of Energy, Charles W. Duncan, February 25, 1980

Bob Hoye
Institutional Advisors

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