"Any investors willing to bet that the commodities boom is running out of steam may need both courage and patience. Major mining companies have wagered more than US$110B on the opposite view."
-Financial Post, February 19, 2011
"Consumer Confidence in U.S. Increases to Three-Month High"
-Bloomberg, February 22, 2011
"U.S. treasury secretary: poor financial regulation in Britain fueled financial crisis."
-Telegraph, February 22, 2011
Regulators seem innocent of knowledge about financial regulations and financial crises. It is runaway speculation that causes panics, and when a mania erupts there is no way of curbing it. Even when the senior currency was convertible into gold there were huge bubbles and consequent collapses. As a prominent banker in the mid-1800s observed, "No warning can save a people determined to suddenly grow rich."
The problem is that governments enjoy tax revenues from the boom and do everything they can to enhance a financial mania. This became more insistent as interventionist economists gained influence. In the mid 1920s policymakers were attempting to keep commodity prices from falling by injecting funds into the markets. With ample supplies of commodities the excess liquidity helped drive financial assets to the moon.
Then, in a fit of recriminatory regulation, the SEC and Glass-Steagall Acts were passed. The first was intended to prevent another 1929 Bubble and one of the populist-backers boasted that it "would put a cop on the corner of Wall and Broad Streets."
The SEC did not prevent another speculative bubble and when whistle-blowers went to the SEC with blatant accusations of fraud the regulatory agency did not act. Failure on both mandates!
Glass-Steagall separated commercial banking from Wall Street banking and when it was time for another great financial mania it was taken off the books. Government could not resist the speculative party!
Has this happened before? Oh yeah.
The South Sea Company was set up as a quasi-government company that had a scheme to fund the state. And when the party launched, the scheme brought in enough money to retire large amounts of outstanding and deeply discounted debt. Then as the bubble was culminating, the government saw too many other companies being floated and moved to constrain the roaring "new issues" market. (For those of us who have been in the markets since 1963, the term "IPO" has never had the same cachet as "new issue.")
The Anti-Bubble Act of 1720 was intended to keep the mania going and a few decades later some considered that it was intended to prevent another bubble. The act did not pass the House of Lords, but in 1772 it was taken off the books. Just in time for the culmination of the next great financial bubble!
History suggests that no regulation will prevent a financial mania; governments will exaggerate the mania and all will condemn a bubble during the distress of collapse. Treasury Secretary Geithner is little different than his counterparts in history. Perhaps his pride and hubris is outstanding, but this only a matter of degree, not distinction.
What do you call today's quasi-government agencies that are set up to fund the state?
More on the Speculative Eruption
Last week's Pivot summarized the development of an outstanding buying frenzy. This was identified in November when our Momentum Peak Forecaster was going straight up. This stopped going up at the end of December and indicated that the action could climax in one to three months. By way of emphasis, this means that the hot stuff goes straight up until it goes straight down—typically—within three months.
At the latest this counts out to around March. For those who deal in quarterly reports or annual averages, this may seem a precise forecast. It should be considered as a six-week window when the hottest items could reverse. Last week's piece noted that technical work, independent of our Forecaster, was registering Upside Exhaustions and these could reverse in March.
Last week's caution was that participants were "dancing on the edge of a cliff," although, "this is ending action and the hot participants may not all peak at the same time." Tuesday's Memo noted the reversal in cotton and faltering prices for other agricultural items as crude oil and precious metals continued strong.
The overall speculative thrust is changing as some items fail and perhaps it could become a "commodity-pickers" market—for a few weeks. To be serious, typically as a great rush culminates the action is focused on fewer and fewer items. On the stock exchange this is the equivalent to declining advance/decline ratios.
At the end of 1979, the fury was focused upon gold and silver. At the end, silver began to underperform gold some two weeks before the top on January 21, 1980.
Other points we have mentioned are that on the Forecaster signals with soaring prices in 1973-1974 and in 1980, there were reports about "food shortages" and extreme trouble in the Middle East. The "Yom Kippur" attack on Israel occurred in October 1973 and our Forecaster registered on November 23, which was three months before the climax. The Iranian hostage incident began on November 4, 1979 and the Forecaster signal occurred on November 9, which was 2.5 months before the glorious blowout on January 21, 1980.
This week, the Conference Board reported that Consumer Confidence jumped from 64.8 in January to 70.4 on the February number. Clearly, consumer confidence is still soaring with our Forecaster. Perhaps it will "blow out" with the culmination of the buying frenzy.
The hit to base metals and agricultural commodities this week is an alert, in real time, to the inevitable culmination of this huge speculation.
Stock markets have been important participants in the All-One-Market phenomenon and have faltered with the setback in most everything other than precious metals and crude oil.
The rally up to early February has been within our Forecaster model, which suggests a cyclical peak for the stock market is developing. On the rush, momentum and sentiment figures reached outstanding numbers that are typically found at a stock market peak. The Forecaster has been anticipating a cyclical peak and technical measures have been confirming this melancholy prospect.
The key question is will the economy turn down with the stock market or will the decline in the S&P lead the downturn in the business cycle?
We know that post-bubble recessions start virtually with the first post-bubble bear market. In ordinary business cycles the stock market leads—by up to 12 months. It is possible to put this in mathematical terms that Keynesian economists usually find so instructive:
Market Peak - Economic Peak = 12 Months
MP - EP = 4 quarters
To be serious, the business cycle could roll over on this developing crisis with very little lag between the start of the bear market and the start of the recession. Let's check back on the last first business cycle out of a post-bubble crash.
According to the NBER, that recession started in May 1937 and the big stock rebound peaked on March 13. Only a one-month lead on that one. Of interest, is that Ron Griess (www.thechartstore.com) points out that the great rebound out of the 1929 Crash ran 104 weeks to the key high on March 13, 1937. The gain on the S&P was 134%.
On our great rebound, the 104-week count works out to a potential high on February 25. For the S&P the gain has been 102% to 1343 on February 18.
Coming out of the 2009 Crash we used 1937 as a model and did not stay with it. We should have as the correlation has been fascinating.
Ron points out another example of a 104-week great rebound out of a financial panic. The rebound out of the 1907 Crash ran until November 20, 1911. Transposed to now, the equivalent high counts out to March 11, 2011—which is more than just interesting. Both post-crash rebounds were followed by a 15% selloff. This works out to around 1135, which was the break-out following the early summer slump.
The financial establishment may wonder how these pages can have a forecast for straight-up speculation and a strong economy and at the same time look for a sharp decline in both.
Well, it is the way financial history works during Anthropogenic Financial Climate Change, or AFGC. This observation refers to all market participants, not just to policymakers who have been naively blamed for not keeping the 1929 mania going. More recently, the Obama administration has naively blamed the Bush administration for not being able to keep the 2007 financial mania going.
The point is that there is no power on earth that can prevent a financial mania and there is no power that can keep one going beyond its shelf-life.
We think the same applies to great rebounds and this one is within six weeks from failing. Confirmation is provided by our Forecaster, which when the big action includes commodities the recession has started close to the heads-up alert. On the signal in November 1973 the recession started that November. On the November 1979 signal the recession started in January 1980.
Wonderful two weeks ago, the outlook is now bleak.
It seems to be time for an old saying: "There is only one cure for high prices and that is higher prices." The conclusion of soaring prices is accomplished as high prices prompt significant increases in production and significant declines in the rate of personal consumption.
We know that the Fed has pledged to boost prices "forever"—or more realistic—while it remains in business. But it has been attempting to inflate currency and credit since it opened the doors in 1914 and booms and busts have prevailed.
Commodities are close to starting another cyclical bear market.
Last week, we noted that the long bond could rally as most commodities weakened, but that rallies would be limited by the possibility of another general wave of bond revulsion.
The risk to corporate bonds is increasing by the minute. Prices and spreads are now vulnerable as this business and commodity cycle rolls over.
S&P earnings go up and down with commodities and the down indicates poor pricing power for business and that means deteriorating ability to service corporate debt.
Since early November, the DX has been building an important base. The recent decline to the 77 level on February 2 seems to be testing the 75.6 level of early November.
The Dollar Index could churn around for a few weeks when another upturn seems likely. Rising through 79 would confirm the uptrend.
Precious Metals Sector
Gold and silver could still rally with crude oil. Precious metals could rally even if crude oil prices leveled off.
Precious metal stocks are a good way to play the trend, but often shares lead the culmination of a bull move for metals. Investors should consider that if crude goes hysterical oil stocks may not perform in the final stage. If crude goes hysterical so will silver and gold go along with the ride, but precious metal stocks may not perform in the final stage.
Our "dancing on a cliff" theme suddenly applied to agricultural and base metal prices. It is not rocket surgery to wonder when it may hit crude oil and precious metal stocks.
Representing the oil patch the weekly RSI on the XOI has reached 82—the highest reading since the 80 attained in 2007.
Gold stock (HUI) momentum is nowhere near as high, nor is momentum as high for Silver Wheaton Corp. (NYSE:SLW; TSX:SLW), which we use as a proxy for the silver camp.
Now for the play in gold and silver: The silver/gold ratio which is sympathetic to the bull move for both has reached a daily RSI momentum of 79.8 which in ordinary conditions would prompt a correction. On stronger moves this measure can get to the high 80s and tradable corrections have followed. That was basis for our Correction Zone that began in November.
Precious metal stocks have rallied in the initial stage of our Construction Zone and investors could take a little money off the table.
This article was originally published on February 24. Author Bob Hoye, chief financial strategist, writes the weekly overview, Pivotal Events, and can be found on SafeHaven.com. In 1998 he founded the Institutional Advisors website, a forum for reliable financial research. Bob's review of financial history provided the forecasting models designed to anticipate significant trend changes. This included the alarming volatility typical of the transition from rampant speculation in tangible and financial assets to severe contraction. His articles have been published by Barron’s, Financial Post, Financial Times and National Post. Bob is frequently interviewed on radio, podcasts and TV.
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