Pivotal Events

By Bob Hoye

Institutional Advisors

December 24, 2009

The following is part of Pivotal Events that was published for our subscribers December 17, 2009.

SIGNS OF THE TIMES:

Two Years Ago:

"I wouldn't panic, investors should stay in for the long-term. Goldilocks is alive and well."

– Larry Kudlow, CNBC, December 10, 2007

"Tough Times Ahead? Banks Put Up For-Sale Signs"

"Now Comes the Yard Sale"

– Wall Street Journal, December 28, 2007

That was during the slide that was severe enough to end the stock market part of the great financial bubble.

*   *   *   *   *

This Year:

"Bernanke: No Asset Bubbles in U.S."

"We do not see any extreme mis-evaluation of assets in the U.S."

– Fox News, December 3, 2009

"Long ago I quit criticizing the Federal Reserve chairman for failing to avert the latest systemic financial disaster. Criticizing the Fed chairman for a lack of prescience is like criticizing a dog for an inability to recite the alphabet. When something is physiologically impossible, why bother?"

– Mises.org, December 15, 3009

"Federal employees are enjoying an extraordinary boom time – in pay and hiring – in a recession that has cost 7.3 million jobs in the private sector."

Government workers are averaging $71,206, which compares to the private sector at $40,331. The article did not include a comment on the "quality" of government jobs.

– USA Today, December 11, 2009

"56% say average government worker earns more than the average taxpayer."

– Rasmussen, December 16, 2009

STOCK MARKETS

We are staying with the theme that the big financial rebound out of a crash has been accomplished – somewhat later than we expected. The fifty percent retracement on the Dow was accomplished along with terrific bullishness.

As measured by Investors Intelligence, Percent Bears declined to 16.7 on December 2 and to 16.5 last week. Strong sentiment continued this week with bulls running three times the number of bears. This is another way of looking at it and the ratio has not been beyond 3 since October 2007 when it reached 3.16. Brokers were happy and trained economists were celebrating the genius of policymakers. Early in the week, the hot action drove the ratio to 3.13, which is in bull market ending territory.

The establishment is back in full song, and Bernanke has pointed out that there are no asset bubbles and no "mis-evaluations".  One “bubble” could be curve steepening.

By reliable measure, stocks are as precarious as in 2007. However, credit markets had been deteriorating since June of that fateful year. After some relief in September, deterioration resumed and took the stock market down.

Going in to this rounding top, credit markets have been benign, which has been a key indicator of the "risk-free" environment. Some researchers call the flight to risk as the "new normal", but it could be that "normal" is behind the times.

Credit conditions have eased since the TED-Spread and the Sub-prime provided the warning on the Dubai World failure. It is worth noting that the brief widening did not specifically point the finger to Dubai or to Greece. Just that something was coming down.

Since then, nothing but sunshine, but stock market internals continue to deteriorate.

Of course, with a research team that has been dedicated to anticipating change the question remains "When?".

As with the change in October 2007, the key beyond extremely bullish sentiment was deterioration in credit from late September. Quite likely it will require something similar.

In the meantime, the gold/silver ratio crept up and briefly touched 65, but did not get through. Rising though will set the uptrend, which would be the warning on the party.

Over in bankland, failures continue and the BKX seems to be doing a rolling top. The big rebound set highs at 48 in late August, 48 in mid September and 49 in mid October. This initial decline was to 41 at the first of November.

With this, our proprietary Bank Trading Guide rallied to 172 in mid September. After a decline the rally tested the high at 168 in October and declined to 155 at the end of October. Taking this out would set the downtrend and this would not be good for most banks and financials.

The low for the Guide was 139 on February 26 when we were advising that the action was so bad that it had to be bought. The low for the BKX was 18.6 on March 6. As noted above, the rebound high was 48.

Near-term, the last low was 41.7 on November 4, and the recovery high was 44.6 on December 2. Falling through the last low will set the downtrend.

Gold Sector: The expected consolidation is working out, but the initial break was too fast. It took only six days to generate the daily Capitulation reading.

On any such signal the low can take a week and today's decline continues the correction. It is worth noting that the rally in the DX is becoming impressive.

Gold stocks (HUI) reached an overbought at 516 at the beginning of the month and have been expected to decline into January. Support could be found at the 390 level.

Gold's real price, as represented by our Gold/Commodities Index (GCI) set an uptrend in September, which began to anticipate a resumption of credit concerns. In late November it reached 392 when the Dubai World default was reported. It turns out that the rise had been anticipating a specific failure, rather than a general one.

After reaching 400 with the Dubai thing, the G/C declined to 373 last Thursday. It is stabilizing and if it resumes the uptrend it would be anticipating the next "problem".

Considering the direction of the dollar, the next "problem" could be more widespread.

Another confirming indicator would be the gold/silver ratio advancing through 65.

In the meantime, senior golds as well as smaller-cap producers can decline further, presenting another buying opportunity for the sector.

Gold's real price will continue its cyclical bull market, which is indicating the usual post-bubble increase in investment demand. Producers are recognizing this and will have to become much more aggressive in building reserves. So far this has been mainly done through acquisition.

Legendary gold rushes have occurred close to the bottom of a great depression – California in 1849 and the Klondike in 1897 are examples.

It is worth emphasizing that the rising real price enhances mining profitability as well as valuations on gold deposits. Senior producers could soon cause a gold rush in the exploration side.

bobhoye@institutionaladvisors.com

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