Find the Cost of Freedom

• Find the cost of freedom buried in the ground
  
• Mother earth will swallow you; lay your body down.
  

Crosby, Stills, & Nash

Back in the days when I had long hair, or any hair for that matter, I would go to concerts whenever possible. One of my favorite groups was a trio known as Crosby, Stills, & Nash. The first time I saw them together was right after Woodstock, and I've probably seen them a dozen times since then. In the early 70's, they would close their gigs with a song entitled "Find the Cost of Freedom". For lack of a better word, it was a dirge and it was aimed at the war in Viet Nam. This and other songs raised the consciousness of the nation's youth and served to unite them against what they perceived to be as an unjust war. Music was just one of the tools they used to bring it to an end[1]. They organized, mobilized, and took to the streets. Usually the protests were peaceful; sometimes they weren't. Every once in a great while something would go terribly wrong and people would die. An image of Ohio National Guardsmen standing on a hill, firing live ammunition down on unarmed teenagers, comes to mind. In that particular case the cost was four dead and fourteen wounded. Compared to the fifty-five thousand young Americans that died in Viet Nam, it probably seemed like a small price to pay. After years of protest and civil unrest, America's youth prevailed and the US withdrew from Southeast Asia. The world didn't come to an end, the communists didn't take over Asia, and the Chinese never invaded American shores. All that really happened was that the United States extricated itself from an otherwise hopeless situation. After that it was business as usual.

Now it's thirty-five years later and it looks like the lessons of the late 60's and early 70's didn't go too far. In its infinite wisdom, the American leadership, Republicans and democrats alike, have gotten themselves involved in not one, but two wars in the Middle East. To make matters worse, they are now eyeing a third possible front. There are other considerations as well. The Viet Nam war was a war of political ideologies: Capitalism versus Communism. Also in 1964, the United States seemed to have a collective "conscience" for lack of a better word. It was only twenty years after WWII and ten years after Korea, parents were all too familiar with the sacrifices associated with war, and they weren't too keen on putting their children on that alter. Finally, there was a draft up until 1972. Think of it as a lottery where you don't want your number called. I remember it well as I was drafted one month before the whole system was scrapped for what we now refer to as an "all-volunteer army". I must say that I wasn't too happy about it. Today's war is quite different. Whether you want to admit it or not, it is a war of religion. The Koran versus the Bible!

Look's look at this concept of a national conscience; if it still exists, it's been numbed by way too many years of cable TV. I truly doubt that it does exist. We as Americans have been so far removed from any real suffering, for such a long time, that we actually believe it can't happen. Better yet politicians get elected by telling us it can't happen. The Great depression and WWII exist only in history books and any survivors are few and far between. Back in the 40's and 50's, people used to meet reality head on. Not anymore! Now we get it by e-mail or cable TV. Everything has a "filter" or is on a "need to know" basis. What I've never been able to figure out is what give someone else the right to decide what I need to know?

The draft is an issue that needs to be treated separately and relates to the consciousness issue. Since the only ones traipsing through the deserts of the Middle East are young men and women who volunteered for the job, they have no voice. For the most part, no one is there against their will. Unfortunately for the recruiting stations spread throughout the US, this war is being played out on CNN, and it is making it very difficult to find new fodder for the cannons. The current President wants to increase the troop strength and is going to have a very difficult time doing so. What most Americans are unaware of are twin bills before the House and Senate calling for the reinstitution of the draft. I don't know if it will ever happen, but if it does I guarantee it will generate more than a little conversation around the old dinner table. It seems to me that the present Administration has done everything in its power to keep the war as far removed from the average American as possible. It's gone so far as to bring the killed in action back to the US in the dead of night and bar the press from filming the arrivals. Out of sight, out of mind! Once upon a time, we used to honor our fallen soldiers. Now we hide them under the cover of darkness.

Due to this lack of social consciousness, it is easy to forget that every conflict has a cost. Nation building is not cheap. Financially the US has close to five hundred billion dollars of other people's money invested in what is now clearly a no-win situation. With no end in sight and no exit strategy, the Bush administration wants to raise the stakes. Congress isn't so quick to jump on the bandwagon this time around but Bush says he's the "decider". I guess he thinks of himself as a Harry Truman, if only he had that kind of character and integrity. So there you have it: a half a trillion dollar war, built on lies and deception, and no end in sight. Along the way we've managed to alienate almost all of our friends so we'll have to go it alone. The real problem is that you just can't abandon Iraq and return to friendly shores. This is a religious war and they tend to follow you to the ends of the earth.

Somewhere along the line, Americans will develop and awareness with respect to the cost, danger, and hopelessness of the situation. As they used to say in the old days, they'll come out of the ether. That's when things will get interesting. As I mentioned previously, the present generation of Americans have never really suffered and they won't take too kindly to the concept. Politicians promised them a rose garden, not a manure pit.

Finally, I would like to discuss the human cost. If you watch CNN it's almost treated as a footnote. "Today five US soldiers were killed when their convoy was ambushed. In other news, the Dow made a new high today." That's about the extent of it. Don't give the public any more than you have to. Well, to date three thousand Americans have died. That's three thousand lives unlived and three thousand sets of grieving families. If I can make a few unrealistic assumptions regarding these young people who sacrificed their lives, that they were all single and male, then there are three thousand young widows before their time floating around out there. Assuming each couple would have had two children, we are talking about six thousand never to be born babies. Now you have nine thousand individuals who ceased to exist, or never existed, and any one of them might have made a real contribution to society. The "I've discovered the vaccine for polio" type of contribution, but will never know because they were never allowed to get that far. These young men will never be husbands, fathers, grandfathers, businessmen, teachers, or scientists. The best they can hope for is to be some faceless name on some wall someplace that all but a hand full of Americans will never recognize. That seems to be an awful high price to pay to maintain a lie.

THE MARKETS

GOLD/SILVER/GOLD STOCKS - I want to start out with my best stuff. Yesterday I made the following comment to my clients: "Most of you have absolutely no business owning gold stocks, or any other stock, at this point in time". I got e-mails from the grave on that one. The not so subtle gist of their collective message was how the hell could I say something like that after I've been telling them to sit tight for so many years? A smart man would say that he had a senior moment and let it go at that, but I've never been one to choose the easy way out. First you need to understand what we're up against. The Dow is at or close to the tipping point and when this steaming, heaping pile of garbage finally rolls over, it will take everything paper with it. That includes gold stocks; at least for the first six months or so! That's what happened during the Depression, for different reasons mind you, and I believe that is what is going to happen now. It appears the gold stocks are already showing the strain. Take a looks at the weekly chart of the HUI below:

Given the bullish behavior of physical gold over the last month, it's difficult to understand why gold stocks are having such a tough time. I have been saying to my clients for weeks that I want to see what happens the day gold has a strong move up and the Dow sells off. On Friday the market gave us our first indication: the Dow was down 56.80 points, gold was up $8.90, and the HUI was down 0.69. Not at all what you would expect is it?

The chart above is not completely bearish in that the series of lower highs is complemented by a series of higher lows. In a bull market, the odds normally favor an upside explosion but I do have my doubts. A sinking ship initially pulls everything down with it. Gold stocks will escape the down draft but at a cost. That cost could be a 25% to 50% decline in value over a three to nine month period. That's what happened during the Great Depression and I think we have a better than average chance of seeing that happen now. Now this is where my clients get confused: in one breath I'm tell them I will sit through it and in the next breath I'm telling them that most of them don't have any business owning gold stocks. On the surface, it appears that I am a wee bit off. Let's see if I can shed some light on the situation. Consider the following:

• I own all my stocks in the Canadian or Peruvian markets and they are denominated in Canadian or Peruvian currency,
  
• I hold nothing in the United States,
  
• I have sat through every correction but one since March 2001[2], and
  
• I think I have a decent grip on human nature.
  

If the US market collapses tomorrow, and the dollar along with it, I will not feel it like the average American will. Also I know, as much as I can know anything, that my portfolio will increase +/- 1000% by the end of 2010 so I can handle the decline mentally. It's discipline! Most investors make a career out of buying high and selling low. Most will succumb to the pressure and sell precisely when I would be adding on. I prefer to spare the average investor the aggravation and have him go to cash, and some gold coins, and take a seat on the sidelines. There is no shame in that. In a collapse, the one who loses the least usually wins. Notice I said you should hold gold coins. Won't gold get caught in that same down draft? Let me answer that with an emphatic NO! Gold is the only real, true store of wealth and when the droppings hit the fan, people will flock to it. Let's take a look at gold's weekly chart:

When compared to the HUI, it's a much healthier picture. Gold recently took out the November 2006 highs and has closed above both the 644.70 and 664.20 resistance levels[3]. This now becomes support. Further resistance will be found at 686.20 and then 728.60 and the latter number is what stopped the last significant rally back on May 11, 2006. I am convinced that we are going to rally to a minimum of 775.00 and we may even test the all-time high of 887.50. Also, try not to lose sight of the fact that we will experience one more 7% correction along the way. When and at what price is anybody's guess? For what it's worth, I suspect the 728.60 could produce such a correction. What will I do about it? Sit tight, that's what! As you can observe, gold is a long way from being overbought. What would happen to gold if the stock market were to turn down with a vengeance? It will continue its bullish trajectory with little or maybe even no interruption. Gold is to be accumulated, both on the way up as well as at the bottom of significant corrections. Gold is not to be sold or traded. Unless you are one of a handful of people in the world who really know what they are doing, gold is not to be traded.

How about silver? How does gold's poor cousin fit into the equation? Well, I like silver more and more with each passing month, but I won' get carried away with it until I see the "transition". Remember when I told you that gold stopped being a commodity and became money? Well silver has to do the same thing. Silver had a bigger handicap in that it started out the bull market as an industrial metal. Once it closed above 9.16, it transformed itself into a precious metal. Now I want to see the conversion into money. For that to happen I want to see a close above 20.73 and that just happens to be my upside target for this leg up in the bull market. Take a look at the Point & Figure chart for silver:

As you can see, I'm not the only one who has high hopes for silver. There is a bullish price target of 21.50. I like these charts because they deal strictly with price and eliminate all the market noise. Before I close, I would like to give you the magic numbers for silver:

These are all the numbers you really need to know. Everything else is nothing more than polite conversation suitable for cocktail parties. I am extremely bullish gold and silver here and for the next three months.

GRAINS - Next to gold, the grains are my favorite subject. It took nine months and three attempts before I was able to get my foot in the door with the grains. Now I not only have an initial position, but I've added on and will sit through any reaction. Wheat, corn, and beans are now clearly on a new leg up in a significant bull market. Driven by historically low supply and increased demand, particularly from Asia, grains should continue their march toward higher prices. Try to remember though that reactions are always a part of any bull market. Friday saw wheat, corn, and soybeans close at 460.2, 406.2, and 749.2 respectively. The latter was a new closing high for this leg up. Let's start out be taking a look at the weekly chart of the Dow Jones Grain index:

Notice that last Friday's close at 170.06 was a new high for the entire move up. You should also discern that the huge gap left back in October 2006 was never filled and that is really quite bullish. Obviously grains are overbought here but they've been overbought for quite some time and they are capable of staying that way for quite a while.

Of the three, wheat has been the weakest and beans the strongest. In fact, beans have been able to consolidate gains at recent highs and then move on to make even higher highs. Corn has shown similar bullish behavior while wheat has drifted lower. Let's take a look at their individual support (S) and resistance (R) levels:

With respect to wheat, there is also decent support at the 455.2 level and we have seen some consolidation and what appears to be accumulation in that area for a month now. I believe wheat holds the key to corns rally. Many were expecting wheat to test good support at 438.5 and that hasn't happened (yet). If that doesn't happen and wheat can rally and close above 485.3, that money will be forced to come in and propel the price up to 537.7. That in turn should be enough to take corn through the 428.7 resistance level. Finally, with respect to beans, the key is to have two consecutive closes above the 779.5 level. This represents a 50% retracement back up toward the 10.63 high posted back in the summer of 2004. Needless to say, I am quite bullish the grains. For those of you who shy away from the futures markets, I recommend two stocks: CRESY and SWP.TO. If at all possible, buy them in their local markets and respective currencies.

OIL - Boy, did everybody pile on the "I hate oil bandwagon" or what? So what does oil do? Why it reverses course and runs up $11.00 and gets traders coming and going. The real questions are: have we bottomed and, if so, where do we go from here? When you really want answers, it usually helps to go to an historical chart and have a good look:

As you can readily observe, the current bull market for oil began way back in 1999 (just like gold!) at a decade low of $10.80. Then it really picked up steam after a correction in early 2003 and chugged all the way up to an all-time high of $79.50 posted on July 14, 2006. (That's just two months after gold posted its bull market high of $731.20.) If my math doesn't fail me, that's a run-up of $68.70 for oil. Now of course we're faced with the inevitable downside reaction and investors, faced with the horrific idea that oil could actually go down, panicked and moved to the other side of the boat. Simply put, they either bailed or sold oil short. All of them! Every last one! By mid-January of this year, you couldn't find an oil bull to save your life.

Oil has now put in some sort of bottom at $51.03 and since rallied as high $60.80 last Thursday. Is this the bottom effectively ending a six-month counter trend move or is there still more to come? I exited my long positions at $63.00 some months back. Recently I bought into oil at $51.75 and even added on at $54.70 so I obviously believe there is hope for the future. Do I share the same conviction for oil that I do in gold? Not yet. Why? Oil is a political football, even more so than gold due to the Middle East issue. Games can and will be played. Can these games change a primary bull market into a bear market? No, absolutely not, but they can alter secondary reactions. So what do you do? I put a stop/loss at $53.32 and I'll let the market do what it wants to. I will risk my paper profits but not my capital.

I am looking for some sort of three to four day reaction in here. Something that could take us down to a minor support level at $56.01, or even what should be significant support at $53.32, but nothing more. I suspect oil has bottomed, but I would not rule out a retest of the bottom. If oil has not bottomed, then I would expect a run down to the $45.15 support level and that should hold under any circumstance. You see that represents a 50% retracement for the entire bull market rally. Take a look at the important support and resistance numbers for oil below:

If we are on a new leg up, and the odds favor that, we should hold $53.32. With respect to resistance, a close above $66.13 would mean that we are going to test the all-time high from last year. I am absolutely convinced that oil is going higher, much higher. My price target for this year is 88.08 and there is a possibility that it could even run as high as $96.67. The bull market for oil is as real as you can get it, so don't bet against it.

SOFTS - The bull market for commodities is slowly spreading though out the entire universe of products. I believe the next group to begin a leg up will be the "softs"; specifically cotton, sugar, and lumber are on the bull market road. As most of you already know, I've made initial incursions into both cotton and lumber. The first was finally successful after three attempts while I am still on the sidelines with lumber. Just last week, I took my first position in sugar at 10.00 and although I am showing a small profit, it is way too early to draw any conclusions. Let's take a look at the daily chart for cotton's March futures contract below:

When cotton bottomed at 50.81 back in November, I took an initial position and then added on at 54.67 on the way up. I was stopped out of everything at that same number during the recent reaction so profits were made but short term profits have never been my main objective. I want to build a position that stands for months if not a year or two. I have yet to achieve that with cotton.

Friday saw the March 07 Cotton futures contract close at 52.76 and that is below what should have acted as good support at 53.19. Thursday's intraday low of 52.00 is the low for this entire reaction down and it remains to be seen if cotton can make a higher low, i.e., hold above the November 20th low of 50.81. I do know that cotton mills in Peru are working overtime and can't keep up. This is after an eight month break where it appeared that Asian nations decided to draw down their own stocks instead of buying in international markets. Now it appears they've come back into the market place and are once again active buyers. If that's the case, we should hold above the November low and start another leg up. I believe that will happen and that is why I took an initial position at 52.10 on Thursday with a stop/loss at 51.10 on a closing basis. Let's see what happens. With respect to lumber, it too looks like we made a possible bottom at 251.70 in the March Lumber contract. On Thursday, I took an initial position at 262.50 and will now sit tight until I see a close above 276.00. I have a stop/loss at 259.50 on a closing basis.

BONDS - Quite possibly the most important market at this point in time. Below I've posted the daily chart for the T-Bonds and it is really at an interesting juncture:

This chart is the work of Robert McLaren at www.mclarenreport.com.au and I strongly recommend you visit his site.

As I mentioned in my previous newsletter, I believe that bonds have topped after a twenty-five year bull market. That's not uncommon for bonds by the way. Bull and bear markets tend to last a generation and sometimes longer. If you go back to early 2005, you'll see that bonds began making a series of lower highs, first at 120.00, then at 118.03, then 115.11, and finally at 114.29. The last lower high happened as recently as December 1, 2006. Pay particular attention to the December 1st high as it appears to be the head in a head-and-shoulders formation. The neckline of that formation is represented by the shorter of the two blue lines highlighted by the arrow. The neckline was violated on five consecutive occasions and then followed by a seven day counter trend (I think) move. That counter trend move topped at 111.09 but never closed higher than 111.03 and that is very significant. We have strong resistance at 111.07 as it represents a 38.1% back up toward the 260-day high.

The bond is at a crucial juncture here. We have had a significant decline followed by an apparent weak counter trend move and now it appears we've turned down again. Take a look at the support and resistance levels for the bonds:

I believe that any close below strong Fibonacci support at 110.02 will lead to a test and eventual rupture of the neckline and that in turn will lead to a panic move down. In very simple terms, whether the Fed likes it or not they will get higher rates. It is no small coincidence that the president of the Federal Reserve Bank of Philadelphia, Charles Plosser, came out on February 7th and said that more rate hikes may be needed. In the end, the Fed has no choice but to go along with the market. I have been short bonds for quite some time, exited my position when we broke the neckline, and sold them again at 110.25. I will stay short as long as we do not close above 111.07. If I see a break below 110.02, I will add on. Such a break will lead to a quick trip down to 108.29 at the very least and probably lower. This will have a very negative impact on the stocks but lend some support to a terminally ill US dollar.

FX MARKET - The US dollar is the currency that you love to hate and one has to be careful that emotions do not get in the way of sound investment decisions. With that in mind I would like to look at the historical chart for the US dollar:

Try as I might, I can't find much good to say about the US dollar. About the only good thing I can say about it is that it hasn't fallen off the proverbial cliff yet. The dollar hit a low note at 80.50 in late 2004 and then spent a year in rally mode, scaling the heights up to 92.50 twelve months later. We`ve now spent 14 months putting in a series of lower highs and lower lows, trading as low 81.90 on December 11, 2006. On Friday the dollar closed at 84.75.

I'm not going to give you a hundred reasons why the dollar has to fall. Suffice it to say that there are just way too many dollars and way too much debt on every level in the United States for the dollar to survive in its present state as the reserve currency for the world. All the major players are aware of the situation and the task at hand is to organize an orderly retreat inflicting as little damage as possible on the "innocent" central banks who are major holders of all things green. With that in mind, let's take a look at the dollar's support and resistance numbers:

I'll be blunt. I see no way on God's green earth the dollar can rally above 86.50 and it probably won't test 85.62 although that chapter is still open barely. In fact, the dollar couldn't close above 85.08 as of today. There is very little upside risk. As far as I can see, it is all to the downside. The first significant resistance will be 83.50, then 82.01, and finally 80.50. I believe the dollar will fall through 80.50 this year and will not stop until 75.38 at the very least. Once the 80.50 level is violated, we'll find out who is going to be left holding the dollar bag as it should become a bit chaotic.

If the dollar is going to fall through the floor, what do you put in your pocket and in your savings account? Well, I've been partial to the Swiss Franc for six years and nothing has happened to change my mind. As of late, I've purchased the Canadian dollar, the New Zealand dollar, and the Australian dollar. They're all commodity based economies and commodities will rule the roost for quite some time. In particular I like the Aussie dollar. Take a look:

For a year the Aussie dollar has been tracing out a series of higher lows and higher highs closing at 77.59 on Friday. The Aussie dollar has been consolidating in the 77.00 to 79.00 area for thirteen weeks now and I suspect that is a prelude to breakout above 80.00. In conclusion, I am long the four currencies mentioned above and will add on to each as the US dollar breaks down.

DJIA - Stocks in general are a real mystery. The Dow continues to inch higher and was finally confirmed by the Transports which does surprise me but then again "it is different" this time. Take a look:

The weekly chart of the Dow is a textbook blow-off and exhaustion to the upside. Last week saw the Dow register a new all-time intraday high at 12,700.28, a high that was not confirmed by RSI, MACD, or the histograms. There is significant resistance at 12,775 and I have suspected for some time that we could reach that high. There are signs of strain everywhere. Let's start with the fact that the S & P as well as the NASDAQ failed to confirm the new highs in the Dow and Transports. Neither did the Housing Index.

I would like to focus for a minute on the two cylinders that run the economy's engine: housing and consumption. Take a look at the daily chart of the Consumer Index:

There is a rather ominous formation referred to as a double top and although I am not a great believer in double tops, this is a textbook example. Finally, let's take a look at the Housing Index:

This is a weekly chart and it shows what is apparently a lower high at 257.07. Everybody has been quick to announce an end to the decline in the housing sector and I believe they are premature, by a couple of years, but that's just me. In both cases, the RSI and MACD did not confirm the respective highs. I have the feeling these two indexes are rolling over, and without them, the economy and the Dow will not survive. Couple this with the possible bond melt down and the demise of the dollar and you can see the problems that face the United States.

In conclusion, one needs to know what to look for in order to judge if a top is "in" or not. I am going to give you a simple guide. The S & P has had six corrections since the June 2006 low of 1216 and not one has exceeded 31 point. An S & P correction of 31 to 57 points followed by a rally to a lower high will be the key that unlocks the floodgates to a major move down. Watch for it and when you see it, you'll know how to react.

References

1 - If you want a good laugh, check out Country Joe Fish and his song "Hell No, We Won't Go!"
2 - I exited the gold stocks in May 2004 and bought back in in September 2004. I used that sale to exit juniors and shift to blue chips. The question of timing was mostly luck and I won't do it again.
3 - All the numbers in bold print are the magic numbers I've mentioned in my last two gold articles. Every time we close above one of them, I add on to my gold position.

Enrico Orlandini

Dow Theory Analysis

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