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I have always been a bit of
a history buff, and if the truth were told, it's what I really wanted to
study when I was at the University. Unfortunately I couldn't figure out how
to make a living at it. Teaching never really appealed to me given my
gregarious personality (I'm being sarcastic), and I never wanted to be a
writer, so I ended up choosing what I thought was a more marketable
profession, i.e., economics. Little did I know! God does have a strange sense
of humor though as I eventually ended up teaching for a while and I write way
too much as it is. The period of history that always captured my imagination
was the time leading up to and including World War II (1929 -1945). It began
with a world wide depression and ended with a war that involved almost every
civilized nation on earth. We began that period still on horseback in many
parts of the US
and left it with the jet engine and rockets. Advances in medicine,
production, manufacturing, and technology during this period were significant
to say the least.
One very active participant
during all this change was Japan.
An over simplification would be to say that this Asian powerhouse was a
highly industrialized nation with a formidable military and no natural
resources. This was especially the case with oil. Japan's industrial base needed
oil and didn't have any. As a result of their needs, they decided to use
their military might to conquer less fortunate neighbors who possessed the
raw materials they needs. Coal, iron ore, grains, and oil topped the list.
This nation building did not go unnoticed by another dominant world power,
the United States of America,
who in fact tried to shut off Japan's
flow of oil in an effort to curb their military ambitions. It didn't work and
Pearl Harbor was a result of that policy. Japan figured
that it had better strike first and hard if it wanted to succeed. They were
wrong. I believe it was Admiral Yamamoto who said, "I fear all we've
done is waken a sleeping giant" or words to that effect.
All very interesting
stuff, but what does it have to do with our here and now? Well, global
conditions are quite similar to the late 1930's with Europe moving sharply to
the right politically speaking and Latin America
moving sharply to the left. This time around the Nationalist movement in
Europe is being lead by France
of all countries and it eventually will put a real strain on the idea of a
European Union. I will predict that the Union is destined to fail given the
fact that nations all end up doing what they deem is in their own best
interest. Try walking into a bar in Modena,
Italy and
tell some Italian farmer that he needs to accept a 10% increase in fertilizer
and herbicide costs so that a French farmer can be more productive. I'll give
you a hint; it won't be a pretty sight. Meanwhile, six thousand miles away in
Latin America, things are taking an
increasingly leftist tone and one of the messages being transmitted is openly
anti-American. Venezuela
is the culprit who gets all the press but Chile,
Bolivia, Brazil, Argentina,
Ecuador, and to a larger
degree Peru
are all following suit. Just like 1930. Peru is the real wild card as
elections are almost at hand and a member of the extreme left is ahead in the
poles. Notice the emphasis on extreme. Mr. Humala is now the leader in the
poles with three weeks to go. The more the Peruvian press tries to paint him
as a murderer, thief, and God knows what else, the more the Peruvian people
get behind him and offer their support. I am thoroughly convinced that if the
press would just not mention his name, his support would dwindle. But they
won't and his popularity will only continue to grow.
Lost in all the rhetoric
is Chile.
Here is a country with a strong economy, a dominant military, and little in
the way of natural resources. Sound familiar? They do have copper, some
agriculture, and fish but that's about the extent of it. Oh, I almost forgot.
They are the sixth largest producer of arms in the world and I'm not talking
about handguns. Chile
produces armored vehicles, missiles, and other goodies. They also have an army
who knows who to use them. A hold over from the Pinochet regime, they are a
carbon copy of the 1939 Wehrmacht, right down to the helmets. Chile has a
highly disciplined, well-armed force capable of defense or attack. There is
nothing like it in the Americas'.
Not even Cuba,
and certainly none of their less fortunate neighbors, could stand up to the
onslaught. There are very few armies like this in the world and no one seems
to notice. Did I mention that they have few raw materials?
Chile has a strong industrial base comparable to Taiwan or any of the other Asian
tigers and they depend on the importation of raw materials. They've tried it
buy there way into other countries and have had some success but you
eventually run into ethnocentrism and protectionism disguised as
"strategic industries" where no foreigner should dare to tread.
Their neighbors are rich in oil (Ecuador),
minerals (Peru and Bolivia), natural gas (Peru), and grains (Argentina). As the following
historical chart of the CRB Index shows, commodities prices have gone through
the roof over the last five years:
 
That means that production
costs have risen and given the inelasticity of prices (producers have little
or no pricing power), their industry has had to absorb the shock. That's not
a marriage made in heaven, and I predict that the Chilean government will
eventually opt for a 'different' solution. Why should I buy the milk if I can
have the cow for free?
Chile is in the awkward position of having to compete with the much larger
economies of China and Japan for a
finite amount of commodities. These countries enjoy an advantage that Chile doesn't have, i.e., China and Japan are willing players in the
Federal Reserve con game whereby the Fed creates massive amounts of debt to
buy Asian good. The Asians take this debt and trade it for commodities that
they use to make their economies grow. The only comment I'll make on this
subject right now is to say that trees do not grow to the sky. China has even taken the game a step further
as they have made significant investments in Peru
(iron ore mines), Chile
(copper mines), and Brazil
(soy bean farms) to name just a few. And why not, the Americans are paying
for it! Chile was not invited
to this party but has duly noted China's
encroachment into Latin America. I predict
that before the end of this decade, and maybe as soon as next year, Chile will do
some encroaching of its own, and it will not be a pleasant sight.
There is an infinite
amount of anything but positive outcomes from such an openly aggressive
policy. Everybody could just do nothing and Chile could continue on its merry
way to "nation building." This is not very likely given Bush'
propensity to go to war. Next, China could decide to intervene
militarily and that would certainly put a crimp in the shorts of the Monroe
Doctrine. Possible but China
could probably find the same resources a bit closer to home and without
having to square off with the US.
In a more plausible scenario the US could intervene militarily and
that would be, in my opinion, a recipe for disaster. Unless the US is
prepared to use nuclear weapons, I would not advise a direct confrontation
with the Chilean armed forces, at least not in their own territory. As
powerful as the US
is, it just wouldn't turn out well. On the other hand, given the need to
distract the masses, it might be just what the doctor ordered for a lame-duck
President.
In conclusion, the US would be
well advised to pay attention to what is going on south of the border instead
of shagging after shadows and ghosts in some far off Middle Eastern desert.
Life has enough problems without having to traipse half way around the world
looking for them. If Chile
could extend its sphere of influence as far as Venezuela,
the US
would have gas lines as far as the eye could see. Eighty dollars a barrel
would be a drop in the proverbial bucket. Then think about $10 copper if Chile takes
over Peruvian copper mines and controls 40% of the world's copper. And I
don't even want to think about natural gas, tropical fruits, coffee, soybean
production, and assorted grains from the Southern Cone. Oh, let's not forget
fish and fish meal. It's all too gruesome to think about and I'm sure you get
the picture by now.
MARKET
COMMENTARY
Bonds - it's always a
question of where to start. I chose bonds because it relates nicely to the
dollar, stocks, and gold movement. I have held for months now that interest rates
have no where to go but up and it stands to reason that, if I am correct,
bond prices must fall. The following Daily Chart of bonds doesn't lie:
In case if you need some
help, this is a bearish scenario. The 50-d.m.a. is trading below the
200-d.m.a. and the bond price is trading below the 50-d.m.a. And let's not
forget to mention that both the 50-d.m.a. as well as the 200-d.m.a. have turned down. RSI is still in neutral territory and
points down while the MACD is clearly oversold and appears ready to turn up.
Stochastics are neutral. With the exception of the MACD, you would be hard
pressed to make a case for a rally here.
It is clear to me that the
US
economy is on the skids and, under most circumstances,
you would think this would signal a beginning of an easy money policy. Well your right. Under most circumstances it would, but we live
in different times now. Europe has been
worried about non-existent inflation for some time and has recently been
raising rates while the Bank of Japan has signaled an end to its zero
interest rate policy and easy money. Couple this with the fact that the US is far and
away the biggest debtor nation in the history of the world, and you can see
that competition for foreign capital will be on the increase. For years,
everyone has printed money like it was going out of style and now the Central
Bankers of the world are going to take the punch bowl away. The US Federal
Reserve has intimated that interest rates would rise to a neutral 4.5% and
bonds priced that in months ago. Then in early January bonds began to dip
even more and I now have the feeling that the bond pit has priced in a 5% to
5.5% interest rate and may even have the audacity to consider 6%!
The present 5% scenario
took bond prices down to strong support at 110.05 and a couple of days ago we
even managed to trade as low as 110.02 on an intraday basis. Then we bounced.
I have been short since we broke below 114.00 many weeks ago and took profits
two days ago, not because we will hold 110.05, but because I don't know what
we'll do from here on out. If we begin to price in 6% to 6.5% interest rates,
we'll break through the 110.06 support at fall down to the next level at
109.02. If that doesn't hold, then it's down all the way to +/- 103.00 and
that would take rates as high as 9%. Given a shrinking economy, you can
imagine the problems that would cause. Will it happen, I don't know but the
burden of proof is on the bond bulls. I will sit on the sidelines for the
moment and wait for a retest of 110.05 before I decide what to do. There
could be as many as 5 tests at this level.
US Dollar - The dollar is
joined at the hip with the bond, and both influence the movement of physical
gold. It is widely held in the press that rising interest rates will lead to
a rising dollar, and both will cause gold prices to decline. Let's take a
look at the Daily Chart of the dollar and compare the action with what we saw
in the bond chart above:
Bonds peaked in
mid-January and declined thereafter (meaning that interest rates began to
climb) all while the dollar bottomed at more or less the same time,
mid-January, rallied for several weeks, and then began a controlled decline.
Currently the dollar is trading at 89.21 and has given back +/- 50% of its
rally. All in keeping with the press releases but not quite what you would
expect, especially when you consider that the bond declined the most from
mid-March to date while the dollar was declining. As far as the myth that
gold prices decline when the dollar is rallying, I would like you to realize
that the dollar rallied throughout 2005 all while gold rallied $114.00! It
kind of shoots that theory all to hell doesn't it?
So what is really going on
here? Remember when I mentioned what I refer to as the Central Bank con game?
In January, foreign Central Banks accounted for only 20% of all US bond
purchases, and for the second consecutive month foreign capital inflows were
not enough to cover the money needed to fill the fiscal, budget, and trade
gaps. And let's not even mention the money needed to fund the twin war
effort. So how does the Federal Reserve do it? Magically, private investors
have stepped in to fill the gap. Bull manure! The Fed, in there infinite
wisdom, has decided to cease publication of M-3. That's the money supply for
those of you not in the know. Mr. Bernanke has some poor civil servant
cranking out dollars until his arm falls off, and why not? No one is
counting! Do not kid yourself, the terms 'private investors,
and 'Caribbean Money Centers' are just euphemisms for the Fed printing press.
The sad truth is they really have no other choice.
So what does this mean for
the dollar? There will be a controlled decline as Asian, Russian, and Middle
Eastern central banks try to manage an orderly exit from the dollar. Human
nature being what it is, this will work for a while,
until someone tries to get cute. Then things will get interesting. For me,
the line in the sand will be when the US Dollar Index finally breaks below
80.00. For the moment we are in a trading range, from 87.50 on the low side
to 91.50 on the high side. Sooner or later we'll fall through the floor and
go on to test support at 85.71, and then it's down to 80.00 and all bets are
off. I have been short the US Dollar Index for two months now, and inversely
long the Swiss Franc since 2001, and I see absolutely no reason to change.
Oil - How did oil go from
looking so good to looking, well, not so good? There is a plentiful supply
for the moment and the market priced in too much of a premium for problems in
the Middle East. At least for the moment! A
good look at the Daily Chart for oil paints a less than optimistic picture:
as a case for a head-and-shoulders top could be made. With the last spurt
above the 50-d.m.a., that case has weakened a bit although we did drop more
that 2.25 on Monday to fall back below the previously mentioned average.
Recently RSI turned down again while the MACD is in neutral territory. The
neckline from the head-and-shoulders formation comes in at +/- 60.00 and I am
very interested to see if it holds. I suspect it won't, and if that's the
case, I wouldn't be surprised to see a trip down to 51.00. Why? The US economy is
slowing and demand is slacking off.
As I stated earlier, the
market has priced in too much risk premium and is beginning to come to terms
with the fundamentally strong supply picture, especially in the U.S. of crude
and gas inventories. OPEC's stated decision not to cut production may or may
not come to pass, but for the moment the market has accepted it at face
value. Also, the hoopla over Iran's
nuclear aspirations appears to be priced in, at least for the next couple of
months. Over the long run, think of it as a toothache that will only get
worse. U.S.
crude stocks rose to 336.1 million barrels two weeks ago, their highest
levels in seven years. While fear of disruption from conflicts and hurricanes
will remain, I continue to believe oil prices can work their way lower for
the next couple of months. Therefore I will remain on the sidelines.
CRB Index - Here is the
real surprise. For months I have been bullish the CRB Index as it
made new 20-year highs at 366.00 back in early February. The rally began
back in late 2001 and, for the most part, has continued unabated for almost
all of that time. The biggest corrections have not exceeded three months from
start to finish. Our current correction is completing its sixth week and has
given up 16 points or 4.3%. The April CRB (CIJ6) closed on Monday at 350.20,
and in spite of a five-day rally, looks weak to me. We have decent support at
349.94 but I am looking for a decline down to 338.00 before it's all said and
done. Why? For the same reason oil will decline, demand is slowing in the
States. Eventually stagflation will set in, most commodity prices will rise,
and we'll begin another leg up. The surge will be aided by sharp declines in
the value of the dollar.
The last time around, I
bought into the CRB at a relatively late stage, at and average price of +/-
315.00, so I took a risk and liquidated my position at 352.60 and, what's
more, reversed and went short. I am firm in the belief that the CRB will
follow the price of oil down. Hopefully there won't be any oil shocks along
the way. In any event, my short position is considerably smaller than my long
position. After all, it is a Bull Market for commodities! Aside from an oil
shock, my only real risk is deflation and Mr. Bernanke promised me he would
drop money out of helicopters before he would let that happen.
DJIA - This is the
toughest call of all. We have been so overvalued (a PER of 20 and an average
dividend of 2%) for so long that you have to wonder just what it will take to
bring down the house of cards. My answer is really quite simple: the very
thing that propped it up for so long is the very thing that will bring it
down. I can sum it up in one word: liquidity. We are floating in it as almost
every major economy in the world created money like there was no tomorrow.
Now they are all going to cut back, with one notable exception, the United States.
Instead of being lost in the herd, we will stick out like a sore thumb. Take
a look at the following Weekly Charts of the DJIA and the
Transportation Index, and you'll see just what I mean. It has been a
relentless, 'grind em up and
spit em out' type of rally. Especially the Transportation Index, which has
lead the way for months. The major force behind all of this has been housing.
In a society that has negative saving and staggering debt loads, the Fed
loaded Americans up with cheap debt in an effort to keep the party going.
Rising interest rates coupled with a world wide (US not included) tight money
policy will literally bring the house down. I contend that the housing market
has in fact already topped as the following Daily Chart of the Philadelphia
Housing Index indicates:
I think housing has topped
although I suspect that we will get a retest of the top. Creative no money
down loans, variable interest rate loans, and even loans with a grace period
where no payment on interest or capital is required for months will be all
the incentive borrowers need to give the key back to their friendly
neighborhood mortgage broker. By the way, all of this creative financing
wasn't invented yesterday. I remember being pretty creative myself back in the mid-70's; then interest rates went to
20% and I wasn't too happy about it either.
According to Dow Theory we
have had secondary confirmations whereby the DJIA has confirmed the new highs
in the Transportation Index with respect to the Bear Market rally. But, and
this is really important, we have not had a primary confirmation. What do I
mean by a primary confirmation? The Transportation Index has long since taken
out its 1999/2000 Bull Market highs and continues to make higher highs almost
every week. The DJIA, on the other hand, has not done so and remains some 400
points below the old Bull Market highs. This non-confirmation is extremely
important, kind of like the Holy Grail for Dow Theorists. Will we see a
confirmation in the future? I am old enough to know that just about anything
is possible in today's world, but I don't see how it can. Falling housing
prices, massive debt, tight money, and higher rates will all conspire to do
this market in. Therefore I chose to sell the market short two days back at
+/- 11,370 basis the JUNE DJIA and I will be the first to admit that I am
jumping the gun, but I think we are very close to a top if not already there.
Besides, it is a small position.
Gold/Silver/PM Stocks -
Here is what I wrote on February 9th: This will be quite short by my standards
and to the point. No charts, no graphs! This is just a simple explanation
that will let you know exactly where I stand. A lot is being said about gold
having topped out and how we are headed down into the depths of despair. I
couldn't disagree more! As most of my clients already know, I felt that we
would encounter significant resistance at the 569.75 level in the spot price
of gold, and that is exactly what happened. Why is
569.75 so important? Well, it just so happens that it represents the half way
mark between the 1981 high and the 1999 low and that, ladies and gentlemen,
brings us to the "50% Principal". When a major Bear Market like the
one gold experienced from 1981 to 1999 come to and end, the subsequent Bull
Market will begin to retrace lost ground. The "50% Principal"
states that once you have made consecutive closes above the 50% mark
(569.75), you stand a very good chance of testing the previous Bull Market
high. That is precisely what we tried to do a couple of days ago as we made
two non-consecutive closes above 569.75.
I then went on to say:
With that being said, I want to talk about yesterday, and today, and even
tomorrow because there is a plethora of less than holy people calling a top
for probably the fifth time in the last month and a half. The first top was
called back on December 12th when we hit an intraday high of 545.00 and then
fell to 493.00 seven days later. My clients used that "top" to add
on. There have been other tops as well, but you get the idea. Now what we are
seeing is a self-fulfilling prophesy of resistance at 569.75, but we have not
yet seen the top. Better yet, this is not the correction that everyone has
been waiting for. What this is, in my opinion, is nothing more than a three
to seven day move down which should be followed by some sort of short
consolidation, and then a resumption of the leg up. This counter trend move
down may find support at 553.25, but more than likely will test 538.00 or
even 527.00, forcing all the speculative weak longs out at just the wrong
time. The
following is a Weekly Chart of gold:
See that long, long
consolidation around the 440.00 mark? And it led to a good rally, not great,
just good. See what we are doing now? It's called consolidation! Also, note
how our "correction" stopped at 538.00! Here's how I ended that
February article: Take a good long look at any previous significant top put
in since the Bull Market began in earnest in 2001, and none of them look like
today's. They all exhausted in an almost vertical
move up and most ended in one-day reversals. Not the case here. There is, in
my opinion, more to come. We will see another test of 569.75 (we have) and I
suspect we may even manage to work our way above it (not yet). I could be
wrong (it wouldn't be the first time, or the last), but I suspect a test of
644.73 will be in order. Nothing is changed as far as I am concerned and I
have no reason to doubt gold at this point in time. Oh, and for those of you
who feel that rising interest rates will spell the end of the Bull Market in
gold, I would like to say this: in 1980 gold hit $820.00/ounce while interest
rates were at 17%!
Finally, with respect to
silver, take a look at the following Weekly Chart in silver and you will
see the same long consolidation period followed by a good rally, only
silver has yet to stop and catch its breath. It has made new highs just about
every week and is now actually leading gold up. What a turn-around! Yes, I
know it is overbought but precious metals can stay overbought a lot longer
than you can imagine. Gold uses its sideways consolidation periods to work
off its overbought condition while silver just plows ahead.
Finally, a word about gold
stocks. The HUI broke out form 280 some months back and had a nice run-up to
350. Since then we have fallen back down to the level we broke out from,
i.e., 280. There is nothing out of the ordinary with that. In fact, it is even
healthy. What
is apparent to me is that the
gold stocks are no longer leading the price of gold up. In fact, the stocks
are now being dragged along kicking and screaming as we've rallied back to
the 300 mark. The HUI is being held back somewhat by NEM, whose share price
has been somewhat adversely affected by labor problems in Indonesia and political problems in Peru. I am
currently long BVN, CDE, GG, GLG, NEM, and RGLD and my only concern is BVN.
There is a leftist politician in Peru, Mr. Humala, who just may
become President and that would not be a good thing. BVN has, in my opinion,
already discounted that possibility (or at least most of it). We are 17 days
away from elections and I may decide to exit my position in the next day or
two. I will
keep you posted.
Enrico
Orlandini
Website : Dow Theory Analysis
Dow Theory Analysis S.A.C.
Lima, Peru
Phone:
001-51-56-973-5599
Email: ebo@dowtheoryanalysis.com
For those of you interested in receiving
information on the Funds we manage, please feel free to e-mail us at ebo@dowtheoryanalysis.com and we will respond as soon as possible.
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