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The United
States is fast approaching a significant
moment in its history. Massive debt coupled with rising prices and a slowing
economy are going to have to be dealt with. In a country where the concept of
fiscal responsibility is overshadowed by "pork" and "nation
building", the consequences of its actions are about to become apparent.
How do I know? Because the dollar and gold are sending out strong signals
that we are on the verge of a change, for want of a better word.
Think about that for a minute. Here you have the opposite
ends of the spectrum. The dollar is an instrument managed by a government
that seems to have strayed from the proper path, while gold is the only true
store of wealth in existence today. The two actually used to coexist. For
almost one hundred years in the US, the dollar held its value.
That all went up the stack, though, when we adopted the Federal Reserve
system more than ninety years ago. Little by little, the dollar lost its link
to gold.
The first fracture came in 1933 when Roosevelt
prohibited its trade within the US; in 1971 gold fell from grace
completely when Nixon closed the gold window. This completed the dollar's
transition into a fiat paper.
I remember 1971 quite well; it was the year I
started to drive. I had a car with a twenty-gallon tank and I could fill it
up for $7. In today's world, $7 will buy two gallons of gasoline in Peru, a bit more in the US and a bit less in Europe.
I could also eat lunch at McDonald's for a dollar back then. I haven't been
to McDonald's in years so I can't comment, but my daughter laughs when I tell
her this and says that's the price of a Coke in today's world.
I mentioned that the US is fast approaching a
significant moment, and that is due to a previous significant moment that we
had back in 1913. That's the year the Federal Reserve came into existence.
Congress saw fit to approve it even though it violated the Constitution.
Despite its misleading name, the Fed was a private entity owned by the
wealthiest families in the world. That's right, a significant number of
shareholders were foreigners! It was probably the first known case of
outsourcing. We were willing to delegate the management of our economy to a
group of men who probably had a different agenda. I suspect the idea was that
they would provide the stability that the heir apparent to the British Empire needed. I guess the Depression was just
an 'oops'.
In any event, a 2006 dollar buys approximately two
per cent of what a 1913 dollar bought and it is not backed by anything other
than the "full faith and credit" of the US government. Since the United States
is the largest debtor nation the world has ever known, I would think that
guarantee is suspect at best, but maybe that's just me.
I'm sure the Federal Reserve system was conceived
with good intentions - or at least, I would like to think so - but it soon
became something altogether different. You see, they formed a company with no
assets and no guarantees offered by anyone. None of these wealthy individuals
pledged their assets or mortgaged their castles. As in all companies, their
responsibility was limited to the amount of capital they were putting in, and
in this case it was a big fat zero.
They then proceeded to print what euphemistically
became known as money, bought gold with it to meet the initial reserve
requirement, and made their money the coin of the realm. If that isn't the
greatest scam in the history of the world, I don't know what is. At best, the
dollar is a hidden tax on everyone's real assets; at worst, it is a fraud.
Being cynical, I believe this was all by design - and we are about to see the
fruits of their labor.
Nixon's closing of the gold window coincided with
another notable event: the conversion of the US from the largest creditor
nation in the world into its largest debtor. This transition was made
possible due to the fact that the dollar had become the world's reserve
currency by the early 1970s. Even our enemies at the time, the Soviet Union
and Vietnam,
wanted the greenback. And once they got them, they were eager to convert them
into other dollar-denominated instruments: bonds. Bonds represent the debt of
the United States, and the
US
could postpone payment of that debt for up to thirty years! That opened the
floodgates, and today we see the results.
If I would have told you thirty years ago that China would become the banker to the United States,
you would have had me committed to an institution. Today, China holds
almost $400 billion in cash and bonds, and it is a real dilemma for both
countries. China sends
goods to the US
and gets paid in dollars. China
buys bonds with those dollars, thereby enabling the US to buy
more Chinese goods. And so on and so on. China
is playing for time, hoping to generate sufficient internal demand in order
for its own people to replace the US as its major market.
Judging from recent comments made by senior
management at the People's Bank of China, they are getting close to doing so.
A week ago, Wu Xiaoling, deputy governor of the People's Bank of China, came
out and said that China
is buying Japanese yen. This statement sent the dollar into a nosedive. A day
or two later we had the usual "clarification" which was followed by
a partial recovery in the greenback.
Two days later, Zhou Xiaochuan, governor of the
People's Bank, said that China
had very clear plans to diversify out of the dollar. This was immediately
followed by another nosedive and another clarification. Unlike the first
clarification, the second one had little or no effect on the dollar and it
continued to drop until Friday's closing bell.
 
A look at a 20-year chart of the US Dollar Index
shows the rather steep decline in November and the break down in what had
been a trading range of 83.75 to 87.10.
If you look closely, you can see an enormous
head-and-shoulders formation with the first shoulder peaking in 1994, the
head topping out in early 2002 and the right shoulder being completed in late
2005. The neckline for this formation comes in at 80.50 and will be very
significant.
I recently read a very interesting article by a
fellow named John Mauldin entitled It's All About Your Time Frame. He
surmised that the dollar could drop another "10-20-30% and for most of
us it would not change a great many things". Mr Mauldin is a smart
fellow and that's why I read him, but I think he's wrong about the dollar and
I'll tell you why.
It goes back to the Chinese and their willingness to
accept a payment that has been depreciating for the last five years (look at
the chart again) and has plenty of potential to fall for another five, if not
more. Today's China is
different than the China
of 2002, and the China
we'll see in 2012 will certainly be a lot different than China today.
By then I suspect it will be the dominant power in the world. They have
signaled their intention to exit the dollar. I am convinced they will do it,
and they won't be the only ones. A declining dollar means rising inflation in
the US
as well as an inability to finance its obligations. And that, my friends,
will affect every man, woman, and child walking God's green earth.
There is a neckline formed by the above mentioned
head-and-shoulders formation and it comes in at 80.50. Up until that point,
the decline will be orderly. If we violate the neckline, I think order will
be thrown to the wind and you'll see a rush for the door. That will create
social and political problems in the US - and not the kind you can
sweep under the rug, either. These problems will be devastating for the
struggling and debt-ridden middle and lower-middle classes, and they will not
take kindly to the situation. You can tell me that the US is not
like that and that it can't happen, but I've lived long enough and traveled
widely enough to know that it can.
Are there any solutions? As far as I can see, there
are is only one real solution and it is quite simple: stop printing money!
If you make an announcement at 8am Monday morning that you will no longer
print dollars and that the US
government will spend only what comes in, I guarantee that by 4pm that same
day the markets will have gone a long way toward correcting the problem. Of
course it will be deflationary and will cause a depression, but it will be
one of your own making, you'll know it's coming, and so can begin now to take
measures to deal with it. If you continue to "stay the course", as
Bush is so fond of saying, you solve nothing and only postpone the
inevitable. The market always does what it wants to do in the end, regardless
of all the Fed interference and manipulation. What's worse, you really have
no idea what to expect once the problem develops. You are forced to react
instead of acting, and any recovery will just take that much longer.
I'm not so naïve as to expect anyone in power
to do anything constructive anytime soon. The recent shift from Republican
control to Democratic control of House and Senate will not produce any
tangible results. Commissions will be convened, blame will be assigned, and
the party will rage on. But all games must come to an end and all accounts
must be settled. Some accounts are settled in such a fashion that everyone
loses, and I suspect that will be the case here. If I am correct in my
assessments, you had best be prepared, and the only way to do that is to own
gold. Whoever owns gold will lose the least. In spite of the constant
manipulation, it is the one thing the Federal Reserve can't destroy, and the
smart money knows that.
Be smart. Give yourself a good Christmas gift and
buy some gold.
Market Commentary
What a month! Yet I don't think it will compare with
what's coming in December. We saw bonds and the Dow going higher, the dollar
in trouble, commodities catching fire, and even oil showing signs of life.
As far as the Dow is concerned, there isn't a bear
in sight. Only 26 per cent of investors are bearish today, and that's as low
as it's been in a long time. There are some contradictions in the market
place right now and that usually requires one to proceed with care. For
instance, the Dow has made new highs while the S&P and Transportation
Index have yet to come close to their all-time highs. We have the Dow rising
in the face of the international disaster in the Middle
East. That's a hard one to figure. Then we have the Fed talking
about the dangers of inflation while bonds are headed higher and rates are
falling. Finally, we have a slowing economy and rising prices!
It's just like 1979, and we all know what happened
to gold with the onset of stagflation. We are headed for some very
interesting times, so let's take a look and see if we can read the tea
leaves.
US$ / CHF: This is a good place to
begin because it goes to the root of all the economic problems in the US. There are
just too damn many of these things floating around, and more every minute.
Dollars are no different than tulips or widgets: if you make too many of
them, you'll have to drop the price in order to get the public to absorb
them.
Better yet, dollars can be likened to a company's
stock. If the company does well, existing and intending shareholders will bid
the price up, trying to pick up a bargain. The opposite is true when the
company comes upon hard times. Shareholders will dump the loser and
speculators will even sell it short. You've already seen the historical chart
for the dollar and it's easy to see that "shareholders" are dumping
their stock in USA, Inc. Now take a look at the following Point & Figure
chart for the dollar:
I really like these charts because they strip away
all the opinions, commentary, and market noise. They boil it down to just one
thing: price action! Here, price is saying that the US Dollar Index is headed
down to 76.00 - well below the 80.50 neckline I mentioned in the
introduction. If that happens, I seriously doubt the Index will stop at
76.00.
Incidentally, the December US$ futures contract
closed the week at 82.42 and we are now within shouting distance of the 80.50
neckline for the first time in many months. I believe we'll have that test,
and eventually we'll break down through it. My bet would be for an eventual
bottom at 56.00 and I believe that would bring about a very different world
than the one we currently live in. I have been short the dollar for months
and see no reason to change.
With respect to the Swiss franc, the opposite is
true. Yes, I know there might be currencies that offer a better profit
potential, but none of them offers the CHF's combination of profit and
security. This is not just an opinion, either. Take a look at the Point &
Figure chart of the franc:
Notice the price target of 98.00! That is almost
parity with the dollar. About five years ago, when we were around 1.65 francs
to the dollar, I told a lot of my clients that we would eventually see
parity. Most of them thought I was nuts. Now the P&F charts seems to bear
that out.
The December CHF closed out the week on an up note
at 83.94. It is a bit overbought but looks like it could go higher. I have
been long the franc for six years and see no reason to change.
GOLD: When I wrote my last Gold Update on November
18, I told you that I believed either of two scenarios were possible once we
opened for business the following Monday:
- We fall
down to $616.20 and eventually break below it, going on to test support
at $602.70. The latter support will hold and a major rally begin. Or:
- We begin a
significant rally right from Monday's open, moving above resistance at
$624.60 and going on to test resistance at $644.50 in short order.
We now know that the second scenario is the one that
played out. The March 07 gold contract closed at $650.70 on Friday, December
1.
In that same article, I also mentioned that there
were several important numbers for an investor to focus on. Gold had support
at 616.60 and 602.70, I said. There would be resistance at 624.60, 644.50,
664.20, 686.20 and 728.60. "Anything else is just noise," I said.
As you can see, we've gone on to take out the 624.60
and 644.50 resistance levels and are now on our way up to test 664.80 and
then 686.20. Neither of these is going to hold gold back for any length of
time. Given the progress that gold has made over the last two weeks, I would
like to discuss what the price action will look like over the coming weeks.
Gold has definitely broken out now and there is no
doubt in my mind that we are headed higher. We have three more resistance
points to deal with, but that will not be the end of the story. We are
shaping up for considerably more than just a test of the May 11, 2006 high at
728.60. Take a look at the weekly
chart:
There is very little to complain about in this
chart. We are far from overbought as RSI, MACD and the histograms are all
headed up. You can see that the price is starting to put some distance
between itself and the 50-wma, and that is a sign of strength. Add to this
the fact that very few people are bullish on gold and you have the makings of
a good rally.
Just how good, you might ask? I believe that gold is
going to a minimum of $775 on this leg up and may even test the all-time high
of $885 before all is said and done. When? Too early to tell, but I suspect
this rally will last into February 2007 at the very least and may even run
into May.
There will be at least one correction of 5-7 per
cent along the way, and probably two. They will likely be short but violent,
so let the buyer beware. I have no idea at what level we could see a
correction but the odds would favor 686.20. From there, a five per cent drop
would take us back down to around $652. What does one do, given the
possibility of such a correction? Absolutely nothing! Sit on your hands and
wait for the inevitable rebound to a higher level.
SILVER: The only thing better than gold is silver.
Like the last leg up that ended in May, silver is now leading gold. You often
learn more about a commodity in its reactions than you do in the movement
that goes with the trend, and silver is no exception. It has resisted any
attempt to sell it off. You can see its strength compared to gold in this
weekly chart of silver:
See how the white metal has moved above its
September high? Gold has yet to do so. With Friday's close at 14.19, the only
real resistance is the May high of 14.74. Once through that, we'll have a
clean run up to good resistance at 18.56 and maybe even as high as 20.73. The
latter is actually my bet for a top. Excellent support is at 1353.40. Like
gold, we should see at least one correction of 5-7 per cent along the way,
maybe even two. Like gold, the reaction will probably be short and violent. I
am long silver and see no reason to change.
GOLD STOCKS: As most of you know by
now, I have held certain positions in gold and silver stocks for more than
two years. My portfolio was structured
with two thoughts in mind:
- I want
security above all, so that means I must stick to the so-called
"Blue Chip" stocks, and;
- wherever
possible, I want to receive regular cash dividends. Receiving dividends
makes it a lot easier to sit through the reactions that always occur.
Following these simple guidelines, I purchased Buenaventura (15%), Coeur D'Alene (15%), Goldcorp (20%), Glamis
(15%), Newmont (15%), Royal Gold (15%), and Silver Wheaton (5%). Silver Wheaton was a late entry; I purchased it by selling 5%
of Buenaventura.
In the race for ever more reserves, Goldcorp
purchased Glamis and that raised my percentage in the former to 35 per cent,
which was more than I want in any one company. Necessity being the mother of
invention, I decided to make a change. This change was aided by the fact that
Goldcorp did something they shouldn't have done. Worse yet, they did something
they said they wouldn't do: they booked what I consider to be significant
losses trying to hedge copper. This from a company that holds itself out as
one that doesn't hedge!
I reduced my holdings in Goldcorp to 10 per cent. I
added to Royal Gold and Silver Wheaton (now 20 and 10% respectively) and
purchased Agnico Eagle (10%) and Golden Star (5%). The latter could be
considered to be a bit speculative. It is my only junior, and I look at it as
a prime takeover target as well as a good company. I owned Agnico Eagle and
Golden Star from 2001 until mid-2004 so I am familiar with them.
With respect to the group as a whole, the HUI
continues to make decent progress. It is being both pulled up by gold and
pushed up by a rising Dow. As a result, the HUI was able to move through what
previously had been good resistance at 349.48 and closed the week at 353.88. Take a look at the weekly chart below:
We have clearly broken out above the top band of a
downward sloping trend line and we are using the 50-wma as support. Note also
that RSI, MACD and the histograms are all headed in the right direction and
have a lot of room to run. The next areas of resistance will be 369.83,
381.74, and then the May high of 401.69.
Will we make it that high? I really don't know. It
depends more on the Dow than the price of gold. Any sharp reversal in the Dow
could pull the HUI down with it for weeks or even months. That is a risk that
I have accepted and I will sit tight through any reaction.
CRB: A month ago there were a lot of doubters when
I said the CRB would test the May 12, 2006 high of 418.50 (basis the January
CRB futures contract), but here we are one month later and we are just a
stone's throw away from it. The principal drivers have been the metals and
grains, although oil has also been acting well of late. The grains have been
just relentless, but more on that later.
The January CRB contract closed on Friday at 410.75 in what has been
an impressive rally. After bottoming at 366.00 in late
September we began a move up that has left a number of unfilled gaps in its
wake, including two large gaps in the last week. We'll find excellent support
at the 400.87 to 402.50 range in the event we experience a reaction. We'll
find resistance at the old high of 418.00 on our way up to 465.00 at
the very least.
That's right; I believe the CRB will head to 465.00
on this particular leg up. Eventually we'll head even higher as cotton,
lumber, and who knows what else all begin their individual surges. Barring a
breakdown in the printing press, commodities should have several years of
hard rallying ahead of them. I am long the CRB and see absolutely no reason
to change.
DJIA, BONDS: It may surprise you to
know that I don't have a lot to say here, other than that I don't like either
market and I currently don't have a position in either. I was long the
Dow (not a misprint, I meant to say long) but took my profits and went back
to my seat on the sidelines.
We are in uncharted waters with a price/earnings ratio
for the Dow in the clouds at 24 and a tiny yield of 1.6 per cent. I see
absolutely no future in trying to buy that. Meanwhile, the Transports and the
S&P aren't even close to confirming the highs in the Dow.
When will the Dow finally have a reaction? I don't
know, but here's a clue:
This is a daily chart of the Consumer Index. It is
the life blood of the US
economy. We appear to be forming a small head-and-shoulders top here unless
my eyes deceive me, and if that is the case, it would be an ominous sign. If
the consumer gives up the ghost here, you can kiss the Christmas rally
goodbye. RSI, MACD and the histograms have all turned down and none of
them confirmed the November top. (The same is true for the Dow, by
the way). Not a good sign. In any event, I want to see more so I will sit and
watch.
Bonds are a mystery wrapped in an enigma. Just about
every time the Fed says something, the bonds do the opposite. The Fed is
talking up inflation so the bonds head up, driving yields down. Go figure. I
have done very well with bonds and am in no hurry to give it all back. I
expect a test of 115.11 and I honestly expect that to hold, but I want to see
it hold before I do anything. Therefore I will sit and watch.
Conclusion
It has been a long and profitable year and it has
required a lot of work to stay ahead of the game. I have attempted to share
this work with you in an effort to educate as many people as possible.
I do not pretend to have all the answers. No one
does. I do have a few insights which can be of benefit to the average
investor, if he'll listen. The stock market is a complicated and difficult
place to earn a living. Most don't succeed and go away convinced that it
can't be mastered. I disagree.
It is my hope that you have found something of value
in my writing. Simplicity is a wonderful thing and we could use a lot more of
it in the world. I've tried to keep things simple. I've also been very
direct; I don't mince words. If you are going to take the time to read this,
you deserve to know what I think. I generally limit my discussion to what the
numbers are telling me and then I convey that same message to you. I don't
beat around the bush and I don't concern myself with the why of a
trend. I leave that for the history books. I just want to know the number.
In closing, this should be my last work for the 2006
so I would like to wish all of you a Merry Christmas and a Happy New Year.
See you in 2007!
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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