Looking Down The Road
Jun 26, 2006
Looking down the road is always a good idea if you want to know
where you are going and avoid any problems. And you can look
in a rear view mirror to see where you have come from and, more
importantly, what dangers may lurk behind you. Trying to look
down the road for direction in markets is of course different
then driving a car. But many analysts try, including me, because
being able to anticipate or analyse dangers that may lie ahead
is important for everyone's financial health.
That some of us analyze it from a bull viewpoint and others from
a bear viewpoint makes for the differences. And everyone has
an opinion about which direction to take to get to their goal,
which is coming out ahead and beating the market (or, in a bear
market, losing less than others).
So, what analysts and other market pundits try to provide is
a road map of where we are going and what to hold to get there.
You would of course not go on a trip without a road map; nor
do you want to be investing without a map. There are fundamental
analysts who examine the innards of companies (micro), and the
economic outlook (macro) as provided by economists, and derive
their conclusions as to whether the company has the value to
justify share ownership, and where we are in the economic cycle
so we know whether to continue to hold the stock or sell. Many
fundamental analysts hold their positions through all sorts of
cycles, both up and down, in the belief that in the long run
the stock market only goes up.
Then there are technical analysts who look at historical price
action on charts and use it to determine future price trends.
Technical analysis has three basic premises: the market action
discounts everything; prices move in trends; and history repeats
itself (John Murphy - Technical
Analysis of Futures Markets). Within the field of technical
analysis there are numerous branches, from people who use simple
support/resistance, trend lines and breakouts to the esoterics
of quantitative analysis, astrology and neural systems. While
the fundamental analyst studies the cause of market movement,
the technical analyst studies the effect.
Of course there are many who use both fundamental and technical
analysis. We use both macro economic analysis and technical analysis.
We are also fans of cycle analysis, which is a study of time
cycles. Time cycles ask the question when? while regular
technical analysis asks which way? and how far?
So, by looking down the road and using cycle analysis, we are
asking all three questions.
Our favourite cycle analysts are Michael Jenkins of Stocks
Cycles Forecast, Ray Merriman of the Merriman Market Analyst
and P Q Wall of P Q Wall Forecast. There are many others;
too many to mention. Some of the core for many cycle analysts
is the works of R N Elliott (Elliott Wave Theory) and W D Gann
(Gann Theory). But there are others who may not be as well known
such as Edward R Dewey (author of The
Mysterious Forces that Trigger Events) who studied thousands
of seemingly unrelated cycles spanning hundreds and even thousands
of years. One of his findings was that there were many cycles
of seemingly unrelated phenomena that had similar cycles. It
reminds us that our life is a cycle, our days are made up of
cycles, and that there are the cycles of the months, the moon,
the sun, the planets, and of course the seasons. These are all
cycles based on natural and astronomical events and are quite
The topic of cycles comes up regularly, even among fundamental
analysts. Fundamentalists may talk about economic cycles while
the technical analyst focuses on seasonality, particularly as
related to commodities. But even the stock market has cycles
during a year, such as when we talk about weakness in the fall,
particularly September/October. "Santa Claus rallies"
that start in November and go through until Christmas or New
Years, the "buy when it snows and sell when it goes"
or "sell in May and go away" rhymes, the summer rally
- all are merely expressions of the seasonality of cycles.
One of our favourite longer term cycles is of decades (something
we learned from all three of our cycle analysts to different
extents). Price patterns tend to repeat themselves (not the actual
price levels) and being able to identify the patterns of a year
in a previous decade, or through the decade itself, may help
you determine the where and the when of the current market. Also
having knowledge of long-term cycles shows you where you are
in the very big picture, even as within that very long term cycles
there are many ups and downs in the markets.
On the subject of long-term cycle studies, there are two we would
like to mention that we believe investors should be aware of.
Think of them as really big road maps. One of them has been popularized
- the Kondratieff Wave Cycle, a cycle that covers anywhere from
50-60 years but may now be stretching out even as long as 70
years. A Kondratieff cycle might be approximated to a life cycle
of a man. The other one is derived from historian Oswald Spengler,
whose best known book The
Decline of the West put forth a cyclical theory of the
rise and fall of civilizations.
Nikolai Kondratieff was a Russian economist in the Soviet
Union who studied long-term capitalist economies (US, British
and French wholesale prices and interest rates) and concluded
that there were peaks and troughs in economic activity that lasted
roughly 50-60 years. Other economists also did similar work that
traced similar cycles back to the Romans and the Mayans and supported
Kondratieff's work. Kondratieff was rewarded for his work by
being sent to Siberia by Stalin, who didn't like Kondratieff's
news that capitalist economies always rose again from their depressions.
He died in a labour camp.
Kondratieff concluded that there were four distinct phases of
his long term cycle - spring (inflationary growth phase); summer
(stagflation, recession); autumn (deflationary growth); and winter
The spring of the current Kondratieff cycle fits the periods
of the 1950s and into the 1960s very well, as the economy experienced
growth with low inflation, low interest rates and rising stock
prices as we came out of the long winter of the previous Kondratieff
cycle that took us through the Great Depression and WW2. The
period of the late 1960s and the 1970s that culminated in two
steep recessions (in 1973-75 and 1980-82) fits the description
of the Kondratieff summer with its themes of stagflation, rising
interest rates, a booming commodities market and a struggling
falling stock market.
The next period of the 1980s and 1990s was a classic Kondratieff
autumn as commodity prices collapsed, inflation fell and economic
growth was steady, although not as powerful as in the 1950s.
And of course the stock markets not only boomed, but in the late
phases went into a bubble (as they had done in the previous cycle
that culminated in the stock market top of 1929 and subsequent
collapse and depression). It was as it has in the past also a
period of rising debt levels, innovation and new technologies,
and greed. The current market topped in 2000 and the collapse
seen from 2000-02 ranks amongst the great crashes, especially
the one in the technology sector. But commodities turned slowly
up during this period - and in the early stages of a Kondratieff
winter, commodities do turn up.
That the current cycle has been supported by massive injections
of liquidity from the US Federal Reserve and the Bank of Japan
is merely a sign of how seriously the monetary authorities took
the potential of a deflationary collapse. Alan Greenspan, who
was perfectly well aware of both the Kondratieff cycle and Elliott
wave analysis, always said that he wanted to be Fed Chairman
at the time of a Kondratieff winter. His proposed solution was
to inject huge amounts of liquidity that would stave off a collapse.
The liquidity was also helped by the Japanese where almost zero
percent interest rates set up the conditions for the carry trades
where money was borrowed cheaply in Japan and reinvested in higher
yield markets including emerging markets.
Many believe that the problems ended in 2002 with the bottom
of the market, and that since that time we are merely resuming
the long-term bull market in stocks. But we were fed by those
liquidity excesses from Japan and the US, and it resulted in
bubbles in the housing market and some emerging markets. The
housing bubble has yet to fully implode but it remains a real
risk. But now we are reaching the event that has hit other Kondratieff
winters, and that is rising inflation (even if the real enemy
Global rising interest rates and contracting liquidity played
a role in the recent global market meltdown. The risk is now
that the monetary authorities will tighten too much, triggering
a bigger meltdown, especially if it is accompanied by a major
geopolitical event. How they react after that is anyone's guess,
but the suspicion is that they would once again flood the system
with liquidity to try to prevent a meltdown. It is then that
we could have our deflationary collapse where even commodities
fall. Except one, we believe, and that will be gold (and possibly
the gold stocks that performed well during both the deflationary
meltdown of the 1930s and the inflationary boom of the 1970s).
We are reprinting our chart of June 28, 2002 that shows the generally
accepted Kondratieff phases for the United States. Note how there
is a peak war (summer) and a trough war (winter). The autumn
plateau is characterized by low interest rates, falling inflation
and falling commodity prices, and they all end with speculative
bubbles that burst.
The theories of Oswald Spengler
are much more difficult to get a grasp on because of the sheer
length of the cycles. While it provides a fascinating look at
history, many will wonder what the relevance is. From our perspective
it is relevant of course to know where one might be in a very
large cycle because it gives us a lot perspective, even if the
interpretation may vary from analyst to analyst. When Spengler
wrote his treatise in 1918-23 (The Decline of the West,
Volumes 1 and 2) he thought the war of 1914-18 was the beginning
of the end of European culture and civilization. Of course it
wasn't, any more than probably the current war or events of today
are. We are not sure if anyone could ever pinpoint when the decline
of a civilization sets in. That can only be determined retrospectively.
But that being said we can recognize signs of a decaying society
even if it plays out over a few centuries.
Spengler's work has been examined by and has influenced hosts
of others, including Samuel Huntington in his Clash of Civilizations.
We also note an interesting theory of application using Elliott
waves in a gold-eagle article (www.gold-eagle.com)
entitled The Rise and Fall of Civilizations (Parts I,
II and III - Joseph Miller, Daan Joubert and Marion Butler, 2001).
PQ Wall refers to Spenglerian cycles in his writings.
Spengler's main propositions are as follows.
1. History can not be viewed as "linear", it is cyclical.
Therefore he rejects the notion that history, especially Western
history, flows in an evolution upward in a progressive manner
from the Greek, Roman, Medieval, Renaissance or Ancient, Medieval
2. History is cyclical and not one just of nations, races or
events, but of "high cultures". He identified eight
such high cultures: Indian, Babylonian, Egyptian, Chinese, Mexican
(Mayan, Aztec), Arabian, Classical (Greece and Rome) and European-Western.
3. Each "high culture" passes through stages of birth
(Spring), development (Summer), fulfillment (Autumn) and decay/death
(Winter). The high water mark is the period of fulfillment -
the height of the culture. The beginning of the end comes when
the culture begins to die out amongst social upheavals, mass
movements of people, continual wars and constant crisis. In the
dying stages rule is determined not by democracy and a free press
but by the rule of money and Caesars in a dictatorship. It is
an imperialistic age.
This is just the barest of outlines. In their treatise, Miller,
Joubert and Butler noted some interesting characteristics in
the period of decline, including pollution, degradation of the
soil, disease, famine, loss of freedom, security problems and
class strife. We summarize and add to some of their observations
below from their essays as they are worth repeating.
Degradation of the soil: Today we are faced with global
warming or climate change, whatever one wants to call it. But
it is real and it is causing the melting of glaciers, the melting
of the ice caps, threatening the rise of seas and an impact on
the weather and even Gulf Streams. The rate of global desertification
is growing from both over-use and global warming. Water tables
are falling in many parts of the world. This may be one of the
single greatest challenges going forward, and wars are inevitable
for both food and water. We are also over dependent on non-renewable
resources such as oil and gas and many commodities. Much of the
current strife and wars can be traced to a global race for control
of these dwindling resources.
Disease: There is a huge threat of natural disasters due
to epidemics and biological warfare. In the past thirty years
we have already had to deal with AIDS and threats from SARS and
avian flu. Many predict worse to come.
Famine: The risk of global famine has never been higher.
Since 1950, global population has increased from 2.5 billion
to 6.5 billion. Over two billion today do not have adequate water
or food. This is a cause behind mass migrations to Western nations,
as people flee their poverty stricken lives dominated by pollution,
inadequate food and water, wars and disease. By 2050 over half
of the world's population will lack adequate food and water.
Something has to give. Global famine is also pushed by climate
change with increased earthquakes, hurricanes, fires and floods
which also played important roles in previous declines.
Pollution: Air pollution kills three million annually
around the world. Many in Chinese cities and elsewhere in Asia
in particular could not survive without wearing masks every day.
Poor sanitation is endemic and kills 12 million annually. The
ozone layer is under duress.
Loss of Freedoms: Our freedoms are under attack, driven
by the fear of terrorism and politicians who play the hate and
terrorism cards to gain power. Fiat credit money has meant a
degradation of money and created credit bubbles which, when they
burst, plunge many into bankruptcy. Individuals, governments
and even corporations are overextended, and all of this plays
on lessening our freedoms. We continue to cite gold as the only
true monetary means and store of wealth. Gold has been money
through the millennia.
Security problems: Security is no longer what it was.
We are threatened - or at least we are told we are threatened
- from without by unstable nations possessing nuclear weapons.
Of course, whether they will use them is not relevant here, but
that they might. That they themselves might be obliterated immediately
by superior military power does not seem to enter into the equation.
We are threatened by terrorism but it is also used by our powers
to control and slash freedoms. We move inexorably towards more
1984-style security and fascism. The corporate world profits
immensely from the growing need for security.
Class Strife: As an elite few become wealthier, class
strife grows. In the US today, walled towns patrolled by private
guards to house the very wealthy are not uncommon. The walled
towns are meant to keep out the lower classes. The middle class
is being squeezed in much of Western society. Wages for the average
man have barely budged in the past decade, even as the rich become
richer. Class strife is not just in individual nations but between
nations as well. In the US one percent of the population controls
over 50 percent of the wealth; on a global basis, 20 percent
of the world's population is responsible for over 80 percent
of private consumption.
Two thousand years ago, Rome stood astride the world and Roman
culture dominated the ancient world. But it also marked its zenith
as the culture decayed into the age of the Caesars and constant
imperial warfare. Today the United States sits astride the world
militarily and American culture and corporations also dominates
the world. But threats are growing on a number of scales, as
we note above. This century promises to bring many of these issues
others outlined above to a head.
They say history repeats itself. But they also say that those
who do not study history are doomed to repeat it. Cycles are
a part of nature and they are a part of history. The evidence
of the Kondratieff cycle has been proven over and over again
and we appear to be once again on the downside of the cycle.
But could we also be entering the winter of the Spengler cycle?
We have no argument that technology and innovation may yet help
us weather many of the challenges that we will face in the next
century. And they most certainly will but it may not prove enough.
Of course we don't know for sure. We can only project what we
know and where it might take us. Many of the signs are there
that caused decay and decline in the past. But having an understanding
of cycles and what they mean may help some of us avoid the pitfalls
that will befall many and help us survive the coming turmoil.
Think of it as looking down the road and seeing what might be
coming and preparing for its eventuality. Sounds like that old
Boy Scout motto: Be Prepared.
Jun 23, 2006
Charts created using Omega
TradeStation or SuperCharts. Chart data supplied by Dial Data.
David Chapman is a director of Bullion
Management Services, the manager of the Millennium BullionFund
Note: The opinions, estimates and projections stated are
those of David Chapman as of the date hereof and are subject to
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