 PIVOTAL
EVENTS - APRIL 10, 2008
Signs Of The Times
Bob Hoye
Institutional Advisors
Posted Apr 11, 2008
Last Year:
"Demand For New [innovations]
Funds Offers a Chance [for academics] to Test Theories, Make
Money"
- Wall Street
Journal, April 21, 2007
The article was accompanied
by a cartoon of an academic, complete with gown and mortar board
hat, riding a bull.
"Hedge Funds are rediscovering
the fundamental law of supply and demand: As they rush to sell
stock in their funds to the public, they are flooding the market."
- Wall Street
Journal, April 23, 2007
* * * * *
This Year:
"Above The Subprime Fray,
Canadian Western Bank Outshines Rivals"
- Calgary Herald,
March 21, 2008
As part of the story, CEO Larry
Pollock, noted "We were not smart enough to understand that
stuff".
"Banks will raise what
capital they can, then they will slow down their growth and stop
lending, and what should be a mild recession becomes a more serious
one."
- William Isaac,
FDIC Chairman from 1981 until 1985
-- Bloomberg, April 8, 2008
In the first half of last year,
we ran the "Dearth Of Credit" piece by von Mises a
few times. The key to the Austrian theories on credit is that
the contraction is not caused by bankers calling loans, but just
becoming a little concerned and stopping aggressive lending.
The rest follows, and the comments by Isaac suggest banking conditions
are well along the usual path.
* * * * *
Stock Markets: In reviewing our comments from the
January 24 edition, there were some not-bad calls. We noted that
our expectation of an important low being set in late January
was working out and that shorts could cover and traders could
take a long position on the general market. Rebounds amounting
to around 50% of the losses were possible.
The count on the Nasdaq decline
was interesting as it set a classic 55-trading-day crash, that
in some examples marked the end of a fabulous bull market. That
was the bottom week of that hit and our January 31 edition called
for the rally to run for some 6 to 8 weeks, which counts out
to around now. Also expected were a few "bad news"
hits, but generally by around now "the street could conclude
that 'brilliant' policy has ended the disquiet and the recession
has been cancelled".
These "fundamental"
expectations also seem to be working out. What's next?
First of all, is the market
up when it should be? - Yes. How sound is the technical action?
- Not good, as A/Ds and buying power have not been robust.
While the rally is not sensationally
overbought, the momentum things on the SPX are at levels reached
on the last few rallies. The overall stock market is again vulnerable
to the next phase of contracting liquidity as well as news of
banking calamities suffered in the past few months, but not yet
reported.
On the nearer-term, our March
13 edition concluded that the Bear Stearns Panic was a test of
the January low and that the rebound could run for a few weeks.
This fit with our goal of a rebound until around now.
As of yesterday, and signaled
by slumping financial stocks (LEH), the market seems to be faltering.
The other interesting feature is that the coal sector (BTU) and
rails (BNI) seemed to run out of steam at the same time.
Over the past week, spreads
and the yield curve were quiet, so the slump seems due to internal
deterioration.
Sector Comment: Readers know our long condemnation
of the banks, which goes back to our "Sell" of last
July and that it applied to "Widows and Orphans" as
well.
On the rebound out of the January
trashing, we expected a 50% retrace on the BKX and that was accomplished
in only two weeks at 96 on the index of banks stocks. We have
been bearish since and last week noted that our Bank Trading
Guide was on the "Sell". This reached a high in early
March that also had an RSI at above 85 and typically the high
for the BKX is set within the next 3 weeks, or by late March.
The key high was 86.5 on April 1. The key comment was on March
27 and that was to sell aggressively.
Base metal miners were also
expected to rally out to a seasonal high in March. And as we
noted last week on the SPTMN, there is overhead resistance at
the 858 level set a few weeks ago. So far the mining index has
reached 867 yesterday.
Our policy in this sector is
to buy on weakness in the last part of the year and to sell on
seasonal strength around now.
INTEREST RATES
The Long Bond: This week, former Fed chairman Paul
Volker, said that conditions were similar to the 1970s. Inflation,
a dollar crisis, and a lot of concern. What definitely is not
part of that lamentable condition was that long-dated treasuries
were on their way to a record high of 15 per cent, as the bill
rate soared to over 16%.
Instead, long rates have been
hanging around 4.35%, with the bill yield at 1.38%. Obviously,
the Greenspan "Conundrum" is still on.
Fortunately, there has been
an explanation. All of the great financial bubbles since the
outstanding example of 1873 were followed by very dramatic declines
in short-dated market rates of interest. In the order of 500
bps to 600 bps. Of course, the senior central bank has always
followed with a sensational series of cuts in administered rates.
This time around, the post-2000
decline in short rates to around 1 per cent was leveraged into
the greatest credit bubble in history. With this, any asset class
was bid up and leveraged. All bonds were bid up as well, but
the long treasury is the only bond sector that is still in play.
In the last week it has recovered from 117.40 to 119.42.
Regrettably and implacably,
overall credit is probably contracting faster than central banks
can create their portion. This was the case during the post-1929
period when the Fed was flushing up liquidity by buying bonds
out of the market. And The Economist observed, in late 1929,
that Fed policy was "benign". The problem was that
the Fed was trying, but the contraction overwhelmed every effort
- mainly because global credit markets are vastly bigger than
all the central banks put together.
Again the long bond is on a
rally and it will likely be turned away at the 121 level. Getting
beyond 122 would be a surprise. At some point, further deterioration
in liquidity will prompt offside accounts to dump long treasuries.
As mentioned above, over the
past week there has been little change in spreads or the curve.
The Dollar Index: According to Ross, the DX is on the
path to an important low. Two weeks ago we noted that it had
to decline further on the test of the 70.70 low. So far the low
is the 71.42 reached earlier today.
Also, as noted last week the
dynamics of the long decline have registered a "Downside
Capitulation" on the weekly, which has shown a number of
reliable readings. This condition can last for a few weeks before
an intermediate rally gets underway.
This summarizes the key dynamics
and another item used at important lows is the "Sequential
Buy" pattern. This is in play and all that is needed now
is weakness into tomorrow.
The dollar index is poised
for a rally and the "sequential' could be the "Goldilocks"
confirmation for a significant move.
The Canadian Dollar has been expected to weaken, based
upon widening U S corporate spreads and weakening commodities.
Since December, it has traded
between 97 and 102+. The latest decline has been from 99.80 last
week to 97.88. This is within a decline from almost 103 that
is setting a series of lower highs. New lows within 6 to 8 weeks
seem possible.
Miscellaneous: Over the past five weeks the Baltic
index has plunged from the rebound high of 8560 to 7619 on March
25. Since then it has recovered to 7760.
Back in January, our view on
stock and commodity markets as well as the Baltic, was that the
"good times" would run into March -- maybe April. Within
a few weeks these could be heading down.
Grains have continued the rebound
after the slaughter of the wheat spike. Rice has been the leader
in accomplishing outstanding gains as well as the rare incitement
of riots. Although involving a different staple, in the distant
past "peasant bread riots" typically marked the end
of a huge bull market in grains.
Once again, this is within
a move for commodities likely to run into March - April.
In late February, the grains
as represented by Goldman's GKX index, reached a rare "Upside
Exhaustion" reading. The action topped out at 513 at that
time and plunged to 405 at the first of April. The rebound has
made it to 446. There is resistance at 450 and the season for
strength is soon coming to an end.
With this, Ag stocks have revived
with Potash making new highs. It is time to start selling again.
COMMENTS FOR ENERGY AND METAL PRODUCERS
Energy Prices: Crude oil gave a rare "Upside
Exhaustion" reading in early March, from which the reversal
could have occurred within a week. This was the case as the high
was 110.35 on March 17 and the initial decline made it to 98.65.
We were looking for the test
and it made it to 108.22 and then slipped to 99.50 on April 1.
Last week we noted that declining through this would set the
downtrend. But, the continuous contract has soared to 110.19
at yesterday's close. The May contract reached 112, which seems
to be in a squeeze.
Oil stocks are not making new
highs. The XOI set the high at 1581 at the end of the year and
plunged to 1212 with the January crisis. The main rebound made
it to 1472 at the end of February and the March financial crisis
took it down to 1292.
The action now seems to be
a big test of the 1472 and so far it made it to 1432 yesterday.
From the January low to the recent high, daily momentum has recorded
quite a recovery.
The oil patch is again vulnerable
to problems in the banking patch.
Last week's view on natural
gas was that more gains were possible as it usually has its seasonal
high well after the one for crude. So far, the high has been
10.36 set in mid March. The first drop with crude was to 8.75
with the March crisis. The next high was 10.21 at the end of
March and it has been churning around since.
There is a possibility that
natgas could get up to a seasonal high over the next 6 weeks
or so, but the action has been vulnerable to financial hits,
as well as to the pending recovery in the dollar.
As advised last week, natgas
stocks should be sold.
Base Metal Prices: Usually, we play the metals for a
seasonal high around March. Sometime the seasonal can run later,
but we should consider that our index, which had declined from
811 in October to 605 in December has soared to 828 in early
March. This compares to the high of 826 back in July.
The initial decline from the
March high was to 731 at the end of March, and the recovery has
been to 779. Following a similar pattern, Goldman's metal index
has recovered to 496 and a little above neutral momentum.
Base metal prices could trade
at current levels for a week or so, but in recovering within
our time frame are vulnerable to the next financial crisis and
pending strength in the dollar.
Gold Sector: The high-profile
GFMS research group has issued advice that while gold could reach
1100, it could fall to 600 next year.
Their reasons are that global
jewellery sales could drop, and as GFMS states this demand is
"the cornerstone of the gold market and makes up more than
half of global demand". Their other concern is that US interest
rates will be rising such that altogether "The whole basket
of drivers will unwind".
It is worth noting what happens
in your typical post-bubble contraction, which is what a rational
researcher would expect on this one. Jewellery consumption that
was fueled by the boom will decline significantly, which was
the case in the post-1929 example. But, this was more than offset
by the increase in investment demand for gold, which is another
feature of a post-bubble contraction.
Another salient feature of
a post-bubble contraction is that real long-dated interest rates
soar. Typically, this is a combination of the nominal rates going
up as the rate of consumer-price inflation turns down--eventually
to less than 0 per cent.
Gold has its best innings during
the first few years of a post-bubble bust, and then with some
cyclical correction can eventually recover its purchasing power
over a much longer period. In so many words, the real price has
enjoyed a significant increase - as real interest rates have
soared - on six out of six great post-bubble contractions.
It seems that the orthodox
gold crowd is still handicapping itself with inadequate research.
On the near term, the dollar
index is close to turning up, and the latest zoom in commodities
is getting overdone within the time window for a top.
On the metals, the rally was
likely to run with the silver/gold ratio rising and when this
reversed, the top for both silver and gold would occur within
two weeks. That was the case, for example, in January, 1980.
This time around, the ratio reversed on March 6 and the high
for both was on March 17. An intermediate decline for both is
underway and silver has been expected to be weaker than gold.
The low for the gold/silver
ratio was 46.2 at the turn, and now it's at 51.7. No big move
but it is in the right direction and the new trend has been set.
The gold/silver ratio always goes up during a post-bubble contraction.
Another feature of the reversal
in the ratio is that, typically, some 2 months later senior gold
share indexes can be down at least 20 per cent.
Our advice through February
was to sell the seniors and to eventually buy smaller caps when
opportunity arrived. We are not there yet. The advice was to
play the short side on silver stocks.
Gold's behaviour through the
ugly course of a post-bubble contraction has been consistent.
The real price has had a significant increase during the first
few years following the climax of a mania. From the 1720 example
to the sixth one in 2000 there have been no exceptions.
On the financial side, this
has been accompanied by a steepening yield curve, widening credit
spreads - and soaring real long interest rates. Including the
usual mob of distraught policymakers, this is working out so
closely to previous examples that it is tempting to call it "Rational
De-exuberance".
-Bob Hoye
Institutional Advisors
email: bobhoye@institutionaladvisors.com
website: www.institutionaladvisors.com
PIVOTAL EVENTS - APRIL 10,
2008
Hoye Archives
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in this report are solely those of the author. The information
herein was obtained from various sources; however we do not guarantee
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