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Signs Of The Times

Bob Hoye
Institutional Advisors
Oct 20, 2008


Energy Prices: Both crude and natural gas prices have been expected to decline into late in the year. Energy stocks could approximate this, but with the understanding that when the rebound comes into the overall market it will pop the sector.

Base Metal Prices are under the same liquidation pressures as everything else. We like to play the seasonal swings in this sector and are looking for an important low over the next six weeks or so.

Gold Sector: Senior golds have been expected to decline with the general bear market until around late October. From the high of 518 in March the HUI has slumped to 204. On a similar move in 1929, Homestake fell from 11.5 to 8.13. Canadian producer, Dome, fell from 5.5 to 3.

Obviously gold shares still track the stock market in a crash and will continue to track into the new year. Somewhere in the first half of 2009 the existing increase in gold's real price should begin to enhance operating earnings. At the same time most commercial, industrial, and financial earnings could be disappearing.

In previous post-bubble contractions the real price has improved for some three years as the orthodox world suffers, and the gold sector shines.

Most researchers still focus on the nominal price but it is only another price series to trade. Some, fully realizing the nonsense of policies of deliberate dollar depreciation, use gold and silver to bludgeon central planners. This can be an expensive habit during a bubble and the immediate phase of the contraction.

Gold's real price declines during a bubble, which impairs earnings. This makes gold equities underperformers. Then in the contraction the real price goes up, eventually making gold shares a premier performer. For example, Homestake's earnings declined from 0.80 to 0.05 with the 1929 financial mania. Gold's nominal price was 20.67 and costs soared with the boom. Then with the bust costs dropped such that by 1932 earnings had improved to 1.24. Gold's nominal price was still at 20.67.

By the end of 1932 the stock had gained 146% to a little over 20. Dome's stock soared to 6.5. This was well before President Roosevelt started imposing his loony ideas, one of which was to join the uptrend in the real price by increasing the nominal price -eventually to 35. Homestake reached 66 in 1939, and was paying 4.50 in dividends. When it comes to mining, the conclusion to be made is that gold's real price is more important than the nominal price.

We have targeted late October as the time to begin buying the seniors. The gold/silver ratio continues to increase, which is indicating that the liquidity crisis is still on. Reaching the low 80s is impressive and moving very well towards our target of around 100. That was reached with the last banking crisis in 1990-1991. This one is much bigger and the ratio could go higher than our initial target of 100.

Signs Of The Times

Early This Year:

"To be sure, a crash in the oil market is not imminent." ­Bloomberg, June 3, 2008

"OPEC has already done what OPEC can do, and oil prices will not come down." -OPEC President Chakie Khelil, Breitbart,com, June 24, 2008

"Avoid Dollar at All Costs" -Jim Rogers, Bloomberg, July 30, 2008

The amount of "at all costs" seems to be open-ended.

More Recent:

"Corporate Bonds Become Fund Managers' Favorite"

"Junk Bonds Look Attractive" -Wall Street Journal, September 29, 2008

At the time, junk was yielding 18%. In two weeks it's down a disastrous 34 points and yielding 27%. The reason for the bullishness on junk was because the economy was slowing. But the research did not include disappearing liquidity typical of the post-bubble world.

"Investor Deleveraging Hits Junk" -Wall Street Journal, October 1, 2008

It seems that ambitious policy makers have finally made a sow's ear out of a silk purse. The Washington Post had a headline: "The End of American Capitalism" Don't they and most interventionists wish, but more than likely the collapse is marking the eventual end of market rigging by a priesthood of philosopher kings. It really takes some mixedmetaphors to get across just how hazardous generations of arbitrary policy can become.

Stock Markets: Carnage continues, punctuated by some violent whipsaws. This screams for review. Last Friday saw the completion of an eight-day selling panic. Weakness into Friday was needed to formally register our Downside Capitulation reading, which is a condition that suggests a tradable rebound could start within a couple of weeks.

The other part of our fall forecast has been the possibility of a tradable low by late October, which was based upon the 55-day count seen on a number of plunges. The other was the post-bubble model whereby heavy liquidation ran into late October, followed by a relief rally and a test of the lows made in mid November.

Clearly the bounce out of last week's panic was a day-and-a-half rebound within a plunging market. We learned of this pattern from a long-time and successful trader on the old Vancouver Stock Exchange who had seen it in a number of crashing individual stocks. It has been happening in the big markets and big indexes as well.

Tuesday's belated update on the Capitulation noted that the S&P rebound amounted to a 44% retrace of the loss since August, which was an instantaneous rally. Now comes the dreadful part -the New York Times, which publishes all the charts that are fit to print, did an outstanding chart showing that this plunge is worse than at the equivalent point in 1929. This was included in yesterday's "Economyths".

If this continues the wash out by the end of the month could be for the record books.

However violent this is, we will stay with the history of the great fall crashes whereby most of them from 1720 to 1929 climaxed in late October and bounced. This, when it comes could be limited by Tuesday's high, or 9786 on the Dow. Then in November the October low would be tested and the market could stage a tradable rebound into the first quarter.

This is the optimistic near-term outlook. Liquidation following the 1825 bubble, which included outstanding action in mining stocks, continued into January, 1826.

However this works out into the new year, the market is in a post-bubble contraction and these can run for a few years.


Credit Spreads continue to widen at the long end. As noted in the front-page quotes the junk bond has sold off by some 32 points in the last two weeks.

In the almost carefree days of last October, junk was trading at an 11% yield. The full decline has been from 100 to 41, or 59 points. This is a disaster as it represents an enormous decline in an important asset class.

The financial markets have become a black hole sucking the prices of most asset classes down, and this could go on for some time. The July 11, 1932 edition of Barron's editorial included some interesting points:

"The Federal Reserve policy of cheapening credit through the purchase of government bonds has been unable to make a dent in the conservatism of borrower or bank lender, in short, every anti-deflationary effort has yet to provide positive results. The depression is sucking more and more bonds into its vortex."

The key point is that the Fed had been providing liquidity by purchasing treasury bonds out of the market. The other point was that the effort wasn't having any results.

Why should it be any different this time around?

The Yield Curve (10s to 2s) continues to steepen and traders should could continue the position.

The Long Bond made the test of the 124 high with a rush to 122 a week ago. So far the drop has been to 113.3. There is support in the 112s and falling through this level will really move the bond revulsion into long treasuries.

As we have been emphasizing, the street has been buying the long bond as a "flight" to safety. This is just plain wrong -the real flight is and has been to bills.

The Dollar Index continues to firm with the panics and then it takes a little rest as the waves of selling abate.

That along with the unwinding of the great "long hot stories" and "short dollars" position provides the fundamentals on dollar strength.

Technically, the ChartWorks used the same analysis that was successful at the important low in December, 2004. The DX decline to 70.7 in March of this year registered a Downside Capitulation and the action completed with the Sequential Buy pattern. The decline to 71.3 in mid July completed an important test. What followed is the strength that we considered would be the worst thing that could happen to the financial markets as well as to policy makers.

Weekly RSI is getting interesting. If this rally is within the old bear market the swing in momentum is almost at the level that ends rallies. On the other hand, if this is the first leg of a long bull market momentum has further to run.

The next few weeks could see some remarkable financial violence.

The Canadian Dollar suffered a severe plunge from 97 on September 22 to 84 this week. Over time, we have found that the two main determinants on C$ weakness are declining commodities and widening corporate spreads.

All three have been evident. The range on the weekly RSI has been impressive from the high of 110 a year ago. Also in the market is that the Conservatives did not win a majority, but they did gain some sixteen seats.

This is a step towards stable government that could become solidly conservative. The Canadian dollar could find support in the low 80s.

The Baltic Index (BDI) continues to crash. The high was 11793 at the end of June and the drop to 1615 amounts to 86%. Beyond indicating that international trade is in decline, it bellows that shipping is in deep trouble.

With some big swings it took five years to get to the top and only two and a half months to give it all up.

Baltic Dry (BDI) 1991 to Current

click image to enlarge

  • This is a weekly chart.
  • The last post is at 2221.
  • The latest price is 1615.
  • Down 86% in 2-1/2 months.

Tales From The Crypt:

"For the first time [in history], the business men of all nations are supplied with statistical information, together with some understanding of the laws of economics. For the first time, we have sound centralized banking systems in all the countries and close cooperation between those systems internationally. Because all these factors are favorable, and because of the universal stirring of desire and ambition to which I have already referred, I believe in the 'Industrial Renaissance'. We are already seeing something of it in the United States." -Bernard Baruch, June 1929

Excerpts from the New York correspondent for The Economist dated October 29, 1929 are instructive:

"The slow and orderly decline turned into a break that surpassed all precedent for swiftness and disorder."

Meetings were held at J. P. Morgan's to discuss the "technical difficulties arising from handling the enormous amount of Stock Exchange business and to the defects of the market as represented by the existence of 'air pockets' (a phrase coined to denote a lack of bids in individual issue)."

Despite the unfolding disaster the existing modern theory of portfolio management was still considered sound. The November 4, 1929 edition of Barron's featured it with the lead headline:

"Attractiveness Of Common Stocks"

"Now on a More Liberal Yield Basis"

"The theory that a well-diversified list of common stocks is a satisfactory medium of investment has at last been tested in a stock market panic. Even at the lowest prices, most investors could have liquidated at substantial profits if they had been holding them for much over a year."

In May, 1931 the largest bank in Austria failed and the June 6th edition of The Economist reported:

"The Credit Anstalt

During the past ten days further important developments have occurred, and there is now good ground for hoping that the corner has been turned."

The Austrian government guaranteed all credits, with the BIS along with ten leading central banks agreeing to also provide credit in foreign currencies.

The story concluded: "The episode, regrettable though it is, has its brighter side."

Actually, that 'episode' marked the start of a massive global banking failure.


Oct 16, 2008
Institutional Advisors

Hoye Archives

The opinions in this report are solely those of the author. The information herein was obtained from various sources; however we do not guarantee its accuracy or completeness. This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized.

Investors should note that income from such securities, if any, may fluctuate and that each security's price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance. Neither the information nor any opinion expressed constitutes an offer to buy or sell any securities or options or futures contracts. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities such as ADRs, whose values are influenced by the currency of the underlying security, effectively assume currency risk. Moreover, from time to time, members of the Institutional Advisors team may be long or short positions discussed in our publications.

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