The October Newsletter
The Leaves Won't Be The Only Thing To Fall!
Enrico Orlandini
Lasco
Report
17
Oct, 2005
We're heading into that time
of year where the word "crash" tends to command a bit
more respect among market specialists, i.e., the months of October
and/or November. Maybe it's just a coincidence, but I see an
ominous cloud on the horizon. Actually, I see a large mass of
clouds and they're as black as night. Anyone who's invested in
the stock market over the last three or four years has little
or nothing to show for it and, if you're still invested, you
can't be feeling too comfortable right now. In short, a simple
saving account would have been a better investment. Then again,
when you buy into a market that's selling at 20 times earnings
and paying a miniscule 1.75% dividend, what can you expect? Two
weeks ago I warned my clients about the "probability",
not the possibility, of a crash. What did I see that made me
so worried that I would crawl out on a limb all by myself? Frankly,
there were and still are any number of warning signals, and I
would like to delve into some of them in the space provided below.
The first such warning sign
comes from the market itself. Focus your attention on the following
daily chart of the cash DJIA and follow along:
It's plain to me that we've
been in a trading range (10,000 to 11,000) for many months, and
I argue that this has allowed the smart money to exit stocks.
This is commonly known as distribution and almost always
occurs at the top. How do I know this is distribution (versus
accumulation)? Well for one, declines are almost always on heavier
volume than rallies. Secondly, rallies usually fail to have any
follow through to the upside whereas down days have an inclination
to come in bunches. Finally, a large proportion of the Dow 30
stocks turned down on heavy volume some months back and that's
usually a sign that big money is looking for the door.
There are other points of interest
as well. Note that the August high in the DJIA was not confirmed
by RSI or the MACD. Neither was it confirmed by the S & P
nor the Transportation Index. Most recently, we see a turndown
in the DJIA with a series of lower highs and lower lows highlighted
by the 50-d.m.a. turning down and touching the 200-d.m.a. We
are now trading well below the 200-d.m.a. and that is not a good
sign. This pattern is also found in the cash S & P
as you can easily see in the following daily chart:
There is one significant difference
though; on Friday the S & P did trade below its July low
whereas the DJIA did not. For months the S & P seemed to
hold up better than the DJIA, as seen in the relationship between
the two moving averages, and now it seems to be just the opposite.
The S & P now seems to be leading the way down.
This in itself wouldn't be
such a bad omen; grounds for a correction at best, but certainly
not justification for a crash. What makes me believe that we
are in for a collapse? Three things actually, and they're all
tied to the backbone of the U.S. economy: housing, consumption,
and credit. Take a look at the following chart of the Retail
Holders section:
This represents consumption
in the U.S. and it's not a pretty picture. The 50-d.m.a has turned
down and is closing in on the 200-d.m.a. Also, we're trading
well below the 200-d.m.a. which now serves as resistance to any
eventual rally. Furthermore, it's very hard not to notice the
head-and-shoulders top and the break below the neckline.
The next chart I want to look
is of the Dow Jones US Real Estate Index is along
the same lines although without the obvious head-and-shoulders
top:
Same scenario: lower lows and
lower highs, the 50-d.m.a. turned down, and we're trading right
at the 200-d.m.a. At the risk of repeating myself, I've attached
the Philadelphia Housing Index as well. It's even
a tad bit uglier:
Note the reemergence of a head-and-shoulders
top and the break below the neckline. Ominous at best! Take away
their houses, and the average American is dead broke.
So there you have it. The consumer
and the housing sector appear to be tapped out. That doesn't
leave much, except for easy money which has been the hallmark
of the Greenspan Regime. "If you want it, we'll print it"
should have been his mantra. Easy Money Al greased the
skids and allowed the banks and brokerage houses to make big
money on the "carry trade". That allowed the banking
sector to lead the way up through out the Bear Market Rally.
In fact, I insist that it was the major feature behind
the rally. The following daily chart of the Philadelphia
Banking Index now seems to paint a different picture:
Indeed, this is probably the
worse looking chart of the bunch. It's the only one so far where
the 50-d.m.a. is actually trading below the 200-d.m.a., and it's
the only one that's made a new closing low for the year (not
intraday low, but closing low). Why so bad? I suspect it has
to do with rising rates and a slowing economy. It's a double
whammy so to speak. This phenomenon is known as stagflation,
and it's not a banker's best friend. For those of you old enough
to remember, the Savings & Loan crisis sprang from the stagflation
of 1979-1980.
These aren't the only examples
I could have given you either. I could have shown you a hideous
chart of Wal-Mart (WMT) instead of the Retail Holders,
and the significance of this is that Wal-Mart represents 1.5%
of the U.S. economy. Too, I could have posted a chart of Fannie
Mae (FNM); quite possibly the worse of the worse. I could
also point to volume studies, the number of new lows versus new
highs, the P & F chart for the DJIA, and so on. The list
is close to endless, but I think you get my point. For a serious
student of the market, the handwriting is on the wall. Given
the fact that the U.S. doesn't produce much anymore, taking into
consideration that housing, consumption, and banking have all
apparently topped, and given the indisputable fact that the United
States is literally swimming in debt, there can only be one outcome...
a serious, gut-wrenching economic readjustment. And here's the
kicker, the very thing that's going to make it even worse than
most people could imagine is complacency:
The preceding chart represents
the Bullish Percentage Index and is notorious in
that it has not dipped below the 50% level for many, many months.
The percentage of Bulls has held above 50%, and 60% in most cases,
since the early part of 2004. That's quite unusual and shows
a smugness among investors that, given all the other factors
mentioned previously, should be the final nail in the coffin.
A true market bottom will see the Bullish Percent Index at 25%,
not 60%.
What can one expect? Well,
I'm sure you noticed that all of the indexes were quite oversold
so I wouldn't be surprised to see some sort of minor rally here.
The S & P broke down from 1,206 and it would seem logical
to see a counter trend rally back to the 1,206 - 1,210 level,
thereby alleviating a bit of the oversold condition. That doesn't
mean it will happen, but it is the best possibility in my opinion.
In any event, once the slide begins in earnest, I expect a move
to 9,850 in short order, followed by a brief respite, and then
a fast move down to the 9,450 level. I would be surprised if
we didn't get a reasonable rally at 9,450 as the market will
be extremely oversold by then. This is probably an attempt to
fine tune the market way too much, and it's also unnecessary.
What's important to take away from all of this is the market
is going to head down and it will head down hard. The Bear Market
rally is over as is the prolonged distribution phase that we've
been experiencing. The only question that remains to be answered
is just what can the average investor do to protect himself?
In all honesty, the average
investor shouldn't be anywhere near this market. He takes neither
the time nor expends the energy required to understand what is
going on around him. He's use to being spoon fed tips by a Wall
Street that had the benefit of an eighteen year Bull Market which
floated all boats. Now the tide has changed and the average man
on the street would be best off being in cash, but Wall Street
will never admit to that. For the sophisticated investor who
actually studies the market, there are alternatives and none
of them involve short term trades. As most of my clients know,
I don't profess to know how to day-trade, so I make only long
term investments and here's what I recommend.
First and foremost on my list
of things to do would be to take a position in gold and
silver. This includes the purchase of physical gold and
silver, as well as futures contracts, and selected mining shares.
The initial position should be done with out trying to "time"
your entry. Just take a position and live with it. It's a Bull
Market and if you bought gold at $480.00 or $440.00, it really
won't matter when gold is at US $1,600/ounce in three or four
years Do not attempt to time the tops and bottoms; you'll only
succeed in loosing your position and paying up to get back in.
What I'm suggesting is the easiest thing to say and the hardest
course of action to follow: get on the Bull's back and stay
on until he's drawn his last breadth! I assure you that the
present Bull Market in gold will last well toward the end of
our present decade, and maybe even longer. We are in the early
stages of the second phase of a Bull Market, a second phase that
will be characterized by the J. P. Morgan's of the world recommending
gold to the general public. It should be noted that the second
phase tends to be the longest in a Bull Market.
As the preceding chart indicates,
gold is doing quite well at the moment, breaking out from resistance
at $50.00 and Friday it closed at $477.70 basis the December
2005 contract, a new closing high for this Bull Market and an
eighteen year high. I must mention that gold is also quite over
bought and due for a correction. Normally, gold works off an
over bought condition by correction to the downside, but this
rally has been different. We correct by moving sideways, a real
sign of strength! My original projection was for a top of 489.00
by the end of the year and I believe that will be attained and
we may even see a marginal break of 500.00. Anything more than
a marginal break above 519.00 would be extremely bullish, and
ominous, at this point in time. If we were to close and stay
above 519.00 for more than three consecutive days, it would be
a clear sign that a financial meltdown of major proportions is
about to occur. A proper analogy would be that of the parakeet
dying in the mine shaft. No one wants to see that just to make
a few dollars.
Silver as depicted below, has
also broken out nicely to the upside and is a buy for the first
time in a long time:
...in what has been a tough
market to trade in. After its fall from grace, silver has been
quietly accumulated for months, range bound between 675.00 and
750.00. That's over now and I am looking for a test of 800.00
at the very least and suspect that 675.00 silver will now become
a thing of the past. This is the first time I've recommended
a buy and hold strategy with silver and it will require patience.
Volatility will be a real issue here so fasten your seatbelts.
As far as the purchase of physical gold and silver is concerned,
keep it simple. Buy the South African Kugerand and the Canadian
Peace Eagle as they are both recognized around the world and
will eventually serve as "money". Avoid ingots and
bars as they will often have to be assayed before you can liquidate
them, a costly process, and you won't know enough to do it when
you buy them. With respect to futures contracts, buy December
2007 and 2008 futures contracts and be sure to leave a lot of
margin. I leave 65% and I only add on when I see a correction
of 10% or more. I began this process in March 2004 with a small
gold fund I manage, I have not liquidated one single contract
to date, and the results will surprise you. I should warn you
that sleepless nights come with the investment. With respect
to silver, buy the December 2006 futures contract without any
attempt to time it and sit tight.
With respect to mining companies,
I am just as selective when it comes to purchasing shares. Junior
companies are out and Blue Chips are in. I currently own the
following gold producers: Buenaventura (BVN), Goldcorp
(GG), Glamis (GLG), Newmont (NEM), and Royal Gold (RGLD).
I also own one silver producer, Coeur D'Alene (CDE).
That's it! I chose these companies for two reasons: these were
the best balance sheets I could find (in 2003) and they offer
the best dividend potential in 2007. Dividends, you all know
what that is don't you? That's when the company send you
a check every couple of months! It's a very strange novel concept
but I guarantee you'll like it if you'll only give it a chance.
GG has paid ten straight monthly dividends, and that's
on top of a share price that rallied from a bottom of $12.50
in early June to Friday's close of $20.09 as the following chart
demonstrates:
That's a 60% share price increase
and a monthly check to go along with it.1
Try to find that on the NASDAQ! Finally, these Blue Chip companies
will also hold up the best in the face of any real Dow meltdown
and, given everything that I've said above, that has to be a
consideration. Over the long run, these stocks will be great
performers. A word to the wise though; I buy all of these on
the Toronto Exchange, in Canadian dollars, thereby eliminating
my exposure to the U.S. dollar.
What else do I recommend? Well,
I made an investment in oil futures a month ago and recently
took profits. I now believe that oil is in a Bull market and
I will look it take a very long term position in oil futures
and oil related stocks in the near future. Last week, oil violated
a trend line that's held in place for months and that indicates
that we'll probably have a correction that could take us to the
US $55.00 range.
I would be very surprised to
see oil much lower, even with the economic slowdown that I've
been projecting. The increase in demand coming from India and
China, along with dwindling supplies and refining constraints,
will serve to drive the price of oil much higher than most could
even imagine.
That leaves us with the U.S.
dollar and the bond market. The latter
is as clear as mud and I really don't have anything intelligent
to say. For months I was convinced that a slowing economy would
drive bond prices up, and that's just what happened. Until recently
that is. A look at the following chart shows a change:
Since I am at a loss to explain
why, I took my profits and will stand aside. It's possible that
this is nothing more than a correction. It's also possible that
rising interest rates and the possibility of stagflation are
giving the bond crew something to chew on. If bond prices are
truly headed down, we'll see resistance at the 200-d.m.a. hold.
If this is nothing more than a correction, we'll see bond prices
rise back above the 200-d.m.a. before too long. I don't really
know at this juncture, so I'll just wait and let the market tell
me.
The U.S. dollar is a different
story. I am absolutely convinced that the dollar is headed down
over the long run and that we are currently experiencing a secondary
Bear Market Rally. Nothing more and nothing less! That rally
shouldn't carry us much higher than 92.00 in the following U.S.
Dollar Index:
There is some resistance at
90.56 and that has served to stop the Bear Market rally so far,
but I suspect a test of 92.00 is still in the cards. I have been
and continue to be long the Swiss Franc for three
years and I will remain long the Swiss Franc for several more
years. Why? Two reasons really: everybody needs to put currency
in their pocket and the Swiss Franc is my choice, and, I look
at it as an insurance policy. If something goes really wrong
in the U.S., the Franc will rally. And if something goes really
wrong in Europe, again the Franc will rally. It's the best of
both possible worlds.
Getting back to the U.S. dollar,
the best I can say is that it's in a trading range (86.00 to
90.50) and could remain that way for several more weeks. What
caused the dollar rally just when everyone was predicting its
demise? Again, two things: too many people were short, and, rising
interest rates coupled with a slowing economy led to an increase
in the demand for dollars. Deflation could and would spark a
prolonged dollar Bear Market rally to even higher levels than
I anticipate, i.e., the 96.00 level, but that remains to be seen.
Right now, I am looking for a top to short and I expect that
top to come in around 92.00. Short term demand for dollars will
outweigh the increased supply being offered by Asia and Russia
as they slowly opt out of the dollar as a reserve currency. Over
the long run though, I believe the dollar will disappear and
gold will become the only true money.
If you have any questions or
would like to make any comments, feel free to e-mail me at ebo@lascoreport.com and
I will respond as soon as possible.
PS
I have attached the following monthly charts of gold and the
DJIA and the former gives a clear picture of the entire movement
in gold since the Bull Market began with the first leg of the
"double bottom" back in late 1999. Even if you don't
believe in gold, the chart is impressive to say the least.
Likewise, the following monthly
chart of the DJIA is quite telling. Notice the blue trend line
and the seven failed attempts to penetrate that line. Seven is
a lot of failed attempts:
1 Likewise, BVN is up 50%,
GLG is up 60%, NEM (an S & P 500 company) is up 35%, and
RGLD is up 51%. CDE, my only silver company, is also up 55% for
the same period.
Enrico Orlandini
For those of
you interested in receiving information on the funds we manage,
please feel free to e-mail us at ebo@dtanalysis.com and we will respond
as soon as possible.
email: ebo@dtanalysis.com
website: www.dtanalysis.com
Orlandini Archives
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