Bob Hoye on Speculative Peak

==== September 27, 2006 Gold Exploration: The Next Leg of the Bull Market? by Bob Hoye The following was sent to subscribers of Institutional Advisors on September 19, 2006. Overview: Gold's real price has long been the key to profitability of mining, as well as to cyclical opportunities, often opposite to the direction of the general stock market. Historically, the CPI in the senior economy has provided the best determination of gold's real price, but the calculation of the U.S. CPI has become suspect. A better alternative has been our gold/commodities index, which is calculated daily. This is a sound proxy of gold's real price, that also represents purchasing power or mining profitability. This has suffered a significant decline since January and this has been accompanied by a relentless decline in many gold exploration stocks. This study concludes that these, as well as the real price, are close to setting a cyclical bottom in anticipation of a lengthy new bull market. Within this, gold stocks should outperform the bullion price as the exploration sector becomes the equivalent of the junior tech stocks in the mid- 1990s. The role of the latter was to fund a great innovation in technology and business. The role of gold's real price and the exploration sector is to meet an extraordinary increase in investment demand for gold that typically follows an era of remarkable credit expansion. Historical: Another term for gold's real price is money and, typically, during a great boom in tangible and financial assets (think industrial commodities and real estate, as well as stocks and corporate bonds), money, or gold's real price, loses purchasing power. The very big asset inflations include the "Roaring Twenties", which ended so dramatically in 1929. Other examples concluded in 1873 and 1825, with the earliest example being the 1720 South Sea Bubble. In all such examples, gold's real price declined to a significant low as speculators scorned cash and leveraged up on the hot stories about stocks, bonds, commodities, and real estate. Once the era of asset inflation exhausted itself, typically gold's real price increased for some twenty years. One explanation is that during the leveraged manias, reckless borrowing and equally reckless lending expands credit to an unsustainable level. In all cases, once the speculative boom breaks it has been followed by a sudden and pervasive loss of liquidity. Under similar devastating conditions, legions of intellectuals and experimental economists have recommended that some agency apply more credit. Interestingly, since as early as 1622 severe liquidity vacuums regularly inspire such impractical visions, but typically Mother Nature finds it more practical to replenish global banking liquidity by increasing the supply of gold. This is prompted by increasing investment demand, which in all cases has been anticipated by changes in the credit markets. Other than the exhaustion of speculative momentum, key determinants have been a turn to widening of credit spreads as market forces begin to ration the availability of credit for speculation. This happens with or without the defiance or cooperation of policymakers. While the action in stocks usually commands most of the attention in a financial mania, speculative excesses also build up in the credit markets. The above paragraph reviews the spreads between high and low grade credits. Another aspect is the mania to borrow short term and lend out longer term. Popularly called "the carry", this time around ostensibly extremely low deposit rates in Japan were ambitiously used to obtain higher rates elsewhere. Typically, the height of a mania is accompanied by speculative demand for credit driving short-dated rates up relative to long-dated bonds. Just as typically, the end of speculation is marked by the reversal of the yield curve to steepening. On this, treasury bill rates decline in yield as long rates increase. Typically, this has occurred in the Fall of the year that the mania climaxed. This was the case in 2000, 1929, and 1873, just to list the most recent. Also, in each of these, gold's real price turned up and initiated a lengthy bull market for the gold sector. Within this, the exploration sector provided outstanding performance. Of course, the usual 3 to 5-year business cycle prevailed and the gold sector action was essentially contra-cyclical. Near-Term: It is important to emphasize gold's real price. During its bear market into 1929, gold stocks underperformed the stock market as earnings declined due to rising costs. For example, Homestake's earnings declined from .73 to .52 per share in 1929 with no change in the nominal price, which was fixed at 20.67 per ounce. Then on the post-bubble contraction, earnings jumped from .74 to 1.24 in 1932 with no change in gold's nominal price. (This did not change until later in 1933.) The improvement was due to the increase in gold's price relative to the costs of mining. On this, Homestake's stock soared from 8 ~ in late 1929 to 20 ¼ in December, 1932. 1929 TO 1932 STOCK EARNINGS DIVIDENDS GOLD + 149% + 138% + 52% Unchanged This was indicative of the industry and, although junior stock quotations are not readily available, the exploration sector soared. There is a reliable report about a young mining broker in Montreal having such a good year in 1933 that one of his larger accounts gave him a new Ford Roadster. Of course, the driving force (no pun intended) was that gold's real price was improving and in 1933 the FDR administration found academic reasons to join the fun and raised the nominal price from 20.67 to 35. Canada's premier producer was Dome Mines and, on the full move, the stock soared from 3 in 1929 to 34 ~ . Earnings soared from .05 to 2.11 and from 1934 until 1941 the dividend was 2.00, which was a handsome return on the 3-dollar low. The discovery that led to the Dome mine was made in 1909, and it is now the longest continuously operating gold mine in North America. Current Conditions: Mark Twain defined a mine as a "hole in the ground with a liar standing next to it ". Be that as it may, but every mine started as a discovery which, in most cases, was made through prospecting or exploration. The biggest mining companies in the world have been the result. As Mark Twain quipped, mining promotion has had a colourful history, but this began to change in the early 1980s when the real price of base and precious metals began a lengthy decline. With accountants facing the daunting prospect of shrinking cash flow, big mining companies reduced their exploration staff. As an example, Placer had one of the great mine-finding teams in history and key members, in being forced out, became successful entrepreneurs in mining exploration. Now big companies are facing the daunting prospect of inadequate reserves. In the "old" days, a prospector would take a showing to a promoter, who would engage a consulting geologist to write up a report. This would be used to promote the stock and raise some money. The relentless energy of promoters required a continuous stream of "stories" and, given probability, eventually discoveries were made. Over the past twenty years or so, highly experienced professionals in exploration have been initiating projects and raising capital. The result is an unusual combination of a high degree of motivation with a methodical approach to business and exploration. Success so far has made the Toronto stock market the leading exchange for mine finance. And, as we've recently seen, from the top of the hierarchy from major to intermediate sized mining companies have been acquiring gold reserves through acquisition or merger. Wrap: Of the attached charts, the final one shows the behaviour of gold's deflated price through all six of the great financial bubbles back to the first one in 1720. Gold's real price declined to a significant low with the mania and then recovered during the initial contraction. Typically, gold's subsequent recovery has been lengthy, with setbacks occurring within the usual 4 to 5 year business cycle. The other charts review this pattern through the bubble that climaxed in 1Q 2000 and the boom that seems to be peaking in 2006. With these, it is evident that the gold exploration sector moves more directly with changes in gold's real price rather than with the nominal price. Very few researchers have been using gold's real price so the link from this to market participants remains curious, but it works. The next step to appreciating the opportunities present in the gold exploration sector is that the real price has been in a steady decline since January, 2006. This has depressed the stocks of some well positioned exploration companies. As outlined above, this appears to be close to a cyclical low for our gold/commodities index and conditions in the credit markets are changing in a manner that typically anticipates a cyclical increase in the investment demand. This could inspire all aspects of the gold mining industry. For investors who can handle today's relative illiquidity in the exploration sector, the risk/reward opportunities are outstanding. GOLD STOCKS AND THE REAL PRICE - 2000 In the Fall of 2000, the HUI turned up with our gold/commodities index (G/C). Gold's nominal price didn't turn up until May, 2001. By that "breakout" the HUI was up 60%. Note how the G/C index rose as the dollar was strengthening. At times then, the real price is more important than the course of the dollar and the nominal price. GOLD STOCKS AND THE REAL PRICE - 2006 Exploration stocks have conformed to the slump in the G/C since January. The real price is attempting to bottom. This is accompanied by changes in the credit markets that typically anticipate a significant increase in the investment demand for gold. Deflated Gold Prices and Financial Bubbles The charts below record the behaviour of gold's real price through all six of the great financial bubbles in history. Data are in senior currency terms. Analysis of gold's real price has avoided the problems deriving from a sole focus upon the nominal price and dollar depreciation. Since late 2003, mining costs have been rising relative to gold's price. This adversity seems close to ending. Analyzing gold's real price and its consistent behaviour during the remarkable financial volatility of our times has been an important adjunct to orthodox determinations about the character and timing of the Indian Monsoon, gossip in the Middle East "Souks" and the schemes of central bankers, as well as estimates of jewelry consumption, which typically increases during a bubble and slumps with the consequent contraction.   Bob Hoye Institutional Advisors 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 securitys 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. « BullionVault.com -- Buy gold online - quickly, safely and at low prices » « Opinions expressed at SafeHaven are those of the individual authors and do not necessarily represent the opinion of SafeHaven or its management. Articles and Talk Back are available via RSS/XML. Please visit RSSHelp for instructions. » === September 12, 2006 Pivotal Events -- Full Version by Bob Hoye If you read the Pivotal Events excerpt on September 9, click here to read the balance of Pivotal Events. Signs Of The Times: "The Fed, which last month left interest rates unchanged for the first time in two years, is the main source of the current [stock market] optimism." - WSJ, September 5, 2006 This goes along with the glowing conclusions by David Wolf, an economist and strategist with Merrill Lynch. When the governor of the Bank of Canada did not change the administered rate earlier in August, the Financial Post headlined "Standing Pat Was the Right Call". Strategist Wolf raved that the governor's non-move was "Looking Like a Genius". Well, the way it worked in 2000 was that during the summer, as short rates were still rising, the consensus was very worried about the next increase in administered rates. As we wrote then, throughout most of financial history rising rates mean that the boom is still on. The time to worry is when market rates of interest start down. Along with the usually concomitant turn to steepening of the yield curve, this indicates that demand for funds to speculate with is diminishing. After all, inversion has always been driven by the urge to speculate. So the consensus now is that the end of the Fed's or any lesser central bank's rate hikes is a mark of genius and is good for the stock market. This is nonsense and suggests that when an economist is elevated to the head of a central bank it gives new meaning to the concept of artificial intelligence. First of all, at the climax of the biggest bubbles going back only to 1873, changes in administered rates by the senior central bank have followed the change in short-dated market rates of interest - usually by a few months. For example, treasury bill rates turned down in September, 2000 and the Fed dropped the administered rate in the first week of 2001. In 1929, short rates started down in June, 1929 and the Fed raised the administered rate to 6% in early August. Then that extraordinary decline started. The other irony is that academics ever since have argued that the hike caused the 1929 crash and the depression. In January, 2001 when the Nasdaq had lost over $3 trillion in market cap, op-ed pieces by different writers laid the blame on the Fed's last rate hike. So this is how the behaviour pattern works. Fully astride the bull market, the consensus in real time celebrates the end of administered rate increases as a plus. Then, when the market is down substantially, the consensus then lays the blame on the last rate hike. Chagrin always seeks a scapegoat. On this go around, the Fed is lauded for the last of 17 rate hikes of a ¼ point each and, as quoted above, the end of this has prompted "optimism" or, in the case of the Bank of Canada's non-move, "genius". The next level of irony is that on the biggest booms the last rate hike has been followed by a severe contraction and the most relentless declines in short market rates, with the administered rate in close pursuit. The Most Substantial Interest Rate Plunges In History  LAST HIKE RATE STOCK MARKET LOW RATE STOCK MARKET LOW  July, 2000 6% 5133 1.12% 1109  August, 1929 6% 381 1.5% 42  November, 1873 9% 441 2% 157 As the stock market began to slide in September, 2000, some within the status quo crowd discovered that they had been had. The adamant faction found encouragement with the immediately circulated notion that the Fed would lower interest rates and that would reignite the boom. James K. Glassman was using the WSJ's op-ed pages to promote his personal revelations that the Dow would soar to 35,000 and, in December of that fateful year, we concluded that "Market forces will permit the Fed to lower administered rates. That's frequently until the business and stock market contraction ends." Of course, the theory was that a bubble was an event created and managed by policymakers and that it could readily be turned back on by a brilliantly timed rate cut. Throughout all of recorded financial history, short-dated market rates of interest have increased during a boom and plunged during the consequent contraction. The senior central bank was able to materially change the administered rate in 1825 and the record is that at cyclical turns (either up or down), it lags the reversal in market rates of interest. Beyond being merely ironical, the popular theory is a profound blunder. The first level is the unsupportable assumption that the senior central bank can and does make the major changes in interest rate direction - no, it follows. The second level of folly can't even get the direction of major events right. Booms have never been reignited by declining rates, but contractions have always been accompanied by declining short rates for treasury bills, or equivalent, in the senior currency. An explanation of how personal revelations about what markets ought to do has become official dogma and could be the subject of an essay entitled "Mother Nature Trumps Keynesian Whims Every Time". In the meantime, 3-month dealer commercial paper rates reach a high of 5.44% on July 25 as the T-Bill rate reached 5.12%. So far, the lows have been this week's 5.29% and 4.96% respectively. More importantly, treasury curve inversion (10s to 2s) reached -10 bps on August 28 and has steepened to 0 bps. At previous cyclical peaks, and although only modest, this change has indicated that the contraction was inevitable. Stock Market: Since early in the year, our theme has been that market forces were setting up a cyclical peak for the stock market. One indicator was that the lesser exchanges had blown out in November and the collapse always fed into the senior exchange. The representative Dubai stock market crashed in February. In the meantime, New York rallied up to what soon appeared as a cyclical peak in early May. The cyclical aspect was indicated by our long-time work on the gold/silver ratio. In March, it looked like the precious metals would zoom to a climax, in which case the change in the ratio from going down to up would likely signal the top of that mania by three weeks and, in turn, this would soon be followed by the peak in base metal speculation. The latter is usually integral to the peak in the stock market as "every bull market has a copper roof". As it turned out, the gold/silver ratio reversed on April 19, which indicated that the top would be in the week centred upon May 10. The key highs are tabled: MAY 5 MAY 8 MAY 9 MAY 10 MAY 11 S&P Nasdaq London Frankfurt Mexico Brazil DJIA Base Metals Gold Silver The action since (nickel is exceptional) has the appearance of a cyclical top, with some of the key highs being tested now. Lately the stock market is fitting a ChartWorks pattern that had to reach a certain upside momentum by August 11. This was a "make or break" requirement, so it didn't "make" it. (Editor's Note: Following is the portion of Pivotal Events not published in the Sept 9 excerpt.) The next stage of the pattern would require the DJIA reaching the upper standard deviation band in late August - early September. This was accomplished on September 1 and September 5, accompanied by the RSI(14) reaching an overbought reading. On this pattern, the initial break measures to around 11,060, with 10,800 possible. Confirmation that the top would likely be a cyclical peak was that our proprietary "Peak Momentum Indicator" registered on May 6. The last such reading anticipated the crash of LTCM and the bank stocks in 1998. (For more on LTCM, just Google it. It lost $4.6 billion in less than 4 months.) This indicator measures speculation and it doesn't matter what it is in. It led the 1974 peak in commodities by 3 months as well as the peak in gold, silver, and crude oil in 1980. By way of summary, the action in stocks, commodities, and residential real estate is indicative of a cyclical peak. The developing break in the stock market will provide more immediate confirmation. Sector Comment: The behaviour of the big U.S. banks and financials this summer replicated the dangerous pattern of the summer of 1998. At the time, we described the pattern as the "Widows and Orphans Short" and this is the description now. On that calamity, Citigroup crashed 60% and leap puts, which were 35 to 45 cents in the summer, reached $14.50 in early October. On the near term, banks are within the overall market rebound likely to roll over this week. As noted last week, the mortgage sector, as represented by LEND, NEW, and WM, have failed. Continue to sell the sector aggressively. INTEREST RATES The Long Bond: Two weeks ago, the advice was to increase the selling of long-dated lower-grade bonds. This was repeated last week with the following added - "Given the measurable technical excesses, it seems appropriate to start selling high-grade long-dated corporates." This was based upon where we are in the credit cycle as well as near-term technical excesses being reached. The LQD (ETF on corps) was close to a level that had ended rallies in the past. We thought the rally would run into this week, but the high was set on Friday, from which it has slipped ½ a point. This could be partially due to the rally in base metals that began last week. So let's look to continue selling and consider that Wednesday's slide in New York pricing of metals, energy, and grains will continue. This lifted bonds late in the afternoon and, with seasonals favourable over the near term, the high side of choppy action should be sold. It is becoming more apparent that the rapid loss of liquidity we have been discussing is about to happen. This could feed into long treasuries so investors could continue to get defensive. Yield Curve: Last week's advice was to start putting on the "steepeners". Developments this week suggest that curve steepening is very much on and will continue in its usual cyclically relentless style. The initial inversion maxed in late February at -17 bps in May. The next inversion ran to -10 bps on August 28. At flat (0 bps) yesterday, the reversal is developing. The inversion to last week is a big test of the earlier extreme and moving through +17 bps will lock in the trend. Given prevailing financial volatility, this could be choppy, but it has a high probability of happening. The Dollar Index was expected to resume the uptrend as stocks and commodities roll over this week. The intra-day low this week has been 84.7 and rising above 85.3 will be constructive in moving the chart out of a month-long wedge (85.5 today). Above 86 will resume the uptrend. Fundamentals for this would include a global liquidity problem that could disrupt the Fed's chronic compulsion to depreciate the dollar. With this, the Canadian dollar could consolidate the recent gains. COMMENTS FOR METAL AND ENERGY PRODUCERS Energy Prices: As it was developing in the Spring, we identified the action in base metals as a cyclical peak. This was also expected for energy prices as well, but closer to the usual seasonal high in late September - early October. This would, of course, be interrupted by weakness into late June. However, the usual subsequent seasonal strength turned into a spike by the hot weather and hurricane "mania" that drove crude's price to 79 in mid-July. This drove natgas to 8.10. The August 3 edition of Pivotal Events noted that the excess was a "weather" market from which prices would correct as the heat wave eased. The August 12 edition of ChartWorks noted that the August rally was not exceeding the July highs and that more of a correction is possible. The August 24 edition of Pivotal Events concluded that it was appropriate to be underweighted the sector. There has been very little by way of rallies to accomplish this. However, crude is now approaching near-term oversold and, as noted last week, when a seasonal move has been, in this case, preempted by a mania that comes too early the price could get in line by rising to set the reversal. The usual high is in late September - early October. We would not try a long trade, but would be a seller into whatever rally is offered. Base Metal Prices were likely to rally with the stock market into this week. Our index (less nickel) rallied from the last low of 650 on August 29 to 707 today. Up 8.8% in only 6 trading days is nice, but this compares to the rebound to 706 on July 12. That was the test of the 779 high on May 11. Senior companies such as BHP, Rio Tinto, and now PD have stalled out at rebounds below the highs achieved in May. The Toronto index of mining stocks (SPTMN) soared on the merger-takeover hoopla until reaching 580 on August 21. Following the correction, the rebound has made it to 576, accompanied by some negative divergences. One way of looking at this is that the senior companies are confirming that the May high for base metals (not including nickel) was the cyclical peak. The action in the index of mining stocks was very much propelled by the mergers and the stall-out suggests that the takeover mania is fully discounted. This was tied to the speculation raging in nickel, which drove the price to 34700 on August 24 when some wag observed that inventories in LME warehouses were down to only 6 hours of supply. To put this in perspective, often when inventories get down to "only" 6 weeks of supply prices start to climb. This is quite the opposite to the huge inventory figures being relentlessly reported in the 1980s slump. If memory serves, it was Simon Hunt who observed that the aluminum inventory was so big that it was the other manmade thing that could be seen from outer space. Times change and nickel, which was the last gasper in the play, dropped 9.4% to 31450 and then bounced to 32245 on Tuesday. At 29550 yesterday, the initial low has been taken out. It is likely that all base metal prices will plunge with the stock market and the classic indicator of a liquidity crisis has been a plunge in silver relative to gold. Golds: Last week, we noted that gold's real price was at a cyclical low. Actually, at 180 it's a little lower than the 183 reached in October, 2000, from which the cyclical recovery ran to 255 in mid-2003. The other point was that credit markets are beginning a change that in the past has prompted a massive increase in investment demand. On the plus side for gold, the treasury yield curve continues its modest steepening trend. This has been accompanied by some widening of the spread between dealer commercial paper and treasury bill rates. This has yet to feed into longer maturities. Another plus for gold is the noticeable weakening of the stock market. This will be enhanced as base metal prices fail and today's slip in New York copper could be the start. So far, the real price, as represented by our gold/commodities index, has jumped from 180 on August 28 to yesterday's 198. This indicator of gold mining prosperity could come close to doubling over the next few years. Last week's advice was "accumulation of gold and exploration stocks can be resumed, with senior stocks being accumulated on weakness". Opportunity would likely occur as the latter decline with the general stock markets.   THUR FRI TUES WED THUR NOON AUG./SEPTEMBER 31 1 5 6 7   High-Yield Spread 339 341 334 331 -- Treasury Curve - 5 - 4 0 - 1 - 2 Base Metal Prices 663 666 691 697 707 Dollar Index 85 84.9 85 85.1 85.5 Gold 625.9 624.4 638.5 633.5 617 Gold/Commodities 187 186 192 198 --   Bob Hoye Institutional Advisors 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 securitys 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. « BullionVault.com -- Buy gold online - quickly, safely and at low prices » « Opinions expressed at SafeHaven are those of the individual authors and do not necessarily represent the opinion of SafeHaven or its management. Articles and Talk Back are available via RSS/XML. Please visit RSSHelp for instructions. » ==== August 25, 2006 Pivotal Events by Bob Hoye EXTRACT FROM PUBLICATION DATED THURSDAY, AUGUST 24, 2006 Signs Of The Times: "I've never seen a soft landing." CEO, Countrywide Financial, which is the biggest home mortgage lender in the U.S. WSJ, Aug. 8 "Recent growth in house prices is not due to speculation in the housing market, such as occurs in bubbles. We argue that our findings point toward the high prices being driven by fundamentals." "Housing Bubble Fears Unfounded" Chicago Federal Reserve - NP, Aug. 23 "The pain that homeowners and homebuilders are now feeling follows a raging national house party in which prices had more than doubled in parts of the country between 2000 and 2005." "'Hard Landing' on the Coasts Jolts those Who Must Sell" WSJ, Aug. 23 Stock Market: As the saying goes "mutton dressed up as lamb". Of course, the imagery is of a former belle of the ball dressing as an ingénue and we take August's action as a sprightly rally within a developing bear market. Actually the "vigour" was mainly shown as an outstanding shift from selling to buying pressures, as calculated by Lowry's. On profitability, the Nasdaq almost made 8% and the senior indexes are approaching overbought territory. Yesterday's slump suggests that the old dame is presenting only the image of youth. Our advice has been to sell the rallies. Sector Comment: Banks and financials have participated in the summer stock rally, with the BKX rising from 105 in mid-July to 113.3 on August 7. This, along with representative bank stocks (JPM and BAC) reaching an RSI of 70+, successfully completed the "Widows and Orphans" sell pattern. As with the last such pattern in 1998, this occurred 13 weeks after the "alert" signal from our proprietary Bank Trading Guide. More recently, the Guide has rallied from 179 on July 31 to 197 on August 16. This seems "overbought" at nowhere near the high of 229 with the "alert" set in April. The next slide in the Guide will anticipate a plunge in global bank stocks. Following the similar topping pattern in 1998, the BKX plunged 42% as, for example, Citigroup crashed 60%. The advice has been that investors and traders should be aggressive sellers of the sector. In this regard, it is interesting that our model has given a "sell" signal similar to 1998 and valuations are the highest since that fateful year. For example, in Toronto banks and financials carry the largest weighting at 30.5%. Within this, the largest bank (RY) is commanding a 3.33 price to book ratio, which compares to 2.98 in 1998. The price to cash flow registers a lofty 13, which compares to 11 in 1998. The comparisons are daunting. We have been mentioning that takeovers on the base metal mining sector mainly happen at cyclical highs for metal prices. While the senior stocks are nowhere near their highs of May, the takeover action has driven the index (STPMN) to a double high in August. This is against some technical negative divergence. Of course, this index of Toronto stocks is being propelled by the takeover mania and a big telltale is that Teck Cominco could not raise the funds to "win" in the nickelodeon game. They should be so fortunate. In the 1960s and 1970s, Teck was built by putting properties into production when metal prices were weak when, on the accounting side - the "numbers" are poor. Over the same time, Cominco, for example, was buying Bethlehem Copper out of the market. In checking insider reports then, this researcher noted that the tendency was to buy at highs for the stock and metal prices or, in accounting terms, when the numbers were good. Naturally, Teck's discipline was sound and eventually took over Cominco when it had become weak through orthodox but unsuccessful policy. Regrettably, it seems that Teck Cominco lost its original discipline and joined the orthodox crowd in attempting the nickel acquisition when the numbers were good. By not providing a financing, the market has blessed an errant Teck. The August 3 advice was to continue lightening up in the sector. Investors and traders can begin to sell more aggressively.   Bob Hoye Institutional Advisors 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 securitys 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. « BullionVault.com -- Buy gold online - quickly, safely and at low prices » « Opinions expressed at SafeHaven are those of the individual authors and do not necessarily represent the opinion of SafeHaven or its management. Articles and Talk Back are available via RSS/XML. Please visit RSSHelp for instructions. » === Beware booming asset markets! The upside potential for equities appears to be very limited despite the likelihood that the Fed will not increase the Fed fund rate at its August meeting. There is much resistance for the S&P 500 between 1290 and 1320 and technical conditions are not supportive of a strong and sustainable rally. Wednesday, August 23 - 2006 I also believe that investors will increasingly focus on corporate earnings, which are likely to disappoint, than on monetary policies. For investors who must own equities, I would, as indicated in the past, be positioned in relatively depressed big market capitalization stocks, such as pharmaceutical shares including Merck (MRK) Schering Plough (SGP), Pfizer (PFE), Bristol-Myers (BMY), and Johnson & Johnson (JNJ). Equally, at this stage of the cycle, I would feel more comfortable owning Citigroup, a stock that has done nothing for the last few years, than brokerage companies whose fortunes are about to change. But, for now, I maintain the view, which I expressed last month. Two-year US Treasury notes yielding close to 5% (yields have come down 35 basis points over the last two month) offer a valid alternative to asset markets for the next three months or so. Since 1981, the long-term bull market in brokerage stocks has been accompanied by a secular decline in interest rates. But, lately, interest rates have been rising, and the only way they could resume their downtrend would be by very tight monetary policies, which would cool down the current synchronized global economic boom. In fact, the 17th baby-step increase in the Fed fund rate to 5.25% on June 29, and the market reaction on June 29 and 30, perfectly illustrates the dilemma the Fed is facing. Dollar decline On the 29th, admittedly from a short-term extremely oversold level, all asset markets soared. (Even bonds staged a minor rebound.) However, the dollar fell on June 29 and 30 against gold and against the Swiss Franc, with the result that by the close on June 30, expressed in Swiss Francs and gold, the S&P 500 hadn't risen but, instead, had declined! A similar situation occurred in the last few days of July. At the time, stocks and even bonds rose, but the dollar declined. Now, the financial sector bulls will argue that a weakening economy will benefit the financial sector, but I look at it differently. I think brokerage stocks could decline by as much as the homebuilders did over the last 12 months. Please note that homebuilding stocks are down more than the housing index because the housing index also includes other building related companies. Brokerage stocks seem to have completed a similar decline as homebuilders did between July and October 2005. But why should brokers decline much more? On the first sign of economic weakness, the Fed will cut again interest rates, which will in the long term be even more inflationary. The point is that while the Fed has increased short-term interest rates since June 2004 and again on June 29, no real tightening has yet occurred, because if money was really tight, the dollar would have rallied and asset markets would have declined much more. No way out! Now, either the Fed allows debt growth to accelerate further in order to sustain growth in consumption (economic growth), which will lead over time to far higher inflation and interest rates, as well as stagflation, or the Fed actually begins to tighten in order to contain debt growth, which will lead, at best, to only a modest economic slowdown or at worst to a severe recession. But, it should be clear that neither option is particularly favorable for the over-leveraged financial sector. A year ago, we turned very negative about the homebuilding sector. We noted at the time that despite positive earnings surprises and buoyant conditions in the housing industry, the shares of homebuilders had begun to decline. (They are now down 45% from their peak.) The same seems to have happened recently with brokerage stocks. Despite very solid earnings gains in the first quarter, the stocks of brokers and investment banks have begun to weaken. Lastly, the flurry of high takeover offers among listed stock exchanges reminds me of the numerous takeovers we saw in the TMT sector prior to its March 2000 peak. === August 08, 2006 Banks and Financials: "A Widows and Orphans Short" by Bob Hoye We are confident of the reliability of our research. A similar approach used in the summer of 1998 merited the same title and, while it applied to global banks, Citigroup, as an example, plunged 60% from $29.58 that fateful July to $11.58 on October 8. 1998 In the first page of charts, the BKX index is used and key to the topping process was the spike and failure of our proprietary Bank Trading Guide in late April, 1998 (bottom clip). This provided the alert to a potential reversal. Marked as (1), it was accompanied by a momentum high as measured by the RSI, also marked (1). Then 13 weeks later, momentum surged to a lower peak (2), which was a few days earlier than the secondary peak on the Guide, also marked (2). Both indicators provided negative divergence against the higher high for the BKX set on July 17, 1998. Amidst discoveries of reckless trading by LTCM, the hedge-fund giant, bank stocks around the world were hit and the 42% crash in the BKX provides the overall measure. Of significance is that the two key highs on the index, as well as on the indicators, were 13 weeks apart and that the crash was accomplished in 12 weeks. Note how the RSI anticipated the bottom in early October. The Bank Trading Guide leads at significant tops and is roughly coincidental at important bottoms. WIDOWS AND ORPHANS SELL : 1998 Vertical bars emphasize the 13 weeks from primary to secondary high. 2006 PRIMARY HIGH This time around, the Bank Trading Guide gave the alert signal in early May, which was accompanied by the high in the RSI and the primary high for JP Morgan. JPM is used rather than the BKX because Citigroup's poor performance recently is constraining momentum on the banking index. These distinctive points were coordinated and, after some consolidation, the market has rebounded. SECONDARY HIGH The interval from the primary peak to the possible secondary has been 13 weeks. Also noteworthy is the negative divergence provided by the lower highs for the RSI and the Bank Trading Guide. COMPLETING EVENT At the secondary high in 1998, a senior bank stock ended the rally with an outside reversal to the downside (elaborated following the next chart). WIDOWS AND ORPHANS SELL : 2006 Once the secondary high is complete, the low should be 12 weeks later. Within the concluding pattern, there is a brief but possibly important trading event. On Tuesday, the trading range for JPM set a higher high than the previous day, a lower low, and a lower close which, in the jargon, is called an outside reversal to the downside. This occurred again today. It is a feature of volatility often seen at important tops as its opposite is seen at significant lows. As an example, the latter occurred with the recent low for treasury bond prices. However, in looking at the topping pattern for banks in 1998, Citigroup set its high of 29.58 on July 21, which also did the "outside reversal" which initiated that crash. It didn't show up in the BKX index. So, at the critical tops in 1998 and now, a senior bank stock concluded the 13 week interval from the primary to the secondary peak. Our Bank Trading Guide was developed in early 1997, when its first usage in real time resulted in a brief 16% slump. This is the third test in real time and the big pattern set in 1998 has been replicated with remarkable fidelity. Thus the confidence in our sell recommendation. Of course, the reason for a significant slump, as in 1998, need not be known ahead of time but, as in any binge of aggressive banking, the mistakes are made on the way up and, inevitably, are revealed on the way down. This study uses a U.S. bank index (BKX) and one stock (JPM) to represent the model. Derived conclusions can be applied to most players in the global banking business ranging from money centre banks to sub-prime lenders. There is no guarantee that the market will continue to follow the pattern, but then there is no guarantee that it won't.   Bob Hoye Institutional Advisors 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 securitys 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. « BullionVault.com -- Buy gold online - quickly, safely and at low prices » « Opinions expressed at SafeHaven are those of the individual authors and do not necessarily represent the opinion of SafeHaven or its management. Articles and Talk Back are available via RSS/XML. Please visit RSSHelp for instructions. » === August 01, 2006 Speculative Peak by Bob Hoye
(Update) Extracted from Pivotal Events Our proprietary Peak Momentum Indicator registered in early May. As outlined below, this is a rare event and one of the more interesting examples anticipated the blowoff in gold, silver, and crude oil in January, 1980. Last Year's Signs Of The Times: "Home Sales Soar Sky-High" "Experts say this is no bubble but sustainable growth driven by confidence." -- Vancouver Sun, June 3, 2005 "Measured by the increase in asset values over the past five years, the global housing boom is the biggest financial bubble in history. The bigger the boom, the bigger the bust." -- The Economist, June 23, 2005 These were from a year ago, and The Economist's view was timely as the home builders index (HGX) peaked at 291 in July and the average house price index topped in August. The HGX has slumped 36% to the recent low of 187. By these measures, the bubble is clearly over and the contraction in this sector has begun. Will this lead to a bust as The Economist observed? Probably. Our proprietary Peak Momentum Indicator topped out in early May. Such signals anticipated the blowout in banks with the LTCM disaster in 1998. (Google LTCM) This signal measures speculative dynamics and it doesn't matter what the game is. For example, on the one in 1987 it was the stock market and the one in November, 1973 led that peak in commodities by 3 months. However, the example in late 1979 may be the most pertinent to today's condition. The signal registered in November, 1979 and led the peak in gold and silver by 2 months. That mania also included crude oil, which plunged from 39.50 in 1Q 1980 to 10.40 in March, 1986. Any price decline eventually dislocates leverage taken on during the price rise and the plunge in crude took out a number of hitherto aggressive banks. This reminds of the crash in the energy play in the mid-1980s. At congressional hearings, outraged politicians were working over the CEO of a busted Oklahoma bank. When asked where the depositors' money had gone, as reported by the Wall Street Journal, he said, "Oh, we spent it on wine, women, and song - the rest we just pissed away." Speculation in house prices was part of that play and, as memory serves, higher end homes in Toronto and Vancouver fell to 1/3 [no typo] of their highs. The latest signal from our Peak Momentum Indicator registered on May 9 and, while it was not as extreme as in 1998 (1.35) or in 1980 (1.37), it spiked to 1.21 and, in reversing, it says the play is over. At the time, we noted that the signal was likely coincidental rather than leading and the rapid cooling of the action in base metals and the stock market seems appropriate. The homebuilders index remains weak and perhaps the likely shutdown of the home as an ATM is forcing the recent plunge in retail stocks. Although the headlines in early 1980 were mainly about precious metals and crude oil, base metals were part of the play and copper rallied from 59.6 to 143.7 on February 11, 1980. The cyclical low was 53.6 in June, 1982. This time around, copper's high was 398 (LME) on May 12 and, so far, the low has been 305. The reduction in speculative fever, while significant, has not encompassed all the games. The blowout in oil, homes, and metals in 1980 was accompanied by the biggest crash in senior currency government bonds in history. Yields soared from 4.4% in 1967 to 15% in 1981. With this, Baa corporates went from 4.78% to 17.29%. Obviously, much of the recent boom has been accompanied by falling long rates as, for example, long treasuries declined in yield from 6.73% in 2000 to 4.31% a year ago (now at 5.10%). Baa corps declined from 9% to 5.71% and the latter, with new issuance and all, represents the biggest bull market for corporate bonds in history. Until the recent increase in long rates, this puzzled the establishment as a "Conundrum". The clearest explanation is that all classes of bonds became another asset class that was bid up with the other but more widely celebrated asset classes. This important financial sector has shown excesses on the upside possibly equivalent to the downside in 1981. Of interest is that the retrospective Peak Momentum reading in 1980 was also a "buy" on bonds. Now it's a cyclical "sell" on most corporate bonds, which have been very much part of an outstanding speculation. A breakdown in lower grade bonds, which is best monitored by credit spreads, will mark the end of the mania in risk and that will likely mark the beginning of a severe leg down in stocks, commodities, and residential real estate.
Bob Hoye Institutional Advisors 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 securitys 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. « BullionVault.com -- Buy gold online - quickly, safely and at low prices » « Opinions expressed at SafeHaven are those of the individual authors and do not necessarily represent the opinion of SafeHaven or its management. Articles and Talk Back are available via RSS/XML. Please visit RSSHelp for instructions. »