Gold mining fundamentals revisited - deflation

Gold stocks are not well understood and not well studied by most investors. Everyone thinks gold stocks are an inflationary play just like all commodity stocks. Gold miners behave differently than other commodity stocks such as oil or agricultural stocks, however. Gold stock fundamentals are actually paradoxically strongest during a deflation.

The reason, it turns out, is basic economics/finance 101 type stuff: gold falls in price less than the costs of mining during a deflation. If the product you are selling decreases in price by 10% (as in gold from the March 2008 peak to now) but your costs decrease even more than 10% (as in oil falling in price by 70% in price), you just increased your profit margins despite a falling price of gold!

Here is a ratio chart of the gold price divided by a basket of commodities to show the relative outperformance of gold since the deflationary storm began:



In the end, gold miner stock prices will reflect the increased earnings deflation brings them. Paradoxically, the greater the deflationary forces, the greater the profit margins for gold mining companies will rise. If the deflationary shit storm we are in spirals out of control and gold goes down to $500/ounce, that means oil will be $3/barrel and unemployment will be 30-35%. Labor costs will drop precipitously for gold miners as every base metal mining company in the world will go out of business and/or cut 90% of its work force in that setting and there will be all kinds of experienced mining talent available for pennies on the dollar.

Once one understands that gold miners are a better deflationary play than an inflationary one, the paradox of investing in gold miners in a deflationary crash makes sense. It's not that gold miners won't get whacked when the general stock market takes a dive, but they will outperform and create net gains while general stocks and other commodities generate steep net losses.

Think about that for a minute. Where can you invest your money in a deflationary shit storm and actually make money? Government bonds pay maybe 0-3% yield, cash in the bank and CDs pays the same, and everything else loses money. Look at how gold stocks did during the last Depression in the 1930s here and take a look at the historical countercyclical nature of gold stocks here.

The non-believers in gold stocks for the period we are in are those steeped in conventional "wisdom" who listen to mainstream media sources and fail to look at history. Did you know that gold is a better protector of wealth during deflationary periods than inflationary ones? Again, it's about relative price not absolute price. If gold drops 20% and real estate and stocks drop 80%, a gold investor can buy a hell of a lot more real estate and stocks once the dust settles.

A new cyclical leg up in this gold stock bull market has begun. The secular gold stock bull market began in 2000, the same year the secular bear market in stocks began. A fast and furious cyclical bear market in gold stocks from March 2008 to October 2008 took only 7 months to wipe out two-thirds of the gains from the first cyclical leg of the gold stock bull market from 2000- March 2008. This is a pretty typical correction after the first cyclical leg up in a bull market.

The current cyclical (i.e. measured in years, not decades) leg up in gold stocks that has started is considered a "wave 3" in Elliott terms and it promises to be a wild, profitable ride. Since the first leg up in the $HUI (a basket of blue chip, non-hedged producing gold miners - aka the gold bugs index) produced gains of 1470% in 7.5 years, the third leg up may provide a similar or even greater relative gain. A gold stock "mania" is sure to evolve since profits for gold miners are about to shoot to the moon and profits for 95% of other publicly traded companies are evaporating.

Road map revisited

I am still short and waiting for another few scary down days before I close my shorts and start getting ready to go long. Here is a potential road map for the S&P 500, which I am not trading, but rising and falling general market conditions are important to be aware of when trading, as individual stocks and sectors always have an easier time when swimming with the current instead of against it!



Here is a recent example in history of such a correction in the S&P 500 one year ago:



The chart patterns aren't and won't be exactly the same but this is a rather common correction pattern in stocks and I suspect a rhyme is coming. The current correction simply hasn't lasted long enough to be complete in my opinion. This has nothing to do with fundamentals, but the bear market crash we just has this fall is worth at least a 4 month correction to work off the excess bearishness, restore some investor hope, and give the downward trend a healthy breather.

We may overshoot the November 2008 S&P 500 low of 750 by a few points just to draw in a few overly aggressive bears who think we're going straight to zero. The people going short near the bottom of this correction will actually help fuel the subsequent rise when they cover their short bets gone wrong (this is why a ban on short selling is a paradoxically a bad idea, by the way).

Things I'll be looking for to help confirm we're bottoming and getting ready to launch upward:

1) RSI down to 30 level/range on a daily chart of the $SPX
2) Put to call ratio ($CPCE) should reach or exceed 1.10 on a daily chart
3) The Volatility index ($VIX) should reach or exceed 55

Once these conditions are met, I'll be looking to close my put option contracts on NEM and KSS and preparing to go long. When I do go long, it will be using call option contracts on Goldcorp (GG) and Royal Gold (RGLD) predominantly, though I may nibble on a few other gold miners. Gold stocks will outperform the S&P 500 significantly during this pending spring rally. I think a 50% gain in the ETF GDX from the bottom of the current correction, which should be completed in 1-3 weeks, is all but guaranteed (a few individual gold stocks will go up 100% or more). The best part is that it will only take 2-3 months to make these types of gains.

Gold - bull trap

I don't trust gold kicking butt right now. Call me a skeptic, and you all should know as full disclosure that I am heavily invested in physical gold and I am a long-term bull on gold. I think we're headed for a steep, sharp quick fall that will provide yet another great buying opportunity (I hope...). Pay close attention to the final peak at the far right of the chart:



Now the gold miners, using a 6 month chart of the ETF GDX as a proxy for the sector. Look for that same price spike at the far right side of the chart:



The strength of gold and gold miners has been impressive. I said the gold mining stock rally would end before December was over and we haven't made any real progress since then. We are now overdue for a quick, swift plunge (which is why I'm short NEM right now despite my longer-term bullishness on the sector). The ratio of GDX to the S&P 500 is also due for a rest and gold stocks should underperform the $SPX over at least the next week or two:



At the end of this correction, which should take at least one week, gold stocks will be the number one sector (ignoring leverage opportunities) for profits, although I think 90% of stocks will rally frantically in a final short-term (i.e. 4 - 10 weeks) rally to complete the bear market bounce before the next deadly plunge. Are you ready?

Uncle Buck

As in the U.S. Greenback. I think she's got one more push up to go before rolling over into a longer-term downward correction. To the charts:



The value of the U.S. currency is very important to investors who denominate gains in that currency. If dollars are stronger, it takes few of them to buy companies/stocks/bonds/commodities because the measuring stick of how their value is measured has changed. This is why fiat currency systems can be so tricky. This is also why inflation is so insidious.

Bottom line: currency up usually = asset prices down. This general premise doesn't always work, as stock markets can rise along with the currency, just like sometimes gold rises on days when the US dollar also does. However, this premise usually applies and having the dollar take one more run up for a week or so fits in well with my investment thesis that stocks, commodities and gold have one more brief correction to go before the spring rally.

The spring rally will gain legs precisely because the value of the U.S. Dollar will decline during the rally. If the currency is declining in value, the nominal U.S. price of the stock market will rise automatically in most cases. This is why the Dow to gold ratio is important and told us we were deep into the secular bear market well before the 2007 nominal top was in. The chart below plots the Dow Jones (red and black candles on the chart) with an overlying plot of the Dow divided by the gold price (black thin line on chart) over the past 15 years. This picture is worth more than 1,000 words (and well over $1,000 if you're an investor who gets most financial info from Cramer!):



Anyone who thinks gold isn't a currency and real money needs to explain why gold is only down 10% from its all time nominal highs while other commodities have been crushed by 40-70%. The bottom line is that when you use a measuring stick that reflects non-debaseable true money, we have been in a bear market for 10 years. People always look at me with a jaundiced eye when I show them the above chart.

Want more conventional proof? How about the Dow priced in Euros aka investing in America from a European perspective:



When a currency is devalued, nominal prices rise. In hyperinflation, as in Zimbabwe, the price of a loaf of bread might be a billion or even a trillion dollars and stocks might rise 1,000% in a year when denominated in the local currency. I'm not saying we're Zimbabwe, I'm simply saying that currency debasement produced an illusory nominal new high in the Dow that was artificial.

By the way, I do believe deflation will last for a while and after the spring rally up in stocks and commodities and the dollar correction down, I believe the U.S. Dollar will get stronger again and rise to even higher highs, confounding its critics. However, I believe gold will rise higher in nominal terms than the dollar and do even better than U.S. cash. Since cash is king and debt is death in a deflation, why be invested in anything besides real, true, honest to goodness debt-free money?

Smells like a trend change...

As someone who trades in options a lot, I am always interested at what the $VIX (volatility or "fear" index) is doing, as it can affect the value of options. I think the $VIX is changing direction here, which means the S&P 500 should be going down for a while. Here's a short-term 60 minute intraday chart:



When $VIX goes up, the value of put options often goes up even if the underlying stock is flat. I have been in KSS (Kohl's corp.) puts and have experienced this in the reverse, as the stock has been fairly flat to down since I bought the options and yet the options price has dropped a little (bummer...). It's not too late to get into these puts for this reason. Once the $VIX rallies, the option price will rise again and that will be a wind in the 'ol profit sails as KSS takes the anticipated dive.

I believe the NYSE composite ($NYA) has already broken down trough its trend line and is supportive of a short-term trend change in general stocks:



One more decent leg down to scare the last of the bulls, then I think that spring fever bull rally I have been waiting for is coming, which will carry almost all stocks to higher levels than seems possible given the horrible state of the underlying economy. Bear market rallies are legendary and offer great profit opportunity for traders. Those not in gold stocks (e.g., GDX ETF) or oil stocks (e.g., DIG ETF) who want to go long need to be patient but get ready to go long once the bottom is in, as it should be a barnburner of a rally.

Long bond rally time!

I previously noted a good shorting opportunity in the long bond (tradable ETF proxy ticker TLT). I think we're due for a trend change and any shorts (I did not take this trade) should be covering now if they haven't already. To the charts, yo.

First, the TLT chart (5 minute short term chart):



Next, the short-term chart of the 10-year government bond yield, which is not truly the "long" bond (this title is a slang term for the 30-year bond):



Remember that U.S. government debt will hold up OK during a deflationary storm, particularly on the short end of the curve, due to a flight to perceived safety. Bonds are a risky long-term play in the event of a currency crisis and have such low yield that a CD may be just as good as a cash equivalent. I shouldn't have to tell you that I hold gold instead...

Important gold and gold stock day

Gold broke a trend line over the past two trading days and has now met up with an older trend line:



Gold stocks were down today despite gold being up for the day and look wobbly and tired (probably from altitude sickness after 100-200% gains over the last few months):



This divergence between gold stocks and the price of gold is often a great clue to a trend reversal at the end of a bull run and is a signal (never used in isolation, of course) to take profits on longs or go short whether we're talking gold itself or gold stocks. The chart below is a 5 minute intra-day chart over the past few days with the GLD ETF [black and red candlestick plot on the chart] used as a proxy for gold price and the GDX ETF [black line plot] used as a proxy for gold stocks:



Anyhoo, I couldn't resist the bait and went short NEM (Newmont) via put options for a quick (likely less than 2 weeks) trade. I previously shorted NEM for a quick 35% profit back in early January, so why not do it again? After this correction, which may take us into mid-February, it will be time to load the boat with gold and gold stocks for the fantastic spring '09 rally.

I am in this to make money first, so I am happy to short or go long anything that I think can make me money. I love gold and gold stocks, but I will short the hell out of either if I think I can make some good money. Gold stocks are volatile and this means big gains in either direction when a move is made. I still strongly believe gold and gold stocks are the best (and only!) buy and hold investments out there for the next few years, but I use gold stocks as trading vehicles and keep physical gold (i.e. real cash money that actually requires effort to produce and is scarce) as my portfolio's bedrock (i.e. only accumulate and never trade).

KSS - an even juicier short this time

I shorted the retailer Kohl's (KSS) a few weeks ago for a quick 25% profit using put options. I got out of the trade without waiting for a bigger gain, which proved lucky, as the stock came back. It is now a juicier short than ever and I couldn't resist buying a boatload of put options today while the stock was in the high 39 range.

This chart is short-o-licious:



This ratio chart (KSS divided by $RLX as a retail sector proxy) also shows how much KSS has been outperforming other retailers:



Anyhoo, I'm in big and looking for a quick score over the next 1-2 weeks.

Gold bug, bitches!

Of course, I'm a gold bug! You can't talk to friends, family or colleagues about gold without them wondering if you're a terrorist or off your meds. This is the exact reason to be a gold bug. The average American has so little understanding of finance and money that they actually think it's weird to believe in real money that has a proven track record of a few thousand years. They would rather believe in the promises of bankstas and apparatchiks, because history has shown how reliable the promises of the likes of Bush, Bernanke and Obama are!

I am proud to be a gold bug because it shows an understanding of sound money, which is required to have a sound democracy. To think that gold is a relic is to think that freedom and honesty are relics. Gold will retain its value much longer than the current promises made by human animals, who I might add, will die quite soon relative to the life of a gold coin or bar.

A fiat monetary system is based on trust and/or force, not intrinsic value or cooperation. On the intrinsic value, mutually acceptable form of money thing? Yeah, gold already won that contest multiple times in hundreds of societies over the past few thousand years. The Dow to Gold ratio chart tells us all we need to know about where we are in the trust cycle, which is what this chart speaks to us about. Once this ratio gets back to one, then I'll think about selling gold for real estate, stocks or some other asset class.

The latest update of the Dow to Gold ratio chart shows it performing and trending exactly as anticipated:



Will I be a gold bug forever? As a citizen of the world yes, but as an investor, HELL NO! Look people, this is about preserving and enhancing what money you've got and will make in the future. To all the people that want to bury their heads in the sand, put money in a shitty 401(k) and stick with stocks for the long haul, I really do wish you the best even though I know that you're fucked. Anyone interested in investing generally wants to be invested in something and there are a finite number of options, so any comparison has to be relative to what else is out there.

Gold is the easy, no brainer way to preserve and enhance wealth until the Dow to Gold ratio reaches one. Why do people hate gold so much? I can only assume mass hypnosis has worked and our fiat system has corrupted our society exactly as predicted by our founding fathers. Why do people think gold will do poorly during deflation? I can only assume ignorance of history, as gold has preserved wealth best during deflations (and currency crises). Why give all your money to a banker or broker so that they can lose it gambling and then potentially refuse to give it back to you when the shit hits the fan? 'Cuz everyone else is doing it and there's safety in numbers, I would guess.

If the argument one is going on is that stocks do better than gold over the long haul, I have two comments: first, the Dow to gold ratio is a roughly 10-20 year cycle and there will be plenty of time to switch back to stocks when they are ready to start delivering reasonable gains for the risk they entail (gold will trounce stocks until the ratio reverts to one again). Second, check back this summer or fall after the market has tanked again and gold has retained its value and I believe this will no longer be true using a full century of data!

If it's a choice between cash/cash equivalent investments and gold, then we at least have a reasonable argument/discussion on our hands. Why not hedge your bets against a currency crisis with some of that cash, since you're not likely to be earning more than 1-3% on your cash anyway? If it's gold versus real estate, stocks, corporate bonds, or foreign currencies, gold is a much better choice (unique investment situations, short-term trading and shorting aside).

So, yes, I am a gold bug and until at least 50% of the population sees that it is only rational to want sound money and market-set interest rates, I will remain a gold bug, bitches. Then I'll probably become the fiat lizard king just to be a contrarian...

Funneling down the pyramid

Exeter's liquidity pyramid, that is. The deflationary/contractionary rout is intensifying. Small snippets of the truth are leaking out piece by piece and they are not pretty. Do you believe bank holidays cannot happen in the U.S.? How about Great Britain? Read this link and think about it for a minute (thanks to the Financial Ninja blog for scooping this one).

The key item from the article in my opinion: "The Treasury was preparing for the banks to shut their doors to all customers, terminate electronic transfers and even block hole-in-the-wall cash withdrawals." Let's review Exeter's liquidity pyramid (stolen from the Long Wave Analyst):



Now, when the shit hits the fan, like it is doing now, every one looks out for number one. Wealth is not being destroyed, it is evaporating in waves. When this "digital" wealth leaves and trust rapidly decreases, people want to "get liquid" to preserve capital. Getting liquid or putting one's money into the safest asset class available makes sense if you have wealth to protect.

We have already seen this in real time with the flight to the perceived safety of government bonds. We are already near the bottom of the liquidity pyramid with U.S. Treasury bills at 0-1% interest. Next comes cold, hard cash, whether "stored" in banks or under the mattress. Banks are obviously suspect and growing more so by the day. If you think there was a banking panic before, wait until the British populace hears about the article linked to above.

When you can't trust banks, you're left with stuffing currency notes in a safe or under the mattress versus hoarding gold. But leaders around the world are jockeying to be able to claim bragging rights for debasing their currency the most in a desperate attempt to re-ignite inflation and punish prudent savers. Those who save by hoarding gold are protected from the whims of the political ruling class.

Of course, the government can "back stop"/guarantee all the banks, but that puts the currency at risk. The FDIC exists and can pay nominal claims in any scenario by printing money out of thin air, but this has exceptional risks associated with it. Take a look at a currency chart for the British Pound over the past 15 years:



So, if government bonds and bills yield close to zero, the currency is unstable, and all other asset classes are taking it in the shorts, where on earth can you put your money to preserve your savings? You should already know my answer to this question, but the answer is what's at the bottom of the liquidity pyramid: G-O-L-D!

How do you think British citizens who took their money out of the bank during the fall panic and put it into gold feel about their investment choice? Let's take a look at a long-term gold price chart denominated in British Pounds (i.e. $GOLD:$XBP or the futures gold price divided by the currency index for the pound sterling):



It's long past time to pretend that banking holidays cannot happen in the United States. Protect yourself by having at least 1-2 months' worth of expenses on hand in cash and put at least 10% of your savings into physical gold coins and/or bars. I think the next 1-2 weeks will provide another great buying opportunity for physical gold (as well as gold stocks).

Off for a week

Going on vacation and posting will be pretty non-existent until a week from Sunday (1/24/09). Happy trading and remember, the next big move should be up in just about all stocks and commodities until the spring.

A gentleman named Martin Armstrong is one of those rare scholars with common sense and an uncanny knack for calling markets. His cycle work is critical reading. If you think I am a little bearish on the future of the markets and economy, please read his rant here.

Excuse the typos, as he is in prison right now (unjustly) and probably typed this from his cell. He is a fascinating dude and I like to keep an eye on his economic confidence model cycle turn dates (which don't always necessarily correspond with market tops and bottoms, but sometimes they do quite accurately). There is a chart of the cycle turn dates below and here is a link to a brief explanation of this cycle.



You may also want to read the latest rant from Karl Denninger at Market Ticker. Another smart dude that saw all this coming from a mile away, though he often focuses on the political side and I have no hope that CONgress or our bankstas will do the right thing.

Now think happy thoughts!

Charting around

I have now bought roughly half the gold stocks I plan to buy during this correction, even though I don't think the correction is over. Corrections are choppy, messy affairs and can be hard to time precisely. I saw a chart pattern I liked in the GDX ETF (a basket of gold miners) and figured we're at the bottom of this "leg" of the correction.

A bounce up should come next, then a bounce back down. The problem with corrections is that sometimes the first leg down makes a lower low than the second. By buying half now and half in a few weeks, I am trying to volume average into the bottom of this correction. Catching the exact bottom and exact top are not realistic goals when trading (though they make for great bragging rights...). The idea is to participate in the bulk of a big move.

Anyhoo, here's the chart pattern that sealed the deal for me:



If this "a-b-c" type correction is really only part of a larger "A", then a "B" up is imminent, to be followed by a "C" down to complete the correction. The final low of the "C" may or may not be lower than the pending "A" wave low, which is why I am buying half of my gold stocks now. I got heavily into Goldcorp (GG) July 2009 calls today, which will be my primary way to play the gold sector. The GDX ETF is a more diversified/less risky way to play the sector and also has options. I also like RGLD and have put in orders on this stock that haven't filled yet.

For those who don't like options, you may be able to make bigger gains by buying the bullish ETF DIG and playing the oil sector with double leverage. This chart is getting ready to explode to the upside and I don't know any double levered bull gold stock ETFs, so this trade may end up being more profitable than GDX for those who don't like options. I may even buy a little for a short-term trade while waiting for gold stocks to finish their correction (another 60 minute chart shown below):



The momentum divergence on the long bond is also unfolding as anticipated and the tradeable proxy for the long bond is TLT. This sucker's going down:



Don't fear the panic - embrace it and profit from it!

Took profits today

Though the market may go lower before the big anticipated bounce into the spring, I sold my SRS and my puts on SSO, NEM, AEM, BHP and KSS today. I put in orders to buy long call options on GG and RGLD, my two current favorite gold miners. These orders won't fill unless gold stocks go lower.

As anticipated, the surge in the Volatility index ($VIX) made the profits fast, furious and easy on my put options, so I took the money and ran rather than letting things ride. My primary efforts now will be centered on hunting for long candidates and trying to time my purchases. My plan is to go with the sure thing and buy call options on gold miners exclusively. I anticipate at least 50% gains from today's low, though the final intermediate-term low for gold stocks may not be in yet. Other sectors may do well also (oil/oil stocks look especially beat up and ready for a massive rally), but I'm going for the guaranteed easy money.

I am betting the farm on gold stocks in a highly concentrated investment/trading strategy using essentially all my investment funds (other than my physical gold holdings, which are not for sale and are never traded). I am also looking to buy some more physical gold when this current correction in the gold price completes, likely in the $760-$775/oz. range, which should happen within 1-3 weeks.

Big picture crap

All those pundits and advisers who keep looking for the rebound in economic activity just around the corner are full of shit. This is not even close to a run-of-the-mill recession and it is dishonest to pretend that it might be. You cannot have Wall Street and the banking system of this country go bankrupt and not affect the real economy in a profound way.

Real estate is toast. You have to understand and believe this fact of reality that cannot be reversed by wishing for something otherwise if you are a homeowner. A five year top to bottom crash is the optimistic scenario (i.e. bottom in 2010-2011) and here's to hoping we don't drag it out for 15-20 years like Japan.

When real estate crashes, it takes the banking sector with it because they're the ones who made the loans and take the hit when foreclosures mount. This time around, Wall Street and Main Street also took the hit because they sold and bought, respectively, toxic derivative products (aka "safe can't lose bonds just don't read the prospectus or do any due diligence") leveraged against real estate. A real estate collapse is a deflationary event that pulls lots of assets and businesses with it. Additionally, the housing boom was the main anchor for our cyclical bull market "recovery" within the context of the secular bear market that began in 2000.

The point of mentioning all this is to comprehend just how big the adjustment our economy is going to need to make to regain its footing. Forget being patriotic or optimistic or whatever hokey bullshit you think you need to parrot based on MSNBC-type "news"/comments. We shipped most of our manufacturing offshore and then invested heavily in a real estate bubble after the internet bubble collapsed. The internet bubble wiped out 401(k)s and IRAs when it popped, but the current bubble is wiping out 401(k)s, IRAs, and is leaving a huge pile of debt behind for millions of Americans that still needs to be paid back.

That debt cannot or will not be paid back by millions of house owners due to job losses/other economic hardship or unwillingness to throw good money after bad, respectively. Walking away from mortgages is a new powerful trend that makes sense for consumers who have no equity in their homes and scares the shit out of banks. People who think this is a subprime problem haven't done their homework. That was only the first wave of three!

Add to this the commercial real estate crash (the ETF SRS is a great trading vehicle to profit from this crash), and banks are, excuse my French, totally fucked. You see, it is considered crass for an individual homeowner to walk away from a mortgage yet it is standard procedure for a business in trouble to default on its debt/obligations. Once retailers and restaurants start declaring bankruptcy in earnest this year (i.e., hundreds more than just Circuit City, Bed Bath & Beyond, Sharper Image, Linens N Things, Levitz Furniture, Bennigan's Steak & Ale, etc.) and get evicted/walk away from their commercial leases, who is waiting in the wings to lease the empty space left behind?

Bottom line, a crippled banking system is here and it's going to take more than 6 months into 2009 to fix it, since the losses to banks are ongoing and actually now accelerating! Without a strong banking system to make loans, even good companies cannot expand and some won't even be able to make payroll on a bad month. Additionally, unemployment is accelerating, not stabilizing, so there are fewer consumers with money to spend on goods and services.

Some charts illustrate that this is more than just a run-of-the-mill downturn:







And the UK, which is just as deep in the doo doo as we are, just cut their short-term government set rate to 1.5%, the lowest since 1694. The bottom line is that this is not a time to be speculating (i.e. investing) with your retirement money unless you know what you are doing. The same people who failed to warn you to take money out of stocks are the same people telling you to stay put now because the recovery from the crash they failed to see coming is just around the corner. Hmmmm.

I like gold because it is real and can't vanish. Yes, its day to day value can fluctuate, but it is the oldest form of currency (along with silver). The people running the printing presses don't think gold is money anymore but they hoard tons and tons and tons of it for some reason that I can't seem to figure out since it's no longer money or a store of value. Money is evaporating right now. Much of it is digital money that was created with no effort and this is the money that stands behind JP Morgan (bankrupt ten times over!), Goldman Sachs (bankrupt!), Citigroup (bankrupt!) and countless other paper tigers that are now on fire.

Once people realize that even the hard pieces of paper we know as real money are no longer worth anything more than a hollow promise, then you'll see the real gold rush begin. The next 1-2 week period should provide a PHENOMENAL opportunity to load up on gold and I will be adding to my holdings. I think the price will drop close to the $750/oz. range and this will be one of the greatest buying opportunities of the entire gold bull market. The secular gold bull market started in March, 2001 and has already yielded gains of 300% (versus negative 20% for the S&P 500 since this time).

Don't miss out on the biggest gains of all in this young secular gold bull market. Buy physical gold at low prices in a week or two and sell gold once the Dow to Gold ratio gets to one. I use APMEX and Gainesville Coins to buy physical gold coins and bars and have been impressed by their service. (Full disclosure: I don't get jack if you order from either of these two companies.)

A few more reasons we're going down

There are many different tools traders can use to try to predict the next move in the market and obviously none in isolation works consistently. When a combination of indicators points in one direction, it gives you a better sense of outcome likelihoods and increases the reward to risk ratio. In the end, trading is educated guessing with risk management.

The three charts below (in addition to an oversold $VIX, price patterns, oversold momentum indicators, volume patterns, and knowing that we are in a bear market correction) helped give me the confidence to initiate short trades last week:







We're oversold, banks ($BKX) and JP Morgan (JPM) have broken down, the $VIX is oversold and due for a bounce up, and there aren't too many short sellers on board yet. Perfect time to go short! Remember, though, that this is a scalp trade for 1-4 weeks duration. Come the end of January or so, I'll be looking to bet the farm going long gold stocks, the only stock sector currently in a bull market.

Rough road map for gold stocks

Along the same lines as my comments below for general stocks, this is what I think will happen with gold stocks over the next few months:



The exact day to day movements are quite uncertain, but I think a correction to the 26-27 level would be reasonable and I think the maximum correction downside would be 24. After that a move to 40 seems like a no-brainer and would give an easy 50% gain in 2-3 months. Once the spring top hits, a correction in gold stocks will occur that will be a significant correction.

However, remember this: gold stocks are in a new cyclical bull market that began 10-24-08. They will NOT be making new lows after the spring top. General stocks, on the other hand (i.e. Dow/S&P 500), will peak in the spring and then will DEFINITELY make new lows below the October, 2008 lows that will make widows, orphans, bureaucrats, retirees and anyone else who falls for this bear market bounce cry.

Also, remember that everyone and their cousin on TV and in mainstream financial sources will be praising Obama, Bernanke, and the wisdom of the markets right before the next plunge, drawing in as many suckers as possible before Mr. Market takes all their money. The recovery is not here, has not started, and is still a ways off.

Gold stocks can thrive in a countercyclical environment, though they are still subject to being pulled by major market moves. Because gold mining fundamentals are rapidly improving as just about every other sector in the economy has deteriorating fundamentals, gold stocks will become the go to sector for those insisting on being bullish in something. Not only will their profit margins explode and stock prices go bananas, but if you buy early in this cycle (like in a few weeks, for example), gold miners will provide you with a handsome dividend yield on your initial investment as early as the end of this year.

Rough road map for stock market

I am short the market right now via SRS and puts on SSO, NEM, BHP, AEM and KSS. These are short term trades, as I believe we are in the middle of a rally that will last until spring. The bear market is NOT over by a long shot, but no market moves in a straight line and there are big profit opportunities going both long and short in even the worst bear markets.

Elliott wave theory is complex and can get a little too complicated for my taste at times, but the rough application of wave counts can be quite helpful in determining where we are in a big picture sense. I believe we just completed the "A" wave up in a wave IV correction and once the current "B" wave down completes, a big "C" wave rally up will begin. Once this "C" wave up completes in the spring (some time between say mid-March and the first week of May), a BIG, NASTY downward leg in the stock market will begin and crush every one's hopes for a recovery.

In chart form, using the S&P as a proxy for general stocks:



Because the bigger trend is up rather than down, my current bearish trades will be closed in 1-4 weeks. I will be looking to get long gold stocks starting at the end of January and will be betting the farm on gold stocks outperforming most general stocks until the rally is over in the spring. I believe 50% gains from the bottom in the gold mining sector are reasonable to expect and 100% gains wouldn't surprise me.

You see, this coming "C" wave up in general stocks will correspond with a 5th wave up in the first bull leg for gold stocks, as gold stocks have entered a new bull market. When the next leg of the stock market bear begins in the spring, gold stocks will simply undergo a bull market correction and will NOT make new lows. However, gold stock sector declines can be rough and deep, so I'll be trying to sell near the top and won't be holding through the correction.

Deflationary bear market

The deflation versus inflation debate rages on, but the market has spoken. We are in a deflationary bear market. This will not suddenly morph into a hyperinflation anytime soon. This has many investment implications. The first is that cash is king. The value of the U.S. Dollar will fluctuate, as will all currencies in our current fiat disaster, but it will hold up until this cyclical bear market is over. In other words, cash will be able to buy more stocks, real estate, commodities and bonds later than now.

This comparative value is important because value is relative when currencies, or money, are unstable instruments. In other words, the U.S. Dollar Index could fall but still gain in value relative to other things. If those other things are what you desire, then you have become wealthier. The easiest examples to perceive this in everyday life are food, consumer goods, and real estate.

If you have the same amount of money as at the beginning of the bear market because you went to cash, you have more cash than someone who stayed in stocks, real estate, or commodities through the fall crash. This means you are wealthier in both a relative and an absolute sense because not only do you have a greater nominal amount of currency value assigned to your investment account(s), but you can buy more food, consumer goods and real estate because these things have fallen in value.

The reason I bring this up is due to the confusion regarding the value of gold. People think that in a severe deflationary bear market, gold will be a lousy asset to own. This is false. Even recent data shows this to be true. If an investor picked the very top of the stock market on 10-11-07 to buy gold or go to cash, the day the stock bull market ended and the day before the current deflationary bear market began, here are the returns for cash and gold for a U.S. investor denominated in U.S. dollars:



The assumptions I used to generate these figures are as follows: I assume the person bought at the highs for the day on 10-11-07 using the continuous futures contract price for gold and the U.S. Dollar Index for cash and used the closing price at the end of the day 1-09-09 for these, and I gave the investor in cash a total of 6% simple interest over the 15 month period to determine how much $100 would turn into.

Some believe that gold only does well in an deflationary environment when it is pegged to the currency, as occurred during the so called first great depression (the second one has started, by the way, in case no one has told you yet). In an early deflationary period, it is true that paper money/cash may outperform gold, but as the deflation intensifies (i.e. what's actually going to happen next in the real world), gold becomes a more sought after haven than fiat currency/paper cash.

There are several reasons for this, but they all boil down to trust. Keep in mind that the government and our central bankstas are trying to create inflation. They are in fact doing everything in their power to create inflation. Short-term government set interest rates are essentially at zero and fiscal "stimulus" (i.e. government debt creation to offest the slowing in private debt creation) is accelerating at a reckless pace. In other words, the government and our central bank are fighting the trend of having a strong currency!

As a believer in free markets and a non-believer in the magic wands of bureaucrats, I trust the ongoing storm of deflationary market forces will trump the action of elected officials. If you believe otherwise, why didn't these people see what was coming and prevent it from happening in the first place? Anyhoo, as deflation intensifies, the government is going to pull some pretty crazy crap and try to defy reality. It will expand debt aggressively in the name of trying to do something to get re-elected and placate the masses.

In this deflationary environment we are in, credit contraction is occurring / credit is becoming scarce. As examples of this undisputable fact, 103% loan to value mortgages have essentially disappeared and the commercial paper market had to be "stabilized" by the Fed to prevent an implosion. Well, there is even a limit to how much government debt can be created. The leash on government spending is market revulsion toward long-term government bonds/debt when the debt load becomes too high relative to the government's income and/or people's desire to hold this debt. If you look at a 30 year U.S. bond price chart, we are clearly approaching this point. Perhaps anticipation of a second massive round of Obamanation stimulation (notice the first is being put together before he even takes office?), once the first fails to do anything but waste money, will tip the scales.

When the long bond price plunges, the interest rate goes up and government ability to borrow more drops. If market intervention by the Fed attempts to prop up the long bond, then the currency will devalue in response. The important thing to remember is that every piece of paper money is backed by the U.S. government ultimately, which is where it derives its value from. Dollar notes are debt instruments and when the credit rating of the person/company/entity standing behind any piece of paper/debt note decreases, so does the value of the promise implied by the piece of paper/debt note.

All major world currencies right now are paper promises by the governments that stand behind them and all are debt instruments. We all know how reliable the promises of governments are in times of trouble. This is why gold is the ultimate currency. It is no one's liability and is accepted as valuable around the world, even if it can't be spent directly at WalMart. As deflation intensifies and one after another government promises a bailout, stimulus, stabilizing measure or whatever other crazy-ass bullshit they come up with to try to improve our economies, currency fluctuations will become more unpredictable and violent.

People will swing from one currency to another based on relative debt loads incurred as debt is suspect during deflation. Gold has no debt. With cash now yielding close to 0%, interest payments are no longer a valid argument for preferring paper money over gold. Bank holidays don't affect holders of physical metal. No confidence smokescreen is needed to assure gold's value - a few thousand years of collective human experience and wisdom have already created it and no modern government can replace it by issuing a decree. Not that they won't try...

Gold is not a way to get rich (that's what gold stocks are for!), but it is a protector of wealth and should be a bedrock of your portfolio in the current environment. Physical gold in your possession has no counter-party risk and no risk of having its value destroyed by the reckless whims of ignorant government apparatchiks. When the dust settles, there is no doubt that gold will have survived the deflationary storm intact and will be able to purchase much more real estate, food, consumer goods, stocks, bonds or whatever else your heart desires. Though cash will do the same, the built in free insurance policy gold provides against potential future currency dislocations is no longer a trivial bonus.

One last juicy short - Kohl's

The retailer (stock ticker: KSS) has me licking my chops enough that I put in an order to buy some put options tonite. I pray the Wall Street gods let this one fill before the plunge begins...



I think the market is rolling over nicely and bell weather JP Morgan (JPM) looks like it has broken down:



It's time for bulls to run for cover! Come back in a few weeks if you're interested in going long...

Another juicy short

Homebuilder Lennar (LEN) is about to take a steep fall. I won't be trading this one, but this is a dream short set-up. The reason I'm not going to take the trade is that the options historically have sucked and not provided enough leverage to make it worth the risk and the brokerage account I have money in to make a trade right now (TdAmeritrade) won't let me short the stock outright.

Anyhoo, the chart is a doozy and the top is probably in today. The risk reward on this one is a no-brainer.



An expanding megaphone pattern in JP Morgan (JPM) was used previously to predict a waterfall decline.

Remember, both the up and down swings in a bear market tend to be fast and furious. Profits of 100% in the home builder sector have been made in less than 2 months! A 20-40% drop in the next few weeks would not at all be unexpected. Roller coaster rides like this are no fun for investors, but for those looking to trade, they can be fun and very profitable.

Debt crisis can't be fixed with more debt

The chart below explains what is happening and why bankers, particularly the Fed, are panicking. It is a chart of household debt outstanding in the U.S. and you can look at it in its original form at a Federal Reserve website:






That flattening at the right end of the first chart is new and tells what is coming. Debt obligations are starting to decline in this country. Bankers hate that. Do you notice how our officials keep trying to say that they are trying to stimulate the banks to get them lending again? Do you know that bankers make much of their money by getting people into debt? Do you know that the reason we are in such a terrible economic situation right now is because everyone (i.e. households, businesses and the government) took on too much debt?

If the problem is too much debt, why would the government want to encourage more debt creation? It's a valid question, isn't it? If people are losing jobs left and right, housing prices are falling, and business prospects are poor, why would any sane banker lend more money to people or businesses? I'll tell you the secret - they won't.

Instead, the government will expand its balance sheet and put every U.S. citizen on the hook for the debt it will create. Obama and Co. are already planning another trillion or so in economic "stimulus" and that's just his first round. By the way, this doesn't count the expense of his inauguration party, which I'm sure will be very modest, cost only a few hundred bucks and have a BYOB motif. The money used by the government to "stimulate" the economy will do the exact opposite and will worsen this recession and turn it into the second great depression.

Do you doubt this? Do you know that the government caused the first great depression? If they would have let the markets restore order, a deep 2-3 year recession would have fixed the problem. Oh, no. They stimulated the living crap out the economy. They lowered interest rates aggressively, they handed out cash like it was going out of style, they created jobs for millions, they took over bad home loans, they even bought commodities and destroyed them to "stabilize" prices. All of these measures failed, just as they have failed in Japan over the past 18 years, and as they fail every time they are tried.

A debt crisis cannot be solved by taking on more debt! Period. End of story. Common sense cannot be discredited by those with PhDs.

Think of the real world. Uncle Lenny takes on home and car loans slightly above his means, then drinks away his paychecks and can't make the payments. He borrows from his relatives to make up the shortfall each month and squeaks by, until he gets into trouble with gambling debts. Then he gets a consolidation loan with a longer re-payment plan, pays back some of his relatives, and starts to make the consolidated loan payments for a few months. Just when things seem like they might be OK, Uncle Lenny loses his job. He starts using credit cards to make his monthly payment obligations until he maxes out a few too many cards, then transfers the balances to other credit cards until finally he is too maxed out and can't get any more credit.

If interest rates are lowered to 0.00001%, Uncle Lenny still cannot make the minimal payments as the principal has simply become too high. Interest rates become irrelevant when debt loads are too high. Think about borrowing $5 billion. Even with an interest rate of zero, you can't make the payments (unless you're Madoff). The only option for Uncle Lenny at this point is bankruptcy (or winning the lottery). The last thing Uncle Lenny needs is to take on another loan and who in his or her right mind would want to give him one anyway?

We have debt overload. The U.S. consumer is finally ready to retrench (i.e. stop spending and start saving). People have been calling for the death of the U.S. consumer for more than 15 years and it is finally here. Yes, we will still spend more than other cultures, but most of us are going to be forced to start thinking twice before paying $5 for a cup of coffee out of necessity. Saving money is a good thing, isn't it?

The flattening out of the chart above is an historic event in the current credit market-driven cycle. It is the concrete proof of deleveraging and the popping of the world's greatest debt bubble. When debts fail to be repaid, bankers get crushed. Defaults are death blows to bankers. The housing crash and commercial real estate crash, which are both moving ahead full steam, are going to cripple the banking system in this country for another few years. Many more bank failures are coming.

Bankers who are insolvent and have been burned by lenders will not lend freely for awhile, as this will only compound their losses. This thwarts the Fed's efforts to "stimulate" the economy. Piling debt on top of a collapsing debt bubble will not work, though it may prompt a currency crisis down the road. The last debt collapse led to the first so called great depression. Why should this time be any different?



We have extended this credit cycle beyond what anyone could have imagined and the hangover as all this debt implodes should not be underestimated. Think defaults on home loans, commercial real estate loans, credit card loans, student loans, car loans, and boat/RV/motorcycle/ATV loans. The government will try to "pick up the slack" by piling on more debt. This at a time when U.S. taxpayers have less money to pay taxes due to job losses, will owe less due to income declines and tax breaks, and will demand greater government services to tide them over until they can get back on their feet. Not only this, but the rest of the world will have less money to invest in our bonds/new government debt as they will be tending to their own internal problems.

One thing's for sure: it won't be pretty and stocks won't be a good buy and hold investment for the next several years.

Secular, not cyclical thinking

Secular is a vague term in investing cycles that denotes a longer term trend typically measured in decades. We are currently in the middle of a secular bear market that started in 2000 and should last until at least 2015. There is a corresponding secular gold and gold miner bull market that is in the same time frame. Can you handle it? Do you believe it? If not, what say you about this 100 year chart of the Dow Jones Industrial Average (stole it and can't give credit as I forgot its source)?



Why is this time different? Do you honestly believe that Georgie W. Bush, Barackster Obama, Benny Bernanke and Hanky panky Paulson have implemented policies that are going to change the usual market cycles? I suppose it can be argued that they are the smartest bureaucrats we have ever seen in this country - this argument could absolutely be made, assuming one was a CRACKHEAD.

Anyway, it's important to remember that bureaucrats don't cause economic recoveries, people betting with their own money and with real jobs do. Waiting for Bernanke to fix the economy is like waiting for a prostitute to cure herpes. Painful and not very effective.

These secular bear market cycles of roughly 15 years or so on average are a necessary part of the economic re-structuring that is needed after a boom that causes capital misallocation. Think of how much money was wasted over the past 5-10 years building mega-McMansions and strip malls that all sell the same stuff! That money is gone - poof! The hangover left behind is a doozy, though. Real estate will not bottom until at least the 2011-2012 timeframe, and that's the optimistic scenario.

Don't expect an economic recovery or new stock bull market until after housing prices stabilize. Anyone who tells you housing prices will bottom before 2011 is ignorant, wasting time wishing due to owning lots of real estate, a government official, or a paid shill for the industry. Ain't gonna happen and I would bet your first born child on it. The National Association of Realtors has been calling for the bottom every month since the first month housing prices dropped. They should never be listened to again by anyone with cerebral hemispheres (i.e. brains, yo).

By the way, banks in this country are almost all bankrupt or about to go bankrupt and the largest ones are the most insolvent. Commercial real estate has fallen off the proverbial cliff and unemployment is accelerating at an alarming rate. In other words, this secular bear market is progressing in the usual manner and this time will be no different than the others in the chart above.

Buy and hold is buy and lose when it comes to general stocks. During these secular bears, simply holding physical gold and waiting to buy stocks until the Dow to Gold ratio gets to the 1-2 range is the easy, no-brainer way to play things. Whatever you do, don't suck it up and hold for the long term because Suze Orman and Ben Stein told you it was OK and everyone's doing it. Stuffing cash under the mattress is a better plan than listening to those two.

The good news is that we're halfway through this secular bear and a new secular bull can be born once it's over in 2015 or so. Also, secular bear markets have cyclical (i.e. 1-5 year duration) bull and bear markets within them. For example, the cyclical bear market from 2000-2003 within this secular bear was followed by the cyclical bull from 2003-2007 and we are now in a cyclical bear that should last at least until the fall of this year.

The other good news is that if you're willing to take the risk, fast and furious profits can be made in bear markets. Think about it. This fall, the S&P lost 43% in 3 months. In the 6 weeks since, it has made 27%. Gold stocks made a 100% gain in the last 2 months. If you're willing to trade and switch sides based on where the opportunities are, bear markets are actually much more profitable than bull market. The problem is that bear markets require more skill and attention.

Once the current correction that I believe started today (but could squirm around a few more days to torture those without conviction) ends in the next 2-4 weeks, another big move up will begin. This up leg may be worth another 27% or more from the next bottom in the S&P (and a 50-100% gain in gold stocks) and it too will only take 1-3 months. Got your trading shoes on?

But back to the theme of this piece, which is that we are in a secular bear and it ain't even close to being over. Those that come to accept this are better off than those who watch Cramer and CNBC and quote the latest bozo who says the next bull will start in 5 seconds. When's the last time these assholes told you to short the market? When's the last time they told you to get out of stocks for a decade? When's the last time they told you to buy physical gold bars and coins? Don't you wish someone would have told you to cash in stocks and buy gold back in 2000 before the internet bubble crashed?

But if these shows tell you the truth, who are their Wall Street advertisers going to sell their stocks to at the top? And I do take it back - Cramer and cronies will tell you to sell stocks at some point in the future. When they do, remember: the bottom is in and it is time to buy stocks with both hands!