2010: Financial Judgment Day

Housing, Gold, Stocks, Interest Rates, Currency - An Intermediate Outlook.

Last month, the Institute For Economic Reality held a discussion on why the current fascination with commodities, especially gold, is a game that is about to turn. Since then, we have seen the stock market peak on January 19th, and then take a turn for the worse. While this was knowable, it is very difficult to determine the time frame for such a peak.

The high octane flim-flam rally that has occurred since March of 2009 has shown to be hollow, as the most basic indicator in technical analysis, showed the rally was inversely correlated with volume. As prices rose, fewer and fewer people could, or were willing, to participate. This smelled of the large zombie banks in New York throwing stocks back and forth to one another in an attempt to sucker in the remaining dumb money. It appeared to work at first, but people appeared not to be fooled. It's tough to speculate in stock wreckage when you have lost much of what you have saved over your life, and your Bainbridgeislanddreamhome is 35-40% below what it was at the peak of the stock market. Speculation is done with money you can afford to lose. Your survival stash isn't something you are going to throw at an enterprise that is less predictable, and has a higher risk/ROI ratio than a roulette wheel.

At the Institute For Economic Reality, we are always trying to push back the frontiers of economic cluelessness in an effort to improve our community. When you have one of the largest contributors to Congressional campaigns constantly dumbing down the population with mindless twaddle such as "real estate always goes up" and "buy now or be priced out forever," someone has to offer an alternative view.

For the past year, we have seen the dollar tank, while everything else has rallied. This would include gold, stocks, other currencies, and bonds. Even Bainbridgeislanddreamhomes managed to perform about 30% above what they would have, had it not been for the epic manipulation by every financial power on the planet to keep them above water. With all that, they still dropped in price. Imagine what it would have been without the manipulation...

Over the President's Day weekend, a discussion was held at the Senior Fellowship level of the IER between the Worldwide Headquarters in Poulsbo, and the currency trading division in Seattle. The subject matter was the intermediate term movements of the macro markets and the most strategic way to capture the movement of the various markets. Normally, the IER does not discuss trading strategies, and the following discussion is not to be construed as trading advice, but an intellectual exercise and explanation of where we find ourselves in the economic morass foisted upon us by the economic illiterate that traffic in such matters.

The IER Chairman asked that the senior fellows discuss how the recent drop in the equity markets is a short term phenomenon and a counter rally will occur and challenge the recent January high. Traditionally, the first drop off the high in the equity markets sucks in the shorts with mindless abandon, and then a squeeze ensues where the shorts pull the ejection handles to avoid getting killed. This happens over and over during the bear market rally, and eventually the short squeeze FAILS to take out the previous high, creating a "double top," or "failing rally," and then both the shorts and longs bail on their positions, sending the markets into the tank. Witness the second half of 2007, or early 2000 as recent examples.

The IER's senior fellow in the currency division did manage to grab most of the dollar rally/euro swoon in the past few weeks, but has since reversed the position to capture the rise of the euro and drop in the dollar. Why? The (Powers That Be - PTB) will not allow Greece to drop everything they have worked for over the past two years and will commit all their resources to keep the fraud functioning. This will cause the shorts in the euro to cover and sell the dollar in the process to cover that short. However, this will likely cause the PTB to spend everything they have to keep the Greeks in the lamb, gyros and Ouzo they have come to expect. That works right up to the point where the Germans run short of patience and money to bail out Portugal, Spain, Italy, Ireland, and the Greeks. Since it is no longer fashionable for the Germans to invade every time they get pissed off, they will resort to withdrawing liquidity.

Why now? What is different now than a year ago? The US debt.

Over the past year, when we have had an international funding crisis (Dubai and Portugal), "mystery money" has magically appeared and buoyed the US debt market, especially US Treasuries. Had it not been for this "mystery money," US bond auctions would have failed to the point where rates would have to rise to fund the auction. The "mystery money" has shown up at the most opportune times to prevent this, BUT other damage has occurred. The IER believes this to be related, and is strong evidence that the perception of global liquidity is a mirage (hat tip to IER's North Texas Adjunct Fellow). Given the Bacchanalia happening in the halls of Congress regarding their spending, the dry patches in the worldwide liquidity pool will become larger, more frequent, and more persistent. The PTB will have to decide which debt debacle will kill them first - the US, or the rest of the world. They know it is the US.

If it aligns with the technical analysis, this would cause a failing rally in relation to the January high. If we take out the January high with elan, this view needs to be broomed and we re-rack and try again. Mulligans are allowed in macro-economic financial analysis.

Looking back to 2008, specifically July-October, we see a pattern that has all the elements of repeating, but on a MUCH larger scale. Here is the IER's take on that time frame.

The markets are made by traders of varying competence. The major markets are currency, debt, equity and commodities, and that is essentially the pecking order sorted according to intellectual firepower. Currency traders have to be right, or they are dead. The leverage they use is the equivalent of playing with high voltage. Know what you are doing, or you get planted the next day. The bond traders need to understand what the currency traders are doing and how the interest rate complex moves, since liquidity is a major player in setting interest rates.

Next up, we have the guys that spent their college years perfecting the beer bong, and think CNBC is actual news - the equity traders. The trade isn't so much on what the underlying company is doing, but the perceptions on how other traders believe traders will view how the stock will trade with traders expectations of what future traders will think. In other words, they are playing a game of finding the "greater fool." What skill they do posses, is largely confined to convincing the general public that stocks are a good buy, "and always go up." (where have we heard that before???)

Finally, we have the commodity traders. These folks are truly the last to know, and the first to get run over. These guys are the ones at the poker table wondering who the mark is.

This is also the order of liquidity, as currency is the most liquid, and commods are the least. This phenomenon lends itself to be an inverse indicator of the ability to manipulate the price.

In the summer of 2008, we had an interesting destruction in the market place. In late July, oil peaked in the high $140s and then was taken out into the alley and shot, but equity continued to run right into August. That's when equity had a local peak. In September, bonds came into the killing zone in such a fashion that Paulson and Bernanke called Pelosi and her crew into a room and told them that absent a $700B tribute, the bond market was going to detonate. The dollar had it's relative peak in October.


See a pattern?

We, at the IER, believe this pattern will repeat in 2010. Here is the blow-by-blow of how it will likely go down.

Equity peaked in January 2010, and then rolled over as European financial stress, as well as political instability (from the banker's perspective) hits the market. The dollar starts to get squeezed (rising in price from being freakishly oversold), taking commods down.

Greece gets bailed out by someone, causing the euro to rise and the dollar to get sold. Commods rise, as well as stocks and other currencies as related to the dollar. Given the manipulated interest rates, the dollar resumes as the major funding mechanism for the worldwide "carry trade" causing it to be inverse to every other store of value on the planet. Traders see this weakness and pile on - shorting the dollar to fund speculative purchases in equity and commodities.

These carry traders are both long commodities/stocks/currencies and short the dollar, which works very well, right up to the point it doesn't. Keep this in mind, as this is EXACTLY what happened with the yen in 2008, but the yen wasn't the world's reserve currency - the Yankee Lira is.

If anything, anything at all, goes haywire, fear (risk) will hit the market place with little notice. This market place is short dollars, and long everything else. The US dollar will be at low interest rates, signifying anticipation of little or no risk going forward, which means complacency has set in and the trade is lopsided.

-Iran could do something stupid.
-China or Japan could try to raise funds by selling US denominated debt (raising dollars).
-Congress could go completely around the bend with its spending. Al-Queida could uncork another one (US.gov told everyone that we are going to get hit in the first half of 2010).
-Europe could blow up.
-Australia could go down the pipe (clockwise).

Anyway...something is going to happen, and the PTB have already shot their wad on Greece and US Treasury auctions (the last 30yr was a failure). When that happens, the dollar, being the world's reserve currency and home to over half of worldwide defense spending and 6000 nuclear warheads, to say nothing of the world's largest economy, third largest population, and despite recent activity, one of the most stable legal systems in history, gets bought out of fear.

We get a short squeeze of cosmic proportions, setting off cascading margin calls as both dollar shorts and commod/equity/currency longs get sent to market in a panic to close out positions. If this happens in proximity to the January high in the stock market, we get a "failing rally/double top," and the "all in short" signal goes out. The rapidity of this will be unprecedented, as anyone offside on this trade (the bulk of the banks in the US and Europe) will exsanguinate in seconds.

Remember, the trade is lopsided and that ALWAYS, without exception, is a prelude to the herd getting slaughtered en masse.

The dollar rises, and everything else gets crushed. Commodities will go first, just like they did in 2008 when the yen got covered. Stocks go next as money that rotated from the commodity market runs dry. Finally, all the shenanigans in the bond market stop as Bernanke moves to save The FED. The accounting gimmicks won't save him this time, as the world finally realizes the money is gone, and has been for some time. He, and his criminal banking cabal use the chaos in the equity markets to get the last pop out of bonds, and then the floor disappears from them.

Everyone dials 1-800-GET-ME-OUT, as the fear is real because we just saw a top and failed to extend it. Failure is fresh in everyone's mind.

We don't need to spill a lot of electrons on how Bainbridgeislanddreamhomes will fair in this bloodletting. They will be on the killing floor, covered with the gore from the bond, stock, and commodity markets. Interest rates will pop hard, without relenting, as money is evaporating all over the globe, at the same time everyone is trying to cover their dollar shorts. Stock charts will look like Moses turned Yosemite Falls into blood, with large, long red candles going straight down, destroying confidence and killing off one leg of the triad of Boomer retirements. Gold, silver, oil, grains, copper, etc all get sold into a worldwide economy in serious retreat. We are looking at $20 oil, $300 gold, $4 silver, and $150K Bainbridgeislanddreamhomes. Given that credit will be temporarily frozen solid, those prices are optimistic.

While currency, bond and stock markets are obvious determinants to the Bainbridgeislanddreamhome market, the commodity market isn't as obvious. Certainly, owner-occupied homes are not going to get margin called, but all the bank REO inventory will, sending prices straight down. Your Bainbridgeislanddreamhome is a place to drink white wine, park your Prius or Nisssan LEAF, and display Obama '08 yard signs. To the bank, it is an entry on a ledger, and nothing more.

That's how we see the debacle unfolding. These are merely predictions, and your mileage may differ. The IER is not a registered investment advisory institution, and this is NOT trading advice. This is nothing more than putting real world landmarks on our current situation in an attempt to educate the inquiring public about the status of our financial landscape.

The IER is largely flat, as we await the failing rally in stocks. Once we see a definite break in commodities (oil and gold will be the best to watch, but silver may very well presage both to the down side, as it is an industrial metal as well as a numismatic metal), attention will turn to the stock market double top. If it fails, it confirms the commodity break, the shorts go out on the SPY, QQQQ, banks and Cramer's famous "Four Horsemen." (AMZN, GOOG, AAPL, and RIMM - BTW, the "Four Horsemen" in the Bible are apocalyptic in origin, so take that for what it is worth). Speaking of Cramer, if he is chirping about new highs in close proximity to the January high, that is about as close to "short with impunity" indicator that there is. If Goldman Sachs is offside (and I doubt it, as they are the ones moving the markets), that will be the kind of short that will land you at the Adventurer's Club sipping brandy and smoking a stogy with Commander McBragg as the ballsiest move in 4 generations. McBragg will be speechless because this is your world, the rest of us are simply passing through...quite.

Dollar long-calls as well as puts on foreign currencies should pay huge, as premiums on the trade will be next to nothing when the double top is made. Remember, everything is a dollar denominated asset, including foreign currencies. That's what "reserve currency" means in practical terms.

Stay solvent. Stay nimble. Stay skeptical.

Ernst Stavro Bloviator
Senior Fellow, IER