A true contrarian look at investing and at life in general.
A special thanks to Mr. Don McEachern for designing the beautiful banner at the top of the web site, and a slightly different one seen on the back issue list.
A sincere note of appreciation to my internet host, DirectNIC, located in downtown New Orleans, for remaining in their offices continuously throughout the disaster, keeping their web sites up and running during almost the entire time of the hurricane and flood. That is service above and beyond the call of duty.
WELCOME TO TRUE CONTRARIAN! I will attempt to create an entertaining, readable, and hopefully refreshing viewpoint roughly once per week. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence from my journal.
Recent comments are in boldface. Using an excellent suggestion of Mr. Dmitry Bouzolin, I am labeling each paragraph with the date on which it was written, beginning with my last update.
I'D LIKE TO TEACH THE WORLD TO TRADE IN PERFECT HARMONY (July 11, 2006): The worldwide financial markets have been moving in nearly perfect synchronization, as is typical of a true worldwide bear market in equities. Here is a brief summary of the causes and behavior:
The U.S. Presidential cycle is the most reliable long-term cyclical pattern in the financial markets. In this cycle, equities show modest gains leading up to the U.S. Presidential election in early November of each year that is divisible by four. Equities disappoint most bullish participants in the following year, then have a sharp decline in January through October of the next even-numbered year. After this collapse, they rebound sharply in the following year, then stabilize in the next election year, as the cycle begins again.
This cycle occurs because the current administration's main goal is to be re-elected, even if the President must be replaced by another person because of the two-term limit. By slowing down the economy in the first half, and then accelerating it in the second half, even if there was a severe recession, the administration can always say that the economy has been "recovering nicely".
Consistent with this cycle, equities were generally flat in 2005, and during 2006 have been steadily declining since January 11 (as measured by QQQQ and similar indices). Since it is only July, not October, there are still about three months to go on the downside. Notice that major lows in U.S. equities have virtually all occurred in even-numbered years which are not divisible by four, including 2002, 1998, 1994, 1990, 1982, 1974, etc.
VXO, the most important measure of implied volatility in U.S. equities, has risen only modestly from its multi-year low, and remains at less than one-fourth its peak level reached in 1997, 1998, 2001, and 2002. Historically, equities can only bottom when VXO is close to such a peak level. Thus, the potential for substantial remaining downside in U.S. equities is far above average at this time. I expect the Nasdaq to decline by more than 25% between now and the final 2006 low this autumn.
Semiconductor shares, as measured by indices such as SOX and exchange-traded funds such as SMH, have broken below their support levels of 2005-2006. Semiconductors have historically led the market both higher and lower since the late 1960s. SOX is likely to soon approach its September 2004 nadir.
As semiconductor shares fall close to their lows of 2004, technology shares will do the same. QQQQ will likely reach 32.50, just above its August 2004 low, before the summer is over, and has a strong chance of dipping below 30 in early autumn.
Central banks worldwide are not only raising short-term interest rates, but are draining substantial reserves from the system. The Bank of Japan in particular has been reducing overall market liquidity at an all-time record pace. As market liquidity contracts, the huge asset bubbles in everything from real estate to art to racehorses to smallcap equities will collapse. This downturn has already begun in earnest for some sectors, such as emerging-market equities, and will soon be apparent in all of these sectors.
Reduced liquidity, and its influence on real-estate and similar asset valuations, will be strongly deflationary and contractionary, and will therefore depress the prices of commodities along with the prices of equities. Eventually, the Federal Reserve will be forced to lower interest rates to counteract these powerful effects, but until then, commodities are likely to retrace all of their 2006 gains, and will even surrender some of their rise from late 2005.
As equities fall, there will be a sympathetic decline in the prices of low-grade corporate bonds, as the likelihood of default begins to sharply increase, and investors demand a much wider spread between the interest rates of low-grade debt and the debt of U.S.-guaranteed Treasury securities.
As money leaves equities, commodities, real estate, low-grade corporate bonds, and mortgage-backed securities, much of it will go into Treasuries. Yesterday morning, July 10, 2006, Bill Gross declared that the bear market in Treasuries was over--a few days too late to get the best prices in four years. Fortunately for readers of my web site, I made the same declaration back on June 27 [see below], allowing my readers to get the best bargains. At least Bill was not too far behind the curve; most investors will be piling into Treasuries much later in 2006, after they have already experienced most of their gains.
As Treasuries increase in value, Treasury yields will continue to decline. This is contrary to what the media keep saying about rising interest rates. It is significant that even though TLT bottomed on May 12, the financial media has become even more insistent in its message that interest rates are rising. When the media is loudly trumpeting any trend that has already begun to turn in the other direction, the ensuing "surprise" as the reversal intensifies is likely to be much greater than normal. Only a few participants in the financial markets are prepared for lower Treasury yields; be sure to be one of them.
As money floods into U.S. Treasuries, the U.S. dollar will steadily increase in value. This is also contrary to the financial media, which keeps talking about a falling dollar even though the greenback has made a pattern of higher lows for several weeks. The traders' commitments for the euro are at an all-time bearish extreme, meaning that the euro will likely fall below $1.20 U.S. within the next several months.
The traders' commitments for the Canadian and Australian dollars are also close to all-time bearish extremes. This is confirming the fact that not only will the U.S. dollar rise versus these currencies, but commodities in general will be falling, as these nations have a substantial percentage of their GDP in the commodity sector.
Consistent with this behavior, copper is likely to have a powerful collapse from its current level of $3.56 to around $2.00 or even lower. It should be remembered that as recently as March, copper was below $2.00 a pound. Crude oil, currently at $73.50 a barrel, has just begun a decline that will put its price below $60 a barrel, perhaps well below $60 a barrel, before the end of 2006. Other base metals, including zinc, nickel, and aluminum, which are all close to euphoric peaks, are set for "surprising" declines over the next several months. Nickel has risen in price for ten consecutive trading days; this kind of behavior is characteristic of a final buying frenzy before a dizzying collapse.
Gold and silver, which seasonally show the weakest physical buying from early July through early September each year, have been moving lower since May 11, and are set for a sharp acceleration of this decline. This pullback has been foreshadowed by a very bearish topping pattern in HUI, the Amex Index of Unhedged Gold Mining Shares.
HUI is completing a head-and-shoulders top with 2 left and 2 right shoulders, as follows:
First left shoulder: 349.48, January 31, 2006.
Second left shoulder: 354.59, April 6, 2006.
Head: 401.69, May 11, 2006.
First right shoulder: 342.68, June 5, 2006.
Second right shoulder: 351.66, July 5, 2006 (not yet confirmed).
HUI is also completing an interlocking head-and-shoulders bottom with 2 left and 2 right shoulders, as follows:
First left shoulder: 278.47, March 10, 2006.
Second left shoulder: 270.54, June 13, 2006.
Head: 2??.??, August ??, 2006 (248 estimated).
First right shoulder: 2??.??, October ??, 2006 (282 estimated).
Second right shoulder: 2??.??, November ??, 2006 (293 estimated).
As is typical of all true bear markets, such as 2001 and 2002, there will continue to be brief, intense rebounds in equities and commodities. These will characteristically be accompanied by a sharp drop in VXO, demonstrating that the bear market is alive and well. Only when VXO finally goes above 40--and probably above 50--will the bear market be approaching its nadir. This will likely occur in early autumn. Precious metals shares might bottom in late summer, as is consistent with their historic pattern. Look for insider buying by top executives, combined with greatly improved traders' commitments for gold, to confirm a bottom in this sector.
HEAVILY BUY U.S. TREASURIES (June 27, 2006): If there's an investment class which is universally despised at this time, it has to be U.S. Treasuries of all maturities. Everyone is obsessed with the notion that inflation will continue to rise for the indefinite future, and that the Fed will continue to raise interest rates. However, there are increasing signs that recession, rather than inflation, is the most serious threat to the economy. Emerging-market equities have experienced declines usually seen only before a major worldwide slowdown, while the recent sharp peak in commodities prices often coincides with the final leg of a long-term economic expansion.
The traders' commitments for U.S. Treasury bonds, reported as of Tuesday, June 20, 2006, showed commercials long 509,147, up 30,239; short 337,095, down 42,148. Thus, commercials were net long 172,052, close to an all-time record, and representing a dramatic increase of 72,387 in just a single week. Thus, those most closely connected with the long-term Treasury market have been very heavy buyers even as the financial media have been disparaging them as an investment class. Shorter-term Treasuries also make a compelling buy at this time.
The U.S. Treasury curve is currently "inverted", meaning that the 2-year yield is higher than the 10-year yield. When this inversion first occurred in December 2005, it was discussed heavily by the media, but dismissed as a fluke, even though it has the most reliable historical record of all indicators in forecasting a recession over the subsequent 1-1/2 year period. When this inversion occurred in recent weeks, it was barely mentioned.
Thus, one of the most unusual and reliable harbingers of an economic slowdown is not even known by the general public. Such an inversion exists less than 2% of the time, and is thus something that should cause intelligent financial commentators to stand up and take notice. Even with equities and commodities generally performing poorly in the past several weeks, and the reliable Presidential cycle pointing to further weakness in both through late summer or early autumn, investors are choosing to take money out of Treasury funds rather than out of equity and commodity funds. Be a true contrarian and buy Treasuries, such as the exchange-traded fund TLT.
HUI CORRECTIONS IN THE PAST 4 YEARS (February 5, 2006): HUI, the Amex Goldbugs Index of Unhedged Gold Mining Shares, has experienced four corrections averaging more than 1/3 in magnitude in the past four years. Here are the precise dates and figures of each such pullback:
2002: 154.99 on June 4, 2002 to 92.82 on July 26, 2002: 40.1%.
2003: 154.92 on January 6, 2003 to 112.61 on March 13, 2003: 27.3%.
2003-2004: 258.60 on December 2, 2003 to 163.81 on May 10, 2004: 36.7%.
2004-2005: 248.18 on November 17, 2004 to 165.71 on May 16, 2005: 33.2%.
2006: 401.69 on May 11, 2006 to ???.?? on ??? ??, ????: ??.?% [I'm guessing the eventual low will be near 248, a decline of 38%].
CONSIDER FUNDS FIRST: Most readers will probably be interested in purchasing gold funds for the majority of their investment, either not having a brokerage account or not wishing to assume the increased risk and volatility of owning shares of individual companies. There are several dozen gold funds. (May 29, 2006) As of May 22, 2006, there is a new exchange-traded fund of gold mining shares called GDX, which is intended to track the Amex-listed index GDM. More information on GDX can be found at http://www.vaneck.com/gdx. The management fee for GDX is currently only 0.55%, which may be increased to 0.79% in another year. Since GDX has the lowest fee of all true gold funds, and can be traded intraday, it is currently my favorite gold fund. ASA is a closed-end fund of precious metals shares, heavily weighted in South Africa. Since the management fee is currently 1.15%, I do not heavily favor it, but it does trade intraday, and so may be worth buying in small quantities whenever its discount to net asset value exceeds 15%, which happens occasionally. All but three of the open-end gold funds charge more than 1.2% percent of the total assets each year as a management fee, in some cases two or three percent annually. Some of these funds even charge significant upfront or redemption fees. If you feel that a particular fund manager has a track record which justifies such a high expense ratio, then please continue to invest in such a fund. However, it is possible that such a manager may not continue his winning streak, or that his success may encourage him to leave for another company or to start his own hedge fund, and the subsequent management will not necessarily be as competent, and may charge a significant fee for switching out of the fund. Caveat emptor. The two funds which charge the most reasonable fees are BGEIX, the American Century Global Gold Fund (current annual expense ratio 0.67%), and VGPMX, the Vanguard Precious Metals and Mining Fund (current ratio 0.48%). I have a strong preference for BGEIX over VGPMX, for the following reasons: 1) BGEIX charges a redemption fee of 1% only if the shares are held for less than 60 calendar days. VGPMX charges a 1% fee if the shares are held for less than a year. 2) BGEIX contains all pure gold mining companies. VGPMX contains several energy and base metal producers. If there is a fear of a recession, or similar economic developments, energy and base metal producers will likely underperform ordinary gold mining shares. Besides, I do not want diversification if I am purchasing a gold fund; I want gold mining shares, period. 3) BGEIX has always been open for new investment. VGPMX sometimes is closed for new investment, even if one has a considerable current holding in the fund. Appendix (May 30, 2005): One of my readers, Mr. Alan Sorin, pointed out that FSAGX, the Fidelity Select Gold Fund, has an expense ratio of 0.89% and a short-term trading fee of 0.75% for shares held less than 30 days. While this is not as low a fee as BGEIX, there is one big advantage: FSAGX is priced every hour on the hour, beginning at 10 a.m. New York time, rather than only at 4 p.m. As readers who have been tracking gold mining shares for many years already know, being able to buy and sell at 10 a.m. is worth a lot, since it is around this time of day that gold mining shares usually make their lows when they are forming an important bottom. Sometimes HUI will rise several percent between 10 a.m. and 4 p.m., as it did on May 10, 2004 (when HUI made its nadir of 163.81). Once it is appropriate to sell gold mining shares, it is also usually advantageous to do so at 10 a.m., when they generally peak during the formation of market tops.
CURRENT ASSET ALLOCATION (July 11, 2006, marked to market): My own personal funds are currently allocated as follows: LONG POSITIONS: stable value fund (retirement fund with stable principal paying variable interest, currently 5.00%), 22%; long-dated U.S. Treasuries and their funds, and long-dated municipal government bonds, including TLT and MYJ, 29%; Treasuries between 2 and 10 years in duration, such as IEF, 5%; gold and silver coins and related metals collectibles, 6%; other collectibles, 0.5%; cash and cash equivalents including a long position in VMSXX, negative 27.5%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, NDX) and related shorts, including short SMH, 42%; short CFC, 3%; short GLD, 20%.
GOLD AND REALITY: Gold and gold mining shares often correlate closely to the real rate of return for short-term U.S. time deposits. The lower the real rate of return, the better for gold and its shares, and vice versa. The real rate of return is equal to the nominal time deposit rate (roughly equal to the anticipated Federal funds rate) minus the inflation rate. (July 11, 2006) At the current time, inflation is about 3.25% while the anticipated Federal funds rate is approximately 5.45%, yielding a real rate of return of positive 2.20%, its highest positive level in more than five years. Since gold and silver strongly prefer a negative real interest rate to a positive one, this is bearish for precious metals. Investors in gold appear to have entirely forgotten its important negative correlation with the real rate of return, making it that much more important at this time. It should be noted that when gold experienced its lowest point in 1999-2001, the inflation rate averaged 2.0% while the anticipated Federal funds rate was as high as 6.5%, yielding a real rate of return of as much as positive 4.5%. This positive 4.5% rate of return is the primary reason why gold fell all the way to $252 per troy ounce, not because of some ridiculous manipulation theory.
LOOKING FORWARD TO 2060: I'll make a very far forward prediction by stating that I believe U.S. equities will make a double bottom in 2010 and 2018, with the Nasdaq bottoming below 400 in 2010, more than doubling sometime thereafter, and then making a final double-bottom retreat to below 550 in 2018, followed by a roaring bull market that will bring the Nasdaq to the 3000-3500 level by perhaps 2035, followed by a relatively mild bear market. The all-time Nasdaq high of 5132 from March 2000 will probably not be seen again until 2060 at the very earliest. (February 5, 2006) Amazingly, Jeremy Grantham, in the February 6, 2006 edition of Barron's, makes the exact same timewise prediction: U.S. equities will achieve their deepest nadir in 2010. His logic is that any asset class typically takes about one decade to go from top to bottom (U.S. equities peaked in March 2000). U.S. residential real estate lovers, take heed: the peak in August 2005 [National Association of Realtors] implies that the bottom for U.S. housing prices will occur near 2015.
LONG-TERM GOLD OUTLOOK: Gold will continue to make a pattern of higher lows as its strong bull market from a nadir of $254.00 in April 2001 to the present continues throughout the next decade or so. Important higher lows included $319.10 on April 7, 2003; $371.25 in the morning of Monday, May 10, 2004; $410.75 on February 8, 2005; and $428.00 on August 30, 2005.
YOUR TYPICAL GARDEN-VARIETY SEVERE BEAR MARKET BOTTOM: U.S. equities in general will continue to decline until the dividend yield on the S&P 500, currently at 1.95%, is between 6.5% and 10.5%. Great bull excesses are usually followed by equally severe recessions.
REMINISCENCE OF THE WEEK (July 11, 2006): When I lived in Baltimore, I used to go to several shops and restaurants for as much as two decades, and got to know the proprietors at some of them quite well. When I finally left in 1985, I didn't have a chance to say goodbye to all of them. Earlier this year, I was visiting one of my favorite delis from the old days, known as Edmart, on Reisterstown Road. They sell something called "hamish mustard" which is out of this world. I thought I recognized the person behind the counter, but I couldn't be sure. He stared at me for a minute, then exclaimed with genuine concern, "You haven't been in here in awhile. Is everything okay?"
AUTOBIOGRAPHICAL SKETCH: I was born and raised in Baltimore, Maryland, U.S.A., and was graduated from the Johns Hopkins University with a Bachelor of Engineering Science degree in May 1982. I have been studying the precious metals markets since the 1970s, and began this web site in August 1996. I have been writing music and short stories since the mid-1960s. I maintain a fiercely independent stand toward the financial markets and toward everything else in life, and am not compensated for my writings by any person or organization with the exception of the advertising banners posted on this site. I am also a pianist, computer programmer, music composer, bridge player, and runner, and enjoy world travel. I appreciate all those who have quoted the various sayings on my web site over the years, which have wound up in some pretty interesting collections.
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