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Updated @ 10:45 a.m. EST, Sunday, November 5, 2006.


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.

Under democracy one party always devotes its chief energies to trying to prove that the other party is unfit to rule--and both commonly succeed, and are right. --H.L. Mencken

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    MORE DEMOCRATS MEANS GRIDLOCK, WHICH MEANS A STRONGER U.S. DOLLAR, WHICH MEANS A LOWER PRICE FOR GOLD (November 5, 2006): Sometimes the most obvious conclusions seem to be the hardest for the mainstream financial media to understand until it is too late to profit from them. Why this is, I have no idea--but it happens over and over again.

    There is no question that, even if the Democrats do not regain control of either the House of Representatives or the Senate in Tuesday's elections, they will have an enhanced numeric presence. With the Democrats either in control of one or both branches of Congress, or with the Republicans having a narrower majority, far fewer spending bills will be passed. Since the Republicans will obviously retain control of the Presidency, even if the Democrats obtain majorities in both the House and the Senate, President Bush will be able to veto any Democratic spending bills. Admittedly, Bush has never vetoed any spending bill during his entire term in office--a new all-time record for profligacy--but he will likely have far less compunction about doing so if the Democrats are in charge.

    Here's the main point: the next session of Congress will pass fewer and smaller spending bills. Less spending means a smaller budget deficit. A lesser deficit means that the U.S. dollar, which already pays among the safest and highest real rates of return in the world, will become even stronger.

    Now, one reads many viewpoints in the financial media--but just as the mainstream media did not permit opinions about falling real estate prices a couple of years ago, they suppress all ideas about a stronger U.S. dollar today. I realize that there is a tendency among some to claim "manipulation" whenever the financial markets go against them. In this case, though, I have facts to back up my claim. In the past several days, I have been asked by several writers in the financial media for quotes on gold, on the U.S. dollar, and on the stock market. In each case, I gave lengthy quotes on why the U.S. dollar would go higher, and tried to make them interesting. And, in all cases, all of these comments were eliminated from any of the media stories on this topic.

    It is obviously forbidden to even suggest that the U.S. dollar will go higher--even though the dollar has been doing exactly that since May 12, which was nearly five months ago. Over that stretch of time, the dollar has been continuing to trace a very bullish pattern of higher lows, including another higher low just in the past week. For three years, the media has been talking about a "falling dollar", and for three years, the dollar has done everything but fall.

    Well, the media may be able to keep me out of the mainstream, but--so far at least--they cannot prevent me from updating my web site. So here it is, probably the only bullish article on the U.S. dollar that you have read for several years.

    Getting back to Congress, it has always been the case that, whenever Congress is the most evenly split, the fewest spending bills get passed, and the stronger that the U.S. dollar has become. A situation in which the Democrats and Republicans are sharing power is sometimes called "gridlock". Whenever there has been gridlock, there has always been less government spending. Perhaps gridlock is the ideal state of affairs, since regardless of whether the Democrats or the Republicans are in charge, bad things seem to happen when either one side or the other is in true control. They end up passing a lot of bills which waste a lot of taxpayer's money, and the greenback progressively declines, making all Americans poorer.

    There is another important reason that, if the Democrats regain control of either the House or the Senate, the budget deficit will decrease, and probably substantially. That reason is taxes. In order to understand taxes, a little historical context is useful.

    In 1993, President Clinton, a Democrat, took advantage of the Democratic majorities in both houses of Congress to pass new legislation that substantially increased income taxes, especially among the wealthy. This tax plan survived until 2001, when the current President Bush took advantage of Republican majorities in the House and Senate to pass a significant income tax reduction.

    However, Bush got greedy and made a major miscalculation. He could have proposed a tax plan which simply reversed the Clinton increases. Instead, he and his advisers decided to propose a much deeper and more sweeping tax cut. There was a lot of opposition to this plan back in 2001, even among Republicans, since it would so obviously cause the budget deficit to balloon to all-time record highs. Therefore, in order to get these deep cuts passed, Bush decided to make them temporary, rather than permanent. He felt that once people became accustomed to lower tax rates, they would become so enamored of them that no one would want to return to the previously higher rates. Bush figured that in a few years, there would be great public support for passing legislation to have these temporary cuts made permanent.

    However, the Iraq war came along, with its huge deficits, and Bush couldn't find a single spending bill he didn't like. So the Clinton budget surplus turned into a huge deficit, and Bush lost any chance of having the temporary cuts made permanent. Here's something which very few people realize: all of the 2001 Bush tax cuts will expire no later than December 31, 2010. Not just some or even most of them--ALL of them. If no new tax legislation is passed by that date, then the ENTIRE Clinton tax package from 1993 once again becomes law!

    So here's the situation: if the Democrats regain control of the House, they will have the Republicans over a barrel. The Democrats will propose an entirely new, entirely Democratic tax package, oriented toward their pet causes, and no doubt with substantial tax increases on capital gains, on dividends, and on the wealthy. If the Republicans agree, fine. If they don't go along, then the Democrats will say, "No sweat. We'll just wait another few years, and then by default we'll revert to the Clinton tax rules." Eventually, unless the Republicans gain control of the Presidency, the House, and the Senate in the 2008 elections, the Republicans will grudgingly have to agree to the new Democratic plan, no matter how much they dislike it.

    So, as of early 2007, the Democrats will be in complete control, taxwise. However the situation is finally resolved--probably with a bone or two given to the Republicans to enable them to save face--there will be higher income taxes, and thus a smaller budget deficit.

    Meanwhile, there's no question that whatever happens in these elections, there will be less financial support for the war in Iraq. Regardless of the actual timetable for withdrawal, once the money dries up, eventually the troops will be on their way out. They're not going to fight without the dollars to support them.

    So, over the next several years, there will be fewer and smaller government spending bills passed, less money pumped into the Iraq war, and higher taxes. All three of these mean a lower budget deficit, and therefore a higher U.S. dollar. Since precious metals have historically moved in the opposite direction of the greenback, this means that once the financial media finally wakes up to this reality, gold and silver prices will decline.

    2006, THE YEAR OF THE FAILED BREAKOUT (October 23, 2006): One very unusual feature of 2006 is that it has seen so many failed breakouts across asset classes. Most of these have been failed upside breakouts. A failed breakout is defined as any security surging to a new multi-year high, then collapsing to a level below where it was when the rally originally began.

    SEMICONDUCTORS ARE LEADING EQUITIES LOWER (October 23, 2006) My favorite leading indicator for U.S. equities has always been the performance of semiconductor indices and their funds, such as SOX and SMH. For nearly four decades, semiconductors have been reliably leading the way both higher and lower for U.S. equities in general. Here is a one-year chart of SMH, an exchange-traded fund of semiconductor producers. The black, nearly horizontal line represents a simple 200-day moving average (with a special thanks to http://freerealtime.com/; chart updated November 5, 2006):



    A picture is indeed worth a thousand words. Notice that SMH in October broke above its 200-day moving average, but has since strongly repelled it to the downside. Therefore, equities in general are likely to soon experience a substantial downward correction that could continue for several months.

    HOW LOW WILL HUI GO? (September 10, 2006): HUI is the Amex Index of Unhedged Gold Mining Shares. How low will HUI eventually go, exactly, over the next several months? One very useful guide is to observe that on December 2, 2003, HUI reached a peak of 258.60 which was not exceeded for about two years. Another guide is found by measuring the entire gain in HUI from its May 16, 2005 bottom of 165.71 to its May 11, 2006 peak of 401.69. If HUI surrenders exactly 61.8% of this increase--known as the key Fibonacci retracement--it would put HUI at 255.85. It's no coincidence that these two numbers are so close. If history is any guide--which it almost always is--then HUI should move a few percent below each of these numbers, and bottom near 248.

    CURRENT ASSET ALLOCATION (November 5, 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 5.25%), 12%; long-dated U.S. Treasuries and their funds, and long-dated municipal government bonds, including TLT and MYJ, 31%; Treasuries between 2 and 10 years in duration, such as IEF, 10%; TOC, 2%; gold and silver coins and related metals collectibles, 6%; other collectibles, 0.5%; cash and cash equivalents including a long position in VMSXX, negative 29.5%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, SMH, NDX, GOOG) and related shorts, 45%; short CFC, 3%; short GLD, 18%; short GDX, 2%.

  • Overview of Gold Mining Shares--including updated gold fund management fees as of October 23, 2006.
  • REMINISCENCE OF THE WEEK (November 5, 2006):

  • Best of Previous Reminiscences
  • Learn more about Steven Jon Kaplan and watch a live interview on MarketWatch.
  • (c) 1996-2006 Steven Jon Kaplan Your comments are always welcome.

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