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Updated @ 10:00 p.m. EDT, Sunday, October 28, 2007.


WELCOME TO TRUE CONTRARIAN! I will attempt to create an entertaining, readable, and hopefully refreshing viewpoint a few times each month. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence.

Logic is the beginning of wisdom, not the end. --Dr. Spock, Star Trek VI

NEGATIVE DIVERGENCES ABOUND IN THE GLOBAL FINANCIAL MARKETS (October 28, 2007): There are numerous negative divergences that are pointing the way toward sharply lower worldwide equities and commodities prices. I will point out those which historically have been the most significant.

Semiconductor shares have been a reliable leading indicator of the overall stock market, and especially of the technology sector, for nearly four decades. Most broad-based equity indices had recently come close to their mid-July peaks, while some had surpassed those levels to set new seven-year highs. However, semiconductor funds and indices such as the exchange-traded fund SMH recently broke below their August 16 lows, and currently stand at their most depressed valuations in more than a half year. This is one of the clearest early-warning signs that equity markets around the world are set for a substantial pullback that will probably persist (with periodic minor upward bounces) until the spring of 2008.

Funds and indices of commodity producers have been consistently underperforming their respective commodities. For example, as the price of gold has frequently set higher peaks in the past few weeks, gold funds such as GDX have struggled to approach their levels from more than two weeks ago. Similarly, even as crude oil has surged well above $90 per barrel, energy indices and funds such as OSX are noticeably lower than they had been on October 11. For several decades, producers' shares have been the single most reliable leading indicator of commodities' behavior both on the upside and also on the downside.

Internal measures of market performance have been deteriorating on a global basis. Even in the hottest markets, the number of stocks advancing has been progressively sliding, while the number of stocks declining has been rising. The ratio of new 52-week highs to new 52-week lows on all major worldwide exchanges has been progressively tilting in favor of new lows for several months. With each new seven-year peak by well-known equity indices, fewer and fewer names have been able to continue rising. A narrowing of the bullish rotational pattern is a reliable omen of trouble for global equities.

Market sentiment has continued to set bullish records even as equity sectors have struggled to surpass their peaks from earlier in the month. When optimism is increasing, while prices are beginning to form a pattern of lower highs, this is a classic sign that the average market participant has overly rosy expectations of future performance at a time when reducing positions would be a far more prudent course of action.

The U.S. dollar index is likely completing a major bottom virtually coincident with the October 31, 2007 meeting of the U.S. Federal Reserve. The mainstream media has propagated the absurd myth that Fed rate cuts are bearish for the U.S. dollar, whereas the historic record over the past 36 years when the greenback was delinked from gold prove that exactly the opposite is generally the case. Approximately 80% of the time, Fed rate cuts have led to a higher U.S. dollar and lower prices for gold and silver. The current all-time extreme negative sentiment toward the U.S. dollar ensures that a strong rebound in the greenback will likely continue for roughly one year, and will power the U.S. dollar index to rally above 90 from its recent low under 77.

  • Overview of Gold Mining Shares (updated in detail on October 28, 2007)
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    AS A DOUBLE TOP IS COMPLETED FOR MANY ASSET CLASSES, THE BIGGEST WORLDWIDE EQUITY/COMMODITY CORRECTION IN NEARLY SIX YEARS HAS BEGUN (October 22, 2007): The media has talked a lot about how the financial markets "keep making new highs". While this has been true for the indices which the media talks about most often, such as the S&P 500, the Dow Jones Industrial Average, and the Nasdaq, and is even more true for emerging-market indices and most commodities, there are several notable exceptions which are likely serving as a clear warning for the serious investor.

    To begin with, most U.S. domestic equity mutual funds have not surpassed their mid-July peaks. Investors who check their accounts online, or peruse their brokerage statements, are probably puzzled as to why they have not enjoyed the gains that they keep hearing about. Similarly, many broad-based domestic equity indices including the Russell 2000 (RUT), the S&P Midcap 400 (MID), and the S&P Smallcap 600 (SML), among many others, never surpassed their highs from the middle of July 2007. A double top is a classically bearish chart pattern.

    While the prices of gold and crude oil had continued to set new peaks as recently as Friday, October 19, the shares of the companies that produce these and similar commodities have struggled, especially since October 11. Very few investors probably realize that even with gold having surged to its highest point on Friday, October 19, 2007 since way back in January 1980, the high for gold mining share indices such as HUI, the Amex Index of Unhedged Gold Mining Shares, has glaringly underperformed. This index topped out at 423.16 on October 11, 2007, which was only 5.345% above its previous peak of May 11, 2006. A mediocre money-market fund would have provided a better rate of return over the same 17-month period of time, with far less volatility.

    Much more importantly, emerging-market equity indices began to rise nearly vertically in September, and have only begun to move lower during the past four trading days. Whenever any financial asset reaches the point of euphoric ascent, there are only two possible outcomes: 1) a continued euphoric ascent; or 2) a collapse. Now that the nearly vertical rise has terminated, the only realistic path is a plunge. If China's Shanghai "A" Index were to decline by 57% from last week's historic peak, it would still be above its February low, so even a half-price blue-light special for many emerging markets would not make them bargains on a fundamental basis.

    As equity indices accelerate their very recent downturn, global speculators will be selling their most strongly appreciated assets such as gold and crude oil, and likely covering their enormous profitable short positions in the U.S. dollar, in order to pay for margin calls on their other accounts--or simply to have tax gains that will be offset by their losses in financial shares, housing-related sectors, and other underperforming equity groups. The steeper that these declines become, the more widespread will be such margin calls and tax-loss selling. The time of year with the greatest tax-related adjustments (i.e., November and December) is closely approaching, so this could create a worldwide snowballing juggernaut effect that will bring down virtually all equities and commodities in its wake.

    Only the U.S. dollar and U.S. Treasuries are likely to appreciate in such a scenario, as has been the case during the first several months of every major equity/commodity correction since gold was delinked from the U.S. dollar in 1971.

    Gold "commercials" are jewelers, fabricators, and others who are most familiar with the gold market since their business is buying and selling physical gold. As a group, they have not been this heavily net short gold since the traders' commitments were first reported in modern form (which was after January 1980), according to the data at http://www.cftc.gov/ . See also http://www.softwarenorth.com/ for more than one decade of this data in easily readable chart form. The traders' commitments are released each Friday at 3:30 p.m. Eastern time. Currently, gold commercials are long 77,405 and short 316,501, for a net short position of 239,096 contracts. Each contract represents 100 troy ounces of gold. This means that once gold begins to decline, it will be a long way down.

    The biggest surprise for investors in gold mining shares will be how quickly they will return to their lows of August 16, 2007. If HUI repeats this bottom, as I suspect will likely be the case, this would represent a decline of more than 32% from its October 11 peak. Such a pullback would be merely average when compared with the previous five such corrections during the past seven years, as described in detail in the link below:

    CURRENT ASSET ALLOCATION (October 28, 2007): 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%), 4.5%; long-dated U.S. Treasuries and their funds, and long-dated municipal government bonds, including TLT and MYJ, 3%; Treasuries between 2 and 10 years in duration, such as IEI and IEF, 3.5%; TOC, 1.0% (bought at a 15% discount); gold and silver coins and related metals collectibles, 6%; other collectibles, 0.5%; cash and cash equivalents including a long position in VMSXX and in the PayPal money-market fund, 7%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, SMH, NDX, GOOG, in that order) and related shorts, 54%; short GLD, 17.5%; short GDX, 2.5%; short USO, 0.5%.

    REMINISCENCE OF THE WEEK (October 28, 2007): .

  • Best of Previous Reminiscences
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