The U.S. Dollar- Déjà vu?

In late November 2009, there were only 2% bulls in the U.S. Dollar. Only 2% of traders thought the U.S. Dollar was going higher. Yet, with all the pessimism towards the Dollar and optimism towards the Euro, the Dollar took off to the upside and the Euro collapsed to new 14-year lows against the Dollar. Then on June 7, 2010, the whole picture changed. There were  98% bulls on the Dollar and 2% on the Euro. Well, here we are again. The U.S. Dollar is down to 3% bulls and the Euro is up to 97% bulls. In November 2009, everybody was talking about hyperinflation, then they "forgot" about hyperinflation in June 2010, and now they are talking about it again. These are natural investor psychology cycles that occur in markets. Everybody loves a market at a top, and everybody hates it at a bottom. The Euro is very overextended, and may be getting ready for another leg down. Meanwhile, its death talk for the U.S. Dollar again,and with Gold at all time highs, Silver at 30-year highs, many commodities soaring due to fears of diminished supply, and the U.S. Dollar at its lowest level against the Yen since 1995, fears of "QE 2" by the Fed and hyperinflation are surfacing. People are talking about how now, both good and bad news is good for stocks. They justify that thought by saying if the news is good and the economy is getting better, the stock market will do well. If the news is bad and the economy is declining, the Fed will initiate more Quantitative Easing ("QE 2") and "fix" the economy and that will be bullish for stocks. This kind of thinking is typical at a market top.  Also of late many of these markets have started all moving together in what EWI calls "All the Same Market". Gold, Silver, the Stock Market, and commodities. this also happened in 2008 when Oil had a blowoff top and collapsed 78% in 5 months. Silver looks like it could be blowing off similiar to the way Oil did. We could be at a major turn here. The rest of 2010 should be interesting, to say the least.

The Case for a Bear Market of Historic Proportion and a Deflationary Depression

There have been many signs lately that the economy is slowing at a rapid pace. The financial media is debating whether or not we will have a "double dip" recession or whether this is just a slowdown. Since the global economy has come back from the abyss, there has been a debate about what type of recovery we would have in the U.S. economy. There is talk of a "V" shaped recovery, which would be the most optimistic assessment, the Nouriel Roubini "U" shaped recovery, whereby we would see anemic growth for a number of quarters, or even a "W" shaped recovery, which would imply a "double dip" recession before the U.S. economy got back on its feet. However, I see it differently. I do not think the recovery will take any shape currently being discussed by economists, financial commentators and analysts. Rather, I believe the U.S. economy is headed for a very large bear market and a deflationary depression. I also believe that we have been in a developing depression since 2000. Most people are looking at the start of the recession as December 2007. This might make sense given that the Stock Market topped out in October 2007. However, as I have illustrated in previous posts, that was only in nominal terms. The "Real Dow", which is the Dow in terms of Gold, peaked in 1999 at 43 ounces of Gold. By the time nominal stock prices topped out in 2007, the Dow/Gold ratio had already fallen significantly from its 1999 peak, and as of today, Friday, August 6, 2010, the Dow in terms of Gold is sitting at 8.84 down 80% from its 1999 peak, as illustrated below:

In my opinion, we have been in a bear market since 2000 because the western world has completed at least a 70-year economic expansion, and in the work of Robert Prechter, a 200-year econoimc expansion dating back to the 1720's following the bursting of the South Sea Bubble in england. In Elliott Wave terms, we have completed a supercyle bull market that started at the 1932 low, and we are now set up for a deflationary collapse, as illustrated in the following Chart of  of the Dow  Jones Industrial Average dating back to the 1920's. One of the guidelines of Elliott Wave principle is that a 5-wave uptrend is complete, prices retrace back down to the previous fourth wave low, which in this case is 777 on the Dow. So, my target for a bear market low is below 800 on the Dow Jones Industrial Average. Often times mania's are completely retraced and then some, as was the case in England in the 1700's with the South Sea Bubble. That is, the bear market following a mania retraces back down to below the starting point of the mania. In my opinion the global credit bubble is no exception, and if anything it is even more severe than anything we have seen before. Therefore, using the logic the Dow should bottom below 777, the 1982 low, or even 572, which was the 1974 low. If this is a Grand Supercycle Bear Market and we undo all of the inflation since the creation of the Federal Reserve in 1913, the Dow should bottom closer to Elliott Wave International's target, below 400. a few specific support levels that Robert Prechter cites in his book At The Crest of the Tidal Wave (1995)  are  95, 161, 195 and 295 on the Dow, These targets sound extreme to most, but so did Robert Prechter's call for Dow 3,000 in the 1980's. The Dow rose more than 4 times that high!

The primary case for deflation, where Dollars gain in value, stems from the fact that the U.S. economy is a credit based system, whereby 95% of outstanding credit has been created by banks using the fractional reserve lending system. A good video to illustrate this is called "Money as Debt" and can be found on Youtube. When the U.S. Dollar was backed by Gold, a Dollar represented a promise for physical gold. However, since the U.S. has been off the Gold standard, the U.S. Dollar has simply been a promise for more promises, or dollars. Many inflationists talk of "devaluing the dollar", but the problem with that argument is that it is not valued against anything, so there is nothing to devalue. The inflation camp also makes the argument that the Fed can just monetize all the debt that is imploding, and it will cause high inflation or even hyperinflation. I make the case that the amount of outstanding credit (hundreds of trillions of Dollars including unfunded liabilities) is far greater than anything the fed would be willing to monetize, so the result is net deflation. The inflationist camp will point to Argentina or Zimbabwe to point out the mistakes the Federal Reserve is making. Rather, I think our current situation can be modeled by that of Japan in the 1990's, where Japan's central bank made monetary policy mistakes that most thought would be inflationary, yet interest rates are at historical lows and their currency is rising in a deflationary environment. This is similar to what the U.S. is going through, where short-term interest rates are at historically low levels. I make the case that the amount of outstanding credit (hundreds of trillions of Dollars including unfunded liabilities) is far greater than anything the fed would be willing to monetize, so the result is net deflation as credit is vanishing from the system at a much faster pace than the amount of new Dollars entering the system. Bank credit is also near historical lows, because banks are  hoarding cash and not willing to lend and consumers are not willing to borrow, both wanting cash (saving in the case of the consumer) more than anything else. I believe interest rates will remain low until creditors start demanding higher rates of return due to a perceived increase in default risk. At this point, as I have illustrated in a previous post  on March 25, 2010 showing monthly charts of the 10-year yield, interest rates should start rising as the bond bubble bursts. Credit should collapse even faster as higher yields force people to default on their debt. This will not be inflationary as most people associate with rising interest rates, because of the reason interest rates will be rising (default risk, not inflation risk). In fact, it will be highly deflationary. I will post monthly interest rate charts when the long-term downtrend line on interest rates is broken, whenever that may be. Deflation appears to be winning the battle, and should until the markets (stocks, commodities) make their final low and there is virtually no credit left. At that point, as Robert Prechter mentions, anything is possible, even hyperinflation if the government decides to start-up a printing press. In the meantime it is best to keep money in the safest possible cash equivalents such as short term treasury bills. The return won't be there now, but at the final bottom investors who keep their money safe now will be able to take advantage of what should be the best buying opportunity in history.

U.S. Dollar "dead" in Fall 2009, now the Euro "to go to parity" against the U.S. Dollar in June 2010

 In March of 2008, the U.S. Dollar was sitting at an all time low against the Euro, with the U.S. Dollar index sitting at 70.70. It was all over for the dollar in the eyes of most, as the percentage of traders bullish on the dollar stood at 6%. Just 6% bulls. Sentiment was so bearish on the U.S. Dollar at the time, that these quotes came out from the media (provided by Elliott Wave International):

      "The dollar is a terribly flawed currency and its days are numbered." (Wall Street Journal quote)
     "It's basically the end of a 60-year period of continuing credit expansion based on the dollar as the world's reserve currency." (George Soros at the World Economic Forum)
     "Greenback is losing Global Appeal... the 'Almighty' Dollar is Gone." (Associated Press)

Well, sentiment was so bearish, and as EWI points out, "the beliefs about a market lean so far over in one direction, that the boat investors are sitting in is about to tip over...". In other words, sellers of the U.S. Dollar were exhausted, and rather than losing its status as the world's reserve currency as most were predicting, the U.S. Dollar index took off in an explosive 27% move to the upside in just one year, from the bottom in March 2008 to the top in March 2009. By the time the Dollar topped out in March 2009, rather than forecasting the end of the Dollar, the media was closer to forecasting the end of the world with headlines such as "Dow 5,000?" and stories that talked about deflation and depression when the Dow was trading below 6,500 and bottoming, and the U.S. Dollar index was trading at 89.62 and topping. Then, in 2009, the U.S. Dollar index had a big retreat as the global economy was going through reflation,  with the buck falling over 17% from its top of 89.62 in March 2009 to its low in November 2009 of 74.17. On November 20, 2009, just six days before the dollar bottomed (and only 5 trading days), I wrote a post on this blog titled "Dollar Doomed? Not so fast." Since that time the Dollar has had yet another explosive rally, this time in the face of entire countries' credit ratings being questioned rather than just individual corporations, as was the case in 2008. The Euro has fallen the most against the Dollar, falling almost 22% against the Dollar from a high of 1.51439 in late November 2009 to a 14-year low of 1.18758 in June 2010. Now, rather than the stories of "inflation worries" heard on the media in March 2008 and November 2009, There are stories all over talking about how the Euro is heading to parity against the U.S. Dollar, as if it won't stop before it gets there. This kind of pessimism has yielded just 2-3% bulls in the Euro, and 98% bulls in the Dollar a COMPLETE change from November 2009, when there were over 95% bulls in the Euro, and just 3% bulls in the Dollar. Below is a chart showing both two extremes in the Euro, in November 2009 and June 2010.

There were inflation and death-of-the-dollar worries at the bottom of the U.S. Dollar, and deflation and depression worries at the top in the U.S. Dollar, when at each turn, just the opposite lay ahead. As Robert Prechter points out, markets always give you a story at a major turn to justify a continuation of the current trend, right before a reversal. In November 2009, everyone was giving you a reason why you should own the Euro and not the Dollar, now in June 2010 everyone is giving you reasons why you shouldn't. In the two major lows in the U.S. Dollar, the story was high inflation or even hyperinflation in the U.S., now its a breakup of the European Union and a demise of the Euro at its 14-year low against the U.S. Dollar. Now, this does NOT mean I am bearish on the U.S. Dollar. By no means am I bearish. However, it has had quite a rally and is due for a rest, just as stocks and commodities were due for a bounce. However, I do not expect this bounce in the stock market to last that long.  I am extremely bullish  on the U.S. Dollar for both fundamental and technical reasons, both of which I discuss in my November 20, 2009 post. In terms of technicals, here is one possible long term wave count on the U.S. Dollar that I show in Chart 1 below. The reason I have waves (4) and (5) in parentheses is because they are hypothetical. Regardless, I still expect the Dollar to take out its  88.71 high, and go much higher. The Dollar is in at least a cyclical bull market, if not a Secular Bull Market. This is going to depend on what down leg in the the U.S. Dollar is being corrected. If the Dollar is correcting the move down from 2000, then it should only be a 3 wave move. If it is correcting a move down on a larger degree (even possibly dating back to 1913, when the fed was created and the Dollar's  purchasing power started diminishing) it should have a MUCH larger move up to well above 120 (2000 high), in a huge short squeeze. (I also discussed the "short-dollar bubble" in my November 2009 post).

The most striking to me of the three quotes from various media sources in 2008, right at the bottom in the dollar,  is the one by George Soros, who implied that "the end of a 60-year period of continuing credit expansion based on the dollar as the world's reserve currency" would mean the end of credit expansion was inflationary was  based on flawed thinking. Let me explain my reasoning with data. The end of the credit expansion Soros was referring to was most likely an expansion in credit from the 1930's, which, indeed, has expanded at an unprecedented rate. This has led not to monetary dollar inflation as most people believe, but Credit Inflation. Most people believe that the Dollar is being devalued by the fed and as a result we will have hyperinflation and the Dollar will be worthless. The funny part about this kind of doomsday sentiment on the U.S. Dollar is that it is no different from any other market, including the Euro against the Dollar in June 2010.  I want to present the following picture: an inflation calculator from 1913. It is from a website called usinflationcalculator.com, and it will calculate how much something that cost a certain amount of money in a certain year costs now in today's dollars. This example shows that a good or service that cost $20 in 1913 now costs $440.42 in 2010, an inflation rate of 2,102%. Whenever goods are more expensive in terms of a currency (in this case the U.S. Dollar) one can tell there has been inflation in that currency (thus the value of the currency relative to other currencies, goods or services goes down). The inflation rate, over a period of 97 years, standing at over 2,100% says something. It says that all these goods and services denominated in terms of dollars have hit an extreme in price. More importantly, sentiment couldn't be more bullish on commodity prices, especially Gold and Silver, which I will also discussed in my last post. Everybody is always talking about inflation and how it is going to run rampant and the U.S. Dollar is going to zero, but there has already been a tremendous devaluation in the Dollar and inflation from 1913. Inflation is up over 2100% and the Dollar has lost more than 90% of its value. To me, this is no different from the sentiment extreme that existed in March 2008, and then again in November 2009, to cause the boat to turn so to speak, with the U.S. Dollar reversing its downtrend sharply in 2008 and again in 2010. The only difference is this is on a much larger scale, and can potentially produce a much larger move up in the U.S.Dollar.

A potential reversal in Gold

Gold Spot prices hit all time high on Monday, June 21, 2010, however Gold reversed intraday and by the of the day they were down 1.83% and closed at the low of the day at 1,232.60. Although sudden, these intraday reversals after making a multi-week, multi-month, multi-year or even all-time highs are quite common when the trend is changing. Another common element at a trend change is a fundamental story to fool investors into making the wrong decisions. In 2001 when the Bull Market in gold started, there was on fundamental reason to own Gold according to most people. People looked down upon it as a non-income producing investment, since it doesn't pay dividends. Among traders, there were only 5% bulls in gold in 2001. Now, with 95% of traders bullish, everybody loves Gold and will give a fundamental justification for why you should own it, just the same as they gave you a fundamental justification for why you shouldn't in 2001. Now, there are commercials for companies looking to "buy your gold", talking about how much the price of Gold has risen since 2001. Well my question is, why would you want to own it if it has already risen better than 5 fold since 2001? The extreme in optimism at gold's peak is normal, just like any other market. By the time Gold bottoms out, people will hate it again, remembering 2001 when there was "no reason" to own gold. I could easily be wrong about Gold, as it is a true store of value, but if the Dollar rises, which I think it will, that will hasten the decline in Gold. Although the fundamentals paint a picture for why you should own gold right now, the technicals are painting a more bearish picture, as illustrated in the attached charts, one being a daily chart and one being a weekly chart of Gold futures. Gold has completed (or is close to completing) a 5-wave Elliott Wave uptrend dating back to the beginning of its bull market in 2001. This move is impulsive and suggests that after an A-B-C correction, Gold will begin a new uptrend. However, in the mean time gold should have a fairly steep correction, perhaps retesting or breaking below its October 2008 low of 680.75. If this happens, I will view it as not only a buying opportunity for the short or intermediate term, but a long term investment opportunity. Gold is a true store of value and the only real money in the world.

The United States of America: So advanced, but have we come too far?

The technical work of Robert Prechter and Elliott Wave International, as well as other sources of technical analysis and social trends suggests this recession is not like any other we have seen before. In fact it suggests we have completed an Elliott Wave uptrend of at least 70 years, of a degree called Supercycle. In fact, we may even have completed an uptrend lasting 200 years, of Grand Supercycle degree, dating back to 1764, right before the declaration of independence and the founding of this great country in 1776. If one looks at all the advancements there have been in this country that opened the door to prosperity for so many, it is astounding. There have been terrific advancements in medicine, transportation, technology, astronomy, and human understanding of so many things. On January 27,2000, President Bill Clinton gave what could be the best report card for America in its history. Clinton began the state of the Union Address by saying "Mr. Speaker, Mr. Vice President, members of congress, honored guests, my fellow Americans: We are fortunate to be alive in this moment in history. Never before has our nation enjoyed at once, so much prosperity and social progress, with so little internal crisis, so few external threats. Never before have we had such a blessed opportunity, and therefore, such a profound obligation, to build the more perfect union of our founders dreams. We began the century with over 20 million new jobs, the fastest economic growth in more than 30 years, the lowest unemployment rates in 30 years, the lowest poverty rates in 20 years, the lowest African American and Hispanic Unemployment rates on record, the first back to back surpluses in 42 years, and next month America will achieve, the longest period of economic growth in our entire history. The Founding Fathers would have been in tears if they could be there. But did social progress go to far?

In 2000, Everything seemed perfect, the stock market was soaring to new highs, everybody was wealthy, and sentiment was at extreme optimistic levels. I would bet that if Americans were given the economic and social picture 10 years down the road, they wouldn't believe it, the same way they won't believe the forecast that Elliott Wave gives for the 10 years after the bottom of this bear market. Instead of calling Elliott Wave International Perma-bears, they will call them Perma-bulls for being so optimistic in a time of economic depression.  These extremes in optimistic sentiment at the end of an uptrend are a normal part of human social progress and suggest a correction will begin shortly. The bigger the uptrend that completes, the more extreme optimism there will be in every financial market, as well as people personalities and attitudes in general. The very extreme optimism that existed in 1999 and 2000 is to be expected considering the size of the uptrend we have completed. However, at the ultimate bottom, there will be extreme pessimism, with people possibly saying the end of the world is coming. This will be a signal that another VERY large advance in human social progress is about to begin, possibly a Grand Supercycle Bull Market lasting 200 years.

Elliott Wave analysis goes much further into depth than just stock prices. It is easy to confuse what these waves of optimism and pessimism really mean. What Elliott Wave Theory suggests is that social mood moves in waves of optimism and pessimism, and that is modeled by stock prices. If this is a Grand Supercycle Bear Market, should people be worried? No. The word I would use is people should use caution, making sure to keep their assets in safe places such as cash and gold. Deflation does not have to hurt anybody. There are safe places to keep one's wealth to be able to capitalize off of the bargains in stocks, commodities and real estate that will ultimately be there at the bottom.

Is Deflation back?

In reviewing the charts of the 10-year treasury yield, it looks as if yields could have had a fake-out move to the upside to fool everybody into thinking the bond bear market was starting. Looking at a weekly chart of the 10-year treasury yield, there is clear negative divergence present on the MACD. This is foreshadowing an upcoming environment of falling interest rates and Deflation. It looks as it though if will be some time before the fed "raises" key interest rates again. I say "raises" because the fed is often credited with lowering or raising interest rates. However, I am including in post a chart (by Elliott Wave International) of the 3-month short term treasury bill rate plotted with the Fed Funds rate that suggests otherwise. It is clear that the 3-month U.S. Treasury Bill Yield moves BEFORE the Fed Funds rate moves, and the Fed Funds rate always follows the market not leads it. The reason is, the Fed can only take the what the market will give them, just the same as investors can only buy stocks for what someone else will sell it to them for. Now one must ask the question, what makes interest rates move? The answer is the demand for, and the supply of, money and credit. As Robert Prechter, Elliott Wave International's President, said in a Bloomberg Television Interview in November 2007 "When People's borrowing needs dry up we'll, its like a sale in a store, the rates start going down, and that's the price of money, the interest rate." I did mention that I thought Interest Rates will be rising in this Bear Market, and I do, except not until later into it. Recent downtrend confirmations in global markets suggests that Deflation will hit ALL markets as Credit Contracts on a worldwide basis, very much the same as in 2008. I have said before that I do not believe the period of contracting credit is not over, but it is just starting. It looks at the moment as though the deflationary environment is returning to global markets. On a fundamental note, world markets are falling as Greece struggles with sovereign debt issues. Ultimately, it looks as though Europe is in big trouble, and by the time this is over, the Euro could be almost worthless. In the meantime, the U.S. Dollar should benefit, as it already has. But, the U.S. Dollar has been rising since November 26, 2009, BEFORE the Greece Debt problem news started surfacing. What could be the reason? I believe its because people assume the wrong premise. People think the reason the U.S. Dollar is rising is because the Euro is falling and because of the bad news out of Greece, Spain and Portugal, and not because of a strong Dollar or the technicals related to the Dollar. I beg to differ. I made a post on November 20, 2009 calling for a bottom in the Dollar. Not because of any fundamental reason, but because there was such an abundance of pessimism in the U.>S Dollar and inflation worries, that a change in psychology was due. That is exactly what happened, as it has had a nice rise since then, and I believe it has much further to go. The Dollar is strong not because it is fundamentally strong, because no fiat currency is, but it is strong due to the fact that the U.S. Dollar is the most inflated currency in the world. There is more debt denominated in U.S. Dollars than in any other currency. There is such a huge volume of dollar-denominated debt in the world that it is not possible for it to be paid off. As the debt contracts in value because it is either being paid off in part(debt settlement) or completely defaulted upon (default), the dollars are being eliminated from the global money supply. As the dollars are are being taken out of the global money supply, the remaining dollars are becoming more valuable. This is the fundamental argument by Prechter as to why to U.S. Dollar is rising in a Deflationary Environment. So, as the demand for money and credit goes down, the price, the interest rate, goes down with it. However, eventually when credit markets return to normal, and demand comes back, it will most likely exceed the supply of credit, and that is when the Bond Bear Market will start, and people will no longer trust the U.S. Government to keep its spending down, so interest rates (the return investors will demand due to a perceived increase in risk) will be rising. In the meantime, however, Deflation seems to be taking over in financial markets, so the trend for interest rates, and most likely commodities, stocks, and real estate, is down, similar to 2008. This might come as a surprise to most after many of these markets, specifically stocks and commodities, have gone up significantly in a reflationary period, convincing everybody the worst is over and a new Bull Market has started, but the reflation is most likely over. But that is what markets do: They fool the greatest number of people possible.

"What if 6 Dow stocks went to zero?"

http://www.youtube.com/watch?v=ZHdXU0Tbo9w

What if they didn't? What if instead Citigroup rallied 460%?

This was the title of a Bloomberg Television segment on March 6, 2009, the exact day of the 6,470 low in the Dow Jones Industrial Average. The video shows how little impact 6 stocks, including, GM, Citigroup,and Bank of America, falling to zero would have on the dow, which is price-weighted. This means the lower the price of the stock, the less of an impact that stocks has on the Dow. These 6 Dow Stocks falling to zero would have taken just 47 points off the Dow. This video was talking about how these stocks falling to zero would indicate much larger problems in the economy and how it would suggest the rest of the stock market would fall along with it. Yet, the day of this gloomy outlook for 6 Dow stocks, the market bottomed and geared up for a 70%+ rally. Citigroup has rallied, low to high, over 460% since its bottom on March 6. Since its low on February 20, 2009, Bank of America has rallied an amazing 685%! Now that the market has rallied over 70% since the low, you don't exactly see this type of gloomy outlook from analysts and reporters on the financial media. Everybody is ready to buy stocks again at these over-inflated prices, but they hated them at the March 2009 low. This process is a natural human psychology cycle in financial markets. Financial market participants herd with the crowd, blow up a speculative bubble, only to see it pop. Yet, when investors get out at the bottom, saying "I give up!" They won't want to get back in until a top is close, and they will naturally try to rationalize it, saying "oh well, its lower than the last time I bought it anyway." This suggests that the traditional laws of supply and demand in an economy do not apply to financial markets. Rather, it suggests that markets "herd" in a series of Elliott Waves, as discovered by Ralph Nelson Elliott in the 1930's (for more on Elliott Wave Theory, see my first post). In the market for milk and other economic markets, consumers receive a certain amount of utility that they believe is more than the oppportunity cost they incur when they trade their currency for goods. They will wait until the price comes down if it is too high to buy it. But in the market for stocks, people don't want to wait for the price to come down, but rather they want to jump on board to ride the stock market higher. Soon everybody is buying into the market until it is up 400%, with no signs of heading down. But all of a sudden, the market reverses. Then it drops lower, and lower, and lower, until the same consumer who waited for the price of milk to come down before buying it didn't do that with his stock portfolio, and lost most of the money he invested in the stock market. at the bottom, he says, " I've had enough!" and sells it, only to watch it double in price off of its extreme price low. It is quite interesting how different financial markets are from economic markets, even though if they were treated the same way people would be much better off. This does not mean, however, that if an investment starts to go against an investor he should wait until the price bottoms and starts uptrending again. He should define his objectives and risk tolerances and set a stop loss, or have a money management plan in place BEFORE investing in the first place. This, I believe, is a key element to financial success.