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WHY WAIT FOR THE ELECTIONS?

There are eight days of trading before voters head to the polls on November 2^nd to decide the outcome of the Presidential elections, but it doesn’t look like the markets will be idle waiting for the elections to pass. The recent high level of complacency in the stock market has been confirming the popular belief that the U.S. stock markets and/or the U.S. dollar won’t go down ugly before the elections. In this time leading up to the vote I’ve been asking myself if the timing is really that simple or if the markets will have a mind of their own and begin to lean in the directions that we should see post election. Financial markets are normally friendly to the incumbent administration with a little easy money to juice a stock rally and keep the money flowing for everyone. Today we are seeing the dollar take another significant hit and stocks have declined seven out of the last ten sessions. If we continue to witness declining stock prices and a falling dollar through next week, Mr. Bush will face serious headwinds on Election Day.

Wall Street is absolutely littered with executives that have no ethics and no respect for the law…only lust for more money and power. It makes me sick!! You people that cook the books and lie are disgusting and I hope you jerks get some serious jail time!! With scandal after scandal, why shouldn’t investors lose confidence…nobody knows who to believe. Even the government statistics of CPI and PPI inflation along with employment and income data are being called into question. Some of the analysts I read are saying why bother with data that doesn’t paint the true picture. In the final analysis one must conclude that this game of bullishness and confidence is showing some major cracks, and for good reason. Once confidence and hope have left the stock market, there won’t be much to hold it up as economic momentum declines and corporate earnings flatten out.

The S&P 500 is trying desperately to hold onto the 1,100 level and just yesterday I was asking myself if the Dow Industrials would hold the August low close at 9,814. When stocks broke lower this morning and the Dow declined to 9,804 it looked like I would get a quick answer, but then the index bounced higher. It looks like stocks were rescued from the fire once again. By the closing bell the S&P 500 made it back to breakeven at 1,103, the NASDAQ Composite added ten points to 1,932 and the Dow Industrials fell ten points to close at 9,886. You still have time to get out with some of the gains left from 2003.

I have been saying that the stock rally of 2003 was a counter-trend rally in a primary bear market, or from an Elliott Wave perspective it was wave two up and we are now preparing for wave three down. This next wave down should be more powerful than the first leg down that included mostly the highly overvalued dot-com and technology sectors. The upcoming decline in stocks should drag all the big-blue Dow stocks down along with the high-flying technology shares. Just look at some of the recent damage to Fannie Mae, Merck, AIG, and today a big hit to Countrywide Financial after they reported third quarter earnings down 47% because refinancing activity was greatly reduced. Countrywide shares fell $4.33 or 11.5% to close at $33.17. The Mortgage Bankers Association said today their purchase index rose 5.8% and refinancing increased by 10.6%, but it’s been too little, too late to help Countrywide today and probably the economy tomorrow.

If you take a look at the one-year daily chart for the S&P500, you can see where support was broken at 1,100 today. At best, the bulls might be able to push the index back up to the 200-dma at 1,120 before the election, but the reports out of Wall Street aren’t helping much. On the daily chart the index is below both the 50 and 200-day moving averages, momentum is declining but not oversold, and we already broke below last month’s low. Why wait around for any more of an election rally? When looking at potential risk and reward I do not see a compelling reason to stay in the stock market except for commodity related issues.

Now let’s take a look at the S&P 500 from a much broader perspective. The 15-year weekly chart also shows declining momentum just like the daily chart, and is poised to break below 50 in relative strength. You can see that the index “price” has held up better than the relative strength, but once the RSI breaks decisively below 50, the party is over. On the weekly chart please note the red neckline of the five-year-old head and shoulders pattern. The neckline was broken to the downside during the stock decline in 2002, but recovered to move back above the line. From the perspective of technical analysis, moving back above a well established neckline is a rare occurrence…it only happens about 5% of the time. While the NASDAQ crumbled, money moved into large cap stocks and the Dow was supported to stay above 10,000. After 9-11 the Dow broke below 10,000, but it didn’t really last for very long as the war rally moved the Dow back above 10,000. On this next leg down we will just have to see if money moves to the larger market cap shares, or if the money departs the stock market all together. After the elections I’m expecting the S&P 500 to fall to the neckline, get a short-term bounce, then continue the decline through 2005. I’m not very optimistic for stocks…just being realistic.

Big Daddy Deep Pockets!

Our record trade deficits and federal budget deficit have rendered the dollar fundamentally unsound. Foreign investment in the U.S. has declined consistently throughout 2004. With capital flows to the U.S. weakening, the dollar is coming under more pressure. Remember that the dollar dropped over 30% in purchasing power during the decline of 2002-2003, but it hasn’t been enough to slow down our imports which would help to correct our negative trade balance. The simple conclusion is the dollar must fall further. So far in 2004 the dollar has consolidated sideways with a trading range of roughly 87 to 93 on the U.S. Dollar Index since March. Today the dollar closed decisively below the 87 level at 86.45 which tells me this consolidation is resolving to another downside move rather than a dollar rally. I don’t believe we will get such a thing as a “synthetic short squeeze” on the dollar due to deflationary pressures…the Fed will make sure there’s enough liquidity to not allow it to happen. A stronger dollar will only make our longer-term problems even worse. With that said, the bearish scenario for the dollar is in place. Now on to gold and silver.

Most serious players in the precious metals arena follow the Commitment of Traders (COT) report that shows the position size of the so-called speculators (specs) and the commercial players. Normally, the commercials never lose in their paper gold and silver trading versus the specs. Most recently, the specs are heavily committed to the long side of the metals and the commercials are holding the short positions. When open interest reaches high levels with the specs long, the commercials dump paper and whatever physical metal is needed to force liquidation by the specs. Once the specs start falling all over themselves trying to sell, the price plummets and the commercials cover their shorts for a profit and the whole process starts over again.

Yesterday looked like a classic time when the commercials were preparing for an attack on the metals, especially silver, but it didn’t happen today…actually, quite the contrary happened. Yesterday silver closed at $7.20, up $0.21 or 3% for the day, but the silver mining stocks didn’t confirm the move. In fact, SSRI, CDE, HL, and SIL all closed lower with PAAS adding only six cents. Today silver closed another 2% higher at $7.34, and the stocks confirmed with gains in the range of 4% to 6%. The stocks are still shy to reflect the current strength in the price of silver, but they are at least considering the possibility of a commercial short squeeze. I could think of no greater justice for the commercial paper-rigging shorts!!! (Glad to see JPM hammered today.) It looks like the specs are not quite as accommodating for the commercials as they have been in the past. In this last consolidation in silver, the contracts have now moved to stronger hands that won’t be so easily intimidated by the commercials. They know the fundamentals of physical supply and demand unlike the commercials.

Now I’m just waiting for Big Daddy Deep Pockets to show up in the silver pits (gold too, but silver would be easy to corner). All we need to blow the silver market apart is someone with about a $billion to challenge the paper shorts…it could be Buffett, Gates, Soros, Saudi oil money, Russian oil money, China’s accumulation of commodities, or just good old investment demand due to a falling dollar. If the shorts want to call Big Daddy’s bluff, Big Daddy just pulls out the Big Bankroll and tells them where to deliver the metal…the COMEX is now empty! In today’s financial world a billion dollars is a drop in the bucket. Some of the big hedge funds could do the dirty all by themselves! I think there’s enough sharks in financial land to smell blood in the water. The paper shorts are cornered in silver with the price above $7.30. If the specs can keep pouring on the pressure, maybe we will get to see the commercials cover at a big loss and force the market higher. The big fly in the ointment for the commercials is the deterioration of the U.S. dollar. It’s tough to bring gold and silver down with a falling dollar. Ha-Ha!!

Many precious metals investors have been looking for a near-term pullback in the metals, and then off to higher prices after the elections and after the commercials roll the specs over. Like I said earlier regarding stock prices, will the markets really make the timing that simple for us…I don’t think so! Look at it from someone like Mr. Soros, who would rather not see Mr. Bush for a second term. What a perfect time to cram precious metals prices higher signaling added weakness to the U.S. dollar.

This could be the beginning of the next big run higher for gold and silver, but we could also see the commercials win again with some help from a firming dollar. At times like this it is important to have a solid long-term investment strategy and a good short-term trading strategy to use varying degrees of leverage in your precious metal holdings. The most common question I get when gold and silver are on the move is, “What is the best way to invest in precious metals?” I’ll be traveling next Wednesday, but will write a piece ahead of time about different ways to participate in the gains for precious metals, or think of it as a defensive strategy to protect wealth against a falling dollar. For the most part, different investment strategies in gold and silver have a great deal to do with the individual investors’ risk tolerance and use of leverage. If you want to get started in precious metals go out and buy some bullion (I have both, but prefer silver), then next week I’ll go through the trade-offs with futures contracts, bullion, mining shares (junior and senior), mutual funds, options, and more. ‘Til then…

Have a Great Evening!

Mike Hartman

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