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Time to Get Short, Part 2

Signs of a top are accumulating. Here’s survey of the market’s happy mood from Wednesday’s Financial Times (love the first line):

Irrational equanimity is back. Not only are developed market stocks back to pre-Lehman levels, but investors’ comfort levels are in a zone not seen since the eve of the credit crisis in early 2007. Apart from US stock indices, this shows up in the price investors will pay to insure against volatility, with the CBOE Vix index down to its lowest since the crisis eve of July 2007, and in sharp reductions in cash cushions held by institutions.

Merrill Lynch’s widely followed survey of fund managers released yesterday, finds that…a majority consider themselves overweight in equities, only 37 percent believe credit default risk to be “above normal” and a net 71 percent believe that corporate earnings will rise 10 per cent or more during the next 12 months. A similar survey of 100 institutional investors by Citigroup found a consensus expectation that the S&P 500 will gain some 11 percent for the year.

Elliott Wave International notes that stocks are rising but volume isn’t:

A few years ago, a question was posed to Elliott Wave International’s president Robert Prechter:

“Under the Wave Principle, what is the most important thing to watch other than price?”

Prechter answered via his monthly Elliott Wave Theorist: “Volume.”

High trading volume is a chief characteristic of a healthy trend, bullish or bearish. The DJIA has rallied for over a year now off its March 2009 low, but volume has consistently been lacking. We’ve shared our thoughts on this fact many times with our subscribers.

“Many market watchers said that the low volume in December was merely seasonal and not bearish. But volume in January has been no higher than it was from December 1 to December 22, and it is still lower than October’s, which was lower than September’s, and so on.”
– Bob Prechter, Elliott Wave Theorist, January 2010.

Even lately, low volume has persisted. Here’s what is notable, though: The market’s down days have generally been on higher volume than the up days. This could mean investors are gradually leaving the market.

For more in-depth look at volume, see Low Stock Market Volume: It’s Even Weaker Than You Think

And here’s a video from technical shop INO showing that US stocks have completed a 61.8% Fibonacci retracement, “a very very key level.”

12 thoughts on "Time to Get Short, Part 2"

  1. Bruce C. – Thanks again. I’m heartened by your last sentence.

    A couple more key issues are the following:
    1) How effective is the Fed at increasing the money supply? Many think the velocity of money into the system, in the form of credit, is very slow because bankers are reluctant to lend and borrowers are also reluctant. The last data I saw suggested that the velocity of money is slow and slowing.
    2) The money multiplier is thought by some to be a myth, and they have data to back it up. It appears that credit is created first, then the money to satisfy reserve requirements comes along later. So there has to be demand to borrow, and supply of credit, then a loan is made and the money supply goes up. The banks then create reserve, in reality or artificially – but I believe that part is less relevant to the model. No money multiplier for printed money.
    3) Have you seen the data showing that a dollar in government debt now has a negative effect on the GDP? The effect of a dollar in public debt on the economy used to be quite positive, back when we were a nation of savers and producers. But it (GDP/Debt) has been steadily declining and has turned negative recently.
    4) However, I believe they have found an effective way to increase the money supply, because bankers are more than happy to borrow cheap money and re-invest it in instruments that are, by design or in effect, being manipulated up. Someone is pushing the stock market up on low volume, and as of the last analysyis I heard about (back in January) – it wasn’t the typical buyers.

    My wrists are intact. I will now go forth and sniff out more info. Thank you again, Bruce.

  2. Duane B.,

    A couple of things you said are very relevant and can help unwind all of this.

    First of all, I’m not so sure that private debt exceeds public debt, but I also don’t see why that matters. “Private” investors can own gov. bonds – but that’s public debt. Banks can hold mortgages – but now more than ever before that’s public debt too (Fannie, Freddie, GNMAs, etc.). People can have money in savings accounts – and that’s public debt as well (backed by the FDIC). Etc.

    Secondly, I agree that credit bubbles are not sustainable, as are all bubbles, but the key issue is whether or not the dollar will be destroyed in the CBs/FED’s attempt to re-inflate/sustain the credit bubble, as wrong-headed as that may be. Some say no, that even governments have their limit and will stop before that happens, and some say yes because they don’t know their limit (remember, we’ve been in unchattered waters for several years now.), and some think that the Obama administration wants to create financial crises, fear, and confusion to justify continued government take overs. I agree that option 1 would seem the most likely to the sane, so let’s all hope that the Washington and Wall Street crowd are somehow wiser and less greedy and myopic than, say, Union bosses. (read “The Beholden State” by Steve Malanga/City Journal, at Best of the Web).

    Thirdly, the time frames can vary between one prediction and another. For instance, I can’t recall any “deflationist” who doesn’t agree that inflation will ultimately result, it’s just a question of when and degree.

    And, fourthly, both inflation and deflation can exist at the same time, and that is what I think we’re seeing now and will continue. I expect the prices of food and natural resource commodities to go up because of diminishing supply and increasing demand; and I expect the price of labor (both professional and menial) to go down because of increasing supply due to globalization and decreasing demand in Western economies.

    But don’t slit your wrists just yet, because I believe some immensely transformative changes are coming (though I’m lacking details on this) that will – or can be – immensely positive.

  3. Bruce – Thank you. I think the deflationist camp maintains that the private debt is several times higher than the public debt. Any inflation would not occur with quite the velocity of deflation during credit contraction due to the unsustainable credit bubble. We are reflating the credit bubble again, but I guess this camp feels it will necessarily contiue to deflate. So the bottom line, they say, is that wealth destruction – including credit destruction – is bigger than anything the Fed can do to inflate. If I got this right, I see two assumptions:
    1) private debt continues to be much bigger than public debt;
    2) credit bubbles are unsustainable.
    I think those things are true at least in the present tense. I know some predict deflation near term, and inflation long term.

    One problem I’ve seen is reports of inflation as well as deflation. So, I begin to think that inflation can occur simultaneouly with deflation, but one may be occurring in the total money/credit supply, but another in isolated or targeted areas. The stock market rally may be interventionary inflation.

    All of this plays a little loose with terms and definitions, and so even if it is “right”, is only as good as the preciseness of the language. I may have misstated what some deflationists are saying, but I’m trying very hard to get this one right, for the sake of my family. I will truly appreciate anything you can add or subtract from my argument, here. It’s very late, so I will spend more time thinking about what you wrote tomorrow. Thanks!

  4. Duane B.,

    Yes, I think you’re right about that, but I also think that’s an over-simplification. Consider, for example, that 45% of that dollar-denominated debt is owned by the U.S. (we’re the biggest debtor nation). Now, there are two ways to pay off that debt: increase revenue via increased GDP growth and taxation and/or devalue one’s the currency (i.e., create inflation). Economic growth in the U.S. is a huge question mark given the ever-increasing growth of government and ever-increasing globalization. Therefore, the only reliable way to pay the interest on ever-increasing debt is to continue to devalue the dollar. But things are getting increasingly dicey. For one thing, the bond holders/creditor-nations are getting ripped off by receiving diluted dollars – and they know it – so they’re starting to make some adjustments. For one thing, they’re starting to refuse to buy any more US bonds at the present terms: they want either fewer bonds or higher interest rates on those bonds. Now, they also know that forcing the US to pay higher rates will depress our economy and necessitate even more deficit spending to take up the slack, creating a vicious circle and possibly outright default, in which they would lose their principle. So, they’re starting to sell their US bonds to reduce their exposure. Doing that tends to increase the relative value of their own currency and lower the relative value of the dollar. We’re actually asking China to do this. Japan has a lot of US bonds too, but they can hardly complain given their situation. Speaking of Japan, one reason they can have the by-far highest debt-to-GDP is because so many of their gov. bonds are owned by their own citizens. It’s like a dysfunctional family affair. Well, the US is heading in that direction too: (I believe) the FED is now buying the bonds from the countries that want to reduce their dollar exposure. Having most of one’s issued bonds owned by one’s self makes the interest rate issue mute, as well as the level of debt. If I’m right about that, then interest rates may stay low seemingly regardless of how much more debt we issue because it will all happen within a house of mirrors. But, you know what they say about living in a glass house.

  5. Bruce C. – I believe the reason the dollar will reign supreme is because in the global debt contraction, most of the world’s debt being denominated in dollars, there will be a high demand for dollars to pay down debt. Does this make sense? (I ask that not like a schoolteacher, but like a schoolkid.)

  6. John,

    Thanks for looking that up. I know the FED doesn’t publish M3 anymore, so I’m getting my info from Shadowstats. I’m not a subscriber, so I’m basing my question on what he said in his latest King News interview. He said M3 was now negative (but not how or why) and that that has always preceded a recession or worsened an on-going one, so he predicts another leg down by the end of 2010 (after a few months of “sensational” job numbers due to the Census) followed by a new round of deficit spending and bailouts (because GDP will actually be negative for the year) and quickly creating HYPER-inflation. In his scenario gold and silver will be the only assets that rise in value relative to currencies and thus holds its buying power.

    Now, Martin Weiss (among some others) disagrees with this final outcome, predicting a deflationary depression like the 30’s (not much worse and with the dollar intact and as strong as ever and the gold/silver price depressed like every other asset), because the CBs will finally stop trying to overcome the deflationary forces of debt destruction.

    Only time will tell, but it would be interesting to know how and why liquidity is disappearing now, and to see if even more is generated if the economy regresses (will MBSs be bought again?, will the debt be monetized?, will the home buying rebate be deepened and extended in May?, etc.) and if that can stop the implosion.

    According to Weiss the gov/FED will capitulate and not even try, and deflation will set in. According to Williams they will try and ultimately fail, destroying the dollar in the process. The dollar is king in Weiss’s future, and toast in William’s. Gold and silver are king in William’s world, but toast in Weiss’s. (He doesn’t address the possibility of them regaining the status of money in the minds of most people and thus usurping the dollar.)

    In my opinion, considering the Obama administration’s agenda thus far, I think they’ll do whatever they can to maximize pro-Democrat votes in November, and any crisis that follows that election will be used to justify the next phase. Frankly, I’ll be shocked if the dollar reigns supreme after the dust settles. What say you?

  7. A question for any one who thinks he knows the answer: Why and how has the M3 money supply turned negative?

    1. Bruce,

      I’ve been asking around and haven’t gotten a satisfying answer yet. One possibility seems to be that the government is starting to drain funds and banks are paying back TARP money. But it’s all so opaque that, like I said, no one seems to be able to point to a line in the Z-1 Report that answers the question.

  8. I thought of another idea that I’d like to share with your readers that also pertains to this article’s theme.

    There has long been speculation that a physical shortage of silver is inevitable in the near future, if it has not already started. This is for two reasons: the annual industrial consumption, and now investor demand as well, exceeds the annual supply; and, the amount of actual physical above-ground silver exceeds the amount implied by the sum of all the paper claims, particularly by leveraged products and ETFs. If this is all true, and there is ever-increasing evidence that it is, then a physical shortage of silver is inevitable, at least at current price levels – and that is the key to what I’d like to predict. Despite the rumors or hope that the price of silver will not be brought down yet again by the major players, now that the regulatory responsibility of the CFTC is being watched, I believe that at least one more massive process of short selling must occur. I say this because it is the only way, under the already tight market, to procure the physical silver that the short sellers will need to close out their positions without taking a haircut (and possibly this time for good), AND to provide the physical silver slated for delivery by the various warehouses. The silver ETFs will be the main targets, although collateral damage will occur elsewhere as well, especially in leveraged claims. If there are enough naked technical long positions then at a low enough price point they are going to sell as they always have, and every share of, say, the SLV sold is so many ounces of silver available to the next claimant. Don’t have enough numbers to try to estimate what that price point needs to be, but considering that $14.65 was the low last time, it should be a lot lower this time.

  9. John,

    Another good article – again. Thank you. You make good points and I basically agree with you and may actually start investing/trading accordingly. However, I do still have some reservations. I think the low volume issue is very important for two reasons. For one thing, as anathema as government interference in the stock market is, it is fairly well established, and essentially confirmed by gov. officials themselves, that that is occurring. It’s all part of the circular Perception Management plan to re-start the economy. A so-called “Plush Protection Team” literally exists to assure steady stock market gains using some of the free money provided by the FED. I know you know that, but my point is that with such low volume market manipulation is relatively easy to do. It doesn’t cost much to get a lot of bang for their buck. Secondly, and related to this, is the prevalence of program trading. Not only are the PPT members able to support prices by buying the relatively few shares that may go on sale, they would mostly be buying from mindless computers. The PPT may even know what algorithms they’re using thus effectively “out thinking” them in a kind of push-me-pull-you manner. If – and this is an unknown to me – there are a lot of regular investors holding shares then, under the circumstances I just described, they would probably not have reason to sell their shares – which, ironically, makes the artificial support even easier. Obviously, if I’m at all right about these inner workings, such a system is inherently unstable, but it would take an significant exogenous event to trigger enough determined selling to cause anything more than an intra-day correction. Just a thought.

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