Cole's Market Insights - August 17, 1997

Domestic Economic News Remains Favorable; UPS Strike Continues

Reflecting the strong dollar and the continuing weakness of labor in a deregulated and globalized economic environment dominated by the corporate right, inflation pressures remain subdued. Wholesale prices fell for the seventh consecutive month in July -- down 0.1%. Consumer prices climbed a modest 0.2%.

The economy continues to expand a decent pace, but is not running away on the upside. Industrial production rose 0.2% last month, and the operating rate fell from 83.3% to 83.1%. Retail sales climbed 0.6% last to 0.7%.

On a less favorable note, productivity rose at a depressed 0.6% annual rate in the second quarter and the Labor Department's estimate of first quarter productivity growth was slashed from 2.6% to 1.4%. Many economists argue the government's productivity figures are understated.

The ongoing labor struggle at UPS promises to be a watershed event for American labor. Public opinion polls show strong public sympathy for the strikers. If the Teamsters manage to win this one, the impact on the union movement and the labor/management power relationship could be as profound as the failed PATCO strike of 1981. A significant improvement in labor's leverage versus capital would undoubtedly hike inflationary pressures, drive down the price of financial assets, and help boost the price of gold and other physical assets.

This week the markets will be focusing on Tuesday's FOMC meeting. The consensus expects no change in policy and the writer concurs.

Stock Market Peak?

This prognosticator's long standing contention that global stock market would peak in August seems to be coming true. After peaking at 8259 (closing) on August 8, the Dow Jones Industrial average had retreated 564 points (6.8%) by Friday August 16. The Dow plunged 337 points last week, with most of the loss occurring on Friday. Other leading market averages also fell sharply though generally somewhat less than the venerable Dow. The market's failure to rally Friday along with bonds was especially discouraging for the bulls. If the market has indeed discounted every possible piece of good news, both real and imagined, the trend from here can only be down.

Those trying to find a clue to bull's end by examining economic trends probably will be frustrated. The market leads the economy and not visa versa. With so many people having made so much money in mutual funds (on paper anyway) and having so much of their net worth in this asset category, the trend of causation is more likely to run from the markets to the economy rather than the other way around.

The writer is VERY BEARISH on the stock market over the next 12-18 months, but does not expect "too much too soon." Those looking for a stock market crash next week in the wake of Friday's 250 point decline probably will be disappointed. Strong support is expect at the Dow 7500 level. The two previous bull market correction during late spring 1986 and early spring 1997 both reversed after dropping approximately 10%. A rerun is expected once this drop reached 10%. One big difference though -- the prospective rally from 7500 probably will NOT MAKE A NEW HIGH. And the subsequent downturn may carry the Dow considerably below 7500, touching off heavy selling by both the public and the professionals. By October the Dow is expected to be in the 7000 area and the FIRST LEG of the looming 1997-98 bear market should be over.

Escalating Currency and Bond Market Turmoil

Mounting currency turmoil undoubtedly was a major factor behind the stock's market's sharp drop last week. A number of southeast Asian currencies have come under heavy speculative attack this summer, with Indonesia the latest casualty. The Thai economy is in a shambles and overseas lenders have pledged massive assistance.

Most European currencies also have fallen against the greenback, with the German mark hit especially hard. The Europeans undoubtedly welcomed a certain measure of currency depreciation as a stimulant to depressed economies. But things seem to have gone too far. Many expect the Bundesbank to soon hike rates in order to keep the beleaguered mark from sliding further.

After rallying strongly against most currencies in recent months, the dollar may finally be topping out. The world is awash with greenbacks and treasury debt, having accumulated enormous amounts these past few years. But everything has limits The ability of the U.S. to run huge deficits year after year in return for nothing but geeenbacks and treasury IOUs may be peaking. Some have compared this persistent overconsumption of goods and services to the tribute exacted by Rome from its overseas possessions at the height of the empire. We hear much talk in Washington about the budget deficit, but little or nothing about the far more important and UNSUSTAINABLE trade deficit.

The prospect of a reversal in the dollar bull has helped push up long-term interest rates. After falling as low as 6.24% in late July, yields on 30-year Treasuries reached 6.65% in mid-August before pulling back to 6.54% last Friday. Talk of 4.5% bond yields is no longer heard in the canyons of southern Manhattan.

Gold: A New Bull Market?

The legendary investor Sir John Templeton has opined that bull markets tend to begin at the point of maximum possible pessimism. This certainly describes the gold market in July. Analyst bearishness was at record levels. Gold and gold stocks had been falling for 18 months, while the Dow Jones averages had soared. Speculative short interest had reached record levels. Talk of $250 gold was commonplace. Rumors of huge central bank sales were rampant, especially after the Australian Reserve Bank announced it had sold most it its holdings. This concerned the market more than other central bank sales because Australia has a large gold mining industry, and the sale was carried out for portfolio management reasons -- not a national emergency of any type.

The writer has long contended that a new gold bull would begin at about the same time the financial bull ended, no matter what the central banks do or don't do. And inflation or the lack of it will be almost irrelevant.

Gold today is as extraordinarily cheap as financial assets are expensive. The Dow gold ratio now stands at around 24 -- about the same as it was before the yellow took off in the early 1970s after decades of artificial price suppression by the central banks. The Dow/gold ratio is higher now than at the 1929 stock market peak.

Note that this century's two previous gold bulls saw the yellow briefly sell at parity with the Dow Industrials during 1933 and 1980. Such extreme readings may never occur again, but there is little doubt the Dow/gold ratio is headed much lower the next few years as gold prices climb and stocks fall.

Older readers will recall that the 1987 stock crash triggered a powerful rise in the bond market. That was a signal the smart money still had confidence in U.S. paper assets and that gold would not move. Indeed the $500 1987 price has yet to be equaled. But with the world now awash in dollars and treasury securities, the odds of all three key markets -- stocks, bonds, and the dollar -- tanking together are much higher than they were then.

From a shorter-term perspective bullion does seem to be have troughed, but it is too early to be 100% positive. Although still falling short of a chart breakout, bullion has rallied modestly to $325 since its early July low of $313. A move above $330 resistance with conviction and subsequent ability to hold above this level on a reaction will provide powerful technical evidence that a new bull has begun. A move above the 100 day MA at $340 would provided additional support. Speculation about a delay in the EMU has reduced the fear of further Central Bank sales. But the key factor behind gold's improved action is concern by the "smart money" that the global paper bull is on its last legs.

Significantly, gold equities have performed quite well in recent weeks -- a very bullish signal. Gold stocks traditionally move up ahead of bullion when a bear trend is ending. The fact that the South African golds are starting to perform well is another positive signal. The South Africans always participate in genuine gold bulls. Their failure to take part in previous rallies of the North American golds was a strong signals those bounces would not last long.

With short-term gold lease having moved up sharply in recent days, it is obvious the speculative shorts are making a last ditch effort to keep the yellow from breaking out. With gold already very depressed and global financial market volatility up sharply, one suspects that profit and loss considerations are not the primary factor motivating many of these shorts. They are striving mightily to keep gold down, because they know that a strong upward move would be very bearish for global financial markets. Keeping the global bubble intact to the last possible moment seems to be their primary motivation.

Our friends at THE PRIVATEER report a very bullish development which has not been widely reported in the financial press. The Reserve Bank of India apparently has agreed to allow the importation of gold using "excess" U.S. dollars to pay the bill. They also want to introduce a parallel money system where citizens could hold deposits in either Rupees, U.S. Dollars, or gold. All would pay interest and people owning gold-denominated deposits would be able to withdraw them in actual bullion. Something for the gold shorts to think about.

UBS analyst Andy Smith has stated "there is no hope for gold" To the contrary, this writer feels there is no hope for stocks at current valuations, but the risk/reward relationship in gold and gold equities has never been better.