Cole's Market Insights - June 30, 1997

Mixed Economic Signals

Reflecting a sharp drop in the transportation sector, durable goods orders dipped 0.6% in May -- weaker than expected. Manufacturing activity slowed in June for the second consecutive month, according to a survey by the American Production and Inventory Control Society. But existing home sales climbed 4.4% last month, above expectations. And consumer confidence hit its highest level since 1969.

The markets will be focusing on next week's FOMC meeting. Most in the financial community do not anticipate a rate hike, but many do project more tightening moves later this year.

The International Monetary Fund (IMF) argues the Fed will need to hike rates soon to contain budding inflationary pressures. But the central bank will be reluctant to hike rates as long as employment costs remain under control, according to leaks by "informed Fed sources."

The Fed's inaction has been a key factor behind the expansion of the stock market bubble to its present giddy heights. Having allowed the bubble to get out of control, they now have a tiger by the tail. If the FOMC hikes rates without a clear economic rationale, the central bank risks being blamed for the "premature" demise of the bull market which has enriched so many of its constituents. But continuation of the monetary status quo risks further inflation of the bubble and an even worse day of reckoning later on.

Stocks and Bonds Little Changed; August Peak Expected

Stocks and bonds came under pressure last week, but the declines were small. The Dow Industrials dipped 1.4% to 7688 and the S & P 500 slipped 1.3%. The Russell 2000 Index of small cap stocks eased just 0.27%.

With the market having lost considerable upward momentum of late, some further weakness would not be surprising, even if the FOMC stands pat. The writer anticipates a drop to Dow 7200-7400 -- depending upon what the FOMC does -- before the market embarks on its final blowoff thrust.

Gold: Moment of Maximum Pessimism?

Investor sentiment towards the gold complex now is as bearish as it has ever been. Some of the participants at the recent Financial Times Gold Conference in Prague projected that bullion would drop below $300 before bottoming. The Market Vane index of gold trader sentiment now shows just 21% of gold traders bullish. This indicator has never been lower; in the past a 30% reading was considered extreme.

Comex short selling activity has picked up massively of late. After rallying modestly early in the week when Japanese Prime Minister Hashimoto suggested his nation might sell Treasury bonds and buy gold if the U.S. does not stabilize the dollar/yen exchange rate, bullion plunged on Friday. For the week, August gold fell from $337.70 to $335.90. Market players apparently concluded that Mr. Hashimoto was not serious and wouldn't dare offend the U.S. Monetary authorities by actually buying gold.

Gold equity options activity also is signaling extreme investor pessimism. On Friday dollar Put volume almost equaled dollar Call volume -- a very unusual happenstance which typically occurs close to an impending bottom. Gold stocks continued to sell off last week, with the higher-cost South African shares again leading the way down.

And once the bottom is in, the huge short-interest virtually guarantees an explosive rally. But a longer-term reversal still depends upon a revival of investor demand. This revival is close at hand if the writer's projection of a big stock market drop this fall proves correct.

But if the myriad Wall Street seers projecting Dow 10,000 by next spring are right, investor demand for gold will remain depressed and so will gold prices. Anybody who believes the Dow will be pushing 10,000 by next spring with only modest corrections along the way, should not be in gold. And, conversely, anybody who is bullish on gold should be getting out of equities. For if the gold bear is indeed close to an end after 18 grueling months, then the bull market in stocks also is on its last legs.