A Historical Review of The American Gold Market - Part 3

Up to this point in the presentation the K-Wave has been explored and the conclusion reached was that the fall season has been extended well beyond historical norms. In addition, a discussion concerning what one should expect during the winter phase of the K-Wave cycle as it related to the price of gold was touch upon and the conclusion reached was whether the US economy evolves into a deflationary or hyperinflationary depression, purchasing power of the investor can be maintained through ownership of gold in the long run. Part 2 of the discussion turned attention toward technical analysis in order to see if it was possible to predict future price movements of gold based upon prior price activity starting at the conclusion of the last bull market which took place in January of 1980. It was also noted that 1980 had also coincided with the conclusion of the summer season of the 4th United States K-Wave cycle. The presentation then went on to show that from a K-Wave cycle analyst's view, the fall season of the cycle during which time commodities in general would fall in price should have concluded between the years of 1992 and 1996. Although the price of gold did rally in 1995, which many thought marked the end of the fall season, it failed to sustain the advance and continued to work itself lower. Finally it was noted in the presentation that there were some researchers at that time who took notice and began an investigation into the possibility of market manipulation which still continues today as evidence continues to surface. Now the time has come to examine what has taken place since the year 2000.

Before continuing to explore what the future may hold in store for investors of precious metals, a brief look at the US equity markets may assist in providing market researchers and investors some indications as to future economic developments. Knowing that the K-Wave winter season had been postponed, did the market activity and response by the Federal Reserve in 2000 and 2001 confirm that the fall season had ended? If so, and based upon the actions taken by both the Federal Reserve and the US government, is it now possible to reach a final conclusion as to whether or not investors should anticipate a deflationary depression or a hyperinflationary depression?

United States investors in the year 2000 suddenly came to the realization as the NASDAQ market began to fall that economic conditions may not be as healthy as many had been reporting. After briefly piercing through the 5,000 level in the first quarter, the market began to decline and by the second quarter had fallen more than 2000 points where it was able to find support (dotted blue line - rising support trend line and the solid blue line - previous highs, in the next graph). What is interesting to note is first the slope of the advance had increased dramatically from prior years indicating speculation had entered the market, and also the black dotted support line which was broken early in the correction. From an investment standpoint, once the value of the NASDAQ had broken through the black lower support line, investors should have exited the market in anticipation of a further decline. Some had, but many remained.

The next important point to be made regarding the NASDAQ was the price channel (solid red lines) which were drawn using the lows in April and May and then drawing a parallel line from the high back in March. Since the initial channel was drawn, the NASDAQ has continued to trade within this range rising up to the upper channel resistance line, and then falling lower to the lower channel support line with predictability. Looking at the chart above, it now appears that unless the NASDAQ decisively moves through the upper channel resistance line and also exceeds and holds above the high of 2328.05 set last May, there is a very high probability that it will once again begin to fall toward the lower channel support line. NASDAQ market analysts will be watching closely to see if the two prior bottoms (1 and 2) will hold on the next correction. If not, they then will look for the NASDAQ to decline sharply lower finding the next level of support between 1,250 and 1,300 points (dotted green short term support line). Based on historic PE ratios, the K-Wave winter factors, current debt levels, along with numerous other related factors, the probability strongly suggests that the NASDAQ will go much lower before it resumes a bull market posture. IMO, investors holding equities in the market should be extremely cautious at this time and be prepared for another correction to resume. It is important that investors keep in mind that if the US economy has just begun the winter phase of the K-Wave cycle, then the markets may in all likelihood continue to decline for at least 10 more years if this season proves to be deflationary.

Whereas the NASDAQ has fallen sharply since the first quarter of 2000, the DJIA refuses to follow and confirm that the US economy has entered the winter phase of the K-Wave cycle. From a market analysts perspective this would not be expected to occur. Instead, one would expect all of the equity markets to fall as deflationary pressures within the economy worsen. When one considers all the factors which strongly suggests that the US economy is struggling at this time and it has entered the K-Wave winter season, how is it that the DJIA has yet to follow the path of the NASDAQ and S&P500?

The best analogy that I can come up with is that several of the compartments on the US equities ship have been flooded and investors have transferred all their belongings into the remaining DJIA compartment in order to find security. The captain of the ship is at the same time focusing all efforts toward maintaining the integrity of the DJIA compartment - the NASDAQ and S&P 500 compartments have already taken on too much water, been abandoned, and therefore are expected to eventually fill to capacity with water. In other words, all focus is now on maintaining the integrity of the DJIA by the captain and his crew. Although the ship is sinking, there is still hope that it will remain afloat long enough to be rescued and towed to port for repairs.

Using this analogy and viewing the chart above, one would have to conclude that although moving into the DJIA has allowed for financial survival by some investors up to this point, according to the channel lines drawn the compartment is slowly taking in additional water and the pressures are building. The only question remaining is how long can the compartment remain safe, and also where will investors transfer to when, not if, the compartment begins to flood? Will investors turn toward precious metals to serve as their financial life raft, or will they not realize the danger which lies ahead and therefore go down with the ship?

According to the long term support line (dotted black line on the chart) the market is already showing weakness that all investors should take notice of. If they did not exit the market at point 1 on the chart, then when the value of the DJIA broke through the channel support line at point 2 they should have. IMO the downside risk far out ways the upside potential and support for the market to the downside will come at the levels indicated by the heavy blue lines. If these are taken out, then the market will in all likelihood decline sharply and confirm the K-Wave winter season along with the NASDAQ and S&P 500.

In conclusion, every step is being taken by the Federal Reserve and the US government in order to provide support to the economy including a tax cut, 11 interest rate cuts, and massive increases in liquidity (expansion of the money supply). Yet deflationary pressures continue to grow as the economy contracts even with all their efforts. What every investor must accept and understand is simply that the laws of economics will always prevail in the end and no amount of market intervention can prevent it from happening. Eventually the US economy is going to experience a K-Wave depression, the only question remaining is the type of depression that will evolve in the years ahead. Granted, not a pleasant thought, but one that can not be ignored if financial survival is to be achieved.

In part one of this presentation, events that investors could and should watch for were listed. At this time, all events which have either already taken place, or are in the process, are highlighted in red. It should be clearly evident to all now that the fall season is 99 percent completed and the winter phase of the K-Wave cycle has started. Take special note of the events that will still need to occur in the winter season - this insight can provide a road map for investors.

Fall Events

Stocks up, Bonds up, Commodities down
Falling raw material, commodity, and farm land prices
Global system awash in cash
Worldwide overproduction and overcapacity
Laissez-faire political posture and deregulation
Expansion by acquisition and takeovers
Record new stock offerings - IPO's
Psychological optimism for society - Roaring 1920's and 80's
Financial speculation
Greed runs wild
Global stock markets boom
Individual investors follow the herd into stocks
Final speculative stock blowoff at the end of fall
Economic growth rate slows significantly from the long wave advance
Slower capital investment pace
Economic growth slower than spring and summer
Interest rates decline
Early deflation and disinflation
Trade protection pressures build
High debt levels continue to grow throughout
Commercial and residential real estate prices peak in the late fall
Banking system weakens and failures begin

WINTER EVENTS

Stocks down, Bonds up, Commodities down
Global stock markets enter extended bear markets
New stock offerings end
Bankruptcies accelerate and high debt eliminated by bankruptcy
Recessions long and recoveries brief
Interest rates spike in early winter and then decline throughout
Economic growth slow or negative during much of the winter
Some runaway deflation and falling prices
Commercial and residential real estate prices fall
Trade conflicts worsen
Social upheaval and society becomes negative
Greed is purged from the system
Overcapacity and overproduction purged by obsolescence and failure
New technologies and inventions developed and implemented
Real estate prices find a bottom
View of the future at low ebb
Debt levels very low after defaults and bankruptcies
Banking system shaky and new one introduced
Free market system blamed and socialist solutions offered
Stock markets reach bottom and begin new bulls in winter
Bright spots appear and social mood improves
Interest rates and prices bottom
New work ethics develop since jobs are scarce
There is a clean economic slate to build on
Investors are very conservative and risk averse
A new economy begins to emerge

As is apparent from the events listed above, should the K-Wave cycle still be valid which it appears to be, then the US economy must endure several additional "events" and much more financial pain must be felt before the spring is to arrive. Unfortunately, most American citizens and investors are unaware of what is to come, yet you can rest assured that the Fed, the government, and Wall Street are all well aware of the current economic situation that sets on the horizon. The only question which remains is whether they will elect to allow for the natural course of events to take place which would be deflationary, or will they intervene and possibly over stimulate the economy thereby causing a hyperinflation to occur? Based upon their actions taken so far, it appears that they intend to intervene in the markets as it becomes necessary.

Still today as this presentation is being written, one can not say with absolute certainty which depression will eventually occur in the United States. Thus far deflationary pressures have ruled the day, although due to massive monetary expansion which has been taking place since the economy began to contract in 2000, one should not be surprised to see in the near future prices for necessities rising while at the same time the economy continues to contract further. Most will remember this economic scenario as stagflation which is the worst of all economic conditions and the most difficult to manage. To understand how markets will react under this condition, investors should review various market performances which took place in the early 1970's.

Up until the 1970's it was believed that it was impossible for an economy to have both a recession and inflation taking place at the same moment in time within an economy. Historical evidence now shows that this was not true. Is it now again possible that the US economy is headed toward stagflation and if so, what can investors anticipate will occur with the stock markets and precious metals?

So far since 2000 the Federal Reserve has been lowering interest rates in an attempt to stimulate the economy. Eleven rate cuts in one year. They have also been "pumping up" the money supply (M3) at an unbelievable rate. In December 1995, M3 was at 4625.5 billion. In December 2001, M3 had grown to 8027.0 billion - an increase of 73.5 percent or an average of 12.26 percent annually. Between December 2000 and December 2001, M3 increased just under 1 trillion dollars at an annual rate of 12.83 percent. Where did all that fiat go and why was this massive increase not showing up in the government CPI data? NASDAQ 5,000 and the DJIA 10,000 should provide the answer.

One must also remember that foreigners are currently holding billions of US Dollars which may at anytime reach or shores should the US Dollar begin to fall against other currencies. Then finally one additional point to keep in mind is that as the economy is contracting, government revenues are falling and government expenditures are rising - already the surplus is gone and deficits are mounting. Eventually the inflation will be reflected in prices for necessities and commodities such as precious metals. It is only a matter of time now before the Fed and the US government will soon be faced with stagflation. Keep in mind one of the events which was listed to occur during the winter phase. Interest rates spike in early winter and then decline throughout.

Above is a graph which shows the price performance and the K-Wave seasons for gold since 1975. As was expected the price of gold peaked in 1980 at the conclusion of the summer phase and then proceeded to decline, again as expected, during the fall phase of the cycle. This presentation has now arrived at the beginning of the winter phase of the K-Wave cycle and so far it had been shown that the US equity markets, with the exception of the DJIA have already began to respond by declining in value due to strong deflationary pressures which are more intense than the inflationary responses being provided by the Federal Reserve. Unfortunately though for precious metal investors who were anticipating a strong price move to the upside in anticipation that the fundamentals would override the deflationary pressure, the markets continue to be restrained within the boundaries of the 20+ year bear market channel. Even though there was a strong move in 1999, and most recently the gold market had put in a double bottom and rallied to just under $300.00 per ounce, the market from a technical view has yet to confirm a long term trend reversal by failing to break through and hold above the upper channel resistance shown on the graph as a dotted blue line. Therefore, even though the winter season has arrived, gold has yet to show definitively whether or not deflation or inflation will lead this economy into the next depression. Eventually the charts will provide the answer that is today still causing the disagreement between the fundamentalists and the market technical analysts. Whereas the fundamentalists say the new bull market has begun, the analysts simply state that it has yet to be confirmed. So what is an investor to think and do at this time in order to protect their assets until a final conclusion is reached? One thing for sure which is known is that whether the economy suffers from inflation, deflation, and now stagflation, investor purchasing power will be maintained until such time that the US economy recovers from a deflationary depression or a hyperinflationary collapse. Gold is the ultimate hedge against economic and political uncertainty.

• First, investors must recognize that there is a major economic adjustment taking place in the US economy.
• Second, they must understand and accept that the K-Wave cycle has begun which will result in a depression.
• Third, investors must take the time needed to understand basic charting techniques such as support and resistance, and price channels, so that they can enter or exit the various markets at the correct time in order to maximize their gains and minimize their losses.
• Fourth, investors must immediately stop listening to the media pundits, the Wall Street guru's, and instead take back control over their own investment decisions.
• Fifth, until such time that final confirmation is determined by the charts, investors must remain open minded and alert to short term market pricing movements.
• Finally, every investor must give serious consideration to diversification of their assets into gold and gold mining shares - a portfolio of 10 - 20 percent in precious metal investments is not unreasonable considering the uncertainty which lies ahead.

Part 4 of this series will take a closer look at the markets, and using short term technical analysis will discuss what price points investors should be watching for to provide them confirmation. Charts will provide investors the clues they will need to protect their assets in this unstable economic and political environment. Instead of predicting what may happen in the years to come, focus will be on what to watch for near term.