Sea Change - 2

The events of the past week have served to reinforce my view that what we are witnessing is a sea change in the markets.

Here is a verbatim quote from my article last week - written and published before the Chinese market fell out of bed.

"As an aside, the 1987 crash was a foretaste of things to come. That was a "tame" example of what I believe will - one day - happen even though there are speed bumps now built in. The 1987 crash was quickly brought under control, and the speed bumps were put in place. I would recommend that serious students of the markets should go back and study those few days in 1987. When the market decides to panic, we will have several consecutive "limit down" days, but we are not there yet. We may be anything up to five years away from that point, but it could well happen sooner. The longer it takes to manifest, the more vicious it will be. The break-up of the Dow Jones Industrials [to new highs] was not a harbinger of good economic times ahead"

From a practical investment point of view, it doesn't matter whether or not the Dow Jones is entering an exponential blow-off phase (the events of the past week have not even shown as a blip on the 86 year chart below - courtesy Decisionpoint.com)

The reason it doesn't matter is that no investor in his/her right mind will have any significant proportion of his/her wealth in the industrial markets today. Flowing from an absence of fundamental underlying values, you should not be invested in the industrial markets.

Having said this, non-investment in the markets should also not lead to woulda-coulda-shoulda hand wringing if/when the markets enter their exponential blow-off phase. Regardless of whether or not this happens, I believe we are witnessing the end of an era.

The computer trading programs were built with a mind-set that was oriented towards buying. In Australia - and I assume in the rest of the world - what manifested during the recent frightening melt-down was the folly of this fundamental philosophical error: The clearing system cannot cope with sudden and large volumes of sell orders that will automatically be generated, simultaneously, by all these trading programs.

Computerised trading programs are designed for people who are ignorant - or dismissive - of the fact that there is a bigger picture. It is like the doctor who prescribes Cortisone for pain management. Yes, it takes away the pain, but it sabotages your body's mechanisms to cope with other life threatening problems - like the healing of ulcerous wounds, and it also makes your bones go brittle. The doctor doesn't care about that. It's not his problem. You came to him with a pain problem and he fixed it.

The chart below - courtesy bigcharts.com - is a graphic depiction of monthly movements in the 30 year yield.

This chart - dating back to 1994 - shows the price that the US Government has to pay on its long term borrowing. Note how it has been travelling essentially sideways for four years.

Total Debt as at 1st March 2007: $ 8,779,928,654,953.70

Total Annual Interest Bill: $411 billion

Total Debt as at September 30th 2005: $ 7,932,709,661,723.50

Difference in Debt: $ 847,218,993,230.20

Excess of annualised debt divided by annual interest: 37.5%

So, not to put too fine a point on it: The Unites States Government is borrowing itself out of contention for future impact on world affairs. It is only a matter of time before the world comes to recognise that the mighty USA has become like a Latin American Banana Republic. At that point, it will be borrowing for no other purpose than to pay interest on its borrowings.

It will eventually become obvious to a blind intellectual hunchback that this state of affairs cannot be sustained.

The word Nu? is a little Yiddish word which has such a depth of meaning that it is impossible to translate into just one English word. Roughly translated, it means, "So what the hell does all this mean and what are we going to do about it?"

There are four possible outcomes:

1. The US Federal Reserve steadfastly maintains the course it has been charting since 1917. It prints its way out of trouble. In this scenario, there will be an exponential blow-off of all markets - including the industrial markets - eventually culminating in a total collapse of the world's financial system
2. The "Markets" move to push the price of money up, flowing from the fundamental principle that 'the higher the risk you want me to take with my hard earned capital, the higher the reward I am going to demand'. If US interest rates start to rise, this will have a cascading effect on world markets and the massive debt edifice that the US Federal Reserves' policies have given rise to will implode - leading to a total collapse of the world's financial system
3. The US Federal Reserve - in conjunction and collaboration with other significant Central Banks - attempts to "manage" the interest rates so that they travel sideways for decades to come. Theoretically, this will have the effect of allowing the mountain of debt to be slowly paid down, whilst keeping the markets in limbo. The problem with this scenario is that the Oil and Coal Lobbies blocked the signing of the Kyoto protocols. This is not the statement of a "tree hugger". As it happens I do like trees. I live in the heart of an oxygen producing forest. The failure to sign the Kyoto Protocols was probably one of the most monumentally stupid political decisions in the history of humanity. Why? Because it interfered with the "drivers" of the world's economy. The ultimate driver of the world economy is "energy". Oil and Coal are yesterday's drivers and, for various reasons, neither of these should be driving the next economic era. (And nor, for that matter, should Nuclear Fission). The emergence, as an example, of GM's hybrid Electric car is a nonsense. When you plug in the car to charge its batteries, you are plugging into a coal fired electrical grid. Who do we think we are fooling here? Failure to sign the Kyoto protocols set back the emergence of replacement economic driver/s by upwards of a decade. Thus, regardless of what the Fed and its cadre of Central Bank friends try to do with the money supply and the price of that money, they will be tinkering with the grease that goes onto the wheel. The problem is that the engine to turn the wheels is worn out. It doesn't matter how much grease you apply, you will not keep those wheels turning without a motor! Result: Total (eventual) collapse of the world's financial system
4. We change our Thought Paradigms. (There are solutions!)

As an aside, a Gold Standard is facile. If we do not change our Thought Paradigms across the board, someone will find a way of circumventing a Gold Standard.

What's the probability that we will change our Thought Paradigms?

ZERO! - if we are going to allow people like Hillary Clinton to "buy" the Presidency. I mean her no disrespect, but neither she nor anyone else in the current political race is suitable to lead humanity into the next era.

Our political systems have become dysfunctional. Our starting point will be to restructure society's leadership based on "meritocracy" as opposed to "ambitious grabbing for personal power". The debate on Hillary vs Obama vs John McCain is a debate on who is the "least worst" candidate. We have outgrown such a nonsensical approach.

We can waste time debating this line of reasoning, or we can get wait for the gold price to show us the way.

The chart above - of the Gold Index - will show us the way. If it starts to scream up past the 165 level, then that will be a signal that the debate is over. It will be time to get down and dirty and start to DO something!

If the Central Banks succeed in preventing the gold price from breaking up, then the pain will linger for only a few more years. The "decades" argument is wishful thinking. We have run out of time. There are two mathematical models which triangulate to 2012 as the last year by which, if we have not changed our Thought Paradigms, the window of opportunity will have closed.

The chart above is a semi-logarithmic scale chart of the $XAU dating back to 1998 (Courtesy Stockcharts.com). The formation on the top right hand corner of this chart looks suspiciously like a flag to me. For the uninitiated, a "flag" formation represents a pause within a primary move.

The picture above is what "The Market" is saying. By contrast, the picture below - of the gold price itself - is what the Central Banks would like the market to see:

This chart is weaker than the Gold Index Chart. It shows a breakdown last August of a rising trendline, followed by a fan formation. It could be argued that the fan formation may turn out to be a Head and Shoulders top formation with two right shoulders. For the record, I don't buy that argument.

Clearly, the $XAU and the Gold Price have been out of synch! They were out of synch when, up to June 1991, share investors did not believe that the gold price was going to rise, structurally. They are out of synch again because the share investors don't believe the gold price is going to fall from here.

Unfortunately, in the long run, market forces always overpower parochial interests. The probabilities of the gold price rising to new highs - at this stage - are therefore strong. This time around, the share investors have a higher probability of being correct.

It follows, that if the guys at the Fed are dumb enough to believe that they and their associates can muster enough force to overcome the forces of Nature, then let the games begin.

It's time for arrogance to give way to humility. That's what this sea change is all about. By the time it has manifested, it will have been a humbling experience across the board. By the time it has ended, we will have embraced new Thought Paradigms.