Eagle Eye View

The concerns of this writer have escalated significantly as a result of a recent unexpected development.

The chart below (courtesy Decisionpoint.com) is a chart of the Dow Jones Industrial Average dating back to the 1920s.

Following the Great Depression of 1929 - 1932 (1930-1933 actually, but the markets were looking ahead) the Dow bottomed and started to rise strongly. By 1942, "Trendline #1" was able to be drawn in, and this trendline remained intact until 1969. It was at that point - when the trendline was penetrated on the downside - that thinking people started to worry about the 'solidity' of the world's economic structures and systems. The gold price, which was at that time fixed at $35 an ounce, became the subject of debate.

In 1970 the writer was a student at university studying for a Masters Degree, and his professor of International Finance gave him a 'courtesy' pass mark in the subject because the writer insisted on arguing that the gold price would rise - when eminent men such as Milton Friedman and Paul Samuelson (Nobel Prize winners, both of them) argued that it would not.

That was an important lesson in human behaviour in our modern society. To succeed in life, it is less important to be 'factually correct' than it is to be 'politically correct'. Substance is a necessary but not sufficient condition for success, but one cannot rise to the pinnacles of success within current organizational structures without Style. Under our current structures, it is mandatory to behave in a 'socially acceptable' manner.

At the extreme, clashes between civilizations occur when there are differences of opinion - at society level - on what is socially acceptable. For example, within Depression-era Germany (and other Axis powers) in the 1930s, it was socially acceptable to argue that 'the end justifies the means'. Britain and its Allies disagreed. That was why World War II broke out.

The War ended, the Allies won, and the world got on with the job of living - until 1969 when the first warning signal manifested in the form of the downside penetration of Trendline #1. (This broad-brush statement is not to trivialise terrible experiences like the Vietnam War but we need to focus on 'core' issues here).

Richard Nixon was president from 1969 - 1974.

He was facing the question of what should be done to protect the US economy. In the end Nixon took a decision that, rather than change the way in which the US managed its economic affairs, he would move to disempower gold as the currency of last resort. On August 15th 1971, he closed the gold window.

In the event, the gold price did in fact start to rise in 1971, and here is what has happened since (courtesy Gold-Eagle)

The gold price was sending out a warning signal that Nixon's decision had not been thought through properly. Eventually, in 1973 - following the twin impacts of the Watergate scandal and the oil crisis (see chart below) this warning was reinforced when the Dow broke down through Trendline #2.

Ultimately, the cause of the problem was that then existing world markets were becoming saturated (see chart below which shows that five of the world's Big Six economies' motor car markets had reached 90% saturation by 1975) and demand was starting to wane.

Source: New Scientist, May 1985.

Short term emphasis was placed on artificial stimulation of existing markets in order the increase consumption levels, rather than the longer term 'solution' of opening up new markets. It was around that time that the motor car manufacturers started in earnest to broaden their ranges to include sports cars, 4-wheel drives, and other 'niche market' vehicles. The economically stimulative monetary policies of the Fed also gave Toyota, Nissan and other foreign manufacturers of fuel efficient vehicles a shot in the arm.

There is insufficient space here to explain why the motor car market is being used as a proxy for 'all' markets. Suffice it to say that, after a home, a motor car is typically the average person's highest cost outlay.

For a while, because of the actions of the Fed, things looked reasonable, and the Dow rose between 1975 and 1981. But the 1,000 Dow level remained a strong barrier to 'progress'.

In 1981 a serious problem began to manifest. Concern amongst those in political power turned into 'Panic Stations' when trendline #3 looked like it might be penetrated on the downside.

At this point in the discussion, it is necessary to digress and briefly discuss the theory of a phenomenon known as "Fan Lines".

Fan Lines typically occur in threes. In the case of a market which has previously been in a Primary Bull Trend, a series of three trendlines, each with successively decreasing angles of incline, pictorially form a fan which provides technical evidence of a market that is deteriorating structurally. It has been discovered empirically over time that the third fan line is typically the critically important one. In a Bull Market, if the third fan line is penetrated on the downside the market can be expected to stop rising and can be expected begin to deteriorate in earnest as a Primary Bear Market unfolds. It's rather like the "three strikes and you're out" principle of baseball.

In 1982 - at the time of the tentative downside penetration of Trendline #3 - there was serious concern amongst political leaders within the Industrialised Nations that the world's developed economies might enter into a 1929 style melt-down. Something significantly different had to be done.

Importantly, up to that point in time, "Balancing the Budget" was still the primary Thought Paradigm of the day, notwithstanding Nixon's closing of the gold window.

What Nixon's decision had signalled was that, as between Nations, settlement of outstanding debts was considered less important by a country's leaders than full employment. By accepting Nixon's decision, world leaders were tacitly agreeing that they did not expect sovereign debts to be repaid - as long as the particular Debtor Nation behaved in a 'socially acceptable' fashion. Thus, with Latin American countries, for example, whose internal behaviour was regarded as socially unacceptable at that time, outstanding sovereign debts were expected to be repaid in full.

Importantly, notwithstanding the action of the man who came to be known as 'Tricky Dick', the concept of balancing the budget within a country's bordersremained the prevalent Thought Paradigm until 1982.

In 1982 this concept of internal budget balancing was also effectively thrown out of the window when President Reagan took a decision to turn the United States economy into a sovereign deficit oriented economy which would, in turn, drive the world economy. It is a logically unattainable ideal to seek to operate on a sovereign deficit basis for any prolonged period of time, and still balance the internal budget. There is also the issue of the $9 Trillion Government Debt which, at current long bond yields of around 5% p.a., requires around $450 billion a year in interest payments - co-incidentally roughly the amount by which the Government Debt has been rising in recent years.

Of course, even back in the 1980s it could be seen that the US could not be expected to be the engine of the World Economy forever, and so other actions needed to be taken. Essentially, these actions revolved around bringing some other potentially large economies (and their growing markets) into the global fold.

• The Iron Curtain came down, and Russia and its satellites joined the party formally
• The Bamboo Curtain came down and all of Asia was invited to join the party.

This should not have come as a surprise. If one accepted the Thought Paradigm that the world economy was/is under 'management' of a loose coalition of Central Banks , then the opening of these markets was a logical next step.

And what a party it has been!

From 1982, the Dow started to rise strongly as the United States began to live like there was no tomorrow. Credit was made freely available. Credit Cards became ubiquitous. Spectacular personal fortunes were made. Wealth spilled out beyond the US's borders and the newly opened world market participants started to sniff - and rise to - the opportunity. One unintended consequence of all this, coupled with population explosion, has been serious environmental degradation.

In about 1999 just as the new millennium came into sight, thinking people began to worry again. Typically, when market prices rise too far north of their rising trendline, stresses start to manifest and pressures start to build for prices to 'revert to the mean'.

The reader is asked to stop for a few seconds and to examine just how far from its trendline #3 the Dow Jones Industrial Index had reached in 1999. It Dow Jones was trading at more than 200% above this trendline! These same thinking people were becoming increasingly nervous and, for the second time in 25 years, the gold price spiked by way of a warning signal.

But this time it was different. This time, the gold price was rising in a vacuum, because gold was no longer 'formally' acceptable as legal tender. It took until 2002 before far-sighted investors started to argue that 'We need to ignore the fact that gold is no longer officially acceptable legal tender. We need to protect ourselves'. Gold entered a Primary Bull Market.

In essence, the Gold-Eagle web site at www.gold-eagle.com was a response to this phenomenon. It provided a forum for much thoughtful (and some mindless) discussion on the gold price, and on where it - and the world economy - might be headed. At last published count, this web site was receiving something like 1,000,000 hits a week. There are also other gold related web sites. An increasing number of people were becoming concerned about the state of the world economy.

Against this background, tensions between Nations started to grow, and views as regards what was 'socially acceptable' began to coalesce. Western Societies, by and large, had become fixated on the concepts of materialism and consumerism as being aspirational. Conservative Islamic communities were starting to question the overall relevance of this. By contrast, within some Islamic communities, the value proposition that human life is transcendentally precious was being subjugated to become less important than the so-called "Will of God". Flowing, yet again, from the proposition that the end justifies the means, violence perpetrated within and by some elements of these Islamic communities began to escalate.

These differences of opinion were far more subtle and complex than the clear cut differences that preceded World War II. As a result, there has been significant, and sometimes acrimonious debate within Western Communities as to who is 'right' and who is 'wrong'. Ultimately, those who are focussing on the West being 'right' are focussing on the transcendental value of human life, and the accompanying 'human rights'. By contrast, those who are arguing that Mr Bush and his Coalition of the Willing are wrong, are typically focussing on the fact that 'money' has become like a god in Western Society, and that we have lost the plot. Both points of view are correct in isolation. When taken together, the 'truth' is not so clear cut.

'The' recent development

Until very recently, many thinking investors (this writer included) were of the view that the Dow Jones Industrial Index could not possibly rise from here. Indeed, the argument was whether the Dow would travel sideways for many years - as it had essentially done between 1966 and 1981 - or whether a Primary Bear Market would manifest - causing the Dow to fall to its trendline at around 3,500. This 'worst case' scenario would imply a fall of some 70%, accompanied by all that this would imply.

But then the Dow broke above 12,000.

This signalled that the rules of the game have structurally changed. Technically speaking, the old trendlines are now no longer appropriate, and a new trendline has been drawn in below:

The significance of this curved trendline needs to be understood.

In simplistic terms:

If a market is rising at (say) 10% per annum compound, and this 10% is a constant rate of increase as in the above table, then a straight line trendline on logarithmic paper will be capable of representing this fact pictorially.

However, if the rate of compound growth starts to accelerate - from (say) 10% p.a. to 11% p.a. to 12% p.a. etc., then this can only be pictorially represented by a curved trendline. This particular type of trendline - a curved line drawn on logarithmic paper - is known as an exponential trendline, and it typically has very significant implications, as follows:

• Emotions within the markets have overcome reason
• The curved trendline will likely become increasingly steep over time as these emotions bubble and froth and, eventually, boil over
• The curved trendline will eventually enter a 'blow-off' stage when prices rise almost perpendicularly (hyperinflation)
• Prices will finally collapse as the dysfunctional markets collapse into disarray.

The Gold Price

Occurring hard on the heels of this break-up to new heights of the Dow Jones Industrial Index has been the break-up of both the gold price and the goldollar index on the daily charts - but this time through the third of three downward pointing trendlines that have been manifesting reducing angles of decline.

(source: Decisionpoint.com)

The fact that the goldollar index has also broken up is very significant. As this index is derived by multiplying the gold price by the dollar index, the implication is that the historical inverse relationship has been negated.

This tentatively validates that we have now entered an entirely new ball game where different Thought Paradigms will need to be applied.

Bond Yields

This writer has been observing for some months now that the markets have been 'hinting' about a potential rise in interest rates.

The chart below shows why this has been a concern, and the reader is reminded that this a monthly chart which is not 'trading' oriented. In the longer term, strategically important trends emerge slowly and this chart shows what trends 'may' be emerging:

In 1999 - the same year that 'thinking' investors caused the gold price to spike, the yield and the PMO oscillator both bottomed. Since then a 'non-confirmation' ensued between 1999 and 2003 when trendline #1 fell whilst the oscillator's trendline #2 rose. Now have a look at what happened to the gold price in 2003.

Then, between 2004 and 2006 trendline #3 fell whilst trendline #4 rose. Another non confirmation!

Of interest, even though the yield did not rise to a new height, it did penetrate the 22 year falling trendline on the upside - albeit temporarily.

And now we again have another - 'tentative' - upside breakout of the 24 year downtrend line in the 30 year yield.

Interim Conclusion

All these chart breakouts are signalling that the probabilities now favour a US economy that will increasingly careen out of control and, eventually, collapse in a heap. In turn - given that these symptoms are manifesting within the world's largest and most significant stock market - this implies that there is an increasing risk that the entire world's economic system is in danger of ultimately collapsing.

Melodramatic?

No, this interim conclusion is based on an objective assessment of the messages that the charts are signalling, albeit subtly at this time. The markets are whispering that the Fed's chickens are coming home to roost.

So what do we do about it?

It is important to understand that the closing of the gold window was not the 'cause' of anything. The closing of the gold window was symptomatic of a state of mind characterised by an aspiration of the few to wield power over the many - an aspiration to ultimately 'control' the environment and everything in it. Such an aspiration is not only arrogant, it is puerile. We need to think like mature adults here.

In principle, we need to:

1. Evolve our Thought Paradigms.
2. Move on from that which has historically worked for society but which is patently no longer working.
3. Turn the page, and start with a clean page - all the time drawing on that which has worked historically and which seems likely to work in the future.

It's a process called 'learning'.

One Thought Paradigm that needs to be modified flows from the recognition that the Western World's political/financial model has become dysfunctional. By way of example: The forthcoming US presidential elections are expected to cost candidates around a billion dollars. Hillary Rodham Clinton is positioning to raise the most money so that she can literally 'buy' the presidency by spending more on sound bite advertising and promotion than any of her adversaries.

This state of affairs is unacceptable because we are running out of time.

For the record, 2012 seems to be the deadline by which, if we have not moved with a sense of urgency to address the macro problems we will have passed the point of no return. There are two unrelated mathematical models which triangulate to this date.

What is needed is a non partisan approach to solving our problems. The time for massaging of egos has past. This disruptive farce that is the US Presidential elections cannot be allowed to deflect our focus away from the need to act urgently. There is too much at stake. There are potential solutions, some of which can be implemented more quickly and practically than others and we need to stop wasting time going down rat holes.

In the end analysis, the definition of "stupidity" is "doing the same thing over and over again and expecting a different outcome". It is this writer's view that humanity is not generally stupid. We instinctively know that we need to change, but we do not necessarily know which direction to travel.

What is needed now is non partisan leadership by leaders of integrity. It is no longer appropriate to seek play these "power games".

Our starting point will be: "Find an environmentally benign energy source to replace oil". This writer, who became a Venture Capitalist in 1987 to address this very question, believes there are at least five which are worthy of serious investigation. Others like Nuclear Fission, Bio Fuel, Wind Energy and Geothermal Energy do not pass the common sense test. Or, as our Islamic friends would easily understand, they do not pass the test of "taqwa".

Look it up, if you don't know what taqwa means.