JAPAN, Will Drive US Interest Rates Up!

In investing, it's important to think unconventionally and creatively while considering risks -- no matter how remote or unmanageable they are -- at the same time. I keep thinking: What would drive our interest rates up in the US? China is the obvious culprit as it's the largest holder of US's fine Treasury obligations.

If China's exports to the US don't recover to the pre-Great Recession level, considering its large overcapacity and bad debt, suddenly it may not be able to buy as many of oUS bonds/bills. Or even worse, it may start selling them.

Then you start looking down the list of who's who in the ownership of oUS government debt, you'll find Japan is only slightly behind China. Japanese interest rates were circling around zero, but they still failed to stimulate the economy that's been in a recession for as long as I can remember. Japanese savings rate were very high and, thus, as government debt ballooned over last two decades, it was happily absorbed by consumers that were net savers -- they had extra funds to invest. However, Japan has one of the oldest populations in the developed world. As people get older they save less, thus the savings rate has been on a decline in Japan (The fact that their exports fell 36% didn't help their savings rate, either. To save, you need income!).

The appetite for Japanese bonds will decline in tandem with the savings rate. The Japanese government (and corporations) will have to start offering higher yields to entice interest in its bonds. Interest rates in Japan will rise, and this of course will put a significant interest-servicing burden on the already highly-leveraged Japanese government. But more importantly, (at least from the selfish US perch) Japan will finally become a formidable competitor for borrowing. US borrowing costs will rise.

Not to appear as “on another hand” economist (I'm not one), but the counter argument to this is the US consumer may become a net saver and will be able to offset declining demand from their friends across the Pacific.

Life After The Autumnal Equinox.

The closing low for the Dow Jones Industrial Average (DJIA) this year was 6547 on March 9. On September 22, the autumnal equinox, the DJIA closed at 9830 -- which represents a 50% gain from the low -- and stalled out.

The S&P 500 hit a 50% gain off its March intraday low of 666 at 999 in early August. A 50% gain off its closing low of 677 equates to 1015, or approximately a Fibonacci 0.382 retrace of the entire bear market.

Did the market hold up until the DJIA could reach its 50% mark off the low -- until quarter end, until the Autumnal Equinox?

Markets seek equilibrium. The 50% Rule is powerful -- acting as a point of balance in the markets. For example, the decline in the S&P from its 2000 peak found its low precisely 50% off that high in 2002.

The S&P attempted to turn down after hitting its 50% mark off the low with a stall out in early August and a stab down on August 17. There was no follow-through.

This period coincided with the five-month retracement after the crash low in 1929. When the fear of that analogue was broken, prices headed higher. The DJIA had a date with destiny apparently.

Both the DJIA and the S&P had dates with their respective overhead 20-month moving averages. This week, both averages returned to the scene of the crime -- the gap down from October 2008. The market reversal from that gap was dramatic, underscoring that many factors converging at this one-year cycle may very well indicate the high for the year may be in.

In addition, a daily chart of the DJIA shows a “Pinocchio” just above the upper channel of resistance. Such overthrows and subsequent violent reversals often define significant turning points.

It's possible of course that the market is undergoing some shenanigans courtesy of mutual fund gamesmanship, and that following quarter end we'll turn back up.

However, do I think there's a better-than-average likelihood that any turn-up will be a retracement and snapback -- a test toward the high? It's possible that the DJIA and S&P will mimic the pullbacks in early August and then again at the beginning of September, but I doubt it. Why? Too many square outs, the calendar, and there are three drives to the top of a channel -- just as there were prior to the correction into July. That has been the only meaningful correction since the March low. At the very least, I think the market has scored an interim high and the ensuing correction should be on par with the sell-off into July. That was just under 10% on the S&P.

In addition to the three drives to a high, the current reaction is the third knife down in the DJIA and S&P. The market often plays out in threes. With the DJIA perched on a rising trend line just above its 20-day moving average going into the week end, it's do or die for the bull thesis.

Conclusion: With the S&P quickly tagging 90 degrees down from high at 1045, the normal expectation would be for a rally attempt. The key word is attempt. There's a good possibility that we're in a downdraft that breaks 1045 more quickly than the “buy every pullback thesis” is allowing for. The bears have learned to cover all support areas when there's no follow-through.

A weekly close below 1045 puts the market in a weak position. A break below the rising trend line on the DJIA from July suggests a test of the 50-day moving average which coincides with a test of the opening range of the year.

The Weekly Swing Chart on the S&P has not turned down yet. That should be the minimum projection before taking the market's temperature. Today that level is trading under 1035. If we get acceleration after the first hour to the downside, the weekly chart could turn down.

Yesterday's follow-through was the normal expectation after the up open: After large down days, especially prominent reversal days, you don't get a reversal back up with an up open -- you need a down open by definition to carve out an upside reversal in those instances.

At the same time, most stocks pretty much hit low after the first hour and went more or less sideways after the S&P tagged 1045. A down open on Friday's morning that holds a first half hour to hour low suggests an attempt to hold today.

I think the S&P could leave a Doji or topping tail on the monthly bar, trading back to the opening range of 1018. It will be interesting then to see if it rallies then like 1978 after the initial drop into October 8. The bottom line is that the end of the first week of October sets up as a turning point. It's 90 degrees from the July 8 low and the mother of all anniversaries: the 2002 low, the 2007 high, and the October 10, 2008, internal low.

The Writing Is Already On The Wall.

After this recent 68.5% move up in the NASDAQ from the March lows, and a 47.5% rally in the Dow Jones Industrial Average (DJIA), this is the question that's on every investor's mind.

To answer it, we must look back in history to crashes comparable to the one we just experienced from the October 2007 highs to the March 2009 lows, a fall of over 50% on DJIA, NASDAQ, and the SP500. Similar periods would be the famous 1929 crash, and the crashes of 1973-74 and 1987.

The Good

In a Clint Eastwood analogy of The Good, The Bad, and The Ugly, there are no "good" crashes, only "good" bull markets that eventually follow. On that hopeful note, let's move on to the bad and the ugly.

The Bad

The 1987 crash with its comparatively modest 36% decline, while not good, was the least bad or ugly of those we'll now look at. It was of such short duration and recovered so quickly that this severe correction isn't nearly as good a "comp" to our present market as "the bad" and "the ugly" crashes of 1929, 2000, and 1974.

When we look at today's powerful 68.5% rally in the NASDAQ, the DJIA of 1974-75 comes to mind. After the DJIA crashed 44.5% between January 11, 73 and October 4, 1974, it rallied a comparable 73.5%. It’s possible that our current rally in the NASDAQ could turn out to be greater than the 1975 DJIA rally because the current NASDAQ had a much worse collapse of 55.5%.

In the past, the DJIA was the proxy for "the marketplace." Many believe that today's NASDAQ has assumed that role, and that it's the more accurate representation of today's overall economy. If that's so, when the NASDAQ finally ends its current powerful rally, we may very well see a series of corrections and rallies such as those that took place in the DJIA between 1975 and 1982, when a new secular bull market was born.

Indeed, a strong case can be made that the true high of our markets was put in with NASDAQ 2000 bubble high, and the first of the crash and rally intervals took place beginning with the crash of 2000-02. The roller coaster sequence of 2000-02 crash, 2002-07 rally, 2007-09 crash, and the current rally of 2009, may indeed be the proof that we're in such a period. Six more years of crashes and rallies doesn't bode well for those investors still faithful to the philosophy of "buy and hold."

The Ugly

When we compare the chart of our current market to that of the 1929 crash, we'll see that they're strikingly similar. The 1929 rapid 48% collapse of the DJIA in 1929, although much briefer in duration, produced a similar price pattern to that of the slow-motion crash in 2008. The total collapse of 53% from the October 2007 closing high to the March 2009 low was much worse than the 1929 crash. Our recent rally of 47.5% since March in the DJIA has been virtually identical to the five-month, 48% rally which followed the 1929 crash.

What happened after the 1929 rally was simply horrific. The DJIA quickly tanked 26%, and by July of 1932, ultimately collapsed by a total of 86%. If our current market continues to follow the 1929-32 pattern, the DJIA should move quickly back to 7200 and finally to a low of 1400 in early 2012. Should this scenario play out, "buy and hold" investors will simply be destroyed. Following the Great Depression, the DJIA didn't return to its 1929 highs until 1954. Using history as a guide, today's “buy and hold” investors who bought in 2007, can look forward to breaking even some time in 2032.

The Outlook Based On History

Ironically, today's DJIA seems to be repeating the DJIA 1929-1932 collapse, as the NASDAQ appears to be repeating the movement of the DJIA 1973-82 roller-coaster period. The conclusion to be drawn here is that we're in a bear market similar to both 1930s and 1970s; one that will be both "bad" and "ugly."

I encourage "buy and hold" investors to take full advantage of this bear market rally and protect the gains that have been achieved since the lows of March. I believe that this current rally should be considered a "gift from ALLAH," sold in order to raise cash, especially in front of October.

Imagine how investors in 1932 must have felt; having held their stock all the way down, they must certainly have looked back at the 1929-30 rally as a great opportunity lost. Simply stated, for at least several years, it's time to move away from buy-and-hold investing by buying low and selling high. Whether you're a trader or an investor, in light of the magnitude of this current rally, you need to be prepared for a potential downside reversal as we enter October -- historically the most famous month for market crashes.

The bottom line is this: The easy money has been made in this rally. I believe that we're nearing the time to "sell high," as this current rally begins to roll over into a downward move of considerable magnitude.

The caveat is this: Once you're off a galloping horse, it's very difficult to get mounted again. So be disciplined in how you begin to take profits and ultimately get short this market.

Think fast... get out now!

The Looming Trade War.

US stock markets have had a very wobbly opening last Monday as fear spreads that the Obama administration has fired the first salvo in a trade war with China.

President Barack Obama made a long-awaited decision on previous Friday about imposing sanctions on China over alleged"dumping"of low-cost tires on the American market. Obama sided with trade unions and imposed stiff duties on $1.8 billion worth of Chinese tire imports.

The United Steelworkers brought the case against China back in April, claiming that more than 5,000 tire workers had lost their jobs since 2004 because of cheap Chinese tires flooding the US market.

Obama's order raises tariffs on Chinese tires for three years -- by 35% in the first year, 30% the second, and 25% the third.

The Chinese government hit back fast, and on many fronts.

On Sunday, Beijing announced it would investigate complaints that American auto and chicken products are being dumped in China or that they benefit from subsidies. China says the US imports have "dealt a blow to domestic industries" and you can be sure Beijing won't have much trouble arguing that US farmers and automakers are heavily subsidized.

On Monday, Beijing escalated its action with a complaint to the World Trade Organization (WTO). The Chinese complaint in Geneva triggers a 60-day process in which the two sides will try to resolve the dispute through negotiations. If that fails, China can request a WTO panel to investigate and rule on the case.

With unusually swift and coordinated action, the official Xinhua new agency quoted the government as saying, "China believes that the action by the US, which runs counter to elevant WTO rules, is a wrong practice abusing trade remedies."

So far, it's a trade spat, not a war. But it's an irritant as Washington and Beijing prepare for a summit of the Group Of 20 leading economies in Pittsburgh on Sept. 24. Obama is set to visit Beijing in November, and his reception could be very frosty.

Amazingly, American tire companies had begged the president not to go ahead with sanctions against China. "By taking this unprecedented action, the Obama administration is now at odds with its own public statements about refraining from increasing tariffs" said Vic DeIorio, executive vice president of GITI Tire in the US. "This decision will cost many more American jobs than it will create." GITI Tire is the largest Chinese tire maker, and a US retailer of low-cost imports.

Although investors are not yet facing World War III between the two economic superpowers, it's enough to make the markets very nervous. The Chinese ADR Index tumbled heavily at the markets' opening, but recovered swiftly as cooler heads prevailed.

Alarmists are worried that China, which holds about a trillion dollars worth of US financial instruments, could declare a real economic war. The tools Beijing could use are worrisome. China could: -

1. Sell dollars it holds faster than it already is

2. Not buy at the treasury auctions in the near future

It's a little too early for China to exercise the nuclear option in this trade dispute, but the events have spread fear in otherwise buoyant markets. Investors in US stocks should exercise caution and consider diversification as worries about the US dollar's devaluation, inflation, and trade wars continue to loom.

Holders of Chinese ADRs should ride out this rough period if they're confident that the shares they hold are from companies which continue to grow profits by double digits.

And, more importantly, they shouldn't be invested in companies dependent on foreign exports.

Is The S&P Finally Burning Out?

If you look at a chart of the last decade as shown above, there were two tops toward 1600 S&P that were toppled -- quickly.

At the highs, few were looking for the things to change so abruptly. Few identified the lows. Much of the Street is now convinced that it's 2003 all over again while you could hardly find a bull in March of 2003.

The bullishness is so ripe that you'd think we'd captured at least 50% of the decline. In fact the popular averages haven't even revisited the scene of the crime from one year ago. Rather they're exactly where they were eight years ago after the bounce, après le deluge, on the close of September 2001, 1040.

The market has a memory. The bears are haunted by the specter that it may be 2003 all over again. If it is, the bulls may be ahead of themselves. Why?

Well the first leg up off the March 2003 low was 374 points. A similar 374 points added to the March 2009 low gives 1040. As you know from the Square of Nine Chart shown on 11/9/09, 1044/1045 "vibrates" off the date of the March 6 low and opposite the current time period

Usually new high recovery weeks end with the indices closing on the high of the week. It they don't close at/near the highs of the week, it may be indicative that the market is burned out. But the S&P needs to break and close below its 20-day moving average and follow through to confirm the significance of 1044 .

The market has a memory. The S&P could still kiss the 1050 level, but as the monthly chart shows, risk is high with 1056 equating to a Fibonacci 38.2% retrace from the 1987 crash low.

Many of you familiar with these reports know that the Thursday the week before options expiration is what I call Misdirection Day. The Thursday the week before options expiration is when the new SP futures are rolled out (in this case December) and often the arbitrageurs want to catch the Street long and wrong. The bottom line is that if the market is up nicely the Thursday before options expiration, it often indicates a strong downside bias into expiration on Friday of the following week. Consequently, selling pressure that breaks above mentioned support levels should be respected.

In addition, drawing a Live Angle from the high in 2000 and the test high in September 2000 through the Low before the High going into the July 2007 high comes in at current levels as well in the S&P.

I suspected that a test of the 950 level is in the cards.

Wats Affecting Your Trading ?

Have you thought about your friends lately? Who do you closely associate with? It's understandable that we find connections with those who resonate with our belief structure, reiterate our passions, and enhance our strengths. Having a badminton-buddy or a health-club partner who likes what you like is a good way to spend time.

So, how do our chosen associations help with our outlook toward the markets? I wanted to talk about this very important factor that seriously affects trading but ironically is often relegated to the recesses -- behind fundamental and technical analysis, entry and exit techniques, stop losses, and so forth. It's far easier to share a chart of some index or discuss a stock. So why spend any time and effort on talking about the company you keep?

Well, how about the fact that it affects your macro biases toward the market, shapes your view about the trades you make, and has more lasting influence on your portfolio than one stock or index chart?

These subtle yet powerful associations are so because human beings are vulnerable to other people's emotions. And that vulnerability is especially important if their beliefs resonate with us. This is summed up eloquently in a quote from an article called Emotional Rescue: “Although human emotions don't spread like colds, they are contagious.”

If our bias is bullish, we'll keep flicking through channels until we find someone who tells us what we want to hear -- that the market is going much higher and it's advisable to put all your money in it. If we have a bearish bent, we'll scout through websites and bookmark those that enforce our already bearish beliefs, and back them with evidence we like. Even if dissenting thoughts crop up, we let them gather dust and take solace in the factual data that supports our original thesis.

Bertrand Russell said: “If a man is offered a fact which goes against his instincts, he will scrutinize it closely, and unless the evidence is overwhelming, he will refuse to believe it. If, on the other hand, he is offered something which affords a reason for acting in accordance to his instincts, he will accept it even on the slightest evidence.”

The irony is that in this age of information, the thing most abundantly available is (you guessed it!) information. There are numerous blogs backing your personal thesis. No matter what we believe in, we'll find evidence to back it. And in the markets, staunchly holding on to any one thing can lead to calamity.

For this reason, I often suggest investors stroll out of their comfort zones and add a few dissenters to their trusted friends via websites that offer opposing views, keeping in mind that you don't have to swing the pendulum all the way. Even if the opposing views are aggravating to listen to and can turn out to be wrong, they often add depth to our perspective since we have to defend our original views.

Dissenters can give us the greatest gift of all: an open mind. This is the prerequisite for a flexible approach toward investing. As Thomas Dewar stated: “Minds are like parachutes. They only function when they are open.”

Kalama Sutra - Angutarra Nikaya 3.65

Teaching given by the Boot-der given to the Kalama people:

Do not go by revelation;

Do not go by tradition;

Do not go by hearsay;

Do not go on the authority of sacred texts;

Do not go on the grounds of pure logic;

Do not go by a view that seems rational;

Do not go by reflecting on mere appearances;

Do not go along with a considered view because you agree with it;

Do not go along on the grounds that the person is competent;

Do not go along because [thinking] 'the recluse is our teacher'.

Kalamas, when you yourselves know: 'These things are unwholesome, these things are blameworthy; these things are censured by the wise; and when undertaken and observed, these things lead to harm and ill, abandon them...Kalamas, when you know for yourselves: These are wholesome; these things are not blameworthy; these things are praised by the wise; undertaken and observed, these things lead to benefit and happiness, having undertaken them, abide in them.

Do You Remember.. The Twenty-First Night Of September..?

It was a blockbuster summer for the bulls on Wall Street. But September is historically the market's worst-performing month, and already we've begun to see some sharp pullbacks. Interestingly enough, on the flip side of the coin, September is historically the best month for gold.

I mentioned buying precious metals mining stocks two weeks ago. If you did, you'd have made about 14% profit so far if you diversified in many stocks (HUI Index), and about 19% if you put your money in the top 3 stocks that my leverage calculator suggests as a speculative proxy for gold.

The price of gold has risen in 16 of the 20 Septembers since 1989. And since this September began, we've already seen some tangible proof as the yellow metal makes new forays toward quadruple digits.

At the moment, gold is on course for its biggest weekly gain since late April.

While September is a good month for gold, it's historically a great month for gold stocks as measured by the NYSE Arca Gold Miners Index. After the typically weak summer months, the gold miners start to perk. Since 1993 when it was created, the GDM has been up 11 times in September and down just five times.

September is also historically a miserable month for the US Dollar -- a bullish sign for gold since gold trades at an inverse relationship to the dollar (more on that later). Looking back 39 Septembers going back to 1970, the dollar has seen negative performance 26 times -- more than any other month of the year.

So what's behind this predictable September pattern as far as gold goes? Several gold-demand drivers converge all at the same time this month.

-The post-monsoon wedding season begins in India.
-The Indian festival season begins.
-American jewelers begin restocking in advance of Christmas.
-Ramadan ends in late September in the Muslim world with a period of celebration and gift-

giving.
-And, in China, the week-long National Day celebration starts October 1. Already in China, gold jewelry demand increased 6% in the second quarter.

While just about everyone in the world is getting ready to celebrate, the price of gold (charts courtesy of stockcharts.com) is getting ready to perform its own celebration dance.

We've just seen a significant breakout from the gold triangle pattern to which I'd referred in the past. The move took place on a very strong volume. This is exactly the type of confirmation I like to see in a breakout.

The RSI Indicator -- proven to be a very valuable tool in timing the gold market local tops -- suggests that gold may need to take a breather before moving higher. Should that be the case, the most probable scenario is a test of the upper border of the triangle pattern.

Still, in the short term, prices may rise a little higher before correcting.

Analysis of the short-term chart suggests that although prices have risen high and fast, this may not be the end of this rally. First of all, the volume isn't low. It was lower on Friday than during the previous two days, but it's still considerably higher than the average during the past few months. Low volume would indicate that the buying power has dried up and price is ready to plunge. I don't see this yet.

Also, when we take a closer look at what happened at the end of May. The RSI was very close to the 70 level in the fourth week of the month, but the price pulled back only for two days and then rallied further. While I can't say for sure that this will happen here, I can say that there are no clear signs of a top yet.

Moreover, taking into account the 1.618 ratio that's also very useful in predicting the range of future price moves, we might expect the GLD ETF to reach levels marked with a red rectangle. This would correspond to gold breaking above $1,000. Should this move materialize, I'd expect it to be volatile.

Gold and gold stocks move together most of the time (what's confirmed by high correlation coefficient values between gold and HUI in the correlations table), so we can say something about gold by analyzing the performance of gold stocks -- here, via the Gold Miners Bullish Percent Index (a market breadth/momentum indicator that's calculated by dividing two numbers: the amount of gold stocks on the buy signal (according to the point and figure chart) and the amount of all the gold stocks in the sector).

The GMBPI itself is currently trading at the overbought levels that in the past, sometimes meant that a top is in. However, that's only part of the story.

Please remember that if during the second half of May 2009 an investor hastily acted solely on the popular use of the RSI that says to sell once it gets above the 70 level, he'd have missed a $50 move in the HUI Index.

It's usually a good idea to put every indicator/tool into the proper perspective before acting on it. Keep in mind that the people who design an indicator want it to work in many markets and usually don't fine-tune it for a particular market. Investors need to make the appropriate adjustments themselves.

Here, when you consider the local tops that materialized when both the RSI and William's %R indicators were in the overbought territory, it becomes clear that these tops didn't form immediately after the overbought levels were reached. Conversely, the HUI's value usually moved higher for several days/weeks before topping. I've marked with vertical, dashed lines each time gold stocks took their time before reacting to the “overbought-sell-now signal."

So, even though the probability of a correction increases, it doesn't mean that it will take place very soon.

Summing up, your approach should depend on your investment perspective and risk preferences. The trend is up for the PMs, but there are a few signs that some kind of breather is likely. This doesn't need to take place instantly, so the question is whether or not to hold your positions in this market.

The fundamentals haven't changed, so I don’t think that selling one’s long-term PM investments is a good idea right now, however the short-term speculative capital is another matter. If you're risk-averse, I'd suggest exiting at least a part of your speculative positions right now, and re-entering during a consolidation. Those of you who accept high risk in order to reap the biggest gains may want to wait for PMs to move a little higher (to levels mentioned above) before closing your speculative positions.

" Ba-de-ya.., dancing in September..

Ba-de-ya.., never was a cloudy day.."

Staying LONG On SPDR Gold Trust ETF (GLD).

While I keep GLD (or SPDR Gold Trust ETF) on my radar at all times, it became actionable on September 2, when it broke out of the triangle formulation.

As you noticed, it's close to an important resistance level, so I would expect some pullback. As long as it's on minor volume and contained at the recent breakout level, it should be considered as a welcomed pullback.

The current stops are at a close below $92.5 (the bottom of the triangle, just below the confluence of 10-, 20-, and 50-day moving averages)

However, I wouldn't short it, expecting such a pullback -- although I have trimmed some of my position in an effort to add to it if it comes lower.

The reason is that gold's coming out of a tight volatility squeeze and the Bollinger Bands have just begun expanding and might signify higher prices ahead. Here's the chart (all my attempts to simplify it have been somewhat limited). That's a different picture from the moves in February and April of this year.

So, recapping, as long as it doesn't violate important technical levels on the downside on heavy volume, I'll continue to play this on the long side. As per the technical targets, let's visit them if it actually breaks out beyond the 2009 highs.

When Shanghai Cracks.

The Chinese Shanghai Composite Index has now recorded four consecutive down-weeks. The Index witnessed another massive sell-off on Monday, declining by a further 6.7% to take its total loss since the peak of August 4 to 23.2%.

The losses happened on concerns of large Chinese share issuance and slowing bank lending. The banking regulator has already instructed lenders to raise reserves to 150% of their non-performing loans by the end of this year -- up from 134.8% at the end of June -- and the central bank has increased money-market rates to drain liquidity.

China, could be the catalyst for triggering a reversal of fortune in global stock markets.

Of the global stock markets I monitor, the Shanghai Composite (2,667) is the only one to have breached its 50-day moving average (3,125) and now has the key 200-day line (2,476) firmly in its sight.

Interestingly, emerging markets have now seen two back-to-back weeks of declines and have been underperforming developed markets for four weeks running, as shown by the declining trend of the MSCI Emerging Markets Index relative to the Dow Jones World Index. Could this be a sign of a broad retrenchment in risk appetite?

A global stock market correction could take the form of either a pullback or a consolidation (i.e. ranging). I suspect we may see at least some degree of reversion to the 200-day moving averages in a number of instances, but I'll be watching closely to ascertain whether we're dealing with a normal short-term correction or a more significant move threatening the primary trend. In the meantime, sit tight and be cautious as markets hopefully realign with the reality on the ground.