Yen Carry Trade May Return.

Japan had lost the race to the bottom against the US. " Ben, Ben, he’s our man / if he can’t print ‘em / no one can! "

As the risk of yen revaluation in deflationary Japan exceeded the risk of dollar inflation in the US -- where the Fed declared its intentions to have inflation rise and then abjured responsibility for inflation when it did rise and as Japan’s customers were forced into “must-do” trades for buying the YEN to pay their Japanese suppliers -- why would anyone take the risk of borrowing the yen when they could borrow the dollar instead?

Now the US is faced with the situation where the G-7 central banks have arrested the upward spike in the yen threatened after the country’s disasters and affirmed the old highs just under 80 as resistance. The net result of this move is a global borrower can now borrow the yen without fear of further revaluation!

The Dollar Carry Into the Yen

If we turn the trade around and look at the two components of the dollar carry into the yen, the interest rates spread and the spot rate return, we can see just how meaningless the interest rate component has been since the US went to a zero interest rate policy in December 2008. The spot rate return on borrowing the dollar and lending the yen has moved higher as Japan has been unable to break away from its deflationary miasma while the Federal Reserve has convinced investors the US will, one day, defeat the deflation that never existed.

Reviving the Yen Carry Trade

If the US does adopt an exit strategy from QE2 and the dollar becomes more expensive to borrow while the yen is not at risk of running away to the upside, the wider interest rate gap between the US and Japan will make Japan the preferred funding source once again. As noted last November, this has not been the case since the financial crisis; we can match the carry return of the dollar into a basket of emerging market currencies quite closely, but the yen carry trade has been irrelevant.

Where does this lead? If the dollar carry seized the baton from the yen carry trade and allowed all manner of emerging market assets to shoot higher in 2009 and most of 2010, then the yen carry trade can return the favor and finance the US should the Federal Reserve adopt an exit strategy. US would tighten; they would un-tighten for the US.

That would be quite bullish for US financial assets should events unfold this way.

The USD Endgame.

The dollar came under extreme pressure again. I expected it to happen in the March. Many people thought I was nuts. They were sure it was the euro that would collapse, despite the fact that the EU is doing everything it can to protect its currency while Fed Chairman Ben Bernanke is doing everything he can to destroy the USD.

On Friday the last confirmation occurred to signal the final collapse is now underway. On Friday the November yearly cycle low was violated. Cyclically this event is a major catastrophe.

We are now going to see the dollar get absolutely hammered for the next couple of months. The viability of the dollar as a currency will be questioned. There is a decent chance it may start to lose its status as the world's reserve currency. (Coincidentally, about the time everyone becomes convinced the dollar is going to hyper inflate will be the point where the three-year cycle low will bottom and we will see an explosive rally, along the same lines as what happened in the latter half 2008.)

This is what all the top pickers in gold and silver fail to understand. They are all trying to call a top based on charts without any understanding of what is happening to the currency.

In a currency collapse the market will flee into assets that will retain their purchasing power. Four weeks ago we went past the point of the stock market being able to protect one from Bernanke's printing press any longer. So buying stocks as a protection is no longer a viable solution.

Four weeks ago spiking inflation rose to the point where profit margins are now being hit. Bernanke will no longer be able to prop up the stock market by further debasing of the currency. Stocks have now decoupled from their inverse correlation with the dollar and will now follow the dollar down.

The more Bernanke prints and the faster the dollar collapses, the faster the stock market is going to fall... and the quicker the economy is going to roll over into the next recession.

What will happen is that liquidity will rush into the commodity markets as the only true protection against the accelerating currency crisis.

This is why one has to ignore the top pickers. Overbought oscillators and stretched conditions are meaningless in a currency collapse. This is all about fundamentals. It's about protecting your purchasing power. You can't do that by exiting the one sector fundamentally best suited to protect you during this storm, which is precious metals.

Now isn't the time to be selling your gold, silver, or mining stocks, it’s time to be buying more.

Could This Be A Technical Case for a Continuing Bull Run ?

Many key stocks are now testing their 200-day moving averages bottoming out, or is their behavior the sign of the bear?

Is this a pause to refresh and just another correction or the start of something more pernicious?

Market history reflects that deep corrections in bull trends such as what occurred from the April top into July 1 are seldom followed up by similar deep corrections over the next 12 months or so.

Consequently, if another deep correction plays out, it will signal a bigger picutre bear market, not a continued new bull market.

And this correction is deeper so far than the November correction. The percentage of NYSE stocks below their 50-day moving averages shows that the percentage of stocks ABOVE their 50 dma’s is just 40%. Put another way, more than half of NYSE stocks are below their 50 dma’s - below the November correction threshold.

Does this "overbalance" of the reading from November indicate a change in trend?

At the same time when 50% or more of stocks hit new 20-day lows, a snapback often times plays out. This occurred on last Wednesday. The snapback came in on cue.

With the S&P tagging the levels where the year opened on Wednesday, it was a likely place for a rally attempt to play out. However, with the average portfolio as reflected by the NYSE percentage above the 50 dma probably below water for the year now, will the animal spirits be able to generate traction?

Previously I thought that a snapback attempt would stick and not to be too eager to short into it and that trade over initial resistance near 1272 implied a run to second resistance near 1290.

The Daily Swing Chart above has not turned up and will eventually. If a higher open on Monday will trace out the first Minus One/Plus Two Sell pattern since the S&P stabbed below its 50 dma. Why? Because the 3 Day Chart is down and two consecutive higher lows assuming we get that Monday will carve out the Plus Two part of the setup.

This will coincide with a backtest of the 50 dma setting up a solid risk to reward short.

Even if the market is tracing out another bullish correction, I think there should be one more move down below Wednesday’s low, likely to 1235ish.

Last week, a friend sent me a chart of the S&P with the following Elliott Wave labeling. Note that another hit at the top of the channel comes in at 1400.

Recently, I mentioned that 1401 is opposite February 18. If the S&P should extend to 1401 following the current correction, it will be squaring out the February 18 high.

The above Square of 9 Chart shows that 1254 is 180 degrees down from the 1344 high. On Wednesdays surge lower, the S&P tagged 1249 intraday, closing at 1254. It is possible that this marks the low of the correction, but the level should be tested or undercut, possibly to 1235. If this is a correction in a bull market then as The Wheel shows 360 degrees up from Wednesday’s low equates with 1400 which ties to the upper end of a daily S&P channel.

Strategy: It looks like we’re in a big "B" wave up, with a big "C" wave decline to come, so I would not be long over the weekend. A decline below 1254 suggests an extension to at least 1235.

Mirroring The Crash In 1987.

Debt is a drug that was sanctioned by the Bretton Woods Agreement in July 1944.

The question is, if a tree is felled in the forest for the purpose of printing more dollars, does anyone hear it if they’re not in the forest?

I think it is fair to say that in denseness of the world currency system, it is next to impossible to tell the trees from the forest.

On August 15, 1971, the US unilaterally terminated convertibility of the dollar to gold. As a result, the Bretton Woods Agreement was de facto ended.

The US dollar became the sole backing of currencies and the reserve currency for member states.

The thing is that fiat monies seldom last more than 40 years. 2011 is the 40th year since Nixon tuned the US dollar into a fiat currency.

Forty days and 40 nights in the desert, the biblical day for a year?

The Fed probably relishes all the talk of deflation mongering while it is printing with both hands as the chatter holds down long-term interest rates.

But, how long will it be until the bond and stock markets begin to discount a disaster of compounding?

What I mean by that is the interest on the US national debt is now around $375 billion annually. In 2020 interest costs will double to $750 billion annually. That assumes interest rates will stay in this vicinity. That is a huge and inordinate chunk of a $14 trillion GDP. US'S creditors will probably want higher interest to make up for the increasing risk as the compounding goes on.

I can’t help but wonder if the quake in Japan will bring things to a head sooner rather than later with the Bank of Japan (BOJ) failing to show at one of US's bond auctions.

This is at a time when the dollar is already under pressure which is underscored by the recent fact that it has not responded to its traditional role as a safe haven. The US dollar seems to have lost its grip on its status as the world reserve currency given its poor price action since the unrest in the Midle East.

Moreover, there may be a huge amount of Japanese liquidation going into their fiscal year end at the end of March. If so, the Street could be caught short puts and long stocks on this "pullback opportunity" -- just like they were during the October expiration in 1987 and ensuing crash. Tuesday should be the tell if they are for sale for expiration: I would watch the big heavyweights, which were pretty much all to the downside except for Apple on Monday. If they don’t rally on Tuesday, the market is vulnerable into Friday. As offered last week, the bulls could experience a blood bath.

Monday was an important day because the Monthly Swing Chart on the S&P turned down. This is only the fourth time it has turned down since the low in March 2009. The behavior from this turndown will be important to observe. The normal expectation when a big wheel of time such as the monthly turns down is for a snapback rally over the next few days in keeping with the Principle of Reflexivity. That snapback attempt may have begun yesterday with the market recovering roughly half its losses. Maybe. Again if the expiration is for sale, all bets are off.

There is a good excuse technically for the S&P to attempt a one- to three-day rally however. The S&P satisfied a measured move at 1282 on Monday. The first move down off the 1344 high was 50 points while a similar 50 point decline off the last swing high (1332 on March 1) equates to 1282. However, 180 degrees down in price from the 1344 high is 1272 which has not yet been satisfied. A down open on Tuesday which tests toward this level could set up a reversal.

That being said the defense team is on the field. There is a lot going on out there besides the fact that the technical condition of the market is in a weak position: The S&P has closed below its 50 dma for the first time since the September 2010 kickoff. The index has also snapped a rising trendline from those lows. So, let’s keep it simple and try not to second-guess things. Surprises happen in the direction of the trend. The problem is that there is always a primary trend and a secondary trend working concurrently like twin strands of DNA. The secondary trend may have broken but the primary trend may still be intact.

The behavior this week following the turndown in the monthly chart will tell us something about the nature of the intermediate trend and the position of the market.

Let’s take a look at the prior instances where the monthly chart on the S&P turned down since the March ’09 low. The first turn down occurred in July ’09. The S&P turned right back up leaving a bullish outside up monthly bar. The first turndown in the big monthly chart found low almost immediately and turned back up vigorously signaling that the market’s agenda was higher. The next turn down of the monthly chart occurred in January 2010. The correction carved out the first Plus One/Minus Two buy set up since the low. Why? The move into February 2010 was the first pattern of 2 consecutive lower monthly lows since the March ’09 low.

Once again the market rallied vigorously into April 2010. From there the Monthly Swing Chart turned down again. However, the action was conspicuously bearish with the S&P accelerating to the downside on the monthly turndown. Another Plus One/Minus Two set up played out on two consecutive lower lows into June. However, the S&P made a slight new low on the first trading day of the new month, July, which carved out an important pattern: The lower low in July left three consecutive monthly lows for the first time since the March ’09 low. The Three Month Chart had turned down. The S&P rallied off the set up but the first turn-up of the monthly in August defined a high suggesting the position of the market was bearish. However, significantly, the S&P never turned its monthly back down. The monthly low remained the July low near 1010 S&P and has remained up -- until Monday.

Note that the move up from March ’09 to the April 2010 top was 13 months with the turn down coming on the 14th month. From the turn-up in August 2010 following the July 2010 low the S&P ran up seven months.

Typically, these six- to seven-month and 13- to 14-month counts are critical to keep count of.

What is interesting is that the range from the 666 S&P low to the April 2010 high is 554 points. Adding 554 points to the 1010 low gives 1564 which ties to the all time S&P high.

The normal expectation from the perspective of pattern would be for a textbook backtest of the April/November highs around 1225 S&P. I can’t help but wonder if after a multi-month decline that the S&P rallies up culminating in tag of 1400 and the upper channel as show completing another 13- to 14-month run periodicity from the June/July 2010 lows. In other words, following this correction, it's possible that the S&P will run up into July or August. July being the anniversary of the 2007 Initial Top and August being opposite or 180 degrees from this year’s February 18 peak.

On the Square of 9 Chart, 1401 is opposite February 18.

Conclusion: 270 degrees in price down from the 1344 high is 1235 which ties to the idea of a backtest of the April/November 2010 highs. A full 360 degree decline off the February high is 1201 which ties to a backtest of the 50-month moving average. In my opinion the primary trend will remain up as long as 1177 which is 50% of the range from 1010 to 1244 holds. It is no coincidence that 1177 ties to the 1173 low in November. Got geometry?

The Quarterly Swing Chart low for the duration of the first quarter of 2011 which has very little time to run comes in at the early October low in 2010 at 1131.84.

The quarterly range from that low to 1344 is 212 points. The mid-point of the range is 1238 which also ties to a back test of the April/November 2010 highs.

The current quarterly low for the first quarter occurred at the beginning of January at 1257.59.

It the S&P slices through 1272 like a knife through butter, it should make a beeline to 1257 and the quarterly low. Below 1257 the S&P could quickly waterfall to 1235.

Strategy: For the last few weeks I’ve reflected on the analogue of the 1987 crash with our February top this year being opposite the February 24 top in 1987. If option expiration was for sale it could be a blood bath eliciting fears of an ugly quarter end for portfolio managers. The crash in 1987 was the Monday after options expiration.

The crash in 1987 was 24 years ago. There is a compelling vibration with 24 squaring the date of February 18, the high, which squares by definition August 24, the high in 1987.

The crash in 1987 played out when a correction in October that mirrored a correction some four months prior failed to hold and the "mirror" broke. I have been pointing to the fact that the current correction has mirrored the correction in November, some four months ago. That is until yesterday. Yet yesterday was accompanied by a strange complacency just as has the devastation in Japan and the unrest in the Middle East been greeted by the market with an unusual complacency as to potential negative financial consequences. I have been warning that if the pattern of the prior correction from last November breaks, the market may go with it as it did in 1987.

Despite an oversold short-term condition, I remind myself that crashes are born not of too much bullishness but of too much complacency, and that the most bearish thing a market can do is continue lower despite it being oversold -- just as the most bullish thing the market did in recent months was continue higher despite being overbought. I remind myself that markets don’t crash directly off tops, but off lower tops. We have a lower top in place in the short-term picture from the February 18 high. Widening the lens, in the big picture, we have what may be a lower high in place from the all-time high.

If the S&P knifes and stays below 1270 on Tuesday, I would not try to catch falling daggers. The plains are littered with the bodies of heroes.

Another Spectacular Up Leg For Gold.

The S&P 500 has rebounded about 100% in 100 weeks. What crisis? What new normal? The economy is recovering and happy times are here again. Old normal is back. Stocks for the long run! Permabears be damned! The permabulls are back! Rates are low, core inflation is low, its Goldilocks time!

US stocks are only following the same pattern they’ve followed in the last three bear markets. The midpoint crash (1907, 1937, 1974, 2008) gave way to a furious rebound in each case. Following 1937, the market retraced 62% of its losses. Following 1907 and 1974, the market peaked three and a half years later after retracing roughly 95% of the losses. Three and a half years and a 95% retracement equates to the S&P 500 peaking at 1500 in April of this year.

Before you assume I’m a permabear gold-bug, take a look back 2009. With the S&P 500 at 764, I called for a 15% decline before the market bottoms and rallies for months and significantly in percentage terms.

Data from Bank of America Merrill Lynch survey of asset managers and hedge funds who cumulatively manage nearly $1 trillion. Shows what percentage are overweight or underweight US equities. The percentage of managers overweight US equities has soared in recent months and is basically at a 10-year high.

This growing bullish sentiment will coincide with the S&P 500 hitting major multi-year resistance. Excessive bullish sentiment coupled with multi-year resistance is not exactly a recipe for a major breakout. It’s a recipe for the end to this cyclical bull market.

Moreover, as we’ve noted time and time again, the factors that will cause stocks to reverse are the same factors that will propel precious metals into the early stages of a bubble. Increased monetization will be required as interest rates begin to rise and as the economy fails to grow fast enough to mitigate the debt burden. New debts and the rollover of old debts will be financed at higher rates, thereby increasing the debt burden which in turn, impacts the government's ability to juice the economy.

Higher rates won’t be good for stocks and higher rates won’t mitigate inflation or inflation expectations. The reason being, when you have a super high debt load (as most Western nations do) higher rates only exacerbate the debt burden. It will force local and state governments as well as the federal government to cut back, which has an impact on GDP. Higher inflation will also cut into corporate margins. We are expecting a mild bear market and not the 40%-plus decline we’ve seen recently.

Moving along to gold, we see a lack of interest in the market yet it is currently only 3% from its all-time high.

Furthermore, a survey of wealth manager of Canada showed only 33% of advisers as bullish on gold. That figure was 64% as recently as the fourth quarter of 2010.

This doesn’t mean gold will immediately soar. More so, it tells us that gold’s downside is limited as sentiment has shifted significantly.

With stocks nearing major resistance carrying excessive bullish sentiment and gold’s downside limited, let’s take a look at the gold/S&P 500 chart (above). The 2009-2010 price action has some similarities to the 2006-2007 price action. The chart shows that this is likely a good time to increase positions in gold and reduce positions in stocks.

After all the bubble bursts of the past decade, everyone wants to be a contrarian. If you are a regular Joe investor, now is your opportunity to be a contrarian and look smart in a few years. Mainstream managers now feel vindicated and feel a chance to promote stocks again. Don’t make the mistake many have already made twice. I’m writing this for the mainstream investor and the retirement investor because I don’t want to see them get sucked back into the market at the wrong time courtesy of asset managers who will find any reason to promote stocks.

Meanwhile, gold is providing an excellent opportunity. Its holding up well while the focus is currently elsewhere. The hot money is out of gold, yet it's only 3% off its highs. In the long run, that is scary bullish. In the coming months look for stocks to peak and for gold to regain its leadership.

Emerging Markets Bashing, Sending Warnings Of Bear Market.

Bear markets begin when something fundamental breaks. Usually the sector initially affected will roll over before the general market and tends to be a warning sign of what lies ahead.

The last bear market was triggered when the credit bubble created by Alan Greenspan's foolish monetary policy burst. It was exacerbated by Ben Bernanke's foolish attempt to debase the currency and reflate the bubble. All he succeeded in doing was to inflate oil to $147, which put the finishing touches on an already crumbling economy.

The market gave us a warning when the financials began to diverge from the rest of the market. Considering that the banks were one of the leading sectors during the '02-'07 bull the fact that they couldn't follow the rest of the market to new highs after the February '07 correction was a big red flag that the bull was on its last legs.

I've been saying for more than a year now that the unintended consequences of quantitative easing would be to spike inflation, which in turn would poison the global economy. I knew all along that Bernanke was never going to create any jobs by printing money and of course he hasn't.

So if inflation is going to sink the economy and kill the stock market we should see warning signs from the sectors most affected by rising inflationary pressures, just like the banks warned us in '07 that the fundamentals were broken.

Sure enough I think we are starting to see those warning signs.

Emerging markets have been hit hard by food inflation. We are now seeing food riots in many third-world countries. Emerging markets, just like financials during the last bull, were one of the leading sectors. The iShares MSCI Emerging Markets Index (EEM) is now starting to diverge from the rest of the global stock markets. It's now on the verge of breaking back below the November cycle low.

The other sector that is extremely sensitive to inflation is the transports. When energy costs spike, shipping companies' profit margins are squeezed. The last two days have seen the Dow Transports fold under the pressure of surging oil prices. Keep in mind oil is only on the 17th day of its intermediate cycle. That cycle lasts on average 50 to 70 days. I think we are going to see $5 gasoline by the time the dollar collapses into its three-year cycle low later this first quarter.

If the market can recover from the recent correction and make new highs I don't expect the transports will be able to follow. That will set up a Dow Theory non-confirmation and most bear markets begin with a Dow Theory non-confirmation.

China is already in a bear market. I think most emerging markets have probably topped and I doubt the rest of the global markets have more than two or three months left before the next leg down in the secular bear market begins.

I think the brief party created by Bernanke's printing press is about to come to an end.

The Asset Class to Avoid.

Whats the worst asset class to invest in right now?

Research suggests the asset class that offers the poorest long-term returns from today’s valuation levels is commodities.

Historically, commodities have generated astonishingly low returns. Based on the Foundation for the Study of Cycles data, from 1264 to 2010 commodities went up 0.70% on an annualized basis. That is rather unattractive.

Using data obtained from measuringworth.com spliced with modern day US CPI figures, over the same time period inflation increased by 0.75%.

After looking at different data sets for inflation indices and commodities over different time periods (spanning centuries in some cases), a pattern begins to emerge. When viewed over very long periods of time, there is a very high correlation between commodities prices and inflation indices.

Perhaps this is not so surprising when one considers that the commodities are a significant component of inflation indices. However, it is always nice to run the data and observe the actual correlation. It is real.

Now this may sound like a rather elementary deduction. But understanding this seemingly simple phenomenon is the key to unlocking the mystery of the commodity cycle.

The commodity cycle is as follows: Commodities do not do much for a long time. Then there is a fantastic spike up for a number of years. Then there is a crash. Lather, rinse and repeat.

What causes these spikes?

The most dramatic catalyst for commodity spikes occurs when a country takes itself off the gold standard. This occurred in the US Civil War, in 1933 when FDR took the United States off of the gold standard on a domestic basis and in 1971 when Nixon cut the final ties to the gold standard on an international basis.

Commodity spikes also often occur when a country runs big deficits. This almost invariably occurs during wars. Since 1900, there have been nine years when the deficit/GDP was above 9%. All were during times of war. All had commodity spikes. The quintessential example of this would be the World War I commodity spike. The most recent nine-year spike would also fit into this category. The US also had big deficits in the Civil War and World War II which contributed to those commodity spikes in addition to being taken off the gold standard which produced a “double whammy” effect.

What causes the crashes?

The high profit margins (due to the spike in prices) attract competition. Competition causes overproduction. Overproduction causes crashes. Eg . like what had happened to Tin prices in the 70s!

Another reason why commodities are poor investments is they have no yield. Actually with storage costs and security costs they have negative yield. This stands in marked contrast to pretty much almost all other asset classes which provide some sort of return on investment.

So after reading all this why would anybody ever buy commodities at all?

Well this is a good question. You can do just fine if you avoid commodities entirely for the rest of your life. However, one can argue you may do even better by keeping all your options open and wait for a time when commodities are poised for a big run.

This begs the question: How do you tell when commodities are dramatically undervalued? While the question is simple, the answer is complicated. The main problem, once again, is commodities have no yield, which makes it difficult to compare them to other asset classes. However, perhaps the mere fact that it is difficult to value commodities because they have no yield is telling you something. Moving forward, another valuation alternative is comparing ratios. This also presents issues as well because the ratios between other asset classes and commodities exhibit a secular upward creep. That is because most asset classes outperform inflation and therefore commodities. This makes timely buy and sell signals by this method impossible in most instances.

There are actually some ways of figuring out when it is a good time to buy commodities for a secular buy and hold strategy. A pretty good time to take a look at commodities is when they have been in a bear market for many years. Since the US was founded, commodity bears have lasted 11-33 years. Another good buy indicator is a lack of investment demand.

Clearly the current situation does not fit either of the above criteria at all. Rather than wasting time trying to figure out whether or not one should still be buying commodities, perhaps people should focus their efforts on figuring out if this is a good time to sell. As mentioned earlier, a telltale sign of the end of a commodity bull is a spike. History says you don’t want to buy them after a nine-year spike such as what we just had. While it is possible that the spike can go higher and longer, the laws of probability simply are not in your favor at this point.

In every instance without exception over the last three quarters of a millennium, if you had bought commodities when they had at least a 176% rally over the last nine years, you had extremely unattractive returns over the next 13-50 years.

1613-1622: Up 254%. Commodities went immediately into a 50-year 78% bear market.

1938-1947: Up 240%. Commodities went down 16% in 1948, 19% in 1949, up 58% in 1950 and peaked in February 1951. Then they had a 37% 18-year bear market. Therefore, in the quarter century after 1947 the upside was 12% (early 1951) and the downside was 32% (August 1968).

2001-2010: Up 238%. (???)

1910-1919: Up 202%. Commodities went immediately into a 13-year 66% bear market.

1971-1980: Up 198%. Commodities went immediately into a 19-year 45% bear market.

In all four prior instances since 1264 when commodities went up 176% in nine years, they went down the next year AND the year after that. If history repeats commodities will go down in 2011 and 2012. I am shorting the CPO big-time, @ RM3900/MT!