The $ignal Is In The Dollar Cycle.

It has been my contention all along that the Fed would print until something breaks. Once that break occurs we will enter the next leg down in the secular bear market. This time I don't expect it to be the credit markets, although we will almost certainly have trouble in the municipal and state bond market. Some may even default.

I actually think the greater risk is from massive layoffs by American state and local governments in an effort to cut expenses and avoid default. When that begins we will see unemployment levels start to spike again.

The real danger is going to come from inflationary pressures unleashed by the Fed's QE programs. We are already starting to see severe inflationary pressures in food and energy and it's already causing social unrest in many third-world countries. Expect this to continue and intensify as we move into the summer months.

Besides starting an inflationary spiral, QE is also "stretching" the stock market cycles.

To explain: The 2009 yearly cycle low occurred in March. The 2010 yearly cycle low should have arrived in the early spring roughly 12 months after the March '09 bottom. We did have a decent correction in early February. That should have marked the yearly cycle low. However, because of QE1 that cycle stretched into July, and was more severe that it should have been absent Fed meddling. We even witnessed another mini-crash -- a direct result of the extreme complacency generated by the QE-driven rally in March and April.

It's now clear that QE2 is going to stretch this cycle also. I now look for the next intermediate bottom to arrive this summer sometime around July (roughly 12 months after the 2010 bottom).

This should correspond with a violent dollar rally as it blasts out of the three-year cycle low.

This should mark the beginning of the next leg down in the secular bear market. Confirmation will come if the correction is severe enough to test the July 2010 lows. In a healthy bull market each intermediate correction should bottom well above the prior low (higher highs and higher lows). A move down to the 1050-1000 level will be a clear sign the bull is in trouble.

We should also see the dollar rally out of the three-year cycle low force the CRB down into its three-year cycle low (actually the cycle runs about two and one-half years on average).

And, gold will go down into a severe D-wave correction. (We still have one more parabolic leg up before this D-wave starts.)

Even though I have been expecting the market to correct (into the normal yearly cycle timing band) I've been warning readers not to short the market because the dollar is dropping down into a major cycle low. I suspected there was the possibility the dollar collapse would stretch the cycles and make selling short very risky.

The time to short will come once the dollar puts in the three-year cycle low and all markets begin the move down into the timing band for the next yearly cycle low this mid-year.

I will be watching for a sign the dollar cycle has bottomed sometime in April or even as late as early May. At that point one might consider looking for a sector, or sectors, that are extremely stretched above the mean to sell short. (Not precious metals though. I never short a bull market.)

Until that time it’s still too early to play the short side. The odds are better positioning for the final leg up in gold's massive C-wave advance.

A Sneak Peek into 2011's Crystal-Ball.

It's almost impossible to find anyone who's long-term bearish on the stock market or economy at this time. In the recent Barron’s poll, every single analyst expected a rise in stock prices next year and continued economic expansion.

I think they're all going to be wrong, horribly wrong.- The Chinese say : "droping one's specticles." I believe next year the stock market will begin the third leg down in the secular bear market. And the global economy will tip over into the next recession that will be much worse than the last one.

I've gone over the three-year cycle in the dollar index many times. The dip down into the next three-year cycle low this spring should drive the final leg up in gold’s massive C-wave. What I haven't talked much about is what happens after the dollar bottoms.

I actually expect this three-year cycle in the dollar to play out almost exactly like it did during the last three-year cycle. When the dollar collapses this spring it will not only drive the price of gold to a final C-wave top, it will drive virtually all commodity prices through the roof, the most important being energy and to some extent food.

It was the sudden massive spike in energy that drove the global economy over the edge into recession in late 2007 and early 2008. The implosion of the credit markets just exacerbated the problem. You can see on the above chart that just as soon as Ben Bernanke drove the dollar below long-term historical support (80), oil took off on its parabolic move to $147.

What followed was a collapse in economic activity and the beginning of the second leg down in the long-term secular bear market for stocks.

This was mirrored by the dollar rallying out of the three-year cycle low. That rally was driven by the severe, but brief, deflationary pressures released as the global economy and then credit markets collapsed.

We'll see the same thing happen again. In his attempt to print prosperity and reflate asset prices, Bernanke is going to spike inflation horribly as the dollar collapses down into the three-year cycle low next spring. Just like in 2008, that will tip the global economy back into recession and another deflationary period as the dollar rallies out of the three-year cycle low.

The stock market will begin the trip down into the next leg of the secular bear market that it's been in since 2000. The global economy will roll over into the next recession, which I expect to be much worse than the one we just suffered, though mainly because it will begin with unemployment already at very high levels.

Contrary to what economists and analyst are saying, at the dollar's three-year cycle low next year it will be time to put our bear hats back on and prepare for hard times and the next leg down in the stock market bear.

Good Times Ahead for Gold..AGAIN!

One of my favorite form of technical analysis: intermarket analysis. Intermarket analysis takes traditional technical analysis much further. Normally, I would look at a market by itself. I'll look at its price action, its potential patterns, and its momentum. Intermarket analysis takes this a step beyond by comparing the market at hand to various other markets. It gives us an idea of what is really going on and where market leadership is.

In regards to gold, intermarket analysis is even more important. Gold is the type of market or asset that thrives when other asset classes are not performing well. Rarely does gold perform well if there is persistent strength in another asset class such as stocks or bonds. We are in a gold bull market, so gold will outperform other asset classes over time. However, it is an important exercise in trying to gauge the near-term outlook for the yellow metal.

Above, I graphed gold against the various asset classes: commodities, bonds and stocks. And also graphed gold against currencies, as it is the currency of last resort.

We can see that gold has already broken out against both corporate and Treasury bonds. The breakout against corporates is very significant as it comes after a two-year base. Meanwhile, gold has just broken out against currencies (ex: US dollar) and a breakout against stocks appears imminent. Commodities are the only group holding up against gold.

The conclusion: In the near future, money will move out of Treasuries, corporates, currencies, and stocks and go into gold and likely commodities. The last time gold looked this strong in relative terms was in the third quarter of 2009 when it began a move to $1,220/oz. With this type of relative strength, it is very likely that gold makes another big move into 2011.

Europe Driving Interest US Rates Higher?

Interest rates, across the board, have actually been spiking since the announcement of the QE2 program on November 3. Not to anyone surprise, the Fed was more or less powerless to lower rates from prevailing levels. I argued that QE2 was really not designed to drive rates down from prevailing levels but merely to “accommodate” the fiscal deficit and prevent a rise in rates that would otherwise occur due to crowding out and other effects.

The bottom line was that the real risk was that interest rates throughout the US economy would rise after the announcement of QE2. Indeed, I believe that the US is currently in a situation anticipated in QE2 May Not Prevent a Rout in US Bond Markets, in which I asked: “How much panic would it create if quantitative easing (QE2) is announced, the Fed starts purchasing Treasuries, and bond yields actually start to rise?”

10-Year US Treasury yields (TNX) have risen almost 60 basis points since the announcement of QE2, municipal bond yields have spiked, corporate bond yields have risen, and mortgage rates have spiked. Indeed, overall, interest rates across the board are actually higher than they were before financial markets began to discount the prospect of QE2.

Having said that, it's important to note that although rates have risen, they are still well below levels that could jeopardize the economic recovery. The question is what happens next.

In the short term, a few issues need to be monitored. For starters, investors should be aware of the fact that the crisis in Europe is actually “bailing out” the US in some sense. In the global competition for capital, troubles in Europe make the US seem like a relative safe haven thereby facilitating the financing of the US fiscal deficit. Furthermore, troubles in Europe will tend to depress global growth expectations and ease fears of commodity-driven inflation. Thus, the situation in Europe will be a key driver in US interest rate dynamics.

Second, any whiff of accelerating inflation in the US could have a dramatic impact on the bond markets. Again, developments in global commodities markets are key in this regard.

Finally, at some point, investor scrutiny is going to be turned toward congressional and presidential action with respect to the US fiscal deficit and sovereign debt fundamentals. Today’s news of the failure of the presidential deficit commission to garner the necessary votes to issue an official recommendation is a worrisome development in this regard.

Conclusion

US interest rates are supposed to be falling, not rising. At least that's what we were led to believe a few months ago when market consensus was excited about QE2 and the Fed’s power to stimulate the economy.

It's now becoming clear what I had been emphasizing prior to the implementation of QE2: The Fed is not really in control of US interest rates.

This sense that the Fed has lost control of interest rate dynamics could add an important element of uncertainty into financial markets in the coming months.

This is particularly important in a context in which investors generally are over-exposed to bonds.

A long bear market in US bonds has probably already begun. Bad news out of Europe is probably the only factor that will be able to sporadically arrest the upward assent of US interest rates in the coming weeks and months.

I believe that US bond rallies due to instability in Europe should be utilized to initiate short positions in various categories of US bonds.

PIIGS Crisis Is Benefiting Japan.

Marc Faber's "bowl of liquidity" analogy, showed us how as a result of the European sovereign debt crisis, money could flow out of PIIGS debt and into equities. I wanted to provide a little more color given the events of the past couple weeks as the crisis has moved from Ireland and Portugal to Spain and Italy.

In the chart above, tells a different story. Here, the Euro Stoxx chart is in orange, the S&P 500 is in white, and the Nikkei is in green. And we see that since the Spain/Germany spread bottomed on October 26, the Euro Stoxx is down 6.5%, the S&P 500 is up 0.2%, and the Nikkei is up a whopping 8.0%! Whoa, what's going on?

What I believe to be happening is that with the current crisis being one more of solvency than liquidity (though Spain may have something to say about that), instead of markets being simply "risk on" or "risk off," idiosyncratic factors are coming into play as global asset allocators evaluate their options. Due to the PIIGS crisis, borrowing costs are rising for the European sovereign market -- yesterday was scary because not only did Spanish 10-year yields rise 25bps, but German 10-year yields also rose -- which feeds back into the private market for European borrowers in the form of more expensive credit. Austerity measures impact growth prospects. And allocators, aware of this, are moving money out of Europe -- not just sovereign debt but equities as well. European-focused funds may be experiencing redemptions, and oftentimes portfolio managers are forced to sell their most valuable assets that still have liquidity (equities) instead of the distressed ones they'd like to unload (sovereign debt). And this money is finding its way not just into real safe havens like US, German, and Japanese debt, but the US and Japanese equity markets as well. After being neglected for so long by investors, the smallest trickle of inflows into the Japanese equity market could create a surge along the likes of the commodities market in the earlier part of the last decade.

This is not to say that it's time to load the boat with Japanese and US equities. The crisis has still not passed. If Spain or Italy seizes up it could do untold damage to all asset markets with the liquidity crisis returning for awhile. But I believe that correlations are breaking down as the crisis shifts from one of liquidity to one of solvency, and when solvency crises intermittently create liquidity crises it's time for investors to think about what to own while assets with true value are being treated no differently than ones that truly might go to zero.

The Fed Could Be Wrong This Time.

Every precious metals investor should be concerned about China, one of the world's fastest growing economies, raising its rates and rising yields. Changes in the rates affect stock prices. China is leading the world and we can see the fears are profound as sell-offs this week were much stronger than any of the relief rallies. If China’s market corrects then the commodity market, which was fueling the equity market, could experience a severe correction. It's a domino effect.

Despite the Fed’s enthusiastic plan to monetize debt and artificially keep interest rates low through bond purchases, yields have risen aggressively for the last 13 weeks. The QE2 program was designed to lower interest rates to improve borrowing and liquidity. Instead the opposite occurred, QE2 is initiating higher borrowing costs. I don’t believe it is coincidence that Ireland’s debt problems surfaced following QE2. China is now on the verge of raising rates to combat imported cheap dollars to bid up Chinese assets, which is putting pressure on markets globally. Rising rates kills equity and commodity markets, which are heavily built on margin borrowing.

The Long Term Treasury ETF (TLT) (above)broke through the trend it had from May until the end of August. This previous trend was largely a result of a deflationary crisis where investors ran from risky assets like the euro to the dollar, and long-term Treasuries were pushing yields to ridiculously low levels. As fear in the markets decreased, due to a temporary stabilization in Europe and the US, investors ran to equities and commodities.

International reaction to QE2 has not been positive. There is an increased risk of emerging markets combating inflation, which may slow down the global recovery. Fears of China and emerging markets raising rates make investors unsure where to turn.

Asset classes have reacted negatively to China’s expected move. Distribution is apparent through many sectors and many international markets. Rising interest rates have a direct influence on corporate profits and prices of commodities and equities.

When studying interest rates it's not the level that is important, it's the rate of change. Interest rates have had a dramatic increase these past two months and we may see that affecting the fundamentals in the economy shortly.

The recent downgrade on US debt from China, signals demand for US debt has been waning. This rise in interest rates puts further pressure on the recovery as the cost of borrowing increases. Economic conditions are worsening in Europe and emerging markets in reaction to quantitative easing and imported inflation. Concerns of sovereign debt issues are weighing in Europe. As yields rise so do defaults and margin calls.

If the 200-day is unable to hold the bond decline and continue to collapse, then rising interest rates could negatively affect the economic recovery. Borrowing costs to insure government debt are reaching record levels internationally. Ireland is expected to take a bailout. Greece, Spain, and Portugal are in danger as well.

Commodities have significantly moved higher along with the equity market for September and October as investors left Treasuries to return to risky assets due to the fear of debt monetization through QE2. Global equity markets have been rising. But the question is, how long? This makes investors reluctant to take on debt, which is the exact opposite of what the Fed’s goals were. Rising yields could lead to a liquidity trap and deflationary pressures.

Bubbles, Signs.. And All Things Nice!

What other bubbles are lurking out there in the global economy?

1. Gold: The price of gold bullion has risen from $294 an ounce in 1998 to $1,404 last week, an increase of 377%. "It's the biggest, baddest bubble of them all," says Robert Wiedemer, author of Aftershock: Protect Yourself and Profit in the Next Global Financial Meltdown. Gold has no intrinsic value. A telltale indicator that gold is a bubble: incessant cocktail party chatter about buying gold and endless investment banks offering to sell gold derivatives. The SPDR Gold Trust ETF (look to your left) is up 28% since the beginning of the year.

2. Real estate in China: Chinese real estate prices are up only 9.1% this year, which may seem more frothy than bubbly. But rising prices are generating rising demand, which is a clear sign of a bubble, says Vikram Mansharamani, whose book, Boombustology: Spotting Financial Bubbles Before They Burst, will be published early next year. The participation of amateur investors like waiters and maids in the property boom is a clear sign of a property bubble in China. The fact that developers are building more apartments than there are buyers is another giveaway.

3. Alternative energy: Solar technology is still uneconomic, yet governments all over the world are subsidizing solar energy firms. "There are plenty of people who shouldn't be in the solar energy industry who are," says Mansharamani. Do we really need 250 venture-capital-backed solar cell companies? The Market Sectors Solar Energy ETF had a 100% gain this year, before dropping back.

4. Commodities: Blame it on the weather, China or the dollar or the Fed, but commodities have shot higher in recent months. Wheat is up 60% this year, and other food commodities like corn have also risen dramatically. "The focus is on the food category for bubbles," says Wiedemer, but industrial metals like copper are also very frothy.

5. Emerging market stocks: As an asset class, these shares have risen 146% in the past two years. "We're only halfway along the way to a gigantic eventual bubble in the emerging markets," says Barton Biggs, the former Morgan Stanley Asset Management chairman who accurately predicted the US stock market bubble in the late 1990s. These countries, such as Indonesia, Australia, Russia and Brazil, are growing wildly even though there's no growth in the world economy. Much of their gains is backed by commodity prices, which are also a bubble (see item No. 4). "I have every reason to believe this will turn into a bubble," says Mansharamani.

6. The US dollar: Although the dollar is down 10% against the euro so far this year, Wiedemer believes the greenback is firmly in bubble territory. He believes it will pop when foreigners stop buying US assets such as stocks and bonds. "Foreigners say, 'I'm worried about inflation -- you're going to pay me back in dollars worth less than when I invested'." While China may hold its dollar bonds forever, he says, pension funds in Japan and insurance companies in Europe will start dumping dollars as US inflation climbs.

7. US government debt: "When this bubble pops you're out of bubbles -- nothing is too big to fail any more," says Wiedemer. The debt bubble is growing very rapidly and will continue to grow, he says. Basically, there's no way the US government can ever pay back the $13.7 trillion it currently owes (mainly to foreigners), and eventually they will stop buying. The bubble pops when the government has trouble selling its debt -- just like Ireland and Greece are experiencing at the moment. Instead of borrowing money, the government starts printing money, which is what's happening now. The Fed's balance sheet has gone from $800 billion in 2008 to $2.2 trillion, and the central bank just announced it was printing another $600 billion. Says Wiedemer: "The medicine starts to become poison." - All these, just when bewildered, lost uncles and aunties are learning from your local research houses' market outlook roadshows about what's QE2!