(09/05/11) Gold Is the Only Glimmer of Hope

Looking back is always helpful in gauging how to move forward...and at this point, the path forward looks very challenging indeed, says Jack Adamo of Insiders Plus.

In the 17 weeks since the market peaked in April, the S&P has had only four up weeks, and one of those was practically zero.

Of more concern, volatility has not abated in the least. Although last Friday finished with a nice 135-point gain in the Dow, it was not before a 397-point peak-to-trough swing.

Tuesday and Wednesday were unequivocally strong days, but volume on Thursday’s selling exceeded either of those days and last Friday’s rally was on the skimpiest volume of the week. On-balance-volume has been slumping since August 19, and visibly disconnected to the downside after Wednesday’s
rally.

We’ve observed lately that volume doesn’t seem to mean as much as it used to, due to all the off-exchange trading—but it cannot be completely ignored either, especially when the total downside price movement greatly exceeds the upside.

Even market technician Ed Yardeni, who is as mainstream Wall Street as you can get, told his clients this week: “…during the first 17 trading days of August, the DJIA has been up during nine days and down during eight days. During the up days, it rose 1,647 points, or 183 points per day on average. During the down days, it fell 2,614 points, or 327 points per day on average. That’s not normal.”

I have one small quibble with Ed, and it’s with his conclusion, not his calculations. It is normal—during bear markets.

I think we could still have another counter-trend rally of as much as 7% or 8% above August 26's close, but whether it would come in one or two bumps or gradually, I have no idea.

History also suggests it could last up to three months. That is not an unendurable time to be hedged in a rising market, but we will probably make adjustments along the way if needed.

Gold Still Strong
The CME raised margins on gold futures again last week—this time by 27%. Since the move was expected, gold plunged nearly $200 in anticipation of the move.

I have two observations about this:

If anyone over at the CME ever looked at a ten-year chart of the price of gold and compared it to a ten-year chart of the Nasdaq prior to the 2000 crash, they would see what is and is not a bubble. Gold is just steadily rising at a measured pace to keep in step with the eroding value of the US Dollar—and now, the Euro.

Two days after the $200 drop, gold has recovered half the loss and is now less than 7% from its all-time high. Compare that to silver’s reaction to the margin raises. It fell about 30%, and has taken nearly four months to recover 40% of its slide.

I’m not here to badmouth silver. I’m pointing out how strong gold is. Central banks are now net buyers of gold for the first time in a generation.

Asian countries in particular are big buyers because they hold a lot of US Dollar reserves that are rapidly losing value. Most Asian countries also have cultural traditions that recognize the value of gold more than the developed European countries.

Given this environment and the shakiness of American and European finances, gold is even more of a safe haven and store of value than it has been for the last ten years. In 2008, gold fell along with equities as people sold everything.

However, gold did not get hit nearly as badly as stocks did. The peak-to-trough drop in gold was 31%. The S&P 500 fell 85% at its worst point. And while the S&P is still 39% below its pre-crash high, gold is 78% above its pre-crash high. I had to go back and double check that number when I calculated it. Even I was stunned.

Gold’s tenacity has not been lost on investors. Whereas it used to behave inversely proportional to the dollar, since July it has been rising regardless of what the dollar does. It is taking on the role of real, stable cash in a risk-averse market, while at the same time rising concomitantly with the expected Fed increase in money supply in an up market.

This one-way move won’t last forever. Expect to see gold fall when the market tanks, and also rise less than the market if the “risk on” spirit gets in full swing.

But the steady underlying strength of gold will continue to build. There is no alternative. Paper money as a store of value has been wholly discredited, and financial assets, while they can be more rewarding, are increasingly more volatile than older investors are willing to tolerate. And it is the older investors who have the most money.

That is why we see money leaving the market at an increasing pace.

No Capitulation
I heard a well-known market technician say on Bloomberg a couple of days ago that recent market action “certainly looks like capitulation.”

For those unfamiliar with the term as regards the stock market, it means the final phase where investors throw up their hands in disgust and say “Just get me out of here.” Capitulation is followed by rapidly rising prices, as smart money rushes in to buy great bargains.

Certainly some people have thrown in the towel, but the market as a whole has not. On Thursday, when the Dow was down well over 100 points, I heard three stories of stocks jumping 15% to 30% on news that they were laying off employees, reorganizing, or “looking for strategic alternatives.”

For those who don’t remember 2000, this is exactly the kind of stuff you saw after the first big downwave in the market. People still believed it was just a correction and everything would be fine, so stocks that had been beaten down were considered “buying opportunities.” (Look for that phrase a lot in the coming months.)

Companies that were losing money would magically turn around by firing people, and companies that were executing poorly would be bought out at big premiums, despite the fact that no company had approached them up to that point. This fish smells very familiar.

Buffett Buffet
We are also being wooed by those who say Warren Buffett’s purchase of Bank of America (BAC) stock last week proves there are great values in the market. I’m sure there are—however, this incident doesn’t prove it, nor does it assure that those great values won’t get greater in the next three to nine months.

I don’t doubt Buffett’s wisdom in the least. However, keep in mind that we are not invited to the same buffet of investments on which he dines.

While his investment in BAC certainly says that the bank is not going away, note that he’s getting preferred stock that is above the common in the capital structure. He is also getting a 6% dividend on it, whereas common-stock holders get 0.5%.

Moreover, Buffett gets 7 million warrants as a sweetener for his $5 billion investment. You don’t.

The Wizard of Omaha made a big investment in Goldman Sachs (GS) at the height of the financial debacle in 2008. How is that working out for him? Fine. He gets 10% interest on his preferred shares and has a load of warrants; I forget the number.

That was on September 23, 2008. How would we of the lumpen hoi-polloi have done if we’d bought GS the next day, based on this show of faith? We would have about 3% total in dividends over the two years, and would be down about 15% on the price. What’s good for Warren is good for us only if we get the same deal.

In summary, this market looks awful. I will continue to pay attention to what my indicators tell me.

If they change, I’ll gladly change my mind and my strategy. Until that happens, I’ll not be swayed by any hype or short-term market blips.

Subscribe to Insiders Plus here...