Edward Gofsky Consulting | The Technical Contrarian
Edward Gofsky Consulting - The Technical Contrarian
Unbiased research and analysis of the financial markets that is not influenced
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FINANCIAL MARKET UPDATE By Edward Gofsky - september 30, 2004
From Wall Street to Bay Street, all the market players are back from vacation

Well here we are at the start of the fall season where the days are cooler and the nights get colder. Leaving the lazy days of summer is a hard thing to do, but if you are a hard core investor this is a great time because from Wall Street to Bay Street all the market players are back from vacation, and we can now start to seriously break down the numbers and chart patterns to try and find out where all the important markets are going.

General Markets and the Economy

Since my last essay in august there has been a lot of things happening in the markets. From oil to gold to uranium and the major stock index's there is a lot of action as fund managers and hedge funds try to position themselves for a final year end run. First off I want to say that it sure looks like the bear market in the DJIA, NASDAQ, and S&P 500 that I have talked about in my last few essays is starting to gain momentum.

As the chart of the S&P 500 shows below, it sure looks like the top was put in back in march at 1163.

Click image to enlarge

I like to use the S&P 500 because I feel it shows a broader and more realistic picture of the U.S stock market. As you can also see from the chart I feel that the 1163 top was the 4 year cycle top that I talked about several essays ago.

The last 4 year cycle top was in March of 2000 so that in it's self is a very ominous sign because we all now what happened after that! There has been a clear downtrend in the major U.S averages and I don't feel that the highs for the year will be taken out with only 3 months left in the year.

I find it so funny that so many people counted this year as a shoe in for easy profits. Don't you remember all the talk back in January as the index's prepared to make their tops for the year. Everyone was saying that since this is an election year in the U.S the markets will have an up year.

People were saying that Greenspan would not raise rates because he did not want to get involved in the Presidential race for the white house. He wanted to make sure that the mass public did not think that he was trying to influence the election.

Well as we all know by now that was a total farce as Mr. Greenspan has raised the Fed Funds Rate by 75% to 1.75 from the ultra low 1% in a bid to create an illusion that the economy is really running on solid ground so the mass public believes rate hikes at this time are acceptable (that has to make Bush happy!). It also gives the Fed a little wiggle room so if they have to they can cut rates in 2005, and try to give the dollar a small taste of respectability before its inevitable downfall.

But even at 1.75% the fed funds rate is very low and very loose. Using the 3 month money market yields as an indication of how low rates are in the U.S are I will use the numbers from my trusty weekly magazine "The Economist". As of Sept 22/04 here are the following 3 month money market yields for the following 7 countries.

  • Australia 5.40%
  • Britain 4.91%
  • Canada 2.46%
  • Denmark 2.25%
  • Euro Area 2.12%
  • Sweden 1.98%
  • United States 1.78%

Click image to enlarge

As I have said before Mr. Greenspan is acting rationally within an insane doctrine of economic policy. By keeping rates low he has caused multiple bubbles in the housing, credit, stock, and derivatives markets. The only thing that is needed to prick his bubbles is what Nassim Taleb author of one of my favorite books "Fooled by Randomness" calls a black swan event or if you will, an unseen event.

This event is something that comes out of left field, something that can not be predicted by Wall Street economists or the Fed. Something like a terrorist event, a major natural disaster, a major derivatives blow up, a major accounting scandal (Fannie Mae!), or China's government decision to start dumping their $483 billion dollar reserve of U.S dollars. Any of these situations could cause major problems for the U.S economy and the financial markets.

By keeping rates so low for so long Mr. Greenspan has brought to many people into the various markets I mentioned above. From marginal buyers of real estate to hedge fund managers borrowing billions of dollars at ultra low rates to buy speculative stocks and options there are simply too many individuals involved in the markets for interest rates to go much higher. The eventual day of reckoning will be a disaster.

But from my own point of view the black swan event this year and maybe the one to tip the scales is the price of oil. As you can see below in my Point & Figure chart from Stockcharts.com oil just hit 50$ yesterday Sept 28 2004. In my last essay in August I had the same chart when oil was in the low 40$ range. So it looks like oil will hit the 57$ level indicated by this awesome P&F chart below.

Click image to enlarge

This is not good news if you are a perma-bull on Wall Street. Believe me, at the beginning of the year most economists and people at the white house would have never thought they would see 50$ oil in an election year let alone in a year with a 4 year cycle top in the major index's and a 75% increase in the Fed funds rate. This stew of economic and financial events is enough to rock the markets and the economy big time after the election in November.

The price of oil has increased over 70% in the past year. This is very, very bad for the economy and for potential inflation down the road. According to Stephen Leeb author of the book "The Oil Factor", every time Oil rises over 80% year over year its rise is accompanied by a major slow down in the U.S economy. This has happened in 73-74, the early 1980's, and in the first gulf war in the early 1990's and at the top in 2000. Well with oil trading over 70% year over year it would seem very reasonable for investors in the broad markets to be very careful.

My point is that there are many things in this market right now that are very bearish towards the general stock markets and the economy. One of the indications that I also look for as an onset of a bear market is what's known as air pocket's in the market. This is when there are a number of stocks that decline over 10% in a single day over a period of time.

Here are a few examples:

  • pep boys -28.5%
  • Hewlett Packard -13.2%
  • Nat'l Semiconductor -14.1%
  • Cisco -10.6%
  • Doubleclick -27.5%
  • Amazon -12.7%

These are just a few of the many stocks that have been hit hard lately. I am not even talking about the disasters at Fannie Mae or Krispy Kreme.

The Fannie Mae story is very funny to me and I will only talk about it briefly here. After all the scandals from Enron and Tyco to Nortel and now Fannie Mae it shock's me to see the amount of people that are actually surprised that Fannie was cooking the books.

People say that a picture is worth a thousand words, well this picture below is a very long term chart of Fannie Mae and it clearly shows as far back as 2001 that the pattern this chart was forming was a bankrupt head and shoulders top (very similar to Enron and the U.S dollar). This chart is very bearish and no one should have owned this stock after looking at the bearish topping pattern over the last few years. The chart pattern is saying that there may be more than just cooking the books at Fannie.

Click image to enlarge

Out of all the bearish things I have mentioned above I find one of the most disturbing things about the economy and the stock markets is that we have in the last few years been witness to the biggest fiscal and monetary stimulus in world history and the major stock index's the DJIA, S&P 500, and NASDAQ are still down -13%, -27%, and -62% respectively from their all time highs back in 2000, the last 4 year cycle top.

This is very bad because I keep asking myself what is going to happen to the markets when this stimulus is gone by 2005. Worse yet, what would happen if taxes were raised? Too crazy you say?

Well let me share a great article that I read in the Sunday NY Times over the weekend. Can you imagine if in 2005 or 2006 you had higher taxes along with everything else I have been describing above? Talk about worst case scenario for the Fed and the white house (Rising oil prices, rising interest rates, and rising taxes).

"Whoever Wins, More Taxes May Be the Only Way Out"
By Edmund L Andrews
Sunday NYT Sept 26th 2004

"It's often forgotten that President Ronald Reagan signed a bill to raise taxes in the early 1980's after first cutting them. President George H. W. Bush abandoned his "read my lips" pledge and raised taxes in 1990. Could Republicans soon be in a similar position again?

It would hardly seem so after their victory in congress last week, when they extended a big part of President Bush's tax cuts worth about $146 billion over 10 years. Since taking office in 2001, President Bush has pushed through tax cuts valued at about $1.9 trillion.

But it is worth asking where things go from here. If President Bush is re-elected, he and the republicans face a big agenda, including an unfinished war in Iraq, and virtually all of his tax cuts will be financed with borrowed money. Unless the government defaults on its debt, that money will eventually have to be repaid.

Faster economic growth will not do the trick. The nonpartisan Congressional Budget office already assumes that the economy will grow at a solid pace in the years ahead and that tax revenues will climb even if President Bush's tax cuts are made permanent.

But if military spending in Iraq continues, even at lower levels, and President Bush prevents the alternative minimum tax from raising taxes on some 30 million families, the budget office estimated that federal deficits from now through 2014 would total $3.5 trillion.

Federal interest payments alone - the "debt tax," as democrats are fond of saying- would climb to $402 billion in 2014 and amount to 2.2% of the GDP. Measured against the size of the economy, those deficits and interest burdens would be smaller than those of the 1980's and early 1990's. But they would be occurring just when social security and medicare entitlements are expected to soar as a result of baby boomer's retirement.

Stuart Butler, a senior fellow at the heritage Foundation, a conservative research group, contends that political leaders will have no choice but to raise taxes if they do not cut back on trillions of dollars in unfunded commitments - most of them associated with medicare, which President Bush and congress expanded greatly with last years prescription drug program.

The pressure to raise taxes is likely to increase for whoever wins the next election. Senator John Kerry, the Democratic nominee, has yet to reconcile his own tax and spending plans.

Administration officials remind audiences constantly that the federal deficits are a largely a result of economic shocks: the collapse of the stock market bubble, which wiped out trillions in stock market value; the recession in 2001; and the plunge in business investment that lasted until this year.

But those problems have almost nothing to do with the budget challenges ahead. The congressional Budget Office estimated this month that cyclical economic problems contributed only $47 billion of this years anticipated deficit of $422 billion. Next year, cyclical economic problems are expect4ed to have almost no impact on the budget, but the deficit is expected to be $348 billion.

Going forward, virtually the entire federal deficit will be a result of structural causes - tax and spending policies set down by the president and congress.

President Bush has called for freezing the level of nondefense discretionary spending over the next few years, which would result in real cuts for many programs, like housing assistance, after adjusting for inflation. But those cuts affect less than one - fifth of the federal budget and would barely nick future deficits. The rest of the budget - social security, medicare, military spending, domestic security and the interest on the debt would grow smartly.

Federal revenues, meanwhile, are expected to climb only modestly. Federal tax revenues, which go up and down in response to policy changes and to the economy, have averaged about 18.6% of GDP since the 1970's. That share plunged after 2000, initially because of the stock market crash and the recession but increasingly because of tax cuts.

Tax revenues in 2004 are expected to make up only 16.2% of GDP, the lowest share in more than four decades. Although the share is expected to climb to 17.6% over the next decade, it would still be lower than it was in the 1960's

To be sure, the federal government could keep borrowing more. But higher debt means higher interest costs. That would itself amount to a tax imposed every time a person borrowed money.

Absent cuts in spending far more draconian than anything President Bush has yet proposed, only one other option remains: higher taxes."

Well if you get some sort of tax increase in 2005 or 2006 along with everything else I have said it does not paint a very attractive picture for the economy and the stock market.

By now you might be asking me if there is anything bullish about the stock market at all. Well after all the research over the last while I have only two bullish scenarios for the stock market going forward until the true bottom in the markets that I see in the fall of 2006, the next 4 year cycle low.

One of the bullish factors is technical and the other is cyclical. The first bullish situation would occur if the DJIA or the S&P 500 could form and complete a massive head and shoulders bottom pattern as seen below in the chart of the DJIA (the S&P chart is very similar). If this pattern is completed it would be super bullish. What are the chances that this situation will occur? The chances are highly unlikely.

Click image to enlarge

The second bullish factor is very interesting. In the history of the stock market, every year ending in 5 since 1881 have been up years for the DJIA. The gains have ranged from 2% to 82% with a median gain of 29%.

This info was provided by one of my favorite books "The encyclopedia of Technical Market indicators" by Robert W Colby. This is the most bullish thing going for the markets at this time and will be used a lot in the media next year.

One cautionary note, if next year is a down year like I think it will be, the 100 year pattern of the years ending in 5 will be broken and that itself is a very bearish event.

This is the situation that I see for the general markets and the economy; it will be very hard for the market and the economy to do well when the Fed Chairman and the policy makers in Washington are trapped in a political and economic matrix where they can't distinguish the real world from their dream world.

Gold, Silver and Uranium

Since my last essay in August, gold and silver have been doing well, especially some of the gold stocks. The HUI and the XAU have done extremely well. As you can see below in the P&F chart of the HUI, the index has done great. There have been 2 big breakouts in the HUI at the 204 level and most recently at the 220 level. The next level to break out of is at the 244 level, then the final breakout over 260.

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As you can see on the chart there is a price projection of 266 which would be super bullish for the HUI. Let's just see if we can get over 260 before we start making higher price projections.

It's hard to forget all the negativity in the gold and silver market back at the C bottom in early may when the HUI hit the 164 level indicated in the P&F chart above. There were people in the financial market that actually thought that this was it for the golden bull. They thought that gold was done and that silver would collapse. Believe me, it was pretty scary and I can only imagine what it was like for people that invest in the gold and silver market that don't really know what they are doing!

As I have been saying for months, investors in gold and silver stocks need to take a longer term view. Keep you eyes on the 20 year chart of the XAU so you don't get distracted by the day to day noise in the markets. The massive head and shoulders bottom in the XAU is one of the most bullish I have seen, and I have seen hundreds of charts of every variety.

Click image to enlarge

Not only is there a very bullish classical technical pattern but the Elliott wave pattern is very bullish too. It sure looks like the wave 2 bottom is done and we are entering the early stages of the wave 3 rally that might take use to the 130-150 level by mid to late 2005. The 150 level in the XAU is pretty much a lock it's just a question of how long it's going to take to get there, so being patient and just watching the pattern do its thing is a must.

Once the XAU gets to 150 all bets are off on where it will go from there. The last 2 times it hit 150 in 1987 and again in 1996 the index fell rapidly, so caution is warranted when it hits the level again. The big difference this time is that rather than before when gold and silver were in a secular bear market, now the 2 metals are in secular bull markets. So the XAU could rocket to 200-300 but let's just wait until we get to 150.

Just so my readers can stay focused on the big picture, I always like to put in some nice long term charts of gold so you can see how bullish the charts are. As you can see in the long term P&F chart below, the massive H&S bottom has been forming since 1992 which is the left shoulder and the double bottom from 1997 to 2001 is the head.

We are now in the early stages of the formation of the right shoulder to complete the super bullish pattern. It could take months or even years to complete but believe me when it does it's going to be on the upside in a big way.

Click image to enlarge

The second chart below is my Elliott Wave count on gold. This pattern is also very bullish as it shows that the 21 year bear market in gold was a 4th wave correction and we are currently in the early stages of a 5th wave rally to new highs above the 1980 high of $850+.

Both patterns in the 2 charts correspond with each other perfectly. When you have 2 charts where both styles of technical analysis come together to tell the same bullish picture it makes the probabilities of the big up move even better.

Click image to enlarge

That is the cornerstone of all my research, to use both styles of analysis to find very bullish situations in the markets. It does not happen all the time but the situation in gold in my opinion is a very special one. Not only do you have the Elliott wave pattern and the head and shoulders bottom, but there are other factors that must be taken into account that also add to the bullish case for gold.

You have to factor in the DJIA/ Gold Ratio that toped out in 2001 perfectly at the wave 4 bottom and the double bottom of the head and shoulders pattern. And also the gold/oil ratio which shows that gold is very under priced historically to oil right now and is due to catch up to it very soon based on the historical relationship between oil and gold.

Adam Hamilton of Zeal Intelligence wrote a great essay about the Gold/Oil ratio a few months back. I highly recommend all my readers take a look at his awesome essay. Just go to my links page on my website and scroll down to my link to the Zeal web site.

The last thing I want to talk about in this essay is the very bullish situation occurring in uranium right now. I have been following the uranium market for about a year now and in that time a lot of things have happened. The story for uranium in my opinion is ultra bullish and the uranium stocks have simply gone ballistic in the last few months.

Just in September alone there was massive volume on all the uranium stocks (which are very few) and the price advances on all of them was very dramatic. I am very, very bullish on uranium and even more on uranium stocks for a number of reasons.

There have been some great essays and articles about the uranium story recently by some of the best minds in the investment business today. Jim Dines, Doug Casey, and Eric Sprott of Sprott Asset Management have really brought out the true case for why uranium and more specifically the uranium stocks are poised to rise in a big way this decade.

Below I will briefly talk about the uranium story and why I think this area is a great opportunity for investors going forward in this decade. But before I do that I would encourage all my readers who are interested in uranium stocks to visit my links page on my web site and go to Jim dines and Doug Casey's web sites and check out their newsletters as they have some great info on uranium and the company's that mine for yellowcake (uranium).

Uranium is the fuel nuclear reactors use to generate electricity. More than 400 nuclear reactors operate in 31 countries and account for about 17% of the world's electricity. In parts of Asia and Europe, nuclear capacity supplies up to 80% of the electricity demand. Nuclear power is the only fully developed non-fossil fuel electricity generating option with the potential for large-scale expansion.

As everyone knows the price of oil is around the $50 dollar level. Some analysts see the price moving much higher over the coarse of this decade and beyond as oil wells around the world dry up or get disrupted by terrorism and war since most of the worlds oil is in very hot spots on this planet (Saudi Arabia, Caspian sea). Governments around the world must secure sources of energy to make sure the lights stay on and the standard of living does not decline.

If China and India (2 Billion people) want the same standard of living as we have in North America, they are going to have to find a lot of oil to use in all the cars and factories to support that kind of lifestyle. Oil currently accounts for 40% of the world's energy consumption, and the world oil consumption is projected to increase by 2.3% for the next 16 years. That means in 2020 the world will be consuming 120 million barrels per day compared to the 75 million barrels we consume today.

Counties around the world are going to have to find alternative sources of energy. It is in their best interest to find sources of energy that are not located in parts of the world dominated by war and politics. The 2 sources of mass energy that can be used with current technology are coal and nuclear. There is a lot of coal in the world, probably a few hundred years of cheap coal is available.

But there is one small problem with coal, It's an environmental nightmare (Coal-fired plants world wide release over 9 billion tones of greenhouse gases into the atmosphere each year) and given the choice most counties would rather have a brand new state of the art nuclear facility with Redundant and automatic safety systems that releases little more than a bit of steam (of coarse the world still has to figure out what to do with all the nuclear waste being stored at plant sites).

As the world starts to run out of oil and gas all the talk about how environmentally unfriendly nuclear energy is will be put to the back burner until better energy alternatives come to the fore front, but that is decades away from happening.

The current world political crisis, with its inherent threat to world energy supplies and prices underscores the need for domestically produced, non-petroleum based electricity. The recent power crises in California and Ontario have sharpened the focus on the fact that North American power usage continues to rise, as it does throughout the world. These factors in conjunction with pressures to dramatically reduce greenhouse gas emissions have prompted the Bush administration to actively support new reactor construction and development in the U.S.

In Europe, it has become apparent that plans to phase out nuclear power plants are unworkable and so, new reactor developments have been begun once again. In Asia, nuclear power development continues to proceed apace.

The development of new simplified reactor designs and the improvement in efficiencies of currently operating reactors have dramatically improved the economics of nuclear power and have actually increased the demand for uranium.

So in my personal opinion there will be a mad rush by countries to get their hands on steady supply of uranium needed to power the many nuclear reactors around the world (440 currently in operation and 30 under construction world wide). In North America alone, rapidly growing demand for power and electricity has reached a point where the grid is increasingly vulnerable to massive failures (everyone knows what happened in California and New York).

In the years to come as china and India seek to attain 1st world living standards, what is going to happen when hundreds of millions of people in china and India want to turn the lights on!

As of today nuclear power contributes about 20% of the electricity in the U.S up from 4.5% in 1973 making it the second most used fuel source for producing electricity (after coal). In china, after experiencing electricity demand grow by 15% per year, the country plans to increase its nuclear generating capacity by a factor of 5 by 2020.

This means 32 new reactors, or 2 per year. But even then nuclear will only account for 4% of its power generation. If china were to attain the same nuclear share as the U.S (20%) it would require 200 new reactors, or half of today's globally installed nuclear base.

That's just one country, India has adopted a similar policy, planning to increase its nuclear generation (now only 2.5% of total power generation) Similar plans are in the works in other developing countries around the world. This is very bullish when you look at the supply side of the uranium equation.

As of today nuclear utilities around the world consume 170 million pounds of uranium each year, but only around 90 million pounds is actually mined out of the ground. This situation is clearly unsustainable even assuming no growth in the number of nuclear reactors.

The balance of the uranium needed to keep the worlds lights on comes from above ground supplies like weapon conversion, mox/breeders, and utility stockpiles, all of which are remaining stable while demand continues to rapidly grow.

The price of uranium has climbed from a low of $7.10 in 2000 to $11.75 in 2003 and Is now trading at $20 a pound according to UxC a uranium consulting company (go to my links page for their website). But even at this price, uranium is well off its all time high of $43 dollars a pound back in 1979. In today's dollars, that's about $109 dollars a pound, and the fundamentals are now much stronger from both the demand and supply sides than they were back in the 1970's.

So there you have it, that's the uranium story and in my opinion it is very bullish. I will be writing a special report about all of the uranium stock I know of in the next few weeks so check my website often as I will be reporting on important events happening in the markets.

One last comment before I finish this edition of the Financial Market Update. I get a lot of e-mail from people around the world who would ask me why I think gold is going higher when one of my mentors Bob Prechter thinks it's going below $250. I think the following will help clarify where I stand in this golden argument.

A lot of people ask me when I comment on my price projection of gold and silver or even mention gold and Elliott wave analysis and show them my wave counts and technical charts for both metals "What about Bob Prechter's call for a final bottom in gold below $250, and the big move in gold since 2001 is a bear market rally?" Well to set the record straight, this is what Mr. Prechter said in his Fantastic 2002 book "Conquer the Crash"

"The markets will signal inflation. Despite my thoughts on the matter, I recognize that international money flows are massive, central bankers can be ingenious, and politics can be volatile. Perhaps there is some way that inflation, whether globally or locally, could accelerate in the immediate future. How can you tell if my conclusion about deflation is wrong and that inflation or hyperinflation is taking place instead of deflation?

There are two sensitive barometers of major monetary trends. One is the currency market. If the price of the dollar against other currencies begins to plummet, it might mean that the market fears dollar inflation, but it might simply mean that credit denominated in other currencies is deflating faster than that denominated in dollars. The other monetary barometer, which is more important, is the gold market. If gold begins to soar in dollar terms, then the market almost surely fears inflation. The bond market will not make the best barometer of inflation because much of it will fall under either scenario.

I hope to recommend gold at lower prices near the bottom of the deflationary trend, but if gold were to move above $400 per ounce, I would probably be convinced that a major low had passed. The ideas in chapters 18 and 22 will show you how to protect yourself simultaneously against deflation and a collapse in dollar value."

Well, gold hit a high of $430 earlier this year and is currently just over $415. So I would have to say that it is really starting to look like Mr. Prechter will have to make a huge announcement very soon that he missed the low in gold back in 2001 and he will recommend a major buy into gold and gold shares soon.

This is only my opinion, and I want to let people know that I highly respect Mr. Prechter, as his books and newsletters have taught me so much about Elliott Wave Theory and how markets work. I just disagree with his call on gold to go below $250.
Edward Gofsky
I welcome all comments and views on my essay. Contact me to discuss this posting.
Elliott Wave Theory, Classical Technical Analysis and Financial Planning
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