Protecting from a COMMODITY AND STOCKS DOWNWAVE...

originally published March 10th, 2011

• Protecting from a COMMODITY AND STOCKS DOWNWAVE...
  March 10th, 2011
• GOLD MAJOR BREAKOUT...
  March 2nd, 2011
• BROAD US STOCKMARKET - evidence that a MAJOR SELLOFF IS DRAWING CLOSE - tactics...
  February 13th, 2011

The so called economic recovery since the 2008 financial crisis is not genuine - it is a veneer created by manufactured money. It is analogous to an individual who is already deeply in debt being suddenly granted a massive increase in his line of credit and going on to live the high life until he arrives at his new debt ceiling. The chief planks of this policy of precrastination are massive increases in the money supply coupled with rock bottom interest rates to mitigate the impact of ballooning debt. There are only two ways that this can end. One is that time is called on the debters by choking off the monetary spigot, the other is that the money supply is ramped exponentially to keep the party going and put off the day of reckoning as long as possible. The former will lead to an economic implosion, while the latter will lead to hyperinflation. Given the instinct of politicians for survival it is reasonable to conclude that they will choose the latter course.

A looming problem that may be already starting to spook the markets is that the Fed's QE2 program to support the Treasury market is due to end this Summer and thus far there is no QE3 organized to take its place. While we can expect an eventual QE3 to be put into place by force of necessity, there could be a very nasty convulsion if the markets go "cold turkey" due to a sudden liquidity shortfall in the interim, and the architects of this broken system may have already planned it so in order that they can reap massive profits by playing the markets on the short side before reversing position and riding valiantly to the rescue with QE3.

From a practical standpoint danger signals have been flashing for months now that the markets are way out on a limb and it has been going on for so long that it has engendered a dangerous complacency that usually precedes a severe decline. Premature shorts have been wiped out and now we have Mom and Pop turning up with what's left of their life's savings to enter the markets, having been getting increasingly frustrated by zero returns in their savings accounts as the markets have steamed higher and higher, another danger sign as they are the habitual losers.

Market technical indicators have been calling for a reversal for months now, as already mentioned, but blatant market manipulation has headed off every incipient reversal in its infancy, by means of a massive back door slush fund created for the purpose, but now that are signs that this will soon no longer work. The black swans are already circling and a range of exogenous shocks threaten to "upset the apple cart". One obvious one is the sudden high oil price, which if it continues will pull the rug from under the economic recovery, especially if the unrest spreads to Saudi Arabia. Another is interest rates - the current zero interest policy is an unsustainable abnormality which if continued will destroy the dollar, and we are already seeing it being undermined by rising rates in countries such as China and now South Korea. One big reason that the dollar has so far evaded more serious retribution is the parlous state of the European Union, which has put massive pressure on the euro, but the continuing advance in the price of gold, which is real money, shows us that continued global ramping of the money supply is destroying the value of all fiat.

Thus it is interesting to observe the ominous technical patterns that are starting to show up in commodities such as copper, and in the major US stock indices such as the Nasdaq and S&P500. Seasonally we would expect to see the markets continue to advance, or at least hold up, until about May, but given that markets discount the future and will be looking ahead to the potential "black hole" of the post QE2 period, they may not survive that long this year. Certainly it will be interesting to see how US Treasuries fare in the absence of Fed buying. Jim Rogers, quoted in Bloomberg today, has remarked "I cannot conceive of lending money to the U.S. government for 30 years", we would go further - you would have to be brain dead to be either a buyer or holder of long-term US government debt, although we are well aware that there could be a temporary spike if commodities and stocks cave in - any such spike should be shorted.

Now to look at several charts and we will start by reviewing the chart for the S&P500 index. Superficially it looks like we are now seeing just another correction on the relentless upward path, as occurred in November of last year, but if you look closer at this chart you can see that downside volume is becoming dangerously high, and a very large gap has now opened up between the moving averages...

Likewise with the Nasdaq Composite index where we can see that a potential Head-and-Shoulders top is forming...

The high downside volume in the Nasdaq is made more clear by this recent 4-hour chart...

Copper's predictive powers for the economy and the markets are renowned, which is why it is known as Dr Copper, and just yesterday it broke down from a Head-and-Shoulders top, which also involved a clear breakdown from its uptrend in force from last July. The message of this development is clear and simple - the broad stockmarket may be about to do likewise and go into severe decline.

With respect to commodities generally, the public are now very bullish, with sentiment at an extreme level that typically leads to a reversal and significant, if not severe, decline. The overall COT reading for commodities is at "nosebleed" bearish levels, with very high Commercial short positions and Large Spec long positions, as is the COT for crude oil, calling for an imminent reversal in the commodity complex.

Pulling all of this together it is thought likely that we are on the verge of a potentially severe decline in commodities and stocks. While acknowledging the seasonal tendency to keep going into May, and the possibility that they could hold up till then, this doesn't look likely this year.

How would a severe decline in commodities and the broad stockmarket impact gold and silver prices and the prices of PM stocks? Well, it would probably get really ugly, as once again investors would "throw out the baby with the bath water". Even though gold recently broke out to new highs, it has been unable to follow through so far and its new highs are thus marginal, making it more vulnerable, and it is certainly easy to see why silver could drop heavily here as it is so overbought at this point. Perhaps this setup explains why PM stocks were unable to break out to new highs along with gold and silver. If a herd stampede develops as in 2008 we could once again see a temporary flight into the dollar and Treasuries, despite their substantially worse fundamentals. Here we should note that with the fiat endgame now considerably closer than in 2008, gold is unlikely to get taken down anywhere near so hard as it was then, and this is why an effective approach by longer-term investors in the sector at this juncture is to hedge rather than ditch holdings.

Alright, so what can PM sector investors do to protect themselves from the risk of a meltdown, bearing in mind that given the continuing long-term bullish outlook for the sector, many will not want to jettison holdings? Put options are one possibility, but the problem with them is that they expire and have eroding time values, and many investors are not familiar with them. Another means of protection thought more attractive and practical at this time is bear ETFs in the broad market or vulnerable sectors, either the non-leveraged or leveraged types, and for many portfolios a mix of leveraged and non-leveraged is considered appropriate.

Following is a list of bear ETFs, mainly on broad market indices, that may be used to protect portfolios from a decline in the commodity and stock complex...

Proshares

1 for 1 (100% of the inverse)

Short Dow 30, DOG $41.66

Short MidCap400, MYY $30.95

Short Nasdaq 100: PSQ $32.90

Short S&P500: SH $41.50

Leveraged (200% of the inverse)

Ultrashort Dow 30 DXD $18.31

Ultrashort MidCap400, MZZ, $41.34,

Ultrashort Nasdaq 100, QID $52.24

Ultrashort S&P500, SDS $21.27

For Canadian subscribers...

Horizons Betapro

1 for 1 (100% of the inverse)

S&P500/TSX60 Bear HIX, C$10.25

S&P500 Bear HIU C$7.91

S&P500 Bear Plus HSD C$9.46

Nasdaq 100 Bear HQD C$7.21

Leveraged (200% of the inverse)

S&P500/TSX60 Bear Plus HXD C$8.34

Also of interest: Copper Bear Plus HKD, C$9.37

To end on a bullish note, the long-term outlook for gold and silver remains spectacularly bullish, due to the fiat money system going into its end game terminal meltdown - it will end with many fiat currencies becoming virtually worthless and the reinstatement of a gold or silver standard or something similar - something which restrains politicians instincts to take the easy way out and inflate. As we go into this phase we may see a far greater allocation of pension fund assets into the Precious Metals sector as this article by Jeff Clark of Casey Research makes dramatically clear, which is likely to have a spectacular effect on prices.