The next leg down appears to be getting underway. Gold may have broken out but the HUI and silver remain below their old highs.

We have to go up to Ottawa next week so we will be issuing a shortened report on Friday.

D.C.

The crisis is over. The huge liquidity injections appear to have worked (injections over the past couple of weeks were well over $400 billion coupled with a lowering of rates for the discount window). The markets are rising again as they are supposed to. All is well. Or is it?

A week or so ago everything was in a panic. The Dow Jones Industrials fell a swift 10% and others fell even more. The Gold stocks as measured by the Gold Bugs Index (HUI) fell a sharp 23% from its recent highs although they have now bounced back roughly 12% recouping almost 40% of the recent drop. And remember the precious metals markets had nothing to do with the recent financial crisis triggered by the meltdown in the sub prime mortgage market. The baby as they say was thrown out with the bathwater. Heck they threw out several babies. Gold itself also fell although at its worst it was only off about 6% considerably less than the gold stocks and the rest of the market. In what now seems to be becoming a broken record we heard rumours once again of central bank sales during the crisis. Enough to make one wonder whether these are timed or deliberate.

We can only guess that the last thing that Fed Chairman Ben Bernanke wants to hear is the word “Bernanke Put”. The Greenspan Put was made famous under former Fed Chairman Alan Greenspan who once declared that he would love to be Fed Chairman during the next Kondratieff Winter so that he could go down in history as the one who prevented the next Great Depression. Yes Alan Greenspan was a believer in the Kondratieff cycle and also followed Elliot Wave Theory. The Kondratieff cycle was named after Russian Economist Nicholas Kondratieff who showed that Western Capitalist economies went through long term cycles of roughly 54-60 years. Each cycle subdivided into four smaller cycles that included early inflation (Spring), inflation (Summer), early deflation (Autumn) and deflation (Winter). Kondratieff wrote about his theories in the mid 1920’s and his reward was banishment to Siberia by Stalin. Stalin apparently couldn’t deal with the part that said that after the Kondratieff winter that the capitalist economies would rise once again. I guess he didn’t understand cycles. At the time the Kondratieff cycle fitted nicely with about the life span of a man so it is possible that today the cycle could stretch to 72-77 years.

The last Kondratieff winter ended with the Great Depression and war and most Kondratieff analysts put the last winter as lasting from 1929-1949 (Ian Gordon). Others say it ended with the market lows of 1942. We have always counted ours from 1949. The most recent spring was 1950-1966, summer was 1967-1982, autumn (and the traditional blow off in the stock markets) was 1983-2000. We and others suspect that the most recent Kondratieff winter got underway in 2000 and is not expected to end until at least 2012 or as long as 2020/2022. We have always been struck by the similarity in the patterns of this decade with the patterns of the 1930’s (70 years). Ray Merriman another cycle analyst we follow has noted what he believes is a 72 year cycle (+/– 12 years) and even a 90 year cycle (+/– 15 years). The last instance of both the 72 and 90 year cycle was 1932 so that would put the 72 year cycle at around 2004 and the 90 year at 2022. So both cycles are falling right into our current Kondratieff period.

In comparing the 1930’s to today we can’t help but note that stock markets topped in September 1929 (January/March 2000); a major collapse got underway that didn’t bottom until 1932 (2002), an explosive rebound took place in 1933 (2003); a sideways market was seen in 1934 (2004); the rally resumed with a vengeance in 1935 and continued well into 1936 and didn’t make its top until March 1937 (while we generally continued the sideways market in 2005 the market had a strong up year in 2006 and continued into 2007 and may have topped in July 2007). What followed was a devastating bear market that didn’t bottom until 1938 and after some chopping around over the next few years didn’t bottom for good until 1942. The reason we go until 1949 is because the entire pattern from 1929 has a very distinct ABCDE shape to it with the A wave bottoming 1932, the powerful and impressive B wave topped in 1937 (and note B waves can even go back to the old highs or even higher), the C wave bottomed in 1942 with the D wave topping in 1946 and the final and usually short E wave bottoming in 1949.

All financial collapses are credit and debt collapses. Every long term cycle is a huge build up in debt and a widening of the wealth advantage. This period has been no different except that it has gone on so long and wealth disparity is wider than it has ever been. All periods of massive debt build ups need to be cleansed. These are a normal part of the cycle. Except of course in this cycle they are trying to bail the system by flooding the system with liquidity and rapidly cutting interest rates. We have seen the massive liquidity injection and there has been rumours of an interest rate cut beyond the discount window cut we have already seen. So will it work?

Already on this rebound we are instantly hearing how the crisis is over and it is an excellent place to pick up bargains. Others are noting the usual array of indicators that say the market has made a major bottom. The fund managers who are buy and hold are all saying this is merely an interruption in a long term bull market and the economies are sound and while growth may slow slightly the long term remains intact. But then they all have their own book to talk. So do the bears for that matter and that is why you have to look at it realistically.

The uptrend from the July 2006 lows has been broken. A gentler uptrend from August 2004 remains intact and on the S&P 500 that line does not break down until we fall under 1300-1325. Daily and weekly indicators have fallen into bear modes but the monthly indicators remain up. So we know the short and intermediate trends have turned down but the long term up trend remains intact. The monthly indicators turned positive for good in the latter part of 2003 and have remained that way thus far. Since the markets turned up in 1982/1983 there has only been three periods where the markets turned negative on the long term and that was during the 1987 stock market crash that lasted into early 1989 and again briefly in 1990 and of course through the 2000-2002 bear market. The 2000-2002 bear market broke the long term up trend from the 1982 lows on the monthly charts and that told us that the great bull market of 1982-2000 was over. Many claim that the rally from 2002 to recently was a resumption of the long term bull. We disagree it has merely been a correction in the first leg down of a new bear market that will last several years as we note above.

The recent breakdown may be signalling the start of the next major leg to the downside. But we can not confirm that until we break down under 1300-1325 S&P 500. Then minimum targets could become at least to 900. Worst case targets could be 500. But in the interim as long as we remain above 1300-1325 we could regroup and go to new highs although cycles do not suggest that will happen but it remains a possibility. The S&P 500 regaining above 1505 would shift the short term back into an up mode and above 1525 we could make an argument for new highs. But in an environment where the concerns over the collateralized debt obligations remain intact then the odds of us regaining those levels above are remote at this time. Major resistance will be seen at 1480.

If anything this crisis threatens to get worse. Which is why we are probably hearing about Fed discount rate cuts if not soon then at the meetings on September 18. Trouble is we are not hearing of others willing to cut at this time. The US$ reacted appropriately and after hitting our key resistance zone at 82 immediately sold off. That lifted gold and silver bullion prices. Already the job losses related to the crisis are beginning to mount. In August thus far some 24,000 job losses including some at a Lehman Brothers mortgage subsidiary. This may be merely the tip of the iceberg. And remember these are not low end jobs but rather high end financial jobs. And major problems remain in the commercial paper market.

The commercial paper market is the source of funds for the best names in the industrial and financial sector. And on the other side hundreds of corporations, financial companies, mutual and pension funds buy paper to park short term money. In the US some $1.1 trillion roughly half of the commercial paper market has been linked to these structured finance notes. And here in Canada there is estimated to be at least $40 billion. Indeed the companies holding the bogus paper covers the realm from Barrick Gold, to Dundee Bank to Nav Canada and tour operator Transat to pension and mutual funds. So did all of these companies suddenly lose their mind and decide to buy billions of dollars of bogus paper? No they listened to the rating agencies DBRS here in Canada and S&P in the USA and they said it is R1 high and A1. This is quality paper and safe. Well no it is not. Certainly not any more. So everyone is running around covering their ass because at the end of the day a lot of people are about to lose their jobs. At DBRS, at S&P at NAV at Barrick at Dundee we could go on. There is game playing with National Bank buying $2 billion to bail out their funds. There is talk of converting it to long term debt. Long term debt? They didn’t buy long term debt they bought short term debt because they have obligations to meet, plans to execute. That is what buying short term paper is all about. Oh and Coventree Financial Group (COF-TSX) who has gone on a wild ride falling precipitously from over $16 to near $2 then back up to $4 when they announced a plan to save the financing for the firm and then suddenly again they can’t roll their paper and poof right back under $2. Do we hear 0 coming up. Okay 10 cents.

US money centre banks have been into the discount window grabbing funds like crazy mostly to try and bail out names like Country Wide Financial (CFC-NY). Okay Countrywide hasn’t fallen as precipitously as Coventree only going from $45 to $15 but the trend remains the same – down. Trouble is no one knows what this paper is worth any more. Converting it to long term debt is not going to solve the problem merely shuffle it around and pretty it up trying to pretend that it is better than it is. And many of these companies are now going to have financial problems because funds they thought were safe and there for a rainy day are no longer there. For financial institutions converting to long term debt will have a negative impact on capital ratios. And what if they need to raise more capital? Will they might but the prices of their stocks will have to fall further – a lot further. Everyone is still frozen and unless the Fed (and the Bank of Canada) are prepared to bail everyone out then someone has to fail and ultimately someone big and important is going to fail. If risk is an element in the markets then they can’t be bailed out or there will be a Bernanke Put and of course at the end of the day it will become a taxpayer bailout to save financial companies from themselves and their own follies.

And attached to a lot of this structured finance or collateralized debt is derivatives. These derivatives are all over the counter (OTC) not exchange traded derivatives. It includes credit swaps and others and now all of those markets are imperilled as well. The industry employs thousands of people to create all of these games and all of them are high end jobs. There will be a lot more job losses. Then ultimately it overflows into the general economy as the banks tighten credit and credit the lifeline of the economy dries up for everyone. While everyone talks of a discount rate cut the reality is that rates might actually rise in a credit crunch even as the official rate falls. Money becomes expensive. And don’t forget that the vast majority of those ARMS mortgages and other adjustable loans have still not come to the forefront yet. Over the next year there are tens of thousands of these loans coming due. The crisis rather than being over is merely in its early stages.

And don’t forget that with the all this paper no longer of credit quality many funds can not by their own laws can not hold this paper. But they can’t get rid of it. There is no market for it. So who is going to buy it? All of this translates into less money for expansion, less money for future investments and a massive credit crunch of major proportions. Oh it will not all come to the forefront at once and the Fed and Bank of Canada and other central banks will pump money like crazy to try and prevent an all out collapse or the allow the collapse in stages. Every government and every central bank in the world will be going all out to prevent a collapse.

So where does one hide? We continue to believe gold remains a core holding. Gold suffered less in this then most other assets. A falling US Dollar will be excellent for gold and central banks pumping money like crazy to prop up the credit unwind is also good for gold. Short term we may have some more work to do here as our cycles remain somewhat negative but by September/October we should be seeing signs of a bottom. Our worst case scenario remains a sudden collapse under $600 to the $550/$560 level. Our best case scenario is that the we just continue to muddle around in the $640-$690 zone until we get ready to break out to the upside over $700. Gold stocks as measured by the Gold Bugs Index fell to long term support at 285 and the rebound has been impressive but we need to break out over 330 on the HUI to give us some sense of comfort that the worst is behind us. Worst case scenario there is a drop to around 240 where very long term support comes in. Another drop under 300 would suggest a test of the 285 area and a possible drop to lower levels. Above 330 we should start working our way back towards 360/370. Gold remains in a long term uptrend since the lows of 2001 despite the year plus longer consolidation corrective period. Seasonally gold has its best period in the last quarter because of the Christmas season and special seasons in India the world’s largest consumer of gold.

Oil prices are also in a weak period. Natural gas prices broke there recent lows and now appear headed for $5. Note we did this last year as well in this time period but the bottom was made in late September. This is a weak period seasonally for both oil and gas. NG has huge support down at $5 and even more down to $4.50. We fell to the $4/$4.50 zone last year. Oil has broken its uptrend from the lows near $50 seen last January. There is support here at $67-$69 but under that level we would fall to $64/$65. Significant support lies at $60/$62. Risk of war remains in the Mid East and we can’t help but note that the Iranian Revolutionary Guard, Iran’s elite military unit some 125 thousand strong has been designated a terrorist organization by the United States. This would be akin to naming the USA’s elite marine units terrorist organizations. Starting a war in the Mid East would be a huge distraction if we really were in a major financial crisis meltdown. While there remains some downside risk in the near term for both oil and gas the next two months is typically a trough period. If a major hurricane heads for the gulf of Mexico that would put upward pressure on energy prices. Oil needs to regain and breakout over $74/$75 to tell us we are headed for new highs. For NG we need at this stage to overhaul $7 with initial resistance now at the $6/$6.50 range.

The current corrective period is a calm before the next storm breaks. This crisis rather than being over is merely at one of its many periods of calm as the market tries to sort out what is really going on. This current period could certainly hang on into the first week of September or we could test lower now and then rally into the mid September. September is traditionally a weak month for the markets indeed its record shows it is the worst month. In 1937 markets had a secondary top in August then another attempt at a top in late September before it fell off the rails completely. In 1987 we had a secondary rally back in September that lulled everyone to sleep before the stock market crash of October. Actually a low in the first week or so of September would be good as we have often noted lows occurring roughly 55 days from an important top (note: in 1987 the market topped on August 25 and bottomed 55 days later on October 19). The top was July 16 for the S&P and July 19 for the DJI so we would look for a low around September 9-12. Then we would get a secondary corrective to the upside. Resistance on the S&P 500 is clear at 1480 and a sell signal would be seen under 1425.

100 years ago in 1907 there was a financial panic that was known as the “Banker’s Panic”. Some even called it the “Poor Man’s Panic” although as with all financial panics it is not the poor that start them but they certainly usually pay for them. In 1907 the stock market fell nearly 50% and the economy moved into recession. April 1906 saw the San Francisco earthquake and as usual the market completely underestimated the impact of the earthquake on the larger economy. (I have a nod here to Subodh Kumar of CIBC who also called it the Rich Man’s Panic in an interview on BNNTV Friday).

Flash forward 100 years later to September 2005 and Hurricane Katrina devastated New Orleans and started the housing meltdown that remains with us today. But going back to 1907 the markets at the time initially viewed the San Francisco earthquake with barely a ripple. Over expansion and financial speculation that had already been in place continued. Later in the year the year the anti-trust suits got underway against Standard Oil of New Jersey and American Tobacco and then a somewhat speculative market suddenly realized things were not what they seemed and a financial panic got underway. The speculation was pushed by easy money and shoddy lending practices from the banking system.

Only in October 1907 did a cadre of banks led by J. P Morgan manage to stem the bleeding as the effectively bailed out the financial system. The result of that action eventually led to the creation of the Federal Reserve as it was felt that that protecting the financial system should not be left to the private banking system. One of the interesting aspects of that time was it was the collapse of a bank known as the Knickerbocker Trust Company that triggered the bailout as it threatened the financial system. Knickerbocker was owned by a commodity speculator F. Augustus Heinze who had parlayed his fortune in the copper market into owning a trust chain that then was involved in a number of financial schemes (one of which was collateralized loan obligations) that eventually collapsed. The banks of course had tightened money and that combined with a credit crunch that played the role that sunk Heinze and Knickerbocker and of course many others.

So will the panic and bail out this time by the Fed play out like 1907? By February 1908 things had recovered and the market resumed at that time what was a longer term bull market. The panic of 1907 while steep and painful was forgotten by 1909 as the market completely recovered itself. A few things stand out in our mind in the events of the past couple of weeks. First what was the panic on the part of the monetary authorities? One would have thought that the markets were down 30% not just back to break even for the year. At the close on Thursday the Dow Jones Industrials was actually up 3.1%, the S&P 500 was down a mere 0.5%, the NASDAQ was up 1.5%, and the TSX was also down a mere 0.5%. Okay so it was August and everyone hadn’t made their 25% yet.

Although we confess we were wrong about one thing here and that was the negative impact on the precious metals stocks and even the oil stocks. Both came under heavy selling pressure yesterday largely due to what we believe was largely serious margin selling. The TSX Energy Index was off 0.5% on the year but the precious metals stocks as measured by the TSX Gold Index that have generally floundered all year were off 23.7% while the Gold Bugs Index (HUI) was down 11.2%. But lets keep things in a bigger picture perspective. Since the DJI topped in January 2000 the TSX Gold Index is up 115% while the DJI is up 9.5%. Since the October 2002 lows the DJI is up 63.6% and the TSX Gold Index is up 48.3%. Gold bullion on the other hand is up 1.6% on the year emphasizing why we have always said you have to hold some bullion (note: that is in US$ and in Cdn$ terms may vary depending on the performance of the Cdn$). From the January 2000 DJI highs gold is up 160% and from October 2002 is up 105%. Gold has outperformed them all. The TSX Financial Index is off 4.6% on the year (2007). All these numbers are based on the close on Thursday August 16.

So with the markets largely unchanged on the year what was the massive injection of liquidity that occurred (easily some $400 billion or more) and now the Fed cutting the discount rate for banks to 5.75% from 6.25%. Note that is not the Fed rate which remains unchanged at 5.25%. Cutting the Fed rate would have more impact as it directly impacts rates in the market whereas the discount rate for banks only impacts money for the money centre banks. Goldman Sachs believes the Fed will cut the Fed rate by 75 basis points by December. Given all of these moves and concerns and with the markets only unchanged something deeper is amiss.

Well it is. Collateralized debt obligations and structured finance. Banks, dealers, hedge funds, pension funds, mutual funds – they all loved them. In a world crying for yield these instruments were perfect because they offered clients a much higher yield then they could get from bank term deposits or buying regular commercial paper or bankers acceptances or even preferred shares .What are they? Well bundle up anything that could be securitized. Mortgages, car loans, credit cards we could go on. Banks bundled them up and selling them helped their balance sheets. Dealers and others loved them because they could make big fees (I recall seeing these instruments regularly with enticing 5-8% commissions attached to them for brokers) and everyone else loved them because they carried a higher yield then you could obtain elsewhere. The rating agencies got into the game by rating the commercial paper backing these instruments as R1 High or in the USA – A1. That meant that whole hosts of investors could buy them from pension and mutual funds to insurance companies. They were a godsend and everyone got rich especially the dealers that invented them as did those who played the games with derivatives and other instruments to hedge them. Oh there were all sorts of little pitfalls with them but they were manageable pitfalls.

But it all started to become unglued with the collapse of the sub prime mortgage market. Suddenly these instruments were not what they thought they were. What were the worth? How could you value them? And then suddenly no one would buy them and the panic was on. One big margin call on the market and in order to raise cash anything not glued to the floor had to be sold. The shocking part we discovered was the huge amount of commercial paper out there backing these instruments. In Canada some $40 billion and in the USA an astounding $1.2 trillion. Grant you the commercial paper markets are much bigger than that estimated in the US to be around $2.2 trillion but effectively this entire thing was locking the commercial paper market. The commercial paper market is the prime source of financing for scores of financial companies and industrial corporations and there is virtually no major corporation that is not involved in this vast market. (Note: I spent roughly 25 years as an institutional money market trader/manager with Export Development Corporation (EDC), CIBC and Confederation Treasury where amongst others we managed the companies commercial paper programs).

Until this past week we had never even heard of Coventree Financial (COF-TSX). But seems they were specialists in the structured finance market or as they called it Asset Backed Commercial Paper (ABCP). DBRS put their paper “Under review with Developing Implications”. Oh! Maybe something was wrong with their review of this paper in the first place. It was a financial scheme nothing more nothing less and now this market is coming apart at the seams. A group of investors led by Caisse de Depot, Quebec’s answer to the Canada Pension Plan, have temporarily bailed out this mess. The reality is they are now stuck with potentially a lot of worthless paper or at least a lot of paper that no one can figure out what it is worth so therefore it is the same thing. No one knows where this paper is, who holds it, how much is out there, how much it has been sliced and diced. And there is a lot of this stuff out there. No wonder the banks and lenders have clamed up and are refusing to lend (causing a credit crunch and liquidity crisis) and at the other end everyone is issuing calming statements whereas in reality there is probably some serious knawing of teeth going on in corporate boardrooms. In the end heads will roll and someone big will collapse.

So is this as bad as it might appear. Well there is even different kinds of structured finance or in the parlance the aforementioned ABCP or collateralized loan obligations (CLO’S) or collateralized debt obligations (CDO’s) so some of it is okay and will survive and others – well ……. Complicating this further is the hedge funds who geniuses that they are leveraged themselves up. It is not unusual to find hedge funds that leveraged themselves up 3-1, 5-1, 10-1 or even 20-1. Of course when Long Term Capital Management (LTCM) collapsed in 1998 they were leveraged 80-1. Their portfolios have to be marked to market. Trouble is if you don’t know what the market is and no one will buy your stuff you have a big problem. Ergo the massive selling of anything not glued to the floor to raise cash. Of course if you are not leveraged you have considerable less to worry about. Not that you can’t lose but you won’t lose a lot in a hurry. So there will be massive attempts to put these things off balance sheet (shades of Enron) and transparency disappears.

And then in the broader market everything seizes up. Lending gets tighter. Poor credits gets nothing. And banks instead of lending 100% mortgages go back to sensibility like 75% mortgage and the resultant pool of buyers dries up. Potentially especially hard hit will be huge luxury condo and other projects where a mere million gets you 1500 square feet but your neighbours are all ultra rich. And we wouldn’t be investing in Mercedes or other luxury cars as the rich man’s panic will soon give these ultra luxury things a big hit as the buyers become unemployed when their fund goes down. Of course that eventually effects even the middle class as they will see credit dry up as well and well the poor – they were always poor so nothing changes for them. It all has a big snowball effect.

Trouble is this was encouraged for years. The Fed (and the Bank of Canada) provided liquidity, slashed interest rates, bailed out the key players to prevent a bigger collapse and the result was not surprising that everyone from the CEO to the “masters of the universe” in the big investment dealers, banks and hedge funds all say simultaneously “we can’t lose, the Fed will bail us out, cheers for the Greenspan/Bernanke Put” leverage up and let’s all party. And so to does the consumer where his debt to income over the past decade just kept rising even as savings fell (not overall but for the vast majority of the population). Now we are on the verge of paying the piper. Oh maybe the Fed and the Bank of Canada and the rest of the world’s central banks can save the day again and create another bubble. We have had at least three in the past decade or so in technology, housing and of course the takeover mania (which now comes to a screeching halt and many of the financings that were driving these deals may now be in deep trouble – think BCE Inc.).

We had thought the markets might fall at a minimum once they topped some 20% by October. This first phase gave us 10% in a hurry (and in some cases and sectors a lot more). Our timing was based on our seeming ability to follow previous cycles and in that case we have often paid closed attention to the 1930’s cycles. The markets in 1937 topped of course in March and a secondary top was seen in August before a major panic/collapse got under way. Other cycles we noted was the 1990 collapse where we topped in mid July. We have oft cited the cycles of major panic/collapses in years ending in 7. 1907, 1917, 1937, 1957, 1977 and 1987 all come to mind. We also note panics in 1837 and 1887. We note in our little table below how long it took to regain the highs and how deep the collapse went. We use the Dow Jones Industrials in all cases.

1907 – Top 96.75 actually in September 1906 – Bottom 53 in November 1907 down 45.2% - Highs taken out in August 1909 2 years 11 months.

1917 - Top 110.15 November 1916 – Bottom 65.95 December 1917 down 40.1% - Highs taken out in October 1919 2 years 11 months.

1937 – Top 194.40 March 1937 – Bottom 98.95 March 1938 down 49.1% - Highs taken out in November 1945 8 years 8 months

1957 – Top 520.77 July 1957 – Bottom 419.79 October 1957 down 19.4% - this was a relatively mild one and a considered a false breakdown before a bigger collapse in 1960 – Highs taken out October 1958 1 year 2 months.

1977 – High 1004.65 December 1976 – Bottom 742.12 March 1978 down 26.1% - Highs taken out in December 1982 (for good although there was a few minor forays above that level before then but none held) 5 years

1987 – High 2722.42 August 1987 – Bottom 1738.74 October 1987 down 36.1% - Highs taken out in February 1991 for good although again numerous forays over the August 1987 highs but none held for more than a few days to a couple of weeks. 3 years 6 months.

So as we see once these panics get underway it takes at least a few years for it to work itself out and in the worst case almost 9 years. We of course don’t know which one this one will be. Technically there has been considerable damage done to the markets and the problem of the structured finance has not gone away and it won’t because it can’t until it is all (or at least the bad parts) are cleansed from the markets. It will in the end bust a lot of careers in the finance world and eventually fall out onto main street with rising unemployment. How bad does it get we don’t know. No it won’t be like the Great Depression but it will be severe.

The drop for the moment isn’t really all that much. Last year the DJI fell some 8% from May to July and the world didn’t end. The highs of May were taken out by October. And overall the global economy is still pretty strong and can remain so as long the credit crunch doesn’t become totally freezing. If it does then it could get worse. There also remains the real risk of a trade war particularly China/USA although we can’t for the life of us see why they would be that stupid but it does remain a real possibility with protectionism very high in some quarters in the US.

Still it appears that we will now embark on at least a suckers rally that could last for a couple of weeks or so. A potential turning point could be the first week of September. Key later on could be the Fed meeting in September where many will be expecting the Fed to cut rates by 25 b.p. But overall we remain that a drop of at least 20% (DJI) will occur by October. The structure in the fall from the July highs appears as an ABC type pattern. If it is a five wave pattern we could see a 4th wave now then a test of the lows that equals or comes close to the previous lows (we call them failed 5ths) before we embark on a better rally over the next couple of weeks.

As to the bullion market more specifically gold despite the gyrations on Thursday very little has changed. Generally gold has outperformed even on the downside losing less. Silver has gyrated more widely. Gold remains in a large symmetrical triangle that breaks out above $685-$695 and breaks down under $640-$650. Thursday once again we held that key $640 level. And if we were to break under that level our downside risk would find support at the $600-$620 level and again at $560-$580. That is our worst case. Silver appears to have broken its recent triangle pattern so we do have to pay attention closely to lows seen last year at $10.60 and $9.90. We don’t believe they will be broken as the supply situation for silver is worse then for gold. Weekly charts for silver are very oversold and at extremes we have rarely ever seen. The HUI broke down out of one possible triangular pattern but the lows on Thursday held a bigger triangular pattern. These supports at 285 are more important and a rising long term up trend line from 2002 is seen near 250-260. The HUI continues to need to break out above 360-370. The panic that took place yesterday in the precious metals and others was we believe quite irrational and panic margin call related selling. Remember that these market have little to do with the structured finance market where the real problems lie.

Gold is the US$ As long as the Fed either inflates by massive liquidity injections or they cut interest rates gold is and will be an eventual big winner. Inflation, deflation, cutting interest rates or massive liquidity injections are all positive for gold. Our cycles still suggest we remain in a period for an important low. A breakout over our key levels should signal to us that low is in. The US$ remains in a long term downtrend and as long as that is the case Gold will rise. There may be periods of strength in the US$ but as we have seen here recently when there definitely was a rush into US$ particularly US Treasury Bills as a safe haven. The Gold stocks have a different problem as they are paper just like other stocks. We always recommend that investors hold some bullion and we suggest at least 10% of your portfolio. This is almost more important then holding gold stocks. We continue to hear that gold and other metals have been in a bubble. But we have never seen any sign of a bubble. Indeed if the US$ remains vulnerable as we suspect we remind everyone that all commodities are priced in US$ and as the US$ falls the commodity prices only have one way to go and that is up. Gold stocks always seem to get beat up in any little mini panic but if we were instead to change our bear market in the broader market to a grinding bear market this would prove positive for gold stocks. No surprise though that in this panic shakedown our stops were hit on our gold portfolio.

While Oil stocks gyrated in the markets on Thursday as well and suffered like all paper we are reminded that oil prices remain above $70 and now even natural gas is showing signs of recovery. So the sharp gyrations downward in the oil stocks of late we believe remains a correction in the context of bull market. The XOI Index held all key support levels this past week and the pullback represents a buying opportunity although there may be more work to do in the correction.

It is possible the first wave of what we believe is a new bear market may be at or near the end. We should now embark on a near term correction of that first 10% drop. For the S&P 500 resistance is at 1450 then 1480-1500. If we are correct that this is a new bear market then the zone 1480-1500 should be about it on a correction. For the moment the March 2007 lows held (barely) and from what we have seen those lows will eventually go but it may not happen until September at the earliest. Gold remains in a bull market and the major support remains $640-$650 and resistance is $685-$695. Even a breakdown under our support zones there are stronger support zones at $610-$620. Oil remains in a major uptrend with near support at $70 then down to $66. Resistance is clear at the highs of $77-$78.

All the interest rate cuts and liquidity injections are not going to change the picture because the problems lie deeper than that. The banks are not going to rush out to lend again because right now even they don’t know how deep this structured finance blow up really is. All panics and collapses are ultimately debt collapses and this one is no different. That a credit crunch accompanies them is also no surprise as basically it is just a bank freeze on any risk. Once the crisis is resolved they always seem to return to their former bad ways and the next cycle gets underway.