Balance Grasshopper (Saut)

“Balance Grasshopper”
September 12, 2011

by Jeffrey Saut, Chief Investment Strategist, Raymond James

‘“I felt a great disturbance in the force ... as if millions of voices suddenly cried out in terror and were suddenly silenced. I fear something terrible has happened.’ Clearly a line uttered by Obi Wan Kenobi in the movie Star Wars, but how appropriate given our sense for the past few weeks that something is/was out of balance in the universe. Whether it is an Argentine default, another Long Term Capital Management (LTCM) hedge fund debacle, a Japanese banking implosion, etc. is not really the point. The point is something is out of balance in the cosmos! We have opined that the current situation is reminiscent of the summer of 1998 when the stock market (DJIA) slid into the end of August and then dove 513 points on August 31st, setting up a decent tradable low. At that time NOBODY knew the reason for said slide – news of the LTCM implosion didn’t surface until weeks later. Indeed, something is out of balance.”

I penned those words on September 10, 2001, 24 hours before “a day that will live in infamy.” I revisit them today not just in memory of the friends I lost on 9/11, but because for the past few months something again feels out of balance in the universe, a sense that is being reflected in the equity markets. One of the things impacting the country’s “balance” was the budget fracas, which surfaced the dysfunction of our government. It also increased the burgeoning “confidence crisis” our nation is feeling punctuated by last Friday’s Freefall (-303 DJIA). That Dow Dive was partly in response President Obama’s innocuous $447 billion jobs speech. In said speech he said “[you should] pass the jobs bill” a subliminal 16 times! The key elements of the jobs plan can be retrieved here: http://www.reuters.com/article/2011/09/08/us-obama-jobs-proposal-fb-idUSTRE7877TG20110908. Interestingly, the Republicans chose not to respond to the President’s speech with the typical post address rebuttal. That decision sparked this vitriolic verbiage from Representative Nancy Pelosi, “The Republicans' refusal to respond to the president's proposal on jobs is not only disrespectful to him, but to the American people.” That night the U.S. Senate did indeed vote to increase the debt ceiling by another $500 billion to fund the “job’s bill,” proving the entire budget angst of a month ago was a sham. And while the Republicans didn’t respond to the President’s speech, the stock market certainly did on Friday.

Also affecting the country’s “balance” has been the European mess. In last Tuesday’s written strategy comments I stated that the European event of the week would be Wednesday’s ruling by Germany’s Constitutional Court regarding the legality of the various bailouts. As expected, the court ruled the rescue plans were legal, which lifted the DJIA by some 275 points on Wednesday. However, what went largely unreported were the court’s qualifications for making future bailouts more difficult. One such clause apparently kills the issuance of Eurobonds. Subsequently, on Friday rumors swirled on the world’s bourses that Greece was going to default over the weekend and the rout was on; and as stocks slid, the U.S. Dollar Index soared, the 10-year Treasury yield broke below 1.9%, and gold rose. The result left the dollar at a new reaction high and technically in a bull market by breaking out of a bottoming formation in the charts that looks strikingly similar to what it did before the Lehman bankruptcy. While it isn’t surprising the dollar’s strength helped buoy bonds, it is surprising that gold rallied along with the dollar.

Speaking to gold, for weeks I have opined the upside gaps visible in the charts are suggestive of an interim top and consequently partial positions should be sold even though I think gold will trade higher over the coming years. Rebalancing such positions is just a prudent asset allocation technique. Yet, I have been pounded with questions as to why I think gold will trade higher in the long run. Well, in addition to rising per capita incomes in the emerging and frontier markets, and a world awash with fiat currencies, there aren’t many of us left who have seen how a real gold bull market ends. Come with me then to the land of yesteryear. It is the late 1970s where the Hunt brothers are attempting to “corner” the silver market. It was a heady time ripe with speculation in precious metals stocks. The biggest speculation centered on a dozen tiny South African gold stocks possessing names like Stilfontain, Vaal Reefs, Western Deep Level, etc. Unfortunately, these stocks were unavailable on our Bunker Ramo quote machines. Consequently, quotes on these companies came in only twice a day over the Telex machine. At 10:30 a.m., and again at 2:30 p.m., the quotes (bid/ask) arrived and were dutifully ripped off of the Telex and carried to the clipboard that resided below the Trans-Lux electronic stock exchange ticker tape. Participants anxiously awaited these postings and feverously huddled around the clipboard before racing to their broker’s desks to place an order. And that, ladies and gentlemen, is how a gold bull market ends. Importantly, we are nowhere near such a fever-pitched point.