The Industrial Production Index

There are three components to Dow's Theory, the movements of the Dow Industrials and Dow Transports are the first two. The final piece to Dow's Theory was called Barron's Business Index or the Barron's Monthly Index of the Physical Volume of Industrial Production and Trade. Unfortunately, After contacting the statistics department at Barron's and the Wall Street Journal I was told that the Barron's Business Index was discontinued in 1938 leaving Dow Theory adherents without a reasonable "real-time" measure of general economic activity.

As an alternative, I have decided to go with the Industrial Production Index (IPI) published by the Federal Reserve Board. To get a detailed review of the viability of the IPI as applied to Dow's Theory, I strongly recommend that you get your hands on the book "Priniciples of Professional Speculation" by Victor Sperandeo. The nice part about the IPI is that when compared to the Barron's Index from 1919 until 1938, there is almost no difference between the two economic indicators. The most important concern about a business activity index like this is that it is as close to real time as we could get. The Industrial Production Index lags the real economy by 2 months at the most. This is contrasted by organizations like the National Bureau of Economic Research (NBER) which routinely reports 1 to 3 years after the fact that the economy has either hit a bottom or a top.

On the right hand column, I have added the final piece to the necessary elements of Dow's theory as was originally intended by Dow, Hamilton, and Rhea. You'll see the Dow Industrials, Transports and the Industrial Production Index. When all of these indices indicate that they are either falling or rising, at the same time, then you will know right away the general direction of the market. Also important is the relative values within the market. The relative value of the market is indicated by the Dow Yield indicator. This will tell you that, regardless of the direction of the market, there are either few or many investment opportunities in the stock market.

Now, let us look at the IPI and see what it could be telling us about the real economic activity from a technical analysis basis. On the chart below, I have included the IPI chart from 1996 until October 2008. From the period of Dec. 2001 until Jan. 2008, we see the rise of the index by 14.73 points. Using Dow's theory, the index is supposed to have support levels at 107.66, 102.75 and 97.84. After breaking through the first support level of 107.66 the index fell to the low of 105.95 in Sept. 2008 before rising to 107.29 in October 2008.

On the chart, I have indicated the resistance level (dark blue line) where the index needs to go above to truly confirm that we might be coming out of this bear market. If the IPI cannot go significantly above the 109.26 level, then the potential exists that the economy could contract even further. Any further decline in the economy could take us back to the 97.84 level, a 9% reduction in business activity.

So far we have the Dow Transports and Industrials with lows established on November 20th. The September low of the IPI needs to continue above the 109.26 level to resoundingly confirm the end to the bear market. Remember, the end of a bear market is not the automatic beginning of a bull market. Therefore, once the end to the bear market is confirmed we will also need confirming action in the indices to show us that a bull market has begun. Touc.

Sources:

• Sperandeo, Victor. Trader Vic II- Principles of Professional Speculation. John Wiley & Sons, Inc. 1997.

Dow at 208,210.50 or...

...What the newspaper headlines would have said at the peak back in October of 2007 if the Dow continued at the current pace when it was last trading at the same level back in June 1o, 1997.

This is the best way to determine if we're truly in a bull or bear market. back in June of 1997 when the Dow first crossed the 7539 level it took until April 2, 1998 before it reached the 8986 level. A grand total of 297 days or 4.87 points per day.

We've covered approximately the same number of points, 1381, in a total of 18 days. This averages out to be 76.77 points for each day. If the current rate of gains were applied to the Dow Jones Industrial Average back on June 10, 1997, we would have seen the peak in October 2007 at 208,210.50.

Since we're not in a bull market all that we can expect are bear market rallies which consist of violent moves up and painful moves down. A bear market rally can surge up to 50% or more in a matter of months as opposed to the years that it takes for a bull market.

Be mindful of the fact that in bear markets, buying stocks is the financial equivalent of catching falling knives. I expect this rally to be complete on or around late April 2009. Knowing this market, it could end long before or after that time frame.

The revision to my previous bear market rally upside targets are:

• 8943
• 9625
• 10,836.11

The most recent move to the 8934 was very close to the 8943 level but the Dow moved down in yesterday's action. A failure of the index to move strongly through the 8943 level could indicate significant weakness in the market and the economy over the next few weeks. Touc.

Research Recommendation: Altria (MO) at $14.99

Altria Group (MO), formerly known as Philip Morris, is the largest domestic produce of tobacco and tobacco related products. MO is currently trading within 5% of it’s 52-week low and has increased its dividend 42 consecutive years in a row according to Mergent Online. Because MO has spun-off its Kraft and international divisions within the last 2 years I cannot do a reasonable assessment of the stock price based on Dow’s theory.

According to Geraldine Weiss’ Investment Quality Trends (IQTrends), which tracks dividend paying companies, MO is undervalued when the company yields 5% or more. In periods before 2001, IQTrends viewed MO as undervalued with a yield of 6%. The current yield on MO is 8.5%. At the current yield, if reinvested in the company, the value of current funds invested would double in approximately 8 ½ years. This doubling of the value would occur provided the company maintains the current dividend regardless of whether or not the stock price rises.

WARNING: According to Valueline, MO has a projected dividend payout ratio of 75% for the year 2008 and 69% for the year 2009 after adjustments for the spin-offs. These payout ratios are extremely high for any company except for a utility. Any pressure on the earnings could result in a 100% or more payout ratio, this could result in a burn of the company’s cash stockpile or borrowing at unfavorably high interest rates.

To get a better understanding to the rational of this investment opportunity we need to consider the many external aspects that impact this stock. First, because of the Tobacco Master Settlement Agreement (MSA), MO is mandated to remain profitable so that it can pay its portion of this all-encompassing lawsuit. Furthermore, states have sold future revenue bonds based on the projected income the MSA was to provide. This fact has forced the various state attorney generals to enforce laws against any “illegal” activity from start-up tobacco companies that wish to operate outside of the state that they are headquartered. Because of the numerous laws that have been set up to protect the newly created tobacco oligopoly based on the MSA, MO has a lifeline that it ordinarily wouldn’t have if smoking was simply outlawed altogether. Aside from being outlawed and taxed 1,400% in an effort to end smoking due to its health risks, which didn’t work in England in the 1700’s, let us look at this company from a different perspective.

The very best analysis of a worst-case scenario on Altria is Jeremy Siegel’s research paper “The Nifty Fifty Revisited.” Although Siegel never intended for it to be an endorsement of buying MO, the paper gives the most compelling reason why MO is and always will be a preferred investment choice at almost any price. Siegel’s overall point in the paper is that if an individual were to invest in the highest P/E stocks at the peak of the stock market in 1972 then, despite the 50% decline in the Dow Jones Industrial Average that followed, investors would have come out ahead by a country mile.

Siegel goes on to examine the famous “Nifty Fifty” stocks of that era which experienced the inflation-adjusted loss in the market of 72% from 1966 to 1982. The ’66 to ’82 period was the second largest decline in the stock market since 1929. Despite this fact, MO returned, after-tax and adjusted for inflation, the highest return at a 13.14% compounded annual rate from the high in 1972 to 1995. Delving deeper into the abyss of data for a little more perspective, from the periods of 1920-1987, 1930-1987, and 1950-1987 MO has had a compounded annual growth rate of 11.37%, 12.17%, and 16.24%.

I personally bought MO when it was trading at $19 in early 2000 yielding 10%. Foolishly, I sold MO at $55 in 2002 for a ridiculous gain of over 200% in 2 years. Had I held on to the stock I would have benefited from the most astounding yield from a company that is among the best run companies, which is saying a lot given the amount of animosity it garners. Best regards in your research of Altria (MO). Touc.

Disclosure: I bought MO at $14.99 on 12/09/2008

Sources:

• Fairholt, Frederick William. Tobacco: Its History and Associations. Singing Tree Press. 1968.
  

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Precious Metals Not So Precious

Back in the old days, every good financial planner worth their salt would have recommended that a truly diversified investment portfolio contain at least 10%-15% of gold or gold stocks. This would have included a portion in real state (not REITs), stocks and bonds.

Generally speaking, there are different reasons why a person would hold each type of asset. Stocks would be held for "long-term" capital appreciation. Bonds would be held for income and real estate would be the inflation hedge. Gold on the other hand would be held if the government couldn't pay it's debts. You would never really want to be in the position of having to cash in on your gold position for obvious reasons. Instead, gold would be something that you pass on to your heirs as a just-in-case insurance policy.

I consider myself a precious metal investor of the most basic type. I do have 15% of my portfolio in gold and silver but I don't invest in gold and silver stocks. I consider precious metal stocks perpetual call options on the price of gold or silver. Therefore, I only speculate in the top gold and silver stocks, Barrick (ABX), Newmont (NEM), Agnico Eagle (AEM), Hecla Mining (HL), Silver Standard (SSRI) and Coeur D'Alene (CDE), when I see that the opportunity exists or that an "unimpeded" precious metal bull market is in place. Otherwise I stay out of precious metal equities.

Why do I stay out of gold equities except for the occasional speculative urges? As indicated in my previous articles on silver, dated November 25th, and gold, dated November 17th, there are market factors to consider before committing money to such a volatile portion of my investment portfolio that is dependent on both the price of gold going up and the general stock market not going down.

What confuses me about "gold bugs," as opposed to gold investors, is that as well informed as they are, gold bugs will not acquiesce to the idea that, generally, gold and silver stocks don't, can't and won't go up during a general stock market decline of 10% or more. Some gold bugs are willing to reference periods like 1929-1932 as a rational for why gold is a necessary hedge during a stock market collapse. To respond to such spurious claims from the gold bugs, I have included the price history of gold and silver stocks from 1924 to 1933. This data is from Poor's, the company that pre-dated the merger of Standard and Poor's.

The price data of the 21 precious metal stocks is resounding since it puts to rest the idea that, a decline in the general stock market would result in an increase in the price of gold and gold stocks. Even with the price of gold being fixed at a $20.67 per ounce, investors were not overwhelmed by the idea of jumping into gold stocks as the highest quality blue-chip stocks crashed 89% from 1929 to 1932.

Notice that some gold stocks ran up in price and peaked before 1929. For the remaining stocks that did peak in 1929, take a look at the high and then the low in 1930. All of these stock fell by at least 50% during this two year period. Some stocks would stabilize while the majority would collapse until 1931 or 1932. Once hitting their bottom in 1931 or 1932 the stocks would then recover, along with the rest of the stock market. The only gold stock from this era that still trades on the New York Stock Exchange is Newmont Mining (NEM). Newmont went from the hefty price of $236 in 1929 to $4.63 in 1932. After 1932, all stocks started moving much higher regardless of the industry group the company was in.

The lone glaring exception to this survey is Homestake Mining. I would have loved to have bought Homestake in 1924 at $35 and never have to watch it fall back to where I got in. However, Homestake is a special situation that is completely unrelated to the general conditions of the market. Homestake Mining has become the rallying cry for gold bugs despite the fact that there are numerous special situations that can be pointed out in other industries during the same timeframe. Homestake Mining will be the subject of future postings on this blog for an understanding of the reason(s) why it went up in price in the face of a crashing stock market.

The only reason that gold was a place where money flooded in periods of panic (1807, 1819, 1826, 1837, 1842, 1861, 1865, 1876, 1884, 1893, 1904, 1907, 1932) was because of government price fixing. If I lived through a panic during any of the prior periods and found that everything was falling in value but the official price of gold was being propped by the government then, of course, I would seek safety in gold. However, without a gold standard, the price of gold has proven to be at the whims of the market as a commodity. Unfortunately, gold bugs have mistaken gold as a safe haven during a panic for the wrong reason. This explains why James Dines, the world's renown gold bug, openly wondered in his October 31st newsletter, “…why aren’t the prices of gold and silver commodities higher…”

Again, when the general stock market declines 10% or more then gold and silver will likely fall as well and may actually lead the decline on a percentage basis. The purpose of these articles on gold and silver is ensure that the money invested is done with an understanding of the forces in play. Gold bugs, understanding the dire nature of the government's fiscal and monetary position, might not be taking an investment position in gold but protection against the government recklessness. For everyone else, gold and silver are true commodities and should be treated as such.

The long term trend in gold and silver stocks as demonstrated by the Philadelphia Gold Stock Index (XAU), which was initiated in November 2000, will eventually head permanently higher. The continuation of that trend will be among the key indicators that the bear market in stocks is at or near an end. Touc.

Sources:

• Dines, James. The Dines Letter. October 31, 2008. page 4.
• Poor's Publishing Company. Poor's High and Low Prices 1924-1934, 1934 Edition. 1934.

• tax freedom day
• when dow first hit a dividend yield of 3% for the first time was august 28, 1993
• Since bailout package was passed on October 1, 2008 the Dow has fallen from 10,835 to 8,400.
• 
  
• The rush to dividend paying stocks is alarming
  

According to the Tax Foundation this year Americans paid of their portion of the Federal tax bill, as measured in number of days, on the date of April 23rd. This was three days earlier, April 26th, than in 2007. If we review the chart on the number of days Americans achieved their "Tax Freedom Day" we find that during years with economic growth we take longer to obtain our freedom. During years of we near the end of this wild and crazy year we now need to look ahead to the time when we as citizens of this great nation must work off our portion of taxes to the government. As 2008 draws to a close it is well worth mentioning that we need to our tax information together for the upcoming filing season.

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Meredith Whitney on Financials

In the following video from CNBC.com, Maria Bartiromo interviews Meredith Whitney. Mrs. Whitney gives you your money's worth regarding the current banking crisis that we're in. Although Mrs. Whitney could be way off the mark in terms of the dire nature of the banking system, it wouldn't hurt to review and re-review what she says and look at her track record from the past. Mrs. Whitney is right more often than she is wrong.

Below is my summary of Mrs. Whitney's remarks (with my comments in parentheses):

• Paulson is not a stable person to be handling such an important job (Paulson may have made some big mistakes that we won't find out about until he is gone)
• Banks reducing credit card limits will have the impact of shutting down the economy well into 2009.
• Banking stocks and market will decline further
• Whitney's estimates for banking stocks are 30%-50% below current estimates
• "Kitchen sink" will be thrown in when reporting fourth quarter banking losses (some over eager buy-and-hold folks are already guessing that the banks are over-estimating their losses and therefore might come out ahead on the rebound. Such a perspective is too hopeful.)
• Re-regionalize the banking system is necessary; there is too much concentration at the top of the banking food chain (Wow!!! This is an astonishing comment since the mergers of many banks have further consolidated the banking system. Sounds like things will get much worse based on this rational.)
• Any semi-conscious bank manager should be hoarding cash. (Nice. brutal. honest.)
• Better clarity can found with off-balance sheet data rather than on the balance sheet where it can be mixed in with other banking data. ( This makes me think of the recent Citigroup move to bring about $1 billion back on the balance sheet. Are they trying to hide something?)
• FASB ruling reduces lenders ability to reprice unsecured credit card loans (This explains why banks would have plans to pull $2 trillion [at least] in outstanding credit lines.)
• Citigroup hasn't seen the worst; will need more capital (Scary; but no surprise.)
• Whitney had to offer solutions since being negative can only go so far (Whitney realizes that if what she says it too accurate over an extend period of time then people will start to accuse her of being the reason for the decline in the banking system. What a tough business to be honest in.)
• If the big banks fail then the insurance fund for the banking industry would clearly go bust (Better move your money to a "big" bank, if it fails then the small banks will not be able to secure your funds.)
• More capital is needed for the banking system especially the big banks (Government's blank check policy ought to fix that.)
• More government money going into banking system means that the crisis isn't over.
• Banks will need to shrink in order to grow (too bad the banks are getting bigger each day. Maybe if we start seeing division being spun off then we can expect some improvement.)
• Expanded lending by the banks will signal the end of the banking crisis which will precede the rise in the markets/economy.
• The only way to reliquify the banks is through investment in the stock (translation: a falling stock price is a bank that is about to go out of business.)
• Wells Fargo is the only large bank stock that is high-priced relative to the where it could go (...and Wells Fargo is one of the last quality large banks out there.)

In the end, if Mrs. Whitney is right about the pain to come then we will have to watch out for the reverberations in the insurance industry as happened to Japan in the 1990's. If you have insurance stocks for some reason then watch out. Touc.

Pay or Don't Play

Robert Rhea is known as one of the great Dow Theorists of the 1930's. It is said that he accurately called the bottom in the stock market in 1932. In Rhea's book, The Dow Theory, there is an idea about bear markets worth pondering. Rhea says the following:

Primary Bear Markets:-A primary bear market is the long downward movement interrupted by important rallies. It is caused by various economic ills and does not terminate until stock prices have thoroughly discounted the worst that is apt to occur. There are three principal phases of a bear market: the first represents the abandonment of the hopes upon which stocks were purchased at inflated prices; the second reflects selling due to decreased business and earnings, and the third is caused by distress selling of sound securities, regardless of their value, by those who must find a cash market for at least a portion of their assets.

With the news that we are now officially in a recession, I think that we have entered the second phase of the bear market according to Dow's Theory. No longer will stocks have the benefit of hope on their side. As the element of hope is out of the market, investors will no longer focus on price appreciation or earnings. Instead, the focus and emphasis for stock investing will be on dividends. If the company doesn't pay then the investor won't play. Touc.

Source:

• Rhea, Robert. The Dow Theory. Barron's. 1932. p. 13.
  
  

Bear Market Rally Targets

The following are the upside targets based on Dow's retracement principal as interpreted by Nelson, Hamilton, and Rhea. The estimated times when each market might hit their respective targets are not part of Dow's theory.

• Dow Jones Industrial Average: 10836.11 around late April or early May 2009
• Dow Jones Transportation Average: 4126.56 around late July or early August 2009
• XAU Gold Stock Index: 136.40 around late February or early March 2009

If these indices go beyond the listed upside target by 30% with increasing volume then the old record highs will be tested. Touc.

Sources:

• Hamilton, William Peter. The Stock Market Barometer. Harper & Brothers. 1922. page 37.
• Rhea, Robert. The Dow Theory. 1932. page 52.
• Nelson, S.A. The ABC of Stock Speculation. Fraser Publishing. 1999. page 40.

No Silver Lining

When I posted on this site, a few days ago, that the prospects of gold stocks are tied to the direction of the stock market, few gold stock investors reacted positively to that idea, despite the fact that it was intended to benefit those who felt inclined to invest in precious metals. This post will further irritate those who, understanding the monetary pressure we're up against with huge government spending, refuse to heed the warning of long established facts.

When examining the investment thesis for precious metals there are two distinct classes. The first is the gold camp while the second class is the silver camp. The gold group is the truly hardened investor with wealth, in dollars, to support an expensive habit. On the opposite side of the precious metal spectrum is silver. Silver is known as the "poor man's gold" and for good reason. Silver is what is purchased when the price of gold has run up so much that it is essentially out of reach of the johnny-come-lately "poor" precious metal investor.

For the purposes of investment analysis, silver has one advantage over gold and that is the fact that silver has been allowed to freely "float" in the open market. This is a major reason why it has been difficult to observe the relationship between gold and gold stocks from the period of May 1781 to August 1971. The last time gold didn't have some sort of government control in the U.S. was the period from December 1861 to January 1879. Silver tells us what many hope that gold could.

During the period from 1929 to 1932, the price of silver ranged from $1.29 down to the level of $0.24. This was a decline in the precious metal of 81.4% in a period of 3 years. Gold on the other hand was fixed at $20.67 as it had been, with a few exceptions, from the period of June 1834 to January 1934. It stands to reason then, that if your silver was falling during the declining years then gold, at a fixed price, would be in greater demand. However, silver was the true reflection of what the market attitude toward gold would have been had the price been allowed to float freely.

"The Dines Letter was openly baffled by the failure of the golds to rise during the 1966 bear market, and, again during the 1969 bear market."

James Dines author of Technical Analysis. 1974.

Today, the price of silver is telling us something very important that should not be scoffed at or ignored. Because of the fact that silver is going up, on a percentage basis, more than gold, it is telling us that the speculators have taken over the market and are therefore buying at any price rather and at the best price. On November 21, 2008, the London Fix for silver was $9.17. At the end of the day November 24th, silver closed at $10.04 a gain of 9.49%. Contrast the silver move with gold's 6.20% move and we've got a potential problem. After all, why would safe haven investors forego the "ultimate" safe haven of gold for the unloved step-child silver? This answer lies in the fact that small investors and speculators are running amuck. Take a look at the stock of silver producers Coeur d'Alene (CDE) and Hecla Mining (HL) rising 72% and 78% respectively in the last two trading days.

Another quirk in the precious metal arena is the current rush to buy one ounce gold coins. The very fact that supply is limited has emboldened may precious metal fans to feel that the only direction for the price is up. From an investment standpoint this isn't the case. What is happening is that coin investments are being mistaken for having the same quality and impact as institutional or central bank bullion buyers. Unfortunately, the lack of coin availability allows the small investor to believe that there must be an economic reason for the high demand even though we are clearly experiencing worldwide deflation. Further proof of a speculative market is the wide bid and asking price of the coins. Dealers, knowing the market and the lack of liquidity, aren't willing to be in the position of being left holding the bag because of speculators.

Sadly, the small investor goes out and buys what they can afford without realizing the history of precious metal prices during the Great Depression which resulted in the destruction of all wealth. The current demand for gold coins and the rapid rise in silver above that of gold is similar to low-priced, low quality stocks going through the roof near the peak of a bull market or the real estate equivalent of Fresno, California properties appreciating 30% in a single year. The time for gold and silver will come when the markets have hit bottom. As demonstrated in the failed acquisition by BHP-Billliton (BHP) of Rio Tinto (RTP), now is not the time. Touc.

"Every bear market has its surprises, and the one area that puzzles us is the refusal of precious metals in the last few months to act contracyclically with the market."

James Dines, editor The Dines Letter October 21, 1966

Related Articles:

• Commentary on Gold and Common Misconceptions
• Precious Metals Not So Precious
• Gold Stock Prices from 1924 to 1933

Sources:

• Fisher, Kenneth. The Wall Street Waltz. Contemporary Books. 1987.
• Dines, James. How the Average Investor Can Use Technical Analysis For Stock Profits. Dines Chart Corp. 1974.
• WIT Financial Publishers. Common Stock Price Histories 1910-1987. 1988.
• Turner, Sarah. "BHP Billition: Rio Tinto Deal No Longer in Holders Interest." Marketwatch.com. Nov. 25, 2008. viewed on Nov. 25, 2008.
• Zhou, Moming. "For Gold, A Tussle Between Two Groups of Investors." MarketWatch.com. Nov. 19, 2008. viewed on Nov. 25, 2008.

Silver: The Poor Man's Gold

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Ceteris Paribus

The term that is the basis of all discussions in elementary economic modeling, especially when comparing two factors, is ceteris paribus. Ceteris paribus means "with other things the same" and represents the best guess as to what is likely to occur provided all thing remain unchanged. Let us take an overly simplistic view of the situation with Citigroup's government rescue plan and determine the potential outcome ceteris paribus.

According to the Wall Street Journal, in an article by David Enrich, the federal government has agreed to absorb $277 billion of $306 billion of losses that Citigroup has identified as "troubled" assets. Additionally, the Treasury is adding $20 billion on top of the $25 billion recently injected into Citigroup as part of the TARP plan. Remember, the $277 billion is separate from the $700 billion bailout package. Again, this current approach with Citi is counter to the early arguments that there needs to be a comprehensive solution, not an individual approach, to the bailouts after the fall of Fannie, Freddie, Lehman, Merrill and WaMu which spawned the TARP plan to begin with.


Now, let's look at only the off-balance sheet portion of Citigroup. The off-balance sheet portion is called an asset by Citi but isn't included on the books. The off-balance sheet items are valued at $1.23 trillion. I don't know why Citi wouldn't include these items on their balance sheet but if the U.S. government is any indication then the off-balance sheet is probably more like liabilities instead of assets.


If the government is going to front Citi $277 billion (a whopping 40% of the total TARP package for only one company) then that would leave $953 billion remaining on the off-balance sheet portfolio. If we split the $953 billion in half and conservatively assume this portion is "troubled" then we have a figure equal to $476.5 billion. Remember when Merrill Lynch auctioned off $30 billion of CDOs or "troubled" assets back in July 2008? Here's what Bloomberg.com said of that auction on July 29, 2008:

In yesterday's statement, Merrill said it agreed to sell $30.6 billion of collateralized debt obligations -- the mortgage-related bonds that have caused most of the firm's losses -- for $6.7 billion. The buyer is an affiliate of Lone Star Funds, a Dallas-based investment manager.

At the time, Merrill was only able to get $6.7 billion, a loss of 78% or $0.22 cents from every dollar originally invested. Therefore, my assumption of a 50% loss for Citi isn't so far fetched.

Ceteris paribus, this leaves Citi with at least $476.5 billion in losses to write down at some point in the future. This assumes that the economy remains in a slight recession, that earnings are the same, that the dividend for this company has been all but eliminated, that there are no further losses in the housing market. All things being equal, Citi is in for hard times. However, if we take 78% of the entire $953 billion then we get a total loss of $743 billion. A sum exceeding the amount of the entire TARP program even after a $277 billion direct injection to Citi from the government.

Clearly our government under Bush/Obama has severely underestimated the extent of how much damage has been done to our financial system. Along with the lack of knowledge that has been demonstrated, the only policy reaction is to have a blank check approach to dealing with the problem. This is what I meant when I said that chaos will ensue when and if Bank of America falls below $14.00.

As I write this at 12:15pm today, Fox Business News host Liz Clayman just said that she went to her Citigroup ATM twice this weekend and the machines said that no money was available to customers. Clayman later joked that if Citi is really in good shape after this bailout then they need to refill their ATMs. Wow!

Sources:

• Enrich, David. "U.S. Agrees To Rescue Struggling Citigroup." Wall Street Journal. November 24, 2008. viewed online November 24, 2008.
• Keoun, Bradley. "Merrill Sells $8.55 Billion of Stock, Unloads CDOs." Bloomberg.com. July 29, 2008. viewed online November 24, 2008.
  
  

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Citigroup Pleas for a Short Selling Ban

In an attempt to stem the tide, Citigroup is requesting that the Securities Exchange Commission (SEC) impose a ban on short selling. This request comes as the CEO of Citigroup, Vikram Pandit, tries to rationalize the nearly 84% decline in Citigroup stock since October 1, 2008. While Mr. Pandit isn't responsible for the mess that Citigroup is in, he is responsible for doing whatever he can to get the company out of its funk. Unfortunately, the idea of putting a ban on short selling is not going to solve anything.

In life we seldom get the chance to see comparable examples of the effect of an idea before actually implementing it. In the case of banning short sells there is one example that stands as a perfect case study. On September 30, 2008, Taiwan's Financial Supervisory Commission (FSC), the equivalent to our SEC, implemented a complete ban on all short selling. Along with this ban on short selling, the FSC has a rule that limits the amount of decline of any stock to 3.5%. After a stock falls 3.5% there will be no trading of that stock until the next day.

With these rules in place to limit the decline of stocks in Taiwan, you would think that Taiwan's main stock index, the TSEC Weighted Index, would have fared much better than the Dow Jones Industrial Average in the period from October 1 to the present. After all, The housing crisis originated in the U.S. The rating agencies that didn't properly rate the debt are in the U.S. The biggest financial institutions in the world that have failed are in the U.S. With all that has happened recently, it would stand to reason that the brunt of the decline in stocks would take place here in the U.S. rather than in Taiwan. Unfortunately, the reality shows that banning short selling has little impact on the market's declines.

From the period of October 1 to November 21 the TSEC index fell 27.64% while the Dow Industrials fell 25.71%. Was there any benefit of having the ban on short selling? There has been no material benefit to Taiwan's ban on short selling. A ban on short selling of Citigroup stock would have a similar effect. By banning short selling, Mr. Pandit blames the symptom, a falling stock price, rather than addressing the approximately $1 trillion in money losing "assets" that aren't on the company's balance sheet. Such an irrational response from a investment professional like Mr. Pandit puts into question the legitimacy of the leadership at Citigroup.

The investment community will zero in on Mr. Pandit's request to ban short selling as a cover for more serious matters at the bank that cannot be resolved through management or leadership. This will put further pressure on Citigroup's stock price and hasten a government inspired merger of equals (the combining of two unhealthy institutions) which will result in a scenario like the combination of CreditAnstalt and BodenCredit of Austria which sparked the worldwide banking crisis in May of 1931. Touc.

Sources:

• Westbrook, Jesse. “Citigroup Urging SEC to Bring Back Short-Selling Ban.” Bloomberg.com. November 20, 2008. viewed online November 22, 2008.
• Young, Doug. “Taiwan extends Short Selling Ban, Limits Stock Drops.” Reuters. October 12, 2008. viewed online November 22, 2008.
• Austria's Economic Development Between the Two Wars. Rothschild, Kurt Wilhelm. F. Muller LTD. 1947.
• Kassenaar, Lisa. "Citi's Wake-up Call." Bloomberg Markets Magazine. September 2008.
  
  
  
  
  

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Keeping Up with the Joneses

After the last two days of trading, the Dow Jones Industrial Average and Dow Jones Transportation Average have resoundingly confirmed the direction of the market. The Industrials fell below 8175.77 and the Transports fell below 3364.98. The strong volume during the last two days added support to the move downward. On November 20, 2008 my index of high quality dividend stocks registered 94 new lows as compared with the previous record low of 100 on October 9, 2008. This means that although the market has been gutted the last couple of days, we're not at a long term bottom.

Another factor that is of concern for this market is that the Dow Industrials broke through its 4% yield to finish Thursday November 20th at a yield of 4.12%. We can only guess that the Dow is headed to a yield of 5% or a closing price of 6226.

As I mentioned in my October 24th posting, there was a considerable gap between the amount that the Industrials and the Transports needed to fall in order for both indices to hit their respective lows of 2002 and 2003. While most market technicians are looking strictly at the Industrials and the fact that the low of 2002 has been reached, I am concerned about the Transports. The Transports are still 32% off of the 2003 low. At the current rate, the Industrials would have to fall an additional 2,748 points in order to accommodate the Transports going back to the low of 2003. This would bring the Dow to a level of 4804.29. Let's hope the Transports don't need to back fill in order for the overall market to go higher.

Unfortunately, we're within 4.70% of my September 17th Dow Theory calculations of 7197.60 for the Industrials. At the time, the Dow closed at 10,609.66. What is more unfortunate is the fact that conditions seem to be deteriorating in the banking system. It is my fear that the number one bank in the nation will have to be merged with any one of the top ten banks simply because the government will not have the resources to bail out the situation. Furthermore, we might be forced to have direct bailout money coming from a foreign nation to try to rescue our banking system. The need for foreign intervention (possibly from China or Japan) might be the catalyst that sets the dollar into a tailspin and pushes up the price of gold. (but I digress.) Evolving problems with the banking system make sustained movements higher very difficult. After a loss of 47% in the Dow Industrials, it is hard for me to believe that the markets can go any lower. However, we need to prepare ourselves for the worst and hope for the best.

Declines of the current market are usually followed by violent moves to the upside. Remain cautious of days when a stock index goes up 5% or more. The new upside targets for the Dow Industrials are:

• 10,858.41
• 9,625.28
• 8,378.95

The 10,858.41 figure is the halfway point from the peak at 14,164.53 based on the November 20th closing price of 7552.29. According to Dow's Theory, a decline is usually followed by an increase which, if extending beyond half of the decline, could indicate that a new bull market is in the making. As long as both the Industrials and Transports accomplish this movement together (but not necessarily at the same time.) The 9,625.28 and 8,378.95 levels are strictly technical in nature and could easily be violated in a bear market rally. Good luck. Touc.

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Commentary on Gold

I was scanning the news headlines on MarketWatch.com and came across this story, titled "Getting it Right and Still Losing." In the article by Mark Hulbert, it is mentioned that experienced investment newsletter writers Harry Schultz, Howard Ruff, and James Dines have lost a significant amount of their investment funds by investing in gold and silver during the market turmoil of the last year. According to Hulbert, the losses sustained by these three market professionals ranged from 64.9% to 70%.

Mark Hulbert's conclusion in this article is that although the newsletter writers had foreseen the coming declines they didn't know exactly when it would occur and therefore were unable to take advantage of the profit opportunities by maneuvering their money on the opposite side of the market downdraft. Because Mark Hulbert has been reviewing newsletters for quite a while it would appear that his conclusions about these three market professionals is accurate. Unfortunately, just as the newsletter writers got the gold market wrong, so too does Mr. Hulbert in his assessment of the actual reason why these people to failed come out winners.

Despite their experience, the mistake that Harry Schultz, Howard Ruff, and James Dines made is very simple. They believed that if the stock market was going to collapse then gold and silver would be the place to invest all of your money. Unfortunately, when the price of stocks fall so too does the price of gold, and to a greater degree, gold & silver stocks.

The only time that gold and silver prices rise at the same time that the stock market falls is when the government itself is on the brink of bankruptcy. While it may be the assertion of the newsletter authors that the government is on the brink of failure the process of actually getting to that point requires a significant amount of bailouts.

So, what evidence do we have to show that gold and silver actually does go down more than the general stock market? Below is a table that shows the performance of the Dow vs. the price of gold and the gold stock index (XAU.) This table was originally created by David Marantette, former publisher of the Goldstock and Dear Dow Letter. In his research, Marantette wanted to emphasis the importance of this concept so he included the available data from the period during a gold bull market (1975-early 1980) to make his point.

Marantette picked all periods that the Dow Jones Industrial Average fell by 10% or more and compared that performance with the price of gold until 1984 and the Philadelphia Gold Stock Index (XAU Index) from 1986 until March 2001. I gathered the data from May 2001 until October 2007. Take note of the fact that out of thirty Dow declines of 10% or more the price of gold/gold stock index declined 28 times. Of those 28 declines, gold fell by a greater percentage than the Dow Industrials in 27 instances.

Given what has been demonstrated the lesson should be clear, gold and gold stocks cannot climb higher at the same time that the Dow Jones Industrial Average is in a declining trend. If the newsletter writers believed that gold was the place to be when the stock market declines then it stands to reason why they lost so much money. Timing wasn't the problem, instead it was the lack of understanding of the relationship between the selloff in the general stock market and a selloff in the price of gold and gold related assets. Touc.

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Gold beats Stocks to the Downside

Gold Stocks vs. Dow Declines
In last week's issue, we showed you what happens when the Dow declines 10% or more compared to the XAU. Our conclusion was that each time the Dow declined 10% or more, the XAU, and therefore the gold stocks, went down a greater percent and for a longer time period.
"Yes, but, but …this time, it will be like it was before 1980 … like the last bull market in Gold. In those days, when the market went down, Gold went up." And so the numerous challenges went this past week.
We knew it was only a matter of time before someone pushed us to take a look back before 1987, and so this week, we made the trip - all the way back to 1975.
What did we find? Does our conclusion, that when the market goes down, gold stocks do also, hold up in Gold bull market times?
Should we still expect that if the general stock market tanks, the gold stocks will too?
First, how did we set this study up? Our comparison was between the Dow and declines of 10.0% or more, and the Philadelphia Stock Exchange Gold/Silver sector index - the XAU. We found that the XAU began trading on 12-19-1983. Our XAU data base starts on 05-15-1984.
The Dow declined -16.70% in 1984, but the decline began in January of 1984, so we kick in our Dow-XAU comparison on the next trade, which doesn't begin until 09-05-1986.
Our Gold data goes back to 12-31-1974. We don't remember when Gold began to trade, but we start with what we have. The first Dow decline of 10% or more, after our Gold data availability, is 07-15-75 to 08-21-75.
Our comparative study covers a range from 07-15-1975 to 06-22-2001. We have taken each Dow decline of 10% or more and compared the performance of Gold (1975 to 1984) and the XAU (1986 to 2001) during as like time periods as possible to the Dow declines. During this period, there are a total of 25 Dow declines of 10% or more. We have put this article and all the trade data relating to it on our www.goldstock.com website. Go to the home page, click on A Recent Issue & Article Archive. Click at the bottom of the page for Archives.
Below are our figures in summary and all the actual trades. Here is what we found: There were a total of 25 Dow declines of 10% or more. Of the 25 declines, there were two times when the Dow went down more than 10% and Gold went up.
Of the 23 remaining trades, 22 of 23 times, either Gold or the XAU went down more than the Dow did. Worthy of note are the 5 Dow declines on the way to the January 1980 price top in Gold.
Three of the five Dow declines caused Gold to decline as well. This was in the heyday of the Gold bull rise.
Our conclusion basically remains the same. Over the past 26 years, we observe that when the general stock market, defined in this instance as the Dow Jones Industrials, declines 10% or more, gold stocks decline a greater percentage over a longer period of time.
The reason this is important is that the myth of "stock market down, gold stocks up" still resides in the minds of investors.
Our general cyclic analysis, in our weekly Dear Dow letter, shows the stock market is vulnerable. Possibly a Dow Jones Industrial decline from the current 10600 level to Dow 7000.
If it happens, we are concerned that it will take the gold stocks down with it. You think this time it will be different? We're betting on history.Following is an example of our data compilation for the entire period:

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Dow Industrials Bull Markets

Below is what the Dow Industrials would have generated if a person had the ability to buy at the exact bottom and sell at the exact top. Of course this is a "no duh" moment. No person could have ever pulled off such a feat. However, this data is intended to put in place a perspective that is seldom mentioned even though it is the goal of most investors.

This is not Dow Theory, it is strictly the Dow Industrials. $100 grews to $403,106,218.46 from 1896 to 1989. This is an average annual return of 43,344.74% over the 93 year history.

I have simplified the information so that a person can compare all Dow Industrial bull markets with the previous information on the Dow Theory.

Original Fund of $100 Date Indu. Average Price % Gain Proceeds Invested August 10, 1896 29.64 $100 sold April 4, 1899 76.04 156.5 $256.50 reinvested June 23, 1900 53.68 sold September 19, 1902 67.77 26.2 $323.70 reinvested November 9, 1903 42.15 sold 19-Jan-06 103 144.4 $791.13 reinvested 15-Nov-07 53 sold 19-Nov-09 100.53 89.7 $1,500.77 reinvested 26-Jul-10 73.62 stocks sold 30-Sep-12 94.13 27.9 $1,919.49 reinvested 24-Dec-14 53.17 sold 21-Nov-16 110.15 107.2 $3,977.18 Funds reinvested 19-Dec-17 65.95 stocks sold 3-Nov-19 119.62 81.4 $7,214.61 reinvested 24-Aug-21 63.9 sold 14-Oct-22 103.42 61.9 $11,680.45 reinvested 31-Jul-23 86.91 sold 3-Sep-29 381.17 338.6 $51,230.47 reinvested 8-Jul-32 41.22 sold 10-Mar-37 194.4 371.6 $241,602.88 reinvested 31-Mar-38 98.95 sold 12-Nov-38 158.41 60.1 $386,806.21 reinvested 8-Apr-39 121.44 sold September 12,1939 155.92 28.4 $496,659.18 reinvested 28-Apr-42 92.92 sold 29-May-46 212.5 128.7 $1,135,859.53 reinvested 17-May-47 163.21 sold 15-Jun-48 193.16 18.4 $1,344,857.69 reinvested 13-Jun-49 161.6 sold 5-Jan-53 293.79 81.8 $2,444,951.28 reinvested 14-Sep-53 255.49 sold 6-Apr-56 521.05 103.9 $4,985,255.66 reinvested 22-Oct-57 419.79 sold 3-Aug-59 678.1 61.5 $8,051,187.88 reinvested 25-Oct-60 566.05 sold 31-Dec-61 734.91 29.8 $10,450,441.87 reinvested 26-Jun-62 535.76 sold 9-Feb-66 995.15 85.7 $19,406,470.56 reinvested 7-Oct-66 744.32 sold 3-Dec-68 985.21 32.4 $25,694,167.02 reinvested 26-May-70 631.16 sold 26-May-72 971.25 53.9 $39,543,323.05 reinvested 4-Oct-74 584.56 sold 21-Sep-76 1014.79 73.6 $68,647,208.81 reinvested 28-Feb-78 742.12 sold 27-Apr-81 1024.05 38 $94,733,148.16 reinvested 12-Aug-82 776.92 sold 29-Nov-83 1287.2 65.7 $156,972,826.50 reinvested 15-Jun-84 1086.9 sold 9-Oct-89 2791.41 156.8 $403,106,218.46

Source:

• Sperandeo, Victor. Principles of Professional Speculation. John Wiley & Sons. New York. page. 106.
  

Bank of America Redux

Bank of America (BAC) was reviewed by me on September 15, 2008. I only applied Dow's Theory to my analysis since there are so many unknown factors in the market. My conclusion on BAC was as follows:

Since Bank of America is now a bellwether stock for the banking industry, Dow's Theory is saying that either this banking crisis has hit bottom (for now) and might trade up from here (possibly in a range) or that anything below $18.44 is going to be chaotic.

Yesterday BAC fell below $18.44 by a wide margin to the level of $17. Prior to the decline below $18.44, BAC's price action seemed to do everything it could to avoid falling further. When and if it happens, a decline below the $14 level will be a period of utter chaos for the banking sector.

Bank of America is ranked #1 in the US in terms of assets. Right behind BAC is Citigroup (C) which is now selling for less than $10. Globally, BAC and C are ranked #1 and #2 respectively. That's Globally! Why is this important? No banks that are ranked #1 and #2 in the nation and the world should have their stock price cut in half in the last two months.

The stealth nature of the most recent banking sector declines will shock the financial system and require more talk of bailouts on top of the already proposed auto industry bailouts. In an economic environment like this, one needs to consider preservation of capital. The base of preservation of capital is the banking system. Right now the banking system is being challenged. Watch these two stocks for indications of where the banking system might be headed. Touc.

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Put a Tarp on it

I like words. I especially like the words that have multiple meanings depending on how the word is used. The important thing about words is that you never really know the meaning until there is context built around the word that is being used. One such word is tarp.

In my minds eye, I’ve envisioned that a tarp is something, usually blue, that you use to cover up another object. In the federal government’s most recent bailout, deemed the Troubled Asset Relief Program (TARP), we have been led to believe that the TARP is meant to “protect” us therefore we as taxpayers should be reassured.

However, the use of every word becomes clear(er) based on the context of the other words and ideas that follow it. With this in mind, I thought it was fitting that the Federal Reserve is now unwilling to disclose the recipients of almost $2 trillion since the $700 billion bailout package was passed. This is a change of heart on the part of the Federal Reserve and the Treasury since they both agreed to “congressional demands for transparency” before the signing of the bill. Considering that this approval of the bailout was with taxpayer money, it would only seem “fair” that taxpayers and guerrilla journalist news organizations, like Bloomberg, have access to the knowledge of where the money actually went.

With the Fed’s unwillingness to reveal the information that is the rightful property of the public, I now know what kind of “tarp” we are looking at. Let us explore the exact etymological nature of the tarp that Congress, as opposed to Progress, passed.

First, tarp is the shortened version of the word tarpaulin. According to Merriam-Webster’s Online Dictionary a tarpaulin is “a piece of material (as durable plastic) used for the protecting of exposed objects or areas.”

However, if broken down to its most basic elements tar-, according to the Dictionary of Word Roots and Combining Forms, falls under two possible meanings. The first is the Greek tarph which means thicket. The other possibility is the Greek tarphy which means thick or close. Given the context of the Federal Reserve’s handling of the TARP program I now have a better understanding of what this program is about. So far the TARP program has proven to be a thicket of bureaucracy meant to be so thick that it is essentially closed off from the public.

Now let’s look at the suffix portion of the word tarpaulin. The –paulin portion is derived from the word pall. What is a “pall?” As a verb pall means “to lose strength or effectiveness.” Another verb definition of pall is “to cause to become insipid.” What is insipid? Insipid is the “lacking in qualities that interest, stimulate, or challenge.” Has the government’s TARP program managed to lack a stimulating effect as was initially promised? I think so but some would argue that the “true” effects would not be felt until at least six months from now.

Since we looked at the verb definition of the word pall, let’s move on to the noun definition. This is my favorite definition of the word pall because it seems so fitting. The noun form of pall means “ a heavy cloth draped over a coffin” or “something that covers or conceals; especially: an overspreading element that produces an effect of gloom.”

Again, it is context that helps us understand the meaning or intent of all the words that are conveyed. Given the context of the TARP program and what has followed so far, I think I have a better understanding of what is happening and what is to come.

If only I knew this was the definition of the TARP program before the vote took place in Congress, I would have been even more outspoken against it. However, my new found knowledge allows me to feel comfortable about what is likely to occur next. There will continue to be a lack of transparency until the death. This would make perfect sense to have a tarp handy so that we as taxpayers don’t have to see the carnage. I have only come to this conclusion because of what I have seen and not what I would like to see. Touc.

Sources:

• Dictionary of Word Roots and Combining Forms. Borror, Donald J.Mayfield Publishing. 1988.
• Fed Defies Transparency Aim in Refusal to Disclose. Pittman, Mark. Bloomberg.com. November 10, 2008.
• “pall.” Merriam-Webster Online Dictionary. 2008. Merriam-Webster Online. 11 November 2008.
• “insipid.” Merriam-Webster Online Dictionary. 2008. Merriam-Webster Online Dictionary. 11 November 2008.
• "tarpaulin." Merriam-Webster Online Dictionary. 2008. Merriam-Webster Online Dictionary. 11 November 2008.
  
  

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Commentary on Gold

I was scanning the news headlines on MarketWatch.com and came across this story, titled "Getting it Right and Still Losing." In the article by Mark Hulbert, it is mentioned that experienced investment newsletter writers Harry Schultz, Howard Ruff, and James Dines have lost a significant amount of their investment funds by investing in gold and silver during the market turmoil of the last year. According to Hulbert, the losses sustained by these three market professionals ranged from 64.9% to 70%.

Mark Hulbert's conclusion in this article is that although the newsletter writers had foreseen the coming declines they didn't know exactly when it would occur and therefore were unable to take advantage of the profit opportunities by maneuvering their money on the opposite side of the market downdraft. Because Mark Hulbert has been reviewing newsletters for quite a while it would appear that his conclusions about these three market professionals is accurate. Unfortunately, just as the newsletter writers got the gold market wrong, so too does Mr. Hulbert in his assessment of the actual reason why these people failed to come out winners.

Despite their experience, the mistake that Harry Schultz, Howard Ruff, and James Dines made is very simple. They believed that if the stock market was going to collapse then gold and silver would be the place to invest all of your money. Unfortunately, when the price of stocks fall so too does the price of gold, and to a greater degree, gold & silver stocks.

The only time that gold and silver prices rise at the same time that the stock market falls is when the government itself is on the brink of bankruptcy. While it may be the assertion of the newsletter authors that the government is on the brink of failure the process of actually getting to that point requires a significant amount of bailouts.

So, what evidence do we have to show that gold and silver actually does go down more than the general stock market? Below is a table that shows the performance of the Dow vs. the price of gold and the gold stock index (XAU.) This table was originally created by David Marantette, former publisher of the Goldstock and Dear Dow Letter. In his research, Marantette wanted to emphasis the importance of this concept so he included the available data from the period during a gold bull market (1975-early 1980) to make his point.

Marantette picked all periods that the Dow Jones Industrial Average fell by 10% or more and compared that performance with the price of gold until 1984 and the Philadelphia Gold Stock Index (XAU Index) from 1986 until March 2001. I gathered the data from May 2001 until October 2007. Take note of the fact that out of thirty Dow declines of 10% or more the price of gold/gold stock index declined 28 times. Of those 28 declines, gold fell by a greater percentage than the Dow Industrials in 27 instances.

Given what has been demonstrated the lesson should be clear, gold and gold stocks cannot climb higher at the same time that the Dow Jones Industrial Average is in a declining trend. If the newsletter writers believed that gold was the place to be when the stock market declines then it stands to reason why they lost so much money. Timing wasn't the problem, instead it was the lack of understanding of the relationship between the selloff in the general stock market and a selloff in the price of gold and gold related assets. Touc.

Burn Rate Revisited

In today’s crisis news we are faced with the prospect that General Motors, Ford and Chrysler are on the brink of failure. One indicator of the speed at which these companies are about to fail is the cash burn rate. The cash burn rate is the speed the company is using its available cash or credit to stay alive. It has been estimated that General Motors is burning through $6.9 billion a month. It now appears that the government is about to grant another $25 billion bailout package to the auto industry. This would be in addition to the $25 billion granted to the auto industry on September 25, 2008.

The discussion of a company’s burn rate reminds me of the beginning of the end of the dot-com bubble with the cover article in Barron’s titled “Burning Up” published on March 20, 2000. It was this article that pointed out the cash burn rate of many internet companies. After the article came out the dot-com bubble burst and it is reflected in the chart of the NASDAQ Index below. The NASDAQ fell 75.40% from the high in March 2000 to the low in September 2002. The NASDAQ has not fully recovered from the previous decline and is currently only 32% above the September 2002 low.

Are we headed down the same road as the dot-coms with the American auto industry? Is it true that “what is good for GM is good for the nation?” In my previous articles I have pointed out the fact that the government was setting up to bailout Cerberus Capital Management and that all forms of bailouts will eventually fail. Now with the news of General Motors’ burn rate of cash exceeding prior estimates we can only expect that the auto industry will first get bailed out (again) then collapse of it’s own weight. Touc.

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