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August 15, 2010

Aurum Pro Tempore

Last weekend I noted that if the trend line defining the bounce out of July gave way, stocks would suffer their first significant correction of the rally. Indeed, the initial infraction occurred on Tuesday, and stocks followed thru to the downside with a 3% swoon the next day. More troubling to the equity outlook, however, is their inability to quickly recapture the 65DMA. Any further weakness from here would almost assure that the cyclical bull died in April and that the next bounce would pose as the final bull trap ahead of a more serious decline:

SPX Daily Chart

I would be remiss if I did not insert a shameless plug here and note that the detailed explanation for this outlook is available in the Member letter.

One could ask a tenable question concerning the Fed... could they just not print enough money to halt the next meltdown? Well, they will certainly try. However, such efforts are becoming less and less effective at producing illusions of prosperity and more and more effective at destroying and footing from which a real economic recovery can begin. Greenspan slashed rates fervently from 2001-03... two years of heavy counterfeiting operations until stocks reacted. The result of that effort was a massive waste of productive resources being piled into constructing homes no one needed.

Once the housing market collapsed, Berskanke began a counterfeiting operation an order of magnitude larger than Greenspan's transgressions. Nevertheless, his efforts have been unable to halt the contraction of private sector credit. In fact, the size of the massive stock rally seen out of the 2009 low can likely be attributed more to mean reversion than to money printing. Therefore, I do not believe that any amount of fiat creation short of a hyperinflationary scale can halt the coming stock market downturn.

In fact, I believe we are more likely facing a currency crisis that will weigh on the economy, equities, and even industrial commodities. I can assure you very few people are anticipating a period during which stocks, oil, and the dollar all decline together, but I believe that such a period lies just ahead.

Naturally, a dollar-based currency crisis will preclude U.S. Treasuries as the target of a safe haven play. Instead, big players will seek the safety of real money... gold... sending its price sky high.

 

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