(OroyFinanzas.com) – I can’t help but feel that we are careening toward a pivotal moment in financial history and the coup de grace may very well come when the Fed meets this week.

As I see it, Mr. Greenspan has arrived at the precise juncture that he´s tried so hard to avoid for so long. Before I go in this direction though, it´s important to understand that Alan Greenspan is a politician, and as a politician he is smart enough to know that he can´t hang on to his job unless he gives instant gratification, telling everyone just what they want to hear. This defect has now become part of our social fabric and it will remain that way until there are fundamental changes in the social, economic, and political structure of the United States.

Unfortunately, these changes will only come about through upheaval. But enough of that; let’s get back to the Fed and their interest rate decision coming up in a few days. I liken Mr. Greenspan to a matador who has come to the realization that he’s just made a terrible error in judgement and is about to be impaled on the horn of a very upset bovine. Too make matters worse; it was mostly a bull (pun intended) of his own creation. An animal blown up out of all proportion by a steroid called distortion. Now it’s just a question of which horn will do the dastardly deed, the right horn or the left horn. The right horn represents the consumer and Mr. Greenspan has done absolutely everything he could think of to get him to live up to his name: He has flooded the market with liquidity, He has given Americans historically low interest rates for a prolonged period of time, and He has blown every bubble imaginable and even a few I couldn’t have imagined just a few short years ago. Couple this with massive government spending and you can see an unprecedented effort to revive a struggling economy. Yet, in spite of this Herculean effort, statistics clearly demonstrate that consumers are cutting back on their spending as the following chart indicates: You are looking at a chart of the Morgan Stanley Consumer Index ($CMR) and it’s not a pretty picture. You will note that Friday closed at a new low for the year. For an even uglier, and maybe more realistic view, take a long look at the S & P Retail Index ($RLX). And yes they are oversold, but that doesn’t mean as much in a Bear Market as it does in a Bull Market. Remember last month I gave you a chart of Wal-Mart and I told you it too was oversold? Well, it’s still oversold today! Time doesn’t necessarily heal all wounds.

I contend that any further increase in interest rates will leave Fed policy dangling like a piece of shish kebab from the right horn of our charging bull. If that’s the case, then what does the left horn offer? Although the lesser of two evils, a decision to leave the interest rate unchanged would be interpreted by financial markets as a clear admission that all the printing and all the bubble blowing failed to produce the necessary results. The Fed’s effort to change the primary trend of a generational Bear Market failed, just like every other attempt that came before it. Therefore I have to conclude that the Fed will sacrifice the consumer and raise interest rates ? of 1% this week, even though it is clearly the wrong thing to do. The Fed wants to keep up the illusion that it’s business as usual, and the only way to do that is to raise rates one more time before the elections. It won’t work, but then again, not much else will either. I don’t mean to belabour the point, but you need to understand that the consumer is in real trouble here. Thanks to Fed policy he is more in debt than at any other time in history. The average American would be out of cash in four months if he were laid off from work today. He became over extended thanks to the housing bubble as this chart of household debt indicates:

It would be easy to place blame on housing alone, but the following chart shows that the cancer has spread to all corners of our nation: I suppose it would be natural to assume that a small increase in interest rates would have little or no impact on housing but I beg to differ. Take a look at the chart for Beazer Homes (BZH), one of the premier builders in the U.S.

If you believe what the market is saying, then you know the housing sector topped out in March and has since made a series of lower highs and lower lows, much like the stock market itself. The higher interest rates as prescribed by the Fed will only lead to a negative effect as:
a.. It diminishes the value of the only “real” asset theaverage consumer has at its disposal, and
b.. It makes it more difficult for him to service his debt. You see, it’s all a process. The market anticipates a top and share prices begin to decline, then inventories build and sales slow. Finally, housing prices decline and the bubble has burst.

Market Commentary
DJIA/S & P – There is so much to say about the DJIA and the S&P that it’s hard to know where to begin. In last month’s Newsletter, I told you that we were in the midst of the third and final thrust before the market heads south. I also mentioned that the previous thrust (the second) had produced a lower low and a lower high and I expected the same thing to happen the third time around. That came to pass on Friday as the SEPT DJIA (DJU4) closed at 9800 which is a new low for the year. Likewise, the SEPT S & P (SPU4) finished the week at 1,063.60; also a new low for the year. This entire move down from the third peak occurred with only one rally lasting longer than two days. All major indexes, with the exception of the Transport Index, have made new lows for the year. That is an important exception.

As my clients know, I have been short the DEC S & P and DEC DJIA since the second peak registered back in early April. Much to their chagrin, I have resisted the temptation to add on to that short position, and for good reason I might add. The Transport Index failed to confirm the May lows for the second thrust and have yet to confirm the lows registered last week. That doesn’t mean they won’t, it just means that they haven’t gotten around to doing it as of Friday’s close. I am convinced they will, but I will have patience and wait for it to happen. The worse thing an investor could do at this juncture is to try to anticipate this market. The following is a year-to-date daily chart of the cash DJIA and it clearly shows the February top followed by a series of lower highs and lower lows. This process has lasted close to six months and represents distribution. Stock moves from strong hands to weak hands in a process like this.

This is text book:
I contend that the distribution process is all but over and the Bear is about to unleash its fury. Although it’s possible that we could hold the 1,064.00 area in the cash S & P, I rather doubt it. If that were the case, I would look for a ten to twelve day rally that would take us no higher than 1,109.00 in that same index. The more likely scenario is that we move with some haste down to 1,020.00 before we experience any kind of rally.

GOLD/SILVER

– The more I look at gold the more I see a huge base being formed. I would almost call it a correction, but I really don’t think the term applies here. After all, the Bull Market in gold began back in 1999 when gold reached a low of $252.00/once. After a n initial rally, the low was tested, and held, in early 2001. From then on we’ve rallied almost without a significant setback; the only exception being in early 2003 when we dropped +/- $70.00 in what seemed like a heartbeat. This first leg up topped out in January 2004 at 425.50 basis the London afternoon fix. As Bull Markets go, that was quite a run. The problem is, the Bulls expected it to last forever and gold just doesn’t work that way.

I believe that we have spent the better part of the last eight months backing and filling in an effort to build a base for the next, and more significant, leg up in what will turn out to be a generational Bull Market for gold. A Bull Market that could very well last until the end of the decade and produce a price superior to $2,500/ounce. I estimate this base building will end sometime between the middle of September and early December. I lean more toward September. I also believe the low for this base may not be in yet. I wouldn’t be surprised to see an intraday print of +/- 357.00 before it’s done. How will I know when the base is complete? I believe it will require two consecutive closes above 413.00 in the DEC GOLD futures contract. I am currently long DEC GOLD from 400.50 and have a 398.00 stop/loss, but this is a small position. I will add on if and when I see a close above 405.75. As far as silver is concern, I view it as a commodity versus gold which is and has always been money. As most of my clients know, I see deflationary pressures under every rock and that makes me bearish commodities. Therefore, the only course of action open to me is the avoidance of silver. That may change at some future point in time, but for the moment I am out of silver. Finally, I continue to maintain the position that gold stocks are to be avoided. I liquidated a significant portion of my portfolio early in the year and the rest two months ago. I prefer physical gold to gold stocks. I was a buyer at 382.00 some weeks ago and I would gladly buy a dip to 365.00, but it may not happen. If it doesn’t, I will buy into strength.

OIL

– A lot of investors have been asking me about oil and I’ve told them all the same thing: oil is politically motivated and I am not a political analyst so I avoid it. In my ignorance, I will tell you that the price rise is relentless and you either have to be long oil or out of it. Anyone who shorts oil must have a death with. A current Point & Figure chart of oil will give you a price target of $56.00.

BONDS

– I have been quite lucky with bonds this year. I have purchased the SEPT BOND on five separate occasions in spite of all the opinions to the contrary. Also, I will exit my current position on Monday, in front of the Fed meeting, in the hopes of buying back at a cheaper price. The last time I did this, it didn’t work and I had to pay up to get back in. I have certain reservations about exiting at this point but I want to book my profits and take a long look at the bond market before I make any more commitments. Over the short run though, I really like bonds. Interest rates can’t go up beyond August because the growth just isn’t there and I could even foresee a lower rate at some future time. I will have more on bonds in a week or two.

US DOLLAR

-This is the one area that I have yet to get a handle on. Originally, I went along with the heard and thought the dollar would have to decline. After all, they print them like they’re going out of style so it seemed like a no-brainer. I was short the US$ INDEX for more than fifteen months and it worked out well. Then earlier this year, I decided that it might not have been as easy as I made it out to be. It all started when I began to see the huge amounts of debt accumulating in the U.S. as a source of domestic demand for dollars. You need dollars to pay dollar denominated debt. More debt, more dollars! What could be simpler than that? Now I look at $44 oil prices and I see an even greater demand for dollar and this time it comes from all over the world. Everybody has to pay for their oil in dollars.

Although deflation will eventually make the staggering debt load unserviceable and lead to a collapse of the dollar, at least the dollar as we know it today, there should be an increase in demand over the coming weeks and possibly months. Whether it’s enough to justify a long position in the DEC US$ INDEX is a question for the ages. I suspect the proper course of action would be to sit and wait for a top and then short the dollar and ride it down to its inevitable conclusion.

E.B.Orlandini

Source: www.lascoreport.com

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