Looking Back at Signs of the Credit Crisis

Though analyzing the past can never guarantee the future, it does at time help provide some indications of what is most likely to come. At issue today is how to determine whether we're going to have a repeat of the 2007/2008 market crash.

We believe that we will at least have a major sell off or two in the future, ala the period of the 1970s as seen below, which was discussed in more detail in our piece on secular bull and bear markets.


You can see a lot of ups and downs--a lot of volatility over the years in nominal terms, while in gold-adjusted (real) terms, the market continued to crash. Note that we have seen a very similar pattern since 2000, with the exception of the period where the credit markets dried up in 2008 and caused the massive sell off into March of 2009 (note that the chart below needs to be updated for further market advances since early August.)


So the question we have now, like all investors, is what we can expect from stocks moving forward.

As we've discussed many times, for the most part, the US stock markets are well overvalued. They continue to trade up on momentum, not fundamentals.

As we've mentioned before and as seen in our technical analysis, as a general rule for gauging US stock markets, we actually use the S&P 500 for analysis. The reason is that the S&P contains more companies and more completely determines the makeup of the US economy. In fact, the S&P 500 can be broken down on a sector basis as follows:

Sector.......................Percentage Makeup of S&P
Financial Services...........20.3%
Healthcare......................13.4%
Industrial Materials........12.2%
Hardware.......................10.8%
Consumer Goods..............9.7%
Consumer Services...........8.8%
Energy.............................6.5%
Software..........................4.5%
Business Services..............3.9%
Media...............................3.9%

Given that a major theme here at Dredd is the indebtedness of the Western countries and the corresponding transfer of wealth to emerging markets, we can see that most of the S&P probably should not be doing well. The US' primary export for years now, due primarily to the domestic consumer economy and the reserve currency status of the dollar, has been financial services because there was always a demand for dollars. Well, that seems to be going away over time. Healthcare cannot be exported to other nations and is being nationalized. Consumer goods and services will probably remain in the tank for a while as consumers cut back spending. Because of lax consumer demand, business services will remain weak domestically, but may do okay if they adjust to serve more global demand. Thus, the expectation will be that the S&P as an index will have to go lower (some stocks will outperform--notably those that have strong export fundamentals like commodity producer stocks). The S&P P/E ratio is way out of line with reality because the current rally is based on the hope that the future economy will improve. It is our belief that once the reality hits the markets that this is not going to happen quickly, we'll see the markets roll over again. As we mentioned last week, that may be in early 2010. Other commentators like Faber, whose latest interview we posted earlier this week, believe it may be a few years out before the market turns over (technical analysis will improve our odds of knowing!).

Of course, there is the uber-bear faction of the market that believes that the market is about to turn over because the credit crisis is waiting in the wings. This is entirely possible--we don't discount that. However, if we take a look back at 2007 and 2008, we can identify some telltale signs that credit market activity was locking up. These indicators need to be watched carefully. If they start to signal another credit crisis return, we would want to diversify all assets into dollars and gold...

Credit Crisis Indicators of 2007 and 2008
First, let's define what a credit crisis is. Wikipedia has a reasonable definition to work with (bold emphasis is ours):

• A credit crunch (also known as a credit squeeze, finance crunch or credit crisis) is a reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from the banks. A credit crunch generally involves a reduction in the availability of credit independent of a rise in official interest rates. In such situations, the relationship between credit availability and interest rates has implicitly changed, such that either credit becomes less available at any given official interest rate, or there ceases to be a clear relationship between interest rates and credit availability (i.e. credit rationing occurs). Many times, a credit crunch is accompanied by a flight to quality by lenders and investors, as they seek less risky investments (often at the expense of small to medium size enterprises).

In short, there was too much leverage in the system where asset prices were bid up based on credit. When housing in the US collapsed, many of the derivatives based on those asset values locked up. That essentially killed any loans among major institutions because it was (and still is) unclear which institutions were solvent, and thus able to pay back loans. This, in turn, forced a further sell off of assets (deleveraging) in order to pay off outstanding margin calls. There was a forced demand for dollars created, which drove the value of the dollar up, and any outstanding money in the markets went into the safest assets out there--US Treasuries and gold. Fundamentally, it was a panic sell off that forced the value of gold and dollars up at the expense of everything else. The issue we wish to address is how to determine if this event will happen again by reviewing what happened in 2007 and 2008.

The charts below state it all, really. The chart below shows the daily US dollar index from October of 2007 to present. We show the dollar because it was the major dollar rally that forced asset markets down.

You can see we've divided the crisis into four periods: Pre Credit Crisis, Warning Period, Credit Crisis, and Post Credit Crisis.

The first technical indicator that something was not right was the TED spread.

What is the TED spread?

• The TED spread is the difference between the interest rates on interbank loans and short-term U.S. government debt ("T-bills"). TED is an acronym formed from T-Bill and ED, the ticker symbol for the Eurodollar futures contract.
• Initially, the TED spread was the difference between the interest rates for three-month U.S. Treasuries contracts and the three-month Eurodollars contract as represented by the London Interbank Offered Rate (LIBOR). However, since the Chicago Mercantile Exchange dropped T-bill futures, the TED spread is now calculated as the difference between the three-month T-bill interest rate and three-month LIBOR.
• The size of the spread is usually denominated in basis points (bps). For example, if the T-bill rate is 5.10% and ED trades at 5.50%, the TED spread is 40 bps. The TED spread fluctuates over time, but historically has often remained within the range of 10 and 50 bps (0.1% and 0.5%), until 2007. A rising TED spread often presages a downturn in the U.S. stock market, as it indicates that liquidity is being withdrawn.

The chart above does not have a long view of the TED spread, so we've included the 5 year chart below as a reference.


You can see that on August 10, 2007, the TED spread jumped above 1 (or 100 basis points). Referring back to the top chart, you can see the 10-Year to 2-Year US Treasury spread suddenly spiked in late March of 2007, just as the dollar was bottoming (entering the trading range noted by the red rectangle). That bottoming pattern for the dollar lasted several months. (Note that the Bob Prechter interview clip from August 11 we posted stated that Bob believes the dollar is bottoming now again. We're not so sure...)

The dollar bottomed out until mid July, 2008 and broke out of the rectangular consolidation area (see why technical analysis can be valuable?), forcing commodities and everything else down. Those signs should have been enough to force most to sell out. If not, there were a few other signs like a sudden rise in the gold/silver ratio and a crash in junk bonds as seen below.

In summary, there was a lot of time and many indicators that things were going awry in the credit markets. Careful attention to the charts would have provided ample time to move to safety.

So, does this mean it's all sunshine and rainbows from here? Hardly. It's clear that the central banks are trying to stay on top of the liquidity issues, but the debt problem for the average consumer remains. Unemployment is rising. Stocks are generally overvalued.

While it's possible we may see a return to the credit crisis of 2007/2008, we believe we will have ample time to avoid a repeating scenario by watching these indicators. In the meantime, there are other reasons why stocks may go down, but the credit markets will probably not be the reason this time.

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Excellent Video on the Dollar Dilemma

Though it's not frequent, occasionally Bubblevision comes out with an interesting interview. This one comes highly recommended.

The key points that we find interesting and generally agree with:

• The Fed watches gold, and attempts to control it, because it's the best indicator of what they're doing to the dollar. Gold is a good buy. (Stay tuned to this blog for a technical buy signal to pick up another batch of gold or gold stocks.)
  
• The dollar is losing its status as the reserve currency. It is actually not possible to manage the currency for the country and for the world if those two entities have conflicting needs. A weakened dollar is actually good for US manufacturing over time, but it's bad for the American standard of living.
  
• The liabilities are unfundable. The dollar must be inflated to lower the cost of paying back the debt. Inflation is a required outcome. The goal is simply a controlled devaluation of the dollar. All talk of "strong dollar"is just that--talk.
  
• 4% inflation for 17 years sounds about right...if they can keep it that low. There is a huge risk when a country has to intentionally devalue its currency. We believe that there will ultimately be an uncontrolled fall in the dollar.
  
• The Strategic Drawing Rights (SDRs), which are an attempt to create an international unit of exchange to replace the dollar based on a basket of currencies, are simply a money printing exercise. There's nothing backing them--yet. Gold may yet end up being the currency of international exchange...
  
• There is a huge geopolitical and national security risk associated with devaluing the dollar. It is, however, inevitable that the risk must be undertaken. (Try reading the book "The Fourth Turning" by Strauss and Howe, available from our Amazon bookstore at the bottom of the blog.)
  

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Peter Schiff Comments On Bernanke

First Faber. Now Schiff. Seems like Yahoo's Tech Ticker is becoming more willing to show a contrarian viewpoint.



Schiff is right. Regulation is not the problem. Tampering is.

With luck, Schiff will beat Dodd out in Connecticut...



Again, Schiff is right. In general, the stock market rally is doomed to failure. Stay with us on the technicals to see when it may be over!

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Federal Reserve Admits Hiding Gold Swap Arrangements

Interesting developments continue. The gold in the US Treasury is the property of the citizens of the United States, held by the US Treasury. Only an act of Congress could allow gold to be swapped with foreign banks.

Will the outrage finally occur once the dollar has imploded from abuse as Americans are left holding nothing but broken promises?

For the uninitiated, the President's Working Group on Financial Markets, aka the Plunge Protection Team (PPT), exists for the sole purpose of "massaging" market directions, usually through futures activity. If you think that there is any true, laissez faire, free market capitalism on this planet, you're deluding yourself. Capitalism is not to blame for the world's mess--planned economies under the guise of capitalism is what's to blame.


Federal Reserve Admits Hiding Gold Swap Arrangements, GATA Says

MANCHESTER, Conn.--(BUSINESS WIRE)--The Federal Reserve System has disclosed to the Gold Anti-Trust Action Committee Inc. that it has gold swap arrangements with foreign banks that it does not want the public to know about.

The disclosure, GATA says, contradicts denials provided by the Fed to GATA in 2001 and suggests that the Fed is indeed very much involved in the surreptitious international central bank manipulation of the gold price particularly and the currency markets generally.

The Fed's disclosure came this week in a letter to GATA's Washington-area lawyer, William J. Olson of Vienna, Virginia (http://www.lawandfreedom.com/), denying GATA's administrative appeal of a freedom-of-information request to the Fed for information about gold swaps, transactions in which monetary gold is temporarily exchanged between central banks or between central banks and bullion banks. (See the International Monetary Fund's treatise on gold swaps here: http://www.imf.org/external/bopage/pdf/99-10.pdf.)

The letter, dated September 17 and written by Federal Reserve Board member Kevin M. Warsh (see http://www.federalreserve.gov/aboutthefed/bios/board/warsh.htm), formerly a member of the President's Working Group on Financial Markets, detailed the Fed's position that the gold swap records sought by GATA are exempt from disclosure under the U.S. Freedom of Information Act.

Warsh wrote in part: "In connection with your appeal, I have confirmed that the information withheld under Exemption 4 consists of confidential commercial or financial information relating to the operations of the Federal Reserve Banks that was obtained within the meaning of Exemption 4. This includes information relating to swap arrangements with foreign banks on behalf of the Federal Reserve System and is not the type of information that is customarily disclosed to the public. This information was properly withheld from you."

When, in 2001, GATA discovered a reference to gold swaps in the minutes of the January 31-February 1, 1995, meeting of the Federal Reserve's Federal Open Market Committee and pressed the Fed, through two U.S. senators, for an explanation, Fed Chairman Alan Greenspan denied that the Fed was involved in gold swaps in any way. Greenspan also produced a memorandum written by the Fed official who had been quoted about gold swaps in the FOMC minutes, FOMC General Counsel J. Virgil Mattingly, in which Mattingly denied making any such comments. (See http://www.gata.org/node/1181.)

The Fed's September 17 letter to GATA confirming that the Fed has gold swap arrangements can be found here:

http://www.gata.org/files/GATAFedResponse-09-17-2009.pdf

While the letter, GATA says, is far from the first official admission of central bank scheming to suppress the price of gold (for documentation of some of these admissions, see http://www.gata.org/node/6242 and http://www.gata.org/node/7096), it comes at a sensitive time in the currency and gold markets. The U.S. dollar is showing unprecedented weakness, the gold price is showing unprecedented strength, Western European central banks appear to be withdrawing from gold sales and leasing, and the International Monetary Fund is being pressed to take the lead in the gold price suppression scheme by selling gold from its own supposed reserves in the guise of providing financial support for poor nations.

GATA will seek to bring a lawsuit in federal court to appeal the Fed's denial of our freedom-of-information request. While this will require many thousands of dollars, the Fed's admission that it aims to conceal documentation of its gold swap arrangements establishes that such a lawsuit would have a distinct target and not be just a fishing expedition.

In pursuit of such a lawsuit and its general objective of liberating the precious metals markets and making them fair and transparent, GATA again asks for financial support from the public and from all gold and silver mining companies that are not at the mercy of market-manipulating governments and banks. GATA is recognized by the U.S. Internal Revenue Service as a non-profit educational and civil rights organization and contributions to it are federally tax-exempt in the United States. For information on donating to GATA, please visit here:

http://www.gata.org/node/16

People also can help GATA by bringing this information to the attention of financial news organizations and urging them to investigate the Fed's involvement in gold swaps particularly and the gold (and silver) price suppression generally.

Contacts:
Gold Anti-Trust Action Committee Inc.
Chris Powell, Secretary/Treasurer, 860-646-0500x307

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September 23 Market Update

We have a mix of charts from yesterday and today as they've been available. Some charts needed updating based on today's events, notably the dollar, and others remained about the same.

Summary
We expect, as we've noted before, a bounce of the dollar at 76 in the short term, which will cause some selling in assets including stocks, gold, and oil. The bounce could last a couple of weeks to a couple of months, though we doubt it will last as long as the bounce around 78. This will create good buying opportunities in stocks of commodity producers for the intermediate term. Long term--and it's not clear exactly when that starts, though we're thinking within the next 6 months to one year--we expect things to get ugly again. The next round will look more like the 1970s stagflationary episode.

On to the specifics.

US Dollar
The dollar made a surprise reversal today. After spiking down below the 76 level intraday, it reversed and had solid gains for the day. This, in turn, forced a sell off in other assets. Stocks went from a positive day to a strongly negative day and gold had a minor sell off. Hopefully, this is the consolidation we've been waiting for in order to find a reasonable entry point. Time will tell.


The dollar is oversold and at support at 76. We anticipate that it may rise up as high as the 50 day moving average*intraday* at around 78.14 on this move. If it moved above that level, it would be considered a warning. You can see the support and resistance levels in red in the chart above.


The trend is easier to see on the intermediate term and longer term views. As long as the blue downtrend in the chart above is preserved and the credit markets remain liquid, markets will continue to rise. You can see that 78.14 would break that blue trendline, which would be a warning flag. A rise in the RSI above 50 would also be a warning. Odds are, we will see the dollar rise to the center of the Bollinger Band around 77.29 before resuming a downtrend.

The above long term dollar chart (weekly) puts things in perspective a bit better. The dollar's rise from 72 was due to the credit crisis. The red rectangle in 2008 shows its consolidation pattern as it broke out. Since then, it has formed a double top, which implies that it will, at minimum, wipe out the gains it made from 72 - 89.

Precious Metals
We are using yesterday's charts for these, but today's minor down day does not affect the analysis.


On the short term chart, we can see the breakout from the triangle (in blue) and the horizontal resistance and support lines (in red), with 1024 being resistance (note that this is the number that Jim Sinclair continues to refer to). Gold is also overbought by several measures. Combined with a possible bounce in the dollar, we may finally see a gold correction to allow some to enter the trade. Any correction will be short lived. For the long term investor (and in this environment, gold is not a thing to be traded lightly...), anything below 1000 is a deal (spot price). There's an off chance we may see something lower like 970, but don't hold your breath waiting for it. You can see why below.

Above is the long term (weekly) chart. With the penetration past 1000, the run toward 1300 is all but guaranteed. A minor correction lasting a few weeks would be a great entry point for those that missed the earlier breakout.

Similarly, silver looks ripe for a correction, and thus an entry point for those that missed the move.

We believe silver will outperform over gold in time, but the risk with silver is higher. As a general rule, silver does not have the monetary respect that gold has. In a credit crisis, silver will "get killed" while gold holds its own. Note that it continues in its solid upward channel with overbought readings on the daily chart. Look for a low in the 14.50 range as the RSI starts to turn up again from just above 30 as a buying opportunity.

Equities
Globally, stocks are showing some mixed signals. We're generally bullish on equity markets, but have a particular interest in emerging markets with growing middle class consumer bases.

In the US, the S&P looks to be headed back toward 1350 from a technical, long term perspective. There's a chance it will face serious opposition at 1250. Fundamentally, the S&P is in deep trouble. However, the charts are what the charts are. We're going to go along for the ride, even if we don't believe there's a fundamental basis for what we're seeing. You can see that the RSI is not yet overbought, though the stochastic is. Expect a correction over the next few weeks to correspond to the dollar's bounce. The length of the correction is proportional to the dollar's strength and no more. This market continues to want to move up. Don't fight the tape.

A similar view is evident on the daily chart. We could see a correction back to 1040 without much angst.

Why 1040? Here's the potentially bearish view of the S&P:

That is a rising wedge--a bearish formation. A drop below 1040 (the lower border in blue) may be the catalyst to take the S&P back to 880. That's something to keep any eye on as we move forward.

Emerging markets, as a general rule, appear to be bullish. Frequently these markets will follow the US in a sell off, so we're cautious about entering them right now.

India broke out of a rising wedge with a bullish breakout, so there's no guarantee that the US rising wedge will end up being a bearish turn.


We will spare you the review through all of the emerging markets. In general, they're all bullish. The one exception, oddly enough, is China's Shanghai Exchange:

Most of the emerging markets, including China, bottomed in November of 2008--before the US markets bottomed in March of 2009. There's a chance that they may forecast another downturn in advance of US market down moves. We can see that on the long term chart, China was overbought and began consolidating. However, it did not turn up and act bullishly recently as one would anticipate. There's no clear path to determine what Chinese equities are going to do next, so we turn to Fibonacci numbers to help out.

We can see that the rally from the November 2008 lows retraced an almost perfect 38.2% level from the October 2007 highs into August of 2009 before turning back to consolidate. Instead of crashing again, the market appears to be consolidating--interestingly enough, around the 50% retracement level between the August 2009 high and the September low. We have fractal behavior in this market.


We would be very concerned about a break below 2639.75. More likely, this consolidation is almost over, probably ending in sympathy with any US market consolidation.

Of particular interest also are the gold stocks in this environment.

The HUI gold bugs index continues upward in its rising channel. There's a chance that with a dollar bounce and corresponding gold market/stock market pullback, that we'd see the HUI reach its 50 day moving average near the bottom of the channel before an uptrend resumes. Now's the time to be picking out those gold stocks and getting ready...

Commodities
Commodities, as measured by the Continuous Commodity Index (CCI), are in an ascending triangle pattern. We expect that we may see the bottom of the triangle "touched" during a consolidation. If prices then turn up from that ascending line, commodities in general would be a buy. This is a very bullish formation once the price breaks out above the horizontal upper boundary.

Dr. Copper continues to tell us all is well in the world. Like silver, it is in a rising channel and has been for a long time.

Crude oil itself is a bit of a conundrum. Today's price action had a very negative effect on the charts. Look for potential buys at 67.50. If that level fails, 62.50 will probably hold. This is one to watch and see what develops in time.


Natural gas, on the other hand, led by a short covering rally, may have some upside potential. We noted a few weeks ago that there was a chance that the breakdown out of the rectangle may be a false breakdown. Just as we were giving up hope that it could turn back up, it did. That huge gap up is a clear sign of forced short covering. This one may have a minor pullback, but it is poised to go much higher now.

Crisis Indicators
All's quiet on the Western Front as it applies to credit stress indicators.


Conclusions
Assets are poised to go much higher after a brief rally in the dollar. Unfortunately for dollar holders, assets are going up because the dollar is going down with no significant relief in sight.

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Marc Faber on the Markets

Marc Faber has called most of this market movement pretty well. We are in general agreement with Dr. Faber on the longer term issues in the Western world (North America, Europe, and Japan), which are not positive while the future of the emerging market countries looks positive.

There is no real economic recovery. The debt loads have simply shifted from the private sector to the public sector, but have not decreased. Monetary policy will have to remain loose (note the FOMC statement from earlier today).

We are talking about an absolute collapse in Western economies.

We are not so confident that we have three good years ahead of us before things get really bad, though...

Take a look at these videos from yesterday's Tech Ticker on Yahoo!

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September 23 FOMC Statement

The official FOMC statement. Bold and italics emphasis is ours to highlight key points.

Press Release
Federal Reserve Press Release

Release Date: September 23, 2009
For immediate release

Information received since the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further, and activity in the housing sector has increased. Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time. [Dredd Note: You must be kidding. Has no one on the FOMC purchased food or energy recently?]

In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010. As previously announced, the Federal Reserve’s purchases of $300 billion of Treasury securities will be completed by the end of October 2009. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.




This was essentially an endorsement of continued dollar weakness and asset market gains. Don't miss out on those. Given that this whole thing is going to turn over at some point and go the other direction, you'll want to be ahead of the curve.

Note that the dollar is struggling to hold 76 on the USDX. This announcement did not help your purchasing power any. But then again, as we've been saying, it is the goal of the US government and the Fed to weaken the dollar to alleviate the debt through inflation.

A full course market update is being put together for posting later today.

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You Should Watch This Video

The main reason that you should be reading Dredd and other blogs on this financial maelstrom....

In a nutshell, 95% percent of your savings is at risk right now. Many of Boomer retirees-in-waiting will never actually retire. Most of them will just go broke.

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