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By James R. Cook
"No matter what happens, a huge market decline lies ahead. The current market strategy is a no-brainer – just as it was during March 2000. Aggressively sell-short the stock market. This time, NYSE stocks are as richly overvalued as NASDAQ stocks. This time around, the coming crash will carry all sectors of the market into oblivion."
I have this friend who dropped $2 ½ million in the NASDAQ market crash. A few months ago he sold everything and got into gold stocks. Recently, he sold the gold stocks at break even and jumped back into the NASDAQ stocks. Fortunately, he caught the war rally for a good gain. Now he sold those stocks and took some profits.
I suspect he’ll be back in the market again soon. He thinks he’s investing. In reality he’s gambling. He’s rolling the dice in the stock market. Deep in his mind he harbors the belief that stocks will come back in a big way. He likes the excitement of making money in the market. He loves checking the stock quotes in the morning paper, watching CNBC and talking to his broker. It’s highly stimulating to be speculating in the market and making money. He doesn’t believe it will end because he doesn’t want it to end. That sentiment goes double for the people in the securities business. They don’t want those big paydays to end. They’ll fight the bear market until the bitter end when the bear devours them.
In January, 2000 we wrote in our newsletter entitled Market Crash, "For those who think the stock market will never crash: Here’s 20 Powerful reasons to believe there will be a panic….." First on the list was, "Unsophisticated investment practices are running wild." That’s still the case today. All too many people are hooked on the stock market as a casino. How else can you explain stock buyers piling into overvalued stocks on every rally. What we wrote in January of 2000 is still the case today. "Time-tested measurements of value are totally ignored. Ten times earnings was a benchmark for stock prices in past decades. When the price-to-earnings ratio climbed much above ten, that stock was thought to be a sell. Under ten it was considered to be a buy. Now stocks at 50….. times earnings are commonplace." Unfortunately, PE ratios of 50 are still the norm while record low dividend yields are stuck below 2%. Most other important ratios are still grossly out of whack.
Three down years in the markets mean things have changed. Stock investors are less exuberant. But they still have the unremitting belief that a bull market lies just around the corner. Many of those who may have sold their stocks didn’t sell their mutual funds. They’re hanging on to them. But most stock fund managers are also breaking the rules of sound investing. They have portfolios loaded with stocks that are overvalued by historical measures. Their cash reserves are at historic lows. Meanwhile, investors who are primarily in cash or bonds are waiting with baited breath to pile back into stocks.
But stock investors have two strikes against them. Corporations who were huge stock buyers are out of the market. Foreign investors no longer wish to acquire U.S. stocks to the extent they once did. These were big players and a major factor in the bull market. Insiders must be worried about this. For every dollar’s worth of stock that insiders in the ten largest technology companies buy, they sell almost $10,000 worth.
Right now market liquidity is not a problem and it may never be. But too much selling can lead to a panic. The Fed hasn’t much room left to lower interest rates. This is their major policy for boosting the economy and it hasn’t worked to date. Stock investors should ask what happens to stocks when the Fed can’t lower anymore?
Virtually all stock investors remain convinced that we are near the lows, or have seen the lows. Under no circumstances do they imagine a drop of any significance below the 7200 low for the Dow. However, stock bubbles never fail to backtrack to the price levels that existed at the time the stock bubble began. If we use August of 1982 as a starting point, that would put the Dow at 776.92 and the S & P 500 at 100. That means that if this bear market acts like every other bear market that followed a stock boom, an 80% to 90% drop in stock prices is still in the cards. If we use the last recession low in 1991, the Dow will drop below 2500.
Our point is that risks are still much too high for you to stay in stocks. The potential for gain compared to the potential for loss (risks versus rewards) doesn’t match up. Furthermore, with profits still declining, durable goods orders dropping, consumers retrenching, and crucial capital goods spending falling even further, the argument to buy stocks because of a pending economic rebound makes no sense at all. Furthermore, weakness in the dollar, aggravated by a monumental trade deficit, should keep foreigners on the sidelines and further depress U.S. stocks. A falling dollar reflects economic failure. If it is also true that the consumer comprises 90% of GDP, and the consumer’s spending, borrowing and confidence are all down while their savings are up, any bullish Wall Street argument is pure bunk. With higher energy costs, the likely end of the refinancing boom, an insignificant tax cut and an avalanche of lost jobs, the question becomes how far will the consumer drag the economy down?
It’s always been said that low inflation is good for stocks. But the Fed’s attempt to rescue the stock market and pump up the economy is the rawest sort of inflating. As this money and credit extravaganza begins to show up in the inflation rate, we’ll no doubt hear that rising inflation has now become good for stocks. It isn’t. Higher inflation means higher interest rates, the ultimate death knell of the stock market.
You can learn about bear markets through bitter experience, or you can learn by studying past bear markets. History indicates that a bear market will be over when values reach rock bottom. That means PE ratios under 10. It means stock prices dramatically lower than today’s levels. It means the end of buying on dips and holding for the long term. More than anything, it means that mutual fund sales will be dead for twenty years and that you, the stock investor, will never want to buy a stock again.
POUNDING THE TABLE
By Theodore Butler
(The following essay was written by silver analyst Theodore Butler. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)
The recent sell-off in silver has created an unusual buying opportunity. I believe we are approaching, or are already at, what may be the final lows, perhaps for a generation. Those, I admit, are strong words. On one hand, silver fundamentals are bullish beyond measure. You can't have a more bullish situation in a commodity than to consume more than you produce. This annual deficit makes silver a long term buy until the deficit is eliminated. That suggests the price will go so high that you can't sleep at night. Even then, in all likelihood, you will sell too soon.
But these silver fundamentals have nothing to do with the immediate opportunity I am writing about now. I am talking about buying silver into this price decline because of the market structure reported in the Commitments of Traders Report (COT). I think the COT is shouting that silver is a buy right now.
My interpretation of the COTs is centered upon the interplay between the commercial dealers and the technical hedge funds. These tech funds operate strictly on moving averages. When the price goes up, and through a certain price, the tech funds buy. When the price penetrates the moving average on the downside, they sell. They are hoping to catch a long term price trend. The commercial dealers, or bullion banks (Bank of Nova Scotia, AIG, Goldman Sachs, Morgan), take the other side of the trade when the tech funds buy and sell.
Perhaps the main hallmark to the decades-long price manipulation of silver has been the lack of competition between the big commercial dealers on the COMEX. For 20 years, these commercial dealers have acted as one in their dealings in COMEX silver. It’s always the dealers in unison, versus the technical funds. Technical funds buy, the dealers sell. And Vice-versa. What motivates the technical funds is a slavish (and foolhardy) addiction to mechanical price signals. And, as consistent losers to the dealers in virtually all their trades on the COMEX, no one could ever accuse the funds of being the masterminds of the silver manipulation, since they are the suckers.
I have not observed the tech funds ever making a profit in COMEX silver at anytime in the past five or ten years. Because of this obvious pattern of consistent losses in COMEX trading, I have taken to calling the tech funds' COMEX trading as stupid. I have also pointed to this manhandling of the tech funds by the commercial dealers as central to the silver (and gold) manipulation. The short term price of these commodities is set on the COMEX, primarily by the tech funds and these commercial dealers. This goes against every principal of commodity law.
Once the tech funds reach a full long position, the market is structured to go down. Alternatively, when the funds are loaded up on the short side, a price rally is almost certain. The good news is that the tech funds have been lured onto the short side of silver, once again. That means silver must rise. In a recent article, I speculated that this situation was the only hope for the cornered King Rat of commercial shorts. "We are seeing evidence of a further concentration of an already super-concentrated short position in silver. I think we’re down to one or two very large commercial shorts who are rigging the silver market. That means the last remaining controlling short (or shorts) in COMEX silver is in a desperate situation. He is like a cornered rat. He is in a very dangerous position because his position is so vulnerable. That also makes him a danger to the market. He must engineer a sell-off, in which the technical funds will go short ten or twenty thousand contracts, and enable him to cover more of his short position." That’s exactly what happened.
On August 14, 2001 I wrote that the tech funds were excessively short. We did explode after September 11 for more than 60 cents. The dealers sold short aggressively and back down we came. On November 21, 2001 and December 11, 2001, I wrote new articles stating that the tech finds were, once again, short. Again, we rallied for more than 60 cents. On October 22, 2002 I wrote an article, "Here Go Again", in which I pointed out that the tech funds were short again and to expect a rally. Soon thereafter, we got another 60-cent rally, stopped again by commercial dealer concentrated short selling. Well, here we go again. The tech funds are heavily short. That should mean we’re going up from here.
My point is that the price of silver is controlled and dictated by the dealings between the commercial dealers and the tech funds. That is illegal. There is no doubt that the commercial dealers are the masterminds. How is it that I have been able to write in advance what the price of silver will do based upon the tech funds’ and dealers’ behavior? Their actions control silver prices, not the real world of supply and demand.
The tech funds are all paper. They have no chance to deliver real silver. They have to buy back their short positions, since they have no other choice. It's just a question of when and at what price they cover. Will the manipulative dealers short on the next rally, and limit the rally to half a dollar or so? I know one thing for sure. One day, when the tech funds are short silver (like they are now), the dealers will not be the normal and usual sellers that the funds have come to expect. There is nothing that requires the dealers to be the willing sellers they have always been on price rallies. When that day comes, as it must, it will be like no other in the history of silver. You want to be holding as much real silver as you possibly can, before that happens.
The silver situation is getting more interesting by the day. On February 27 and 28, what looked to be a single buyer, initiated a purchase of over 6000 call options in the December 2003 silver option. About 1500 were bought in the $6 strike price, and over 4500 were done in the $7 strike price. Six thousand contracts equals 30 million ounces. The options expire on November 24. The total premium paid, or cost, of the options was about $2 million. In my memory, this was the largest single option transaction in the 20 year history of the COMEX silver options market. The buyers and sellers are anonymous. Most likely, it’s an institutional buyer. Two million dollars is a big bet that silver will be higher than $6 or $7 by November 24. If silver doesn’t reach those levels by November 24, the buyer loses $2 million. It may be that it’s just a straight speculation by someone very bullish on silver.
Perhaps the buyer was not speculating, but bought the options as protection against a silver price advance because of an existing short position. Barrick Gold comes to mind. This amount is in the ballpark of what they said they were interesting in settling. Or it could be one of the big concentrated commercial shorts who have been manipulating the silver market for years and has decided to cover. The trade makes sense to me as a good speculation, and it makes extra good sense as price protection for an existing short. While it’s true that $2 million is a lot of money for an out of the money option, at $10 per ounce these options would be worth well over $100 million. If silver got to $15 by the end of November, the options would be worth $250 million dollars. Not bad for a $2 million bet. If this derivative moves into the money, it will be like dumping rocket fuel on a supply and demand fire.
The sellers, or grantors, of these silver options took in the $2 million that the buyer paid. They get to keep it if silver stays below $6 or $7 an ounce by the end of November. But if silver moves above those price levels in the next eight months, the sellers will be in a world of hurt. They will have to come up with hundreds of millions of dollars, if silver moves into the low double digits outlined above. Most of these sellers are not capable of meeting such a financial obligation. With silver below $5, the sellers have practically no margin requirements. They have put up just about zero money to back this trade. The COMEX allows this. But if silver runs to $10 or $15, these sellers will have to come up with hundreds of millions of dollars. To stop their financial hemorrhaging, they will have to buy silver at any price. (Bankruptcy isn't an option either, as the exchange guarantees all transactions.) At a certain price to the upside we have guaranteed panic buying that’s built massively into the silver market. This doesn’t include the huge additional shorts in the futures market or the large lease obligations. Furthermore, it's not just the 30 million ounces discussed here, but hundreds of millions of ounces held short in COMEX options, ticking like a live grenade. The panic buying this could create is beyond your imagination. This is an example of the derivatives' danger that Warren Buffett referred to.
I write about the COMEX and the COTs because the more knowledge you have about silver, the better off you will be. The COMEX paper short-selling shenanigans I describe have had a strong downward influence on price, but will eventually have a commensurate upside influence. But, more than anything, it is the law of supply and demand that argues for you to own real silver. Never has the world witnessed a situation like we have in silver today. It isn’t possible to have a long term deficit in a commodity without the price exploding. You can’t have current consumption exceed current production, with visible inventory reduction, and not have prices go up.
If there were no long-term manipulation, the price of silver would not be presenting the opportunity of a lifetime. So I ask you to look at these manipulated, depressed prices as a special bonus. Most people buy gold and silver for protection against inflation, a falling dollar, a stock market crash, or war and world turmoil. These reasons are important, and not to be underestimated. But, at the core, there is one, and only one, primary reason to buy and hold silver. There is less and less of it in existence every single day. There’s less above ground and less below ground. There’s less than there was a year ago and less than there was hundreds of years ago. There’s less silver in existence, but more money and more people than have ever existed in history. You don't need to know more than that. Then there’s the bonus that more than 99.9% of the people in the world don't have a clue as to the real story in silver. Take advantage of your good fortune by buying real silver now.