This stuff isn't my area of expertise, but it is my Bond -trading officemate's. He thinks the Fed's actions have backed them into a rat hole, and are hurting the housing market and all forms of credit. His arguments seem very logical to me. Far more so than Najarian saying on CNBC this am that the Fed is keeping rates low to help credit card customers?! Huh? When the likes of Citi are raising card rates to 25% on their best, high credit score decade + customers??

Ponder this:

The Fed continues to say it will leave rates near zero for a LONG time. Hence big buyers are scooping up huge amounts ($44B per month) of 2-yr notes at absurdly low yields and a very tiny spread to the already pinned Funds rate. If the Fed were to suddenly change its tune, the owners of these (big banks, sovereign funds, etc) would get crushed. So the Fed is trapped - it can't publicly signal rates are going up without first secretly telling these big note holders that they are going to do so, so these guys can start unwinding. If they even signal this publicly, it'll be too late. Not to mention what would happen to the massive Fx carry trade bubble when the dollar strengthens.

Furthermore, by keeping the rates low, the Fed hurts the housing market. Banks do not need to, and are not, going out on the risk curve to make money. They can gather deposits for nearly nothing and make a big fat spread in treasuries. The long end of the yield curve is staying high (curve is very steep) because the bond vigilantes are afraid of inflation due to the Fed's easy money policy. Who needs to make mortgage (or small business etc) loans when there is a "risk free" 3-400 bp spread ripe for the picking? Risk free that is until the Fed raises rates. Which they can't. But they have to at some point. Hence they have to give a "wink wink nudge nudge" to all the big players. Which they can't - that wouldn't be unethical and would hurt those not in the know.

Trapped indeed...

I had to take a few moments away from shouting at the circus-of-the-inane on CNBC to vent. All the focus on this jobs number this morning should confirm to any rational person that the great majority of what goes on in Wall Street is a complete waste of time at best and a criminal destruction of value at worst.

Being trained as a scientist in a former life just makes it harder to watch this garbage. Yesterday afternoon some random NYSE floor monkey, CNBC's "expert of the moment", expounded that if the unemployment rate came in at 9.9%, the market was going to the moon, Alice. But (God forbid) if the rate was 10%, we're all doomed. At which point my left eyeball began twitching followed by my Bond-trader office mate and I embarking on a 30 minute session of throwing things (Literally and figuratively) at the TV. Only a session of cranking some classic reggae could calm us.

10% vs 9.9% - this my friends is far less than a rounding error. It means less than nothing, It is simply a round number vs. a non-round number - NOTHING MORE. And based on this alone, truckloads of money is wagered on Wall Street. Consider that today's jobs lost were 190k vs a consensus of 175k. Good God, the unemployment rate is 10.2%!!! Head for the fallout shelters! We missed consensus by 15 THOUSAND jobs. Never mind that September was revised better by 44k jobs, and August better by 46k. And never mind that the consensus is a compilation of predictions made by economists that have no better way (or past record since the beginning of recorded history) to predict the economy than the seagull circling my building. The one advantage they have is that people ASK them to predict the future, and PAY them to do so. As far as I know, no one does the same for the seagull. That is, unless he "calls" (caws?) a market bottom of top. Then he'll be guest host on CNBC for sure. The only question then will be whether a gull can out-bellow Kudlow.

Please try to remember in the face of this noise that the only good INVESTMENTS (as opposed to speculations) are those that do not require you to predict the future. And these are getting tough to find.

Dr Brett at TraderFeed sees signs of a topping process.

Jeff Miller sees high risk in most sectors, but an opportunity for the careful trader to stay with the rally.

Trader Mike suggests that earnings reports had better be stellar or else down we go.

John Dorfman says the Stock-Market Bulls Have Room to Keep on Running

And 247WallSt says despite the rally there are still some key very active stocks which have not recovered anywhere close to the same amounts with the overall stock markets.

Per the RSI and many technical analysts, we still have more room to run (we haven't crossed 70 yet).

And the academics say... well nothing right now because they're still too busy writing papers about what happened 6 to 18 months ago...

(Calculated Risk Blog)

The market continues to rally since March, yet Bernanke says "accommodative policies will likely be warranted for an extended period."

Barry Ritholtz describes our current rally as The Most Hated Rally in Wall Street History.

Interestingly, The Dollar-Adjusted S&P500 shows the extent to which money illusion has bolstered the apparent performance of US equities (Sean Corrigan, Diapason Commodities via Izabella Kaminska at FT Alphaville).

Babak at Trader's Narrative shows the US Dollar's Weakness vs. Gold's Strength.

We'll see if the Bulls can continue to slaughter the Bears today as we head into the weekend.  The Post Office and most schools are closed on Monday for the Columbus Day Holiday, but the markets are open.

Before I get into the description of these trades, let’s not forget that high risk trading brought Wall Street to its knees.  Greed allowed banks like Lehman Brothers and Bear Stearns to make high risk trading a huge proportion of their total businesses, and it ultimately lead to their demise.  No one should ever risk more than they can afford to lose, and (via leverage) many Wall Street banks risked 30+ times more than they were even worth.

The U.S. Dollar has been weakening steadily for nearly a decade, and it’s not going to stop.  Sure there will be short term trend reversals and the pundits will make the trend seem ambiguous, but the long term trend must remain intact.  The sheer volume of stimulus pumped into the US economy to combat the financial crisis combined with the Federal Reserve’s indication that rates may stay low for sometime can have only one result: A weaker U.S. Dollar.  Check out this phenomenal (as usual) op-ed in the NY Times by Warren Buffett.  He eloquently describes “The Greenback Effect” in terms of a natural phenomenon known as the Butterfly Effect.  In Summary, Buffett says the greenback effect will cause the purchasing power of the U.S. dollar to melt, and he says the dollar’s destiny lies with Congress.  In my viewpoint, Congress ain’t gonna do anything to protect the U.S. Dollar as long as Barack Obama and the Democrats are in control.  Obama and the Democrats may or may not be good for the U.S. people, but they are indisputably bad for the U.S. dollar (see Investorwalk Members Only site for specific USD trading alerts).

Increasing Downside Market Risk is becoming a reality.  As the recent market melt-up slows (as Paul Castro has exceptionally described), the market will likely capitulate as it searches for a new comfort level.  This capitulation ultimately increases the risk of sharp market declines.  The VIX (the stock market fear indicator) has been steadily declining over the last year, but it still remains at historically high levels indicating the likelihood of a sharp market decline is still a strong reality.  Not to be spooky or superstitious, but some of the worst stock market crashes in history have occurred in October (check out this link by Jeffrey Suat showing historical October market crashes), and now may not be a bad time to take out a little insurance.  Buying puts on the overall S&P500 can provide windfall profits when the market declines sharply.  Further, there are specific high beta stocks poised for even more extreme falls if and when the market does hit that sharp pullback that is due.  Another bad sign for the economy is the continued high level of unemployment.  For example Peter Schiff believes a jobless recovery is a bit of an oxymoron.  Over the long term, I am long equities, but I am willing to bet a relatively small portion of my total savings on a sharp near-term decline because the cost is low and the benefits are high if and when this thesis comes to fruition (see Investorwalk Members Only site for specific trades).

As a final reminder, excessive high risk trading caused the financial crises we continue to endure today.  For me, high risk trading is a small allocation (<5%) of my total portfolio.  The overwhelming majority of my investment portfolio is allocated to equities because I believe equities are the best long term (10 years+) investment opportunity available to me.

Per the Investment Company Institute, as of the end of August 2009 liquid assets (cash and cash-equivalents) at US stock mutual funds have declined to 4.0% of total assets.  This is down from a peak of 5.9% as of the end of February 2009.  As is their tendency, US equity mutual fund managers were at their most fearful a few short weeks before the end of the 2007 to 2009 downtrend.  Now that it appears they're getting greedy again, it's time for prudent traders to start feeling fearful. 

I saw an article in Barron's the other day describing the current uptrend as a "Red Bull" market rather than a garden variety bull market.  I tend to agree with them as US equity mutual fund managers have stampeded willy nilly into long positions over the 6-month stretch from the end of February 2009 to the end of August 2009.  Consider, by contrast, that post dot.com implosion it took from February 2001 until June 2005 for liquid assets at US stock mutual funds to go from 5.9% to 4.0%.  What took over 4 years to happen after the last major uptrend peak has now taken only 6 months.

In fact, the low in liquid assets as a % of total assets leading up to the dot.com zenith occurred in March 2000 when liquid assets reached a zenith of 4.0% of total assets, the same month most of the major stock averages topped out.  Liquid assets as a % of total assets bottomed out at 3.5% in July 2007, 3 months prior to the October 2007 uptrend peak in most of the major stock indexes. 

A saving grace for those long the market is that I'm not yet seeing signs in my other favorite indicators that a downtrend is at-hand.  Here is a quick rundown of my other favorite indicators which I'll be watching closely for clues to a change in trend;

• Investor's Intelligence Bull/Bear %'s continue to remain below the extremes they reached in October 2007 when bullish % reached a high of 62.0% and bearish % reached a low of 19.6%.  The most recent bullish % was 50.6% and the most recent bearish % was 23.6%.  Bottom line; still plenty of skepticism to power the uptrend higher.
• The NYSE cumulative advance/decline line remains at levels last seen in October 2007 when the major indexes were at all-time highs.  Bottom line; both the generals and the troops continue to remain engaged in the push higher.
• New highs on both the NYSE and the Nasdaq exchanges continue to expand as the price indexes surge higher.  Bottom line; # of new highs confirming the upward move in prices.
• The Coppock Curves of all the major stock indexes bottomed out in either March 2009 or April 2009 and continue upward.  Bottom line; the lows earlier this year were major bottoms.
• The Guppy Multiple Moving Averages show the short-term and intermediate-term moving averages moving upward together with the short-term averages in the ideal position of being higher than the intermediate-term averages.  Bottom line; big money, which scales into and out of the markets, continues to support higher prices.
• Both the S&P 500 and the Nasdaq Composite experienced Golden Crosses in June 2009 with, in the case of the S&P 500, the 50-day moving average continuing to power ahead and constructively diverging from the 200-day moving average.  However, in the case of the Nasdaq Composite the picture is a bit unsettling with the 50-day moving average now rising more slowly than the 200-day moving average.  In other words, the 50-day and 200-day moving averages are now converging on each other, which puts them on the path towards a Death Cross.

In sum, the weight of the evidence continues to support the line of least resistance being upward still.  But as Jesse Livermore would say, the advance raiding party of the main bear army has just dashed by.  Those long the market should not expect much in the way of assistance from US equity mutual fund managers as they're mostly all-in at this point.  As such, it behooves anyone long the market to remain alert for a change in trend in the coming months.

(click image to launch)

My first visit was almost two years ago, and again it was invited by another firm that was then newly listed at NYSE and I was there for their 1st day of trading. The coincidence is in both events, the person next to me was someone from Kellogg, a famous and renowned market-maker firm with long history and close relationship and association with NYSE. Both of them are very senior managers of Kellogg and both were telling me very inspiring stories about what happened in the days right after 9/11 which was a Tuesday. 

Apparently the day after 9/11, many NYSE staff and people from associated firms such as specialists, camped at the board room (a large conference room with very high Tiffany ceiling which was used as the trading area in its early days of NYSE) and worked overnight non-stop for several days. Even the NYSE chefs didn’t go home and stayed there all those days in order to cook for people working there along the clock. And many of those people had close colleagues and friends just lost their life days ago. The unbelievable thing is they moved the whole AMEX floor over to the NYSE floor and NYSE and AMEX (a separate company at that time) were able to stick together at this special time. They managed to make themselves functioned smoothly and traded together in this already busy and clouded area without any preparation in such a difficult moment. In a normal process, this could take at least a year to accomplish, but they did it in less than 5 days, weekend included. Market re-opened next Monday on September 17, 2001. A miracle in NYSE’s long history of over 200 years, which was founded in 1792. What an accomplishment by NYSE!

You can see today's opening bell here.

The WSJ reports that other Ivy League money shops, who jumped on the "illiquid diversification" train late, will also report similar losses for the year. Brown has reported 27% losses. More plebeian institutions that stuck to more plebeian investment strategies like 60-40 stocks-bonds, only lost about half as much.

So now the poor Ivy guys must halt expansion projects, cut staff, etc. Yet, the endowment managers claim that their long-term results justify their strategy. Ok, maybe if they were running a hedge fund. But I could've sworn that endowments were supposed to maintain a fairly stable asset value and generate reliable and sufficient income to support the Universities' daily activities. Somehow, forced staff cuts, expense rationing, reduced recruitment, and an environment where "no expenditure is immune from scrutiny"  just doesn't make the strategy seem just....

But take heart, the managers seem to be learning their lessons, after sweeping up the ashes from the collectively created massive bonfire fueled by tens of billions of burning dollar bills. They now say they have learned to better "reflect the risk tolerance of the University". Well God bless them! After torching untold billions, and pocketing untold millions, they have finally learned the most basic concept of fiduciary duty. Here here!!

Just in case the endowment heads haven't had time to write down the takeway lessons here, I figure I'll give them a hand. That way, they won't have to take their eyes off their Bloombergs and waste time writing the email to staff themselves.

"What I Learned in 2008-9"
by (insert Ivy League Endowment Manager's name here)

1: Diversification is good, if the assets actually don't correlate to each other that is. This must include times of economic panic.

2: When the doodoo hits the fan (e.g., in times of economic panic), most everything correlates. I.e., it ALL goes down. Except for those Treasury things. And cash of course. I guess having an allocation of -5% cash (i.e. we leveraged up our already illiquid investments) wasn't the best idea. Who knew?

3: Illiquidity is not so good. At least if you need the money at some point, or maybe ever. In fact, in the aforementioned scatological environment, illiquid stuff somehow gets even MORE illiquid. Like, you can't even withdraw it any more!

4: Illiquid investments, at least a whole lot of them, may not be appropriate for endowments that must regularly pay people for things. It's tough to pay for stuff with a tree.

5: It is generally not a good idea to pile into various investments because everybody else is doing it. Yes, they may work for a while, but then all of a sudden they don't. It's really not a good idea to pile into private equity, an illiquid investment, at the same time that one the biggest practitioners sells itself to the public (see Blackstone IPO). It's even dumber to sign long-term contracts committing us to future huge investments in private equity, because we NOW KNOW that private equity investments don't always earn 25% a year. In fact, it seems they can even lose value! Man, if I ever get my hands on that Schwarzman character...

6: Giving a large percentage of our assets to outside mangers is great, because we can spend more time counting our bonuses and less time actually managing investments. Just try to make sure next time that they don't s*@k. That way we hopefully won't have our bonuses clawed back again.

7: IQ does not equal investing success. But it does get you a position at a big endowment with a fat fat paycheck. If we look good and act good, hopefully the assets keep coming in. Plus we'll give most of it to other managers anyway (but see #6). 

8: Does anyone know a good balanced mutual fund we can copy?

Let us review the 5 obvious key levels for gold from this monthly close chart above. As you can see, each resistance level becomes a support level once gold breaks out. This is why the monthly chart provides a better prediction on a long term basis and gives a more solid perspective about future gold movement than a daily or even a weekly chart, which tends to be more volatile and misleading on tops and bottoms.

Most people refer to the current gold bull market as a repeat of the 1970s. This is true since there are many similarities of price movement between the two. From the chart above, we can see five major levels since almost 40 years ago from the early 1970s, after the U.S. government abandoned the gold standard of fixing gold at $35/oz. Let us review them one by one.

Level #1: $100/oz. Once the cap of $35 was lifted in early 1972, the floodgate is open. We saw gold quickly explode to $200 in 3 years on the monthly chart (spot gold price was over $200 on a daily chart). During that time, gold did take 2 years to rise above the $200 mark until 1974. Then there was a severe correction, bringing gold back to $100, a 50% retreat, lasting for almost 2 years. The $100 mark, once broken, became a resistance in 1976 for gold. Gold has never fallen below $100 since.

Level #2: $250/oz. Similar to the correction from May 2006 to August 2007, gold took off again in a spectacular run, from $100 all the way to over $800 (daily spot price) in 3 years. At the peak of the then bull market, people were waiting in line for banks to open to buy gold, and those days may be very well ahead of us. However, there was a scary correction toward the end of 1978 when gold broke below the $200 level, resembling the recent correction in 2008 when gold failed to break $1,000 and headed down to $680 (more on that later). Even so, gold at slightly below the $200 level provided the support which once was resistance back in 1974. I decided not to include $200 but combine it with $250, a much more significant level.

For the next 20 years of bear market for gold, you can see how strong the support level of $250 is. In the severe corrections of 1982, 1985, 1992, especially 1999 and eventually 2001 when Mr. Gordon Brown (now prime minister of Great Britain) was dumping 2/3 of her majesty’s gold, no one was able to break this level even with 20 years of gold manipulation, dumping and futures shorting from the collaborative and joint efforts by Fed, western central banks and a few Wall Street bullion banks. It is believed that without this heavy manipulation by governments in late 1990s, and if we let gold run its natural cause from pure cycle standpoint, the bear market of gold should have bottomed in the mid-late 1990s. But even with all these tremendous efforts, they could only manage to knock gold down by merely $50/oz! What a waste of our taxpayer's money and her majesty’s gold. The only winners were those few Wall Street bullion banks which were shorting futures in order to depress gold price while enjoying the interest rate spread from what was borrowed from the government to what was earned from the market.

Level #3: $500/oz. In 2003 and 2004 when gold broke $400, I already sensed this gold bullish run was for real, unlike any of the previous bear market rallies, a change in major trend. But I was still not 100% certain. However, when gold broke the $500 level in 2005, again the floodgate was open. I felt very confident that gold would never return to the $500 level again for the life of gold (again on the monthly close chart). The 2006-2007 correction looked scary and long, lasting a year and half, like the 1975-1976 one. However, gold didn’t get even close to the $500 level (stopped around $550).

Level #4: $700/oz. in 2007, I declared if gold can stand comfortably above $700, then gold will never drop below this level forever on the monthly close basis. The credit crisis in 2008 was the worst among all corrections, including the 1929 market crash. In order to survive, institutions, especially hedge funds, were dumping everything including gold to get liquidity (cash), driving everything below liquidation level. Gold is no exception and it was steamrolled by the financial crisis like all other assets. On the daily chart, it broke $700 to reach $680. However, from the weekly chart, let alone monthly chart, gold didn’t break $700 which was a big relief. Gold, as the ultimate currency, survived the $700 test in even the most fearsome correction beyond anyone’s imagination.

During the last 2 years, you have heard many renowned gold experts who “guaranteed” that $800 would be the unbreakable support at this latest correction. But I have never treated $800 as a meaningful support level. The reason lies in 1980. Just look at the monthly chart above. Everyone is talking about $887.5 gold in 1980, but it was just a blip lasting for a few minutes. This price was not even showing up at the daily close chart, let alone monthly chart. In fact, gold had never stayed above $700 for a month, not even close. Worse, long term gold investors buying gold above $500 (Level #3) had not seen any profit from 1981 for almost 25 years, until gold finally broke $500 in 2005 for good. The same thing happened in 2006 - gold briefly broke $700 to reach $730 but didn’t stay there for long. It was not until 2007 when gold decisively broke the key $700 level that I could feel comfortable about it, and it has done well so far. If you are not a short term trader and ignore the daily volatility, it seems that the monthly chart will give you a better picture for the long term.

Level #5: $1,000/oz. A even round number of $1,000 is always an important level for any actively traded securities. Since early last year, gold has attacked this level 3 times, including the current 3rd time and succeeded breaking it. As it is often said, the 3rd time is the charm. Will gold stay above $1,000? Who knows. Technical analysis is always after the fact and it only tries to get insights from historical patterns and there is obviously no guarantee on anything. However, if this 40 year pattern holds and gold stays in the 4-digit territory for a month, the chance is very good that gold will never fall back to $1,000 level again on the monthly chart. This implication is huge, which means anyone who has bought gold before today below $1,000 will make a profit, a true safe haven.

The discussion above is from a technical perspective. Fundamentally, gold can’t be stronger now than ever. In 2007, I successfully predicted the collapse of the banking industry and $1 trillion in losses. Looking back, my prediction was too conservative, and probably should have said several trillion. The banking industry has already gone through the first phase of free fall, with the Fed dumping trillions of taxpayer's money implicitly and explicitly to provide some temporary shoring. However, the upcoming second dip will be much worse, with the commercial real estate market taking the same percentage hit as its twin sister, the residential market, which will suffer again from all the ARM interest rate increases for the next 2 years.

The number of bank failures will be like fireworks in the sky one after another in the next two years. Don’t forget the total number of institution failures during the S&L crisis approached 4 digits (1,000). The fundamentals for the S&L crisis are no different than today’s since both are deeply rooted in the crash of the real estate market, except back then there were no tons of “creative” and toxic financial products. In addition, most of the S&L institutions were smaller than a typical bank, on average, in assets and social implications, so today’s failure of each bank has about 10 times more impact than a typical S&L institution then. Imagine 500 bank failures, as Wilbur Ross predicted.

The worst is yet to come. The first phase of the banking crisis has only wiped out bank equities, but the second phase will wipe out many bondholders. However, eventually I expect customer deposits will be protected, with the FDIC drawing a huge credit line from the Treasury Department, otherwise the $10 billion on their current balance sheet would get wiped out overnight. In the first phase, government through its TARP program decided to take the hit by inserting itself between equity and debt to protect the bondholders of big banks. This is why we saw strange things such as Bear Stearns’ equity owners being wiped out while their bondholders made profits with their bonds being upgraded to the same level as JP Morgan bonds. Why did all big bank bonds suddenly become Treasuries guaranteed by the government? What happens to the basic corporate structure of capitalism that both equity and debt share the risk together?

TARP was ill-fated from the very beginning. When a few former banking “elites” and now government officials decided not to rescue Lehman since the firm was not politically connected, had no political muscle to implicate them and was the fiercest competitor of their former employer, they decided not to grant Lehman the much needed but small capital request. However, when AIG was in hundreds of billions of dollars in trouble, much of which was owned to their former employer and would have been wiped out along with their huge stock positions, they determine to save AIG at all cost by using taxpayer's money. The money then flowed from AIG via the infamous toxic credit default swaps to become bonuses of their already super rich bankers and traders, while many of the middle class and working class have never received a single bonus in their life. It is basically saving the rich by ripping off the poor, all in the name of free market and capitalism. This kind of behavior raises many ethical and moral issues of conflict of interest, credibility, justice and fairness of our whole social system and the people who are leading them.

When the second economic dip comes, dumping money like we did during the first one won’t work. We have already seen the sign of diminishing effect. The biggest impact is always when it was done the first time. The more money being dumped, the less effect it has on the system. Pretty soon we will only see the unexpected and unwanted negative consequences of this monetary inflation. This is really common sense and doesn’t need a PhD in economics like Bernanke to do a dissertation and to run millions of Monte-Carlo simulations to prove it.

Helicopter Ben, an “expert” on the Great Depression, thinks whenever he dumps more money, the system will react. The more he dumps, the bigger the reaction from the system. He forgets the human system doesn’t behave like the math model in his computer, especially when the credibility and fairness of the system is in deep trouble. The only good thing about reappointing Bernanke is it will eventually put the whole existence of Fed into question. It is a “fool me once and fool me twice” thing. The continued dumping of money will only scare people into anticipating unexpected negative consequences, including hyperinflation and the collapse of the US dollar. This day will come after the second economic dip of the depression, or even sooner.

It leads back to gold. In this sense, gold not only saves people during inflation, but also during depression. Gold is the only credible, trustful, fair, safe and honest asset left in the whole universe. It is the foundation on which all other assets are built upon. This is the only asset which can, once and for all, end the capital manipulation, distortion, rip-off, and cover-up by Wall Street during 20 year Greenspan era.

With gold now in four digit territory, it is the end of an era and is the beginning of a new era: the gold era.