Gold Update

Gold remains in a long term bull market. Chartwise,
I view the metal as extended by about $50.

Gold has been trending lower on my weekly chart since
the $730+ oz. blow-off top in May. One would have to
allow that the big thrust up since July, 2005 has not
yet been defeated. That would occur if gold fell below
$570. over the next several weeks.

The weekly gold macroeconomic indicator has been trending
down since mid-summer and is now just slightly above
the yearend 2005 level. Weakness primarily reflects the
drop in the oil price over this period coupled with a
further tightening of Federal Reserve bank credit.
Despite the slowing US economy, the basket of cyclically
sensitive materials prices I also include has held up
well. The macro indicator now suggests a price of $500 -
510. for gold, down slightly from the peak $520. seen
earlier in the year.

I guess gold is holding nearly $100 oz. above the base
$500 indicated by the model because gold players are
expecting that a softening economy will push the Fed to
begin accelerating liquidity growth reasonably soon. At
the worst, the Fed will probably add liquidity before
long if only to underwrite the forthcoming holiday season.
There is no shortage of gold bulls still looking for a
big pop in the metal from a geopolitical crisis involving
Iran's nuclear fuels program. But that scene is quiet
now.

October is often a weak month for gold on a seasonal basis
as it is for oil. The gold market could still respond
positively if the Fed picks October as the month to ease up
on liquidity suppression for a stretch. The primary dealers
through which the Fed works are also the main market makers
in currencies. A weakening dollar may well tip off the gold
traders when the Fed does loosen up.

I view the short term outlook for gold as a coin toss now.
If you have an interest in gold or are considering taking a
long position, compare your return projections against my
view that there is clear downside risk up to a $100 oz. if
the positives you perceive do not pan out in the weeks ahead.

Oil Market -- How Is Your Luck?

Oil price bulls are breathing easier this week. Crude
has held support around the $60 bl. level and has bounced
to the upside, buttressed by rumblings of concern by OPEC
and the newly fashionable idea that the US has finagled the
crude price down temporarily to support Republican re-election
chances in November. There is also talk that Iran's nuclear
plans will resurface soon as a hot item that may spark some
buying.

Interestingly, crude is just entering its weakest seasonal
period. Moreover, seen in a wider time frame, the outlook
for crude supply / demand is not favorable for the bulls
without incidents that might trigger panic buying, as inventories
remain very high. I would also have to say that I believe
there is better support in the low to mid $50's than at $60 bl.

But, oil is oversold and we cannot begrudge it more in the way
of a bounce. Over the next couple of weeks it could go to the
$67-68 area without violating the downtrend in place. As I
say, "How is your luck?".

Falling Knives -- Oil & Gas

Oil

The oil price has fallen sharply since the panicky
hedge buying ended in late June. the powerful and
dynamic uptrend in place since 2003 has been broken
decisively. Cover stocks are at or near multi year
highs and there is fresh supply coming onstream in
2007. However, capacity utilization at the wellhead
is still running high.

It is a new ball game, and players need to adjust
accordingly. There is substantial trend support now
in the low to mid $50s per bl. and if oil stays on
the weak side, that would be the next interesting area.
As often as not commodities make spike bottoms as
opposed to lengthy basing periods, so traders need to
be mindful that a sudden turn around to the plus side
could mark a low. Let the falling knife fall if you
want to come in long and think now whether you want a
base to look at or whether you are willing to play a
spike with a stop under it. Barring some major new
event, the fundamentals will be fuzzily negative
reflecting the cover stock overhang and the headwind
of a slow economy.

Nat. Gas

Gas has collapsed from the late 2005 high of $15. mcf.
It is down nearly 70% and has caught hedgies in its
volatile clutches. There is very long term trend support
and several year base support in a range of $4.00 - 5.00.
There is a seasonally strong month straight ahead. There
is still a storage overhang. Let the knife fall. Think
through whether a spike up is for you if there is no
flag waving base. Recognize a drop to $4.00 would not
surprise any seasoned trader. Recognize also that a
bounce up to $5.50 - 6.00 mcf. next month would still
have gas in a bear market.

Best of luck.

Monetary Policy

The Fed is widely expected to keep the Fed Funds rate
steady at 5.25% at tomorrow's FOMC meeting. Based on
traditional rate setting data, a conservative could
still make a case for a higher Fed Funds rate. Data
available through early September show industrial
activity and business loan demand at strong levels.
Moreover, unit labor costs have accelerated sharply
to 5% yr/yr. So, if the FOMC elects to stay in the
"pause" mode, they will be continuing to work off
their economic forecast.

Reflecting the sizable weakness in broad commodities
composites, my longer term inflation indicator -- a
twelve month % ROC measure -- is about to fall below
year earlier levels for the first time since 2001.
From this perspective, the Fed is on sounder footing.

Fed Bank Credit and the monetary base have been flat
since May '06, as the Fed has wrung out Greenspan's
last hurrah, when he let Fed Credit expand at a
rapid 5% rate over a short interval in late '05 -
early '06. However, with the economy having slowed,
BB must be careful to cushion it with a reasonable
expansion of the Fed's portfolio to meet the holiday
season.

Stock Market Diagnostic

With the moderation of inflation pressure underway, my
S&P 500 Market Tracker is accelerating to the upside.
By October, the Tracker could cross the 1400 mark on
the "500." The main reason is that the Tracker is
quickly translating more modest inflation into a higher
p/e ratio (the twelve month earnings estimate is running
a little below consensus). So the Tracker says the market
is adjusting to prospects for less inflation pressure
more slowly during this often nervous seasonal period.

The "500" is running modestly ahead of my monetary base
model. I interpret this to mean that investors are betting
on a benign monetary policy going forward. The monetary
base has been on the flat side since May, '06. Soon, the
base will be due for a seasonal expansion to accomodate the
holiday season, and the market appears to be anticipating
same.

My dividend discount model has been in a strong uptrend
for several years reflecting the excellent 10% growth of
the S&P 500's dividend. The model's value trails that of
the "500", because over the long run, it seems too risky
to posit a continuation of 10% dividend growth. However,
the market is not at enough of a permium to this model to
warrant much concern now.

The premium of the S&P 500's earnings / price yield has
narrowed further relative to the "risk free rate" (91-day
T-bill yield %), but not enough to trigger a warning.

Summary

Investors are counting on a continuation of good progress
for earnings and dividends through 2006, and are betting the
Fed will not take action which could damage the market.
Investors are also more cautious about the degree of
deceleration of inflation in the short run, which is
holding back the market.

Long term, investors are exhibiting no caution about the
prospects for earnings and dividend growth, but such
lack of caution is not yet overdone.

Economic Comment

As expected, the US economy continues to show signs it
will slow further. Measured yr/yr, the $ value of
production continues to rise faster than does consumer
spending. Inventory accumulation although still moderate
is accelerating. This all suggests further moderation of
production, a headwind for materials prices and a
deceleration of profits growth. The latter should be more
pronounced in Q4 '06, as last year's Q3 results were
hurt by Katrina and Rita.

The production side of the economy has been growing faster
than has the broad measure of liquidity (my M-3 proxy). This
liquidity deficit has constrained the stock market. Over
the next several months, the real economy may well require
less liquidity, leaving a positive residual for the stock
market. This does not assure a stronger market, but it would
certainly not hurt.

The yr/yr% measure of the CPI has dropped through its twelve
month moving average, confirming a moderation of inflation.
Moreover, the sharp decline of fuels and some key materials
prices so far this month reinforces the idea.

Stock Market -- The Seasonal Nasty Is Here

Investorus Nervousa is at hand. The symptoms can last into
early October. This is one of the more delicate times of the
year, so we'll see how the current rally holds up against
the usual case of the September Willies.

9/11 -- Remembrance After All

It is the pensiveness and forbearance of people in the
greater New York area that you most notice on 9/11 days.
We go about our business, but we know there are thousands
of people in our midst who are brimming with grief. We
do not know who as we mix with all the strangers around us.
We give everyone a wide berth. There is silence on this day
even with everyone at work, the kids in school, all the
stores open. And even if we are free of immediate loss, we
think back to that shimmering late summer morning five
years past. We have moved on, but the shock has not worn off;
each anniversary brings it back along with the sadness and
for most, the deep anger.

Going forward, it is that anger that most concerns me. It is
very powerful in us, but subtle. Perhaps it was exploited by
GWB to move the country to attack Iraq. I do not know. Ask him.
What I do know, as I read about how foreigners have lost their
regard for us and how we are seen as the primary danger in the
world, is that they too sense the anger. But, they underestimate
it, for they have seen only the wrath of an insouciant, spoiled
dilletante who inhabits our White House. They have not seen the
America I know lash out in earnest.

So on this day of quiet remembrance, it my hope that time will
pass peacefully enough to allow the fury within to dissipate and
that our enemies will not underestimate us......

Oil Comment

The oil market is trading well down from the $70-72bl
needed to sustain the powerful uptrend underway since 2003.
As discussed prior, this is a weak seasonal period for oil,
but the dip is a reminder of the speculative arc of pricing
over this period, as players anticipated hurricanes and
varied geopolitical difficulties seen as bullish for oil.
We may get the storms, both in the Gulf and with Hurricane
Khameini, but take this little dip as a reminder that with
oil cover stocks at multi year highs, processors will
crush the market if they cut back further on disaster hedge
buying.

The weekly chart has turned bearish, taking out support running
back into 2005. Click.

The monthly chart I have attached needs some compression to show
perfectly how oil has just come off a parabolic up extending back
to the late 1990s when it was a mere $10 bl. This chart also suggests
that oil needs a natural or geopolitical disaster to return to
that powerful uptrend. Click.

Stock Market -- Seasonal & Technicals

Seasonal

Historically, the period that runs roughly from post-Labor
Day through the end of October is one of stock market
vulnerability. Knowledgeable market players know this all
too well. It is an edgy time when strategists can even
pressure themselves to look for negatives or to overemphasize
minor ones. In this way, they look good if the seasonals
hold to form. In a like manner, many investors and traders
tend to adopt a more critical or stand-offish attitude. To
boot, there are players out there who think the well respected
four year cycle low, "due" in 2006, has not played out yet.
Occasionally, the seasonal lore has weighed heavily enough
to create a self-fullfilling prophecy.

Technicals

The technical view as I see it is not at all so bleak and is
out of synch with the seasonal view. I have to affirm that
the market is mildly overbought short term on price level,
and moderately overbought based on my A/D oscillator. But,
these readings are not at all ominous. As I read the tea leaves,
the market is in an uptrend that can last into 12/06
reflecting a positive turnaround underway in key internal supply/
demand factors coupled with an uptick in my longer term
momentum measure. I see the SP500 eclipsing the 1326 interim
peak established in May and eventually moving up to challenge
trend resistance of 1350 - 1375 later in the year. I also
suspect that as the rally matures, there will be a strong
albeit temporary rotation back into the small and mid cap
groups.

This piece can serve as a technical companion to last week's
"Out Of Synch" post (8/30).

Out Of Synch?

My view for some time has been that we would have a period
of slower economic growth and lower inflation over the 2nd
half of 2006. Inflation potential has diminished significantly
although you cannot take it for granted, since the acceleration
of inflation in this cycle has been driven by commodities prices,
which are inherently more volatile than the broader economy. I
foresaw slow economic growth but no recession in the cards.
In the US, recessions begin after the economy has hit effective
capacity, overheats and undergoes a liquidity squeeze engineered
by the Fed and carried out by the banks and credit markets. No
such conditions hold sway today. There is still idle capacity,
inflation is set to cool and the banks have money to lend.

As expected, the leading economic indicators have weakened, not
enough to signal a downturn, but enough to raise eyebrows. My
view has been that lower inflation would boost real incomes,
confidence and spending before the ax fell. The inflation
primarily reflects hoarding and not overheat. I am
staying with this view and will sweat it out for a while.

To compound my felony, I have posited that 2007 would see a
stronger economy, re-ignition of inflation, and an end to the
"pause" period by the Fed. Next year is a between elections year
and may be an ok time for the Fed to go after inflation further.

Unlike most observers, I expect the stock market to progress in
a reasonably steady manner through the end of this year into the
beginning of 2007 before a top of consequence ensues and the
broad market falls by 15-20% as the environment turns hostile.

The more standard view of the market's prospects is for a rather
weak September and early October followed by a rally of substance
that could carry well into 2007, if not beyond.

One lovely thing about this business is that you get to see whether
you were right or not and to what extent.

I wrote this little screed because it was on my mind and I knew
it would bug me every time I sat down to write something. I am
going to let go for now and re-visit the projection around the
end of the year.

Geopolitical Tension Eases

The Iranian response to the UN Security Council package
re Iran's nuclear enrichment program was accompanied by
wide ranging war games in Iran and not further provocation.
A round of diplomacy may lie ahead as neither side has
definitively closed the door to further discussions.
The tenor of discussions on both sides suggests each is
laying the groundwork to blame the other if it winds up
that Iran moves on with its enrichment activities and faces
sanctions of some consequence as a result. However, no
resolution of the issue is likely right away.

The UN must accelerate efforts to bring a large multinational
force on board in Lebanon to defuse further the tension between
Israel and Hezbollah. So far, both sides are acting with
reasonable forbearance.

My intent is to get back to trading.

Oil Price ($72.65 bl)

The foiled terror plot to blow up in-flight commercial
aircraft scheduled for intercontinental transit from
London to the US created concern demand for J-9 fuel
would fall sharply and turned a normally seasonally
strong month into a weak one for oil -- at least month
to date.

The crude price has bounced this week from an oversold
and must hold $70 - 72 over the next month to maintain
the fierce uptrend underway since the spring of 2003.
Crude has also dropped inside the upper channel line
for its advance running back to 1999. Crude has had
trouble holding above that latter line for long since
the year 2000. Importantly, the issue of whether crude
can maintain the super strong three year trend or will
slide back into a much broader trading range could
well be decided over the next two months.

From a long term perspective, the seasonal outlook for
crude strongly suggests weakness from now through the end
of October. However, that could obviously change if the
US hurricane season spawns a bad one that damages
production or if Iran and the UN Security Council tangle
badly in the weeks ahead. The point here is that some
special event or series of same will likely be needed to
keep crude strong through October.

Envisioning Goldilocks

The stock market as well as bonds are buying into The
Fed's view of a slowing of economic growth coupled with
less inflation pressure. I focus on stock market factors in
this comment, as I am still not interested in bonds, which
I see as overvalued.

My SP500 Market Tracker shows the following readings for the
SP500 (now 1295):

4/06....................1307
5/06....................1270
6/06....................1265
7/06....................1293
8/06..(estimated).......1325

The Tracker did catch the spring dip and the subsequent recovery
in the market. The model has steadily rising profits over this
period with the volatility entirely explained by changes to the
yr/yr CPI%. With the sharp drop of the CRB Commodities Index over
the past 5 days, August is at least off to a good start for a
favorable inflation reading.

By my analysis, the fitful rally underway since mid-June primarily
reflects short covering and the expenditure of portfolio cash
reserves. My broad M-3 equivalent money measure is up 9.0% yr/yr
through July, while the yr/yr change in the $ value of production
is up 9.2% over the same interval. Although this has been a good
environment for profits and dividend growth, the real economy has
drained liquidity from the financial markets. The bottom line
is that the stock market likely needs both slower growth and
inflation to sustain an uptrend.

Moreover, if the M-3 equivalent measure begins to lose steam, The
Fed will have to move in quickly to provide monetary liquidity to
avoid a squeeze. An easy way to turn a soft landing into a harder
one is for the Fed to be late with this step.

Inflation in the new century has been driven by commodities prices,
especially fuels. Because commodities are so volatile, stock
players need to remember that changes in the levels of commodities
composites can quickly add to or diminish stock values. Oil has
dropped about 10% in price over the past month. It is oversold in
a seasonally strong period at present, so stock players have to
watch it closely. Note, positively, that since the production side
of the economy has been growing faster than consumption in past
months, inflation does face a headwind until production and
consumption come into better balance.

The earnings / price yield for the SP500 is now 6.3% This compares
to a 5.1% yield on the 91-day T-bill (risk free rate). The spread
is positive -- normally good for equities -- but rather thin. So,
again we see the importance of maintaining reasonable growth coupled
with more progreess in reducing inflation.

The yield curve is flat. This does not bother me as long as the banks
are lending, and lending they are at a good clip. Note though that in
an economy where production growth slows, credit demands moderate
and banks get edgier about lending. This brings us back to the point
made earlier: The Fed has to be ready to move on a slowing of credit
demand and liquidity growth.

The moral of the story is that engineering a soft landing which segues
into a "goldilocks" period is no mean feat. Recognize the elevated
risk potential.

Brief Stock Market Note

Strong rally today. My basic trend index, which measures
demand vs supply in the market, has not yet turned positive
so I am on the sidelines. Geopolitical risk remains high,
although a significant short term component of that risk
will settle out if the cease fire holds in Lebanon.

Hezbollah did its jack in the box routine to unsettle Israel
and do some strategic damage as well. It has been a bust to
date. They failed to lure Israel in to a guerilla style
battle in So. Lebanon, hit Haifa but no other strategic
targets, and now face a 30K man armed force which will
take up residence south of the Litani. Iran has pumped
about $5 billion into this operation over the years and
when it really needed Hezbollah to distract Israel from
Iran's nuclear program, Nasrallah and the boyz flopped.
Iran may hold Nasrallah's tootsies to the fire in the days
and weeks ahead, as it plays out its own nuclear program
cards. So, Nasrallah may get another shot short term, which
means this situation could remain live.

Changing Tactics

The stock market did provide a profitable rally to trade
over the 7/18 - 8/3 period, for which I am thankful. But
my view is now more cautious for the short run. My basic
trend index -- which measures buying pressure net of
selling pressure and is not a price index -- has remained
in a waterfall decline since making its high on 5/9 of
this year. the main reason has been the strong down volume
behind the declining issues over so many days since 5/9. It
suggests a relatively steadily deepening oversold for the
broad market reflecting pressure on small and midcap issues
and positive rotation into the more narrow SP500. I have
no problem with a rotation toward big caps, but I do have a
problem when the key broad barometer I use does not confirm
a positive turn in the market. At this point, I think risk
a bottom and stay out of the market until my basic index
shows some authority to the upside. For reference, the
1700+ issue Value Line Arithmetic ($VLE), a non cap weighted
index, is a price index I like.

I am also happiest trading when things going on out there in
the world are not nagging at me. I am concerned about Iran's
adventurism in Lebanon and how It will express its decision on
the incentives vs sanctions deal re its nuclear fuels program
set for Aug. 22. My concern here is that Iran, now on quite
a geopolitical roll, will overplay its hand with consequences
not good. This is a personal decision and not one I would offer
as advice to others. I have no insider insights to share on
this, just a deep concern.

If in the interim the market gets itself into high gear one way
or the other, I may trust its wisdom and play. But for now I
am in cash and on the sidelines until the geopolitical faultlines
clarify some. I will of course keep up the blog.

FOMC Meeting

The several cyclical indicators that correlate best with
changes to the Fed Funds Rate all remain strong, although
growth momentum has either rolled over or is peaking. By
my reading, the FOMC should elect to raise the FFR% yet
again.

Should the Fed elect to pause the FFR% at the present level
or perhaps signal a pause is in effect after one final boost
today, they would be operating more on an economic forecast
than on data in the can. Such a move would not be without
precedent, although the Fed usually prefers not to use a
forecast as its decision tool. The forecast that might drive
such a decision would be that the slowing of housing and
consumer spending is sufficient to lead to a slowing of
manufacturing and production growth coupled with an interim
peaking of capacitiy utlization and an eventual sharp
reduction in the growth of business short term credit demand.
These are realistic expectations, but one may have to allow the
FOMC leeway to seek a little more in the way of confirmation.

Gold Comment ($660oz.)

Gold has entered its strong seasonal period to reflect
higher commercial demand for the forthcoming holiday
and South Asia wedding seasons.

My macroeconomic gold price indicator, which went flat
for several weeks right after gold came off its May, '06
parabolic top, is again trending up, albeit modestly.
This model suggests a fair value for gold of $515 - 520oz.
With the global economy to slow further, the best bet
to keep the indicator trending up in the short run is
if oil, also in a seasonally strong period, continues to
advance.

In a 7/6/06 note on gold, I mentioned that gold would be very
overbought if it rose from its then current price of $633 up
to the $665 - 670 area. It did, and the profit takers came
in with a vengeance when the overbought was achieved.

With gold now in the $660 range on a rising 200 day M/A, the
upside limit goes to $685 - 690. First of course, gold would
have to push through last resistance up around $670.

Now that gold is off that parabolic run, traders are resorting
to more normal technical disciplines. This factor plus the
current elevated price of gold relative to fundamentals suggests
continued price volatility likely lies ahead.

Stock Market

I started out the year thinking the SP500 would wind up
2006 up about 12% to 1400, and that progress to that mark
would be relatively smooth. I have been around far too long
to take projections of this sort too seriously, preferring
instead to re-visit them for diagnostic purposes.

Right now, the market is running about 4.5% behind the
projection on a straight line basis. Given moderate volatility
standards, that is no big deal. However, the diagnosis is
of interest. The economy and corporate earnings have proceeded
about as expected. Inflation has been stronger than anticipated,
with the prices of oil and gasoline the main culprits. This
latter development has resulted in some additional shrinkage
of the p/e multiple.

Now, the economy is slowing reflecting further weakness in housing
and sluggish consumer spending. No surprises there. With the
consumer and housing slow, the production and business service sectors
can be expected to follow suit. Yr/yr % earnings comparisons will
dwindle some in the second half of the year, but the chances for a
strong market would still be pretty good if inflation pressures
were to diminish. That would allow the Fed to pause rates and
would bolster the case for a significant bump up in p/e.

The strong trend of commodities prices during the current economic
recovery has added substantially to corporate earnings, particularly
in the areas of oil and gas and industrial materials. But this same
trend has also driven the inflation rate up, resulting in
retardation of the p/e multiple. As it now stands, the strong
price trend for the commodities market overall remains in place.
Now a downshift of inflation normally follows an economic
slowdown, and there are still five months to go in 2006. At the
same time, I would have to say that the tenacity of the push in
fuels and materials prices has been something to behold, especially
since bull moves in commodities can be easily tripped up by the
development of speculative inventory imbalances.

Looking toward 2007, I am still of the mind that a decline approaching
bear market proportions is in the cards. I am guessing that the Fed
will pause short rates before this critical November off-year
election, but that It will resume raising rates at some point
next year as the economy again strengthens and inflation pressure
resurfaces.

Economic Comment

The flash GDP report showed the economy grew at only a
2.5%AR for Q2, confirming expectations for a slowdown.
Viewed yr/yr, the broad economy grew by about 6.5 - 7.0%.
This compares to yr/yr growth of dollar production of
9.0% and suggests there is inventory in the system
which could be worked off in the current quarter via
reduced production growth schedules. In turn, that may
take some pressure off industrial commodity prices, but,
it will also result in potential earnings shortfalls among
the industrial and commercial service sectors.

The stock market also took heart this week from a weaker
oil price, which reflects growing appreciation of how very
high cover stocks are.

But note that the US is just moving into a seasonally strong
period for commodities and energies, so even though a slowing
industrial sector can weigh on the commodities markets, it
in no wise follows that significant inflation moderation is a
done deal. Click here to see recent April - July lulls in commodities
price action.

"On The Way.....Wait"

Grizzled army vets will recognize the expression above as the
communication by an artillery or rocket battery that a round has
been fired. Hezbollah / Syria / Iran are calling the shots in the
beleagured country of Lebanon at present. They likely have plans that
may scuttle the current round of negotiations regarding a ceasefire
between Israel and Hezbollah and open the way to further expose Israel's
vulnerability to attack from the north. I suspect Hezbollah may have
missiles that can be fired from well north of the Litani river and
which can strike hard well into the Israeli heartland. Such a development
would greatly increase tension and danger not only in Israel and
Lebanon, but beyond.

Iran bankrolls Hezbollah and is simply calling in markers -- "Time to
earn your keep." Syria is on Iran's pad, too and is in it for the revenge.
I believe Iran wants to show the West and others on the UN Security
Council just how much clout it can wield in the Mid-East. By putting
Israel in greater danger, its message is that it can cause profound
upset in this troubled region, and that the US and others must think
long and hard about the imposition of sanctions on Iran should it elect
to proceed with its uranium enrichment programs. In short, is it worth
a broad Mid-East war to sanction Iran?

Iran promised to respond to the UN sponsored package of incentives vs.
sanctions re its nuclear programs by August 22. That gives it a little
over three weeks to have Hezbollah further increase tension and peril
within the region. As Iran sees it, this will greatly increase their
bargaining power when it comes time to talk turkey on its nuclear
development.

I lay this all out to highlight the potential for sharply increased
volatility in the capital and energy markets in the weeks ahead. All
players need to be extra diligent about positions and interests as
events unfold.

Iran accuses the US and Israel of seeking to remake the Middle East
in a way that suits them. What we are seeing is blowback from Iran
and Syria as well as Iran's declaration that it is now to be seen as a
very big player in the region. If I am right that Iran has a nasty card
or two to play prior to August 22, market players must be prepared
for another round of escalation should Israel and the US decide on a
strong reaction.

I hope I am wrong about all of this, but it just seems like straightforward geopolitical hardball to me. It need not end badly. Iran, with its additional
leverage could secure a deal acceptable to all in exchange for curbing
Hezbollah and working to cool strife in Iraq. But, since no one player
controls all the pieces on the board, matters can slip out of hand once
Iran puts its next strategic piece into play.

Stock Market -- Technical

As discussed in the July 18 post, the broad market is oversold
and due for a rally even though the basic trend is weak. Analysis
is complicated by the fact of rotation. Risk aversion has grown
since the May 09 - 10 market top. Players have moved out of small
and mid-cap stocks more aggressively than they have with the large
caps, as represented by the SP500. Through Friday 7/21, The SP
Midcap was 12.8% off the May '06 high and the SP Smallcap was down
13.9%. This compares to a 6.4% decline for the SP500.

Going into today, the SP500 is up modestly from its 6/13 low and only
mildly oversold in the short run. The weekly chart shows a deeper
oversold on a 6 - 12 week basis. The broader market is deeply oversold
across both the short and intermediate terms, with the NYSE TRIN at
a high 1.22 for the 60+ trading day span since the May top. This reflects
the compressed strong selling pressure in the small / midcap universe,
especially among the cyclicals, including business technology.

Going forward, the case for a rally reflects the strong oversold condition
of the broad market plus entry into a brief seasonally strong period which
could run out through US Labor Day (9/04). The SP500 could provide
continuing leadership, as the mood of increased risk aversion may not
reverse so quickly.

My primary indicators show a down market. Thus even if a tradable rally
is developing, it is simply unclear whether it would be durable enough
to reverse the downtrend. The work I do with NYSE breadth measures shows
that selling pressure has been trending up since early in the third
quarter of 2005, while buying pressure has naturally been trending down.
Since these volatile trends could extend for another 8 - 10 weeks before
resolving, I intend to be reserved about making market direction calls
beyond the very short term.

Stock Market -- Technical (SP500: 1227)

Back in April, I mentioned that the stock market looked best
suited to go sharply lower. In May, I put a guesstimate of
1200 as a low point for the SP 500.

I am not a sharp enough technician to know whether the market
will drop down to 1200 or not. My work indicates that the
market is weak and is growing progressively oversold. My
quandary is that my primary indicators are pointing lower,
but some key measures of oversold conditions indicate we are
very close to a tradable low.

So, as a guess, I'll go along with the idea of a low in the next
four to six trading days followed by a healthy rally.

At any rate, I am looking to go long, but since timing is not
my forte, I will wait for an upturn and some confirmation that
long is the right side of the trade.

Window Into Vulnerability

Like many others, I have been keeping up with the geopolitcal
developments of the past few weeks. There were no real surprises
until yesterday when a souped-up Katyusha rocket fired by Hezbollah
struck well into the port city of Haifa. That Hezbollah and perhaps
Hamas might now have even mildly upgraded weapons systems puts a
dangerous new spin on the Israeli - Arab conflict.

Israel will obviously want to re-establish buffer zones in southern
Lebanon as well as Gaza. Moreover It must make a fresh assessment
of its vulnerability to rocket fire, and It will want to probe
Hezbollah and Hamas positions to discern whether It may be
subject to other upgraded weapons. At a minimum, Israel will
want to establish large enough buffer zones to better protect
population concentrations. The hits on Haifa put the President of
Iran's recent comments about the destruction of Israel and Zion
into a more concrete context.

Of course, Israel always knew this day would come, when its
vulnerability to larger scale destruction would become more apparent.
To me, it adds a major new element of uncertainty to the usually
precarious mid-east military calculus.

Perhaps near term Israel can chase Hezbollah and Hamas far enough
away from its borders to secure its position and bring the
several hundred thousand Israelis up from shelters. Longer term,
Israel will have to look at how it might disable these two
hostile factions because allowing them too much proximity to its
borders could prove extremely dangerous if we are at the beginning
of an era when terror can bring heavier destructive payloads.

The easy thing for a veteran investment professional and trader like me
is to sound worldy about the current crisis and advise that we have
seen it all before and to be ready to jump on opportunities that may
come up as geopolitical tensions further rattle nerves in the markets.
But, critical differences arise from time to time, and we may have one
now with Israel in a tighter squeeze than usual.

I'll be lokking at the markets over the weekend, but I plan to study
the Israel vs. terror groups conflict with even more emphasis.

Banking System

The investment portfolio of the banking has remained on the
flat side over the past year, with banks concentrating on
expanding loans and leases. The big movers have been C&I
(business) loans and the real estate book, with both advancing
13.5% yr/yr.

With indices of mortgage origination and refinance down
substantially over the past year, it is evident that banks are
growing market share in the financing of real estate. C&I
loans have reached a level relative to the banks' investment
portfolio, where it may be expected that banks may begin to
size up loan opportunities more cautiously as system liquidity
has run down rapidly since mid-2004. Liquidity depletion is
not worrisome and has proceeded in a normal cyclical fashion,
but it is time for a "heads up" nonetheless.

Banks have funded the sharply expanded credit opportunities with the
sale of jumbo deposits -- up over 20% yr/yr -- and commercial paper,
which has increased by more than 15%.

The Fed has eased up on the brake for primary monetary liquidity,
having moved from substantive tightness through most of 2005 to
a more neutral stance. So far, I would rate this a sound move,
as demand for short term business credit can run down quickly
once an economic slowdown takes hold. Failure to anticipate
such a development can result in a painful liquidity squeeze.

Gold Note ($633oz)

Both gold and oil are moving into strong seasonal pricing
periods that run from July into October. Commercial demand
for both strengthens into the autumn.

My gold macro indicator, which jumped higher last autumn,
has progressed slowly in 2006 and has been flat since the
mid-May blowoff top for gold. Since an economic slowdown
is developing and since the Fed has moved liquidity up
only modestly this year, the best bet for gold would be
a strong showing from oil and natural gas prices as we
progress into Fall.

I noticed in browsing various sites that bullish sentiment
for gold has jumped at an astronomic pace since the recent
quick bottom and upturn in price. The gold gurus have been
piling on to the bandwagon.

My micro economic work on the gold market puts fair value
at $450-460 an oz. The macro work puts fair value at $500 -
525oz. On a short term technical basis I have gold as strongly
overbought at $665-670oz.

Interest Rate Profile / Bond Market

By my nearly 100 year regression model of short rates vs.
the consumer price index (CPI), Fed Funds should be 5.75%
rather than the current 5.25%. The Fed is pricing off key
GDP account deflators which yr/yr have moved up to 3.0%
and suggest an FFR% of 5.25%. Since I believe the CPI,
despite its many flaws, is a more realistic inflation
estimate, I conclude short rates are still on the low side,
and provide a negligible incentive to save.

Based on data at hand, short rates should still be trending
higher. However, and as mentioned in the 6/29 note, such
may not be the case by the mid-August FOMC meeting, as the
economy is slowing. In fact, my bevy of cycle pressure gauges
are nearing breakdowns, signaling milder growth ahead.

The national yr/yr CPI through May is 4.1%, about the same as
for the New York metro area. With 4% inflation, there is little
incentive for me to buy bonds, and I have stayed away from this
market for over a year. With 4% inflation, I would like to see
a US Treasury at 7% instead of the current 5.27%.

The yield curve is essentially flat in the Treasury market. A
flat yield curve normally suggests a significant slowing of economic
growth is at hand. This is because a flat to inverted yield curve
signals a liquidity squeeze is developing and that credit
availability is coming into question. Such is not the case now.
The US economy is slowing, but credit remains ample. Thus the
flat yield curve represents not so much a dark view of economic
prospects as it does the opinion of the market that a moderate
economic slowdown will reduce inflation pressure and ultimately
allow the Fed to ease again. This is born out by the continuing
tight yield spread between top quality corporates and "A" rated
intermediate bonds. The forecast implicit in current bond yields
goes beyond what I would care to sign on to at present.

The long Treasury has been rangebound between about 4.25% and 5.50%
since 2003. The market has been very sensitive to the momentum of
production growth and the trend of industrial commodity prices over
this period. Accelerating production growth and rising industrial
prices have lead to rising yields, and decelerating production
growth and quiet or declining industrial prices have provided
the bond market rallies. We may be moving into a period of
lower production growth and quieter industrial pricing that could
last for several months. So, there could be a rally in bonds. I
doubt it will carry far if the Fed keeps short rates on a plateau
which I suspect is the course it will follow. A more powerful
bond price move could occur if the economic momentum decreases too
sharply, but my indicators do not suggest that drastic a slowdown
at this point.

Oil Market & Sector

The peak driving season is well underway in the US, and
afterward, in the autumn will come the heating oil season.
In keeping, oil has entered a period of seasonal strength
which can run late into autumn. The oil price bulls are
out in force and the stocks are drawing more enthusiastic
support from analysts and pundits. There's the hurricane
season to worry over and, just to make it interesting,
the heavies on the Security Council have asked Iran to
respond to their proffered basket of goodies vs. sanctions
proposal re Iran's nuclear fuels program by July 5.

The hurricane season is a case of que sera sera. Iran
reacted positively to the goodies, but has been stalling
on responding, so the first pressure point there in a while
comes up this next Wed. the 5th.

This seasonal period for oil may be interesting not only for
issues that may affect supply, but demand as well, as an
uptrending price may, at some point, trigger much more
vigorous conservation efforts which could well come on top of
slower global economic growth. Demand for oil has been
taken as relatively inelastic. Nothing could be further from
the truth. Folks everywhere now know that the real price of
oil has jumped and shows no sign of receding. So, if you are
long the oils and the service companies keep the demand side
of the equation in firm view.

Investment managers tend to sell decelerating earnings
growth. Since oil stock earnings are very leveraged to
price, oil not only needs to rise in price this season, it needs
to rise a lot, say to $80 - 85 a bl. by late 2006 to keep the
yr/yr earnings momentum of the oil stocks at a high enough
level to maintain solid outperformance relative to the broad
stock market. That's another good strategic reason for you to
watch how demand responds to price.

To stay in the powerful uptrend underway since mid-2003, the oil
price needs to stay above $68 a bl. in the month ahead.

Now, a couple of charts. The first is a daily for WTI crude. Sure
enough, the bulls have kicked off the season. Note the nice upturn
of MACD, but note as well that the price is approaching a short
term overbought and important resistance. Click now.
The second chart is a weekly of WTI. The top panel shows the
52 week price momentum.

Monetary Policy

The FOMC is widely expected to raise the FFR% another 25
basis points to 5.25% tomorrow, 6/29. The cyclical case
for higher short term rates is still in place based on data
at hand. However, with the leading economic indicators
now signaling more modest growth ahead, a further increase
or hikes to the FFR% cannot be taken for granted beyond
this end-of-June meeting. The Fed will have a battery
of flash reports for economic activity in June to look
over at the meeting, and this fresh data can be expected
to color comments released with the rate decision.

On the liquidity front, the FOMC has tamed the Greenspan
volatilty in the Fed.'s portfolio and in the monetary base,
with both now trending in line with a shift of restrictive to
neutral. This is a favorable development from a tactical
point of view.

US Economy

Following the devastation of hurricanes Katrina and Rita
in the twilight of 2005, most economists posited a sharp
rebound over the first half of 2006, as business returned to
normal and large storm damage insurance and Federal Gov. funds
went to work. And, that's exactly what we got, with the
yr/yr dollar value of production rising to a strong 8.6%. The
Federal Reserve did not "mop up" any excess liquidity, but
the real economy did. With production growth rising faster than
capacity over most of this period, inflation accelerated, driven
by already high global operating rates for oil and industrial materials.

Unwisely, I suspect, analysts raised earnings estimates for both
2006 and '07, based on the strong showing of the economy over
most of the first half of this year.

The shorter term economic indicator sets I follow point to slower
economic growth over most of the rest of this year. Moreover,
my longer lead time indicators also point to moderation of
growth ahead.

I watch the trend of capacity utilization very carefully, because
that is a critical variable for the Fed in setting monetary policy.
In the wake of the 2001 recession, capacity utilization dropped
to nearly 74% by early 2003. Those very low readings were the
worst since the brutal washout of 1981-82, and reflected a steep
decline for US manufacturing. Since Q2 '03, the US operating rate
has recovered to nearly 82%, and if the recovery trend continued
as is, the economy would hit effective capacity and strong overheat
conditions by the end of 2007. The main or underlying reason has
been the slow growth of capacity in the wake of such a steep
recession for manufacturing.

A six to nine month slowdown for the economy would take some of the
heat off inflation potential. Moreover, capacity growth may accelerate
in the interim since producers may not want to risk the chance of
losing market share a year or two out because they have no new
capacity to meet a higher level of orders.

I think the scheme outlined above is pretty much what the Fed is
aiming for. To stay out of the political fray, the Fed may want to
pause raising the FFR% ahead of Nov. '06 elections. That would
give them 2007 to tighten further if need be, so that when the
2008 presidential election rolls around, they may again be able
to stay out of the political limelight.

My shorter term inflation indicators have softened in June, and
the longer term reading continues to show a moderate downtrend.
But these are volatile series, with a wide band of commodities
prices playing a major role. In this regard, it is easy to see
why the Fed has insistently jawboned the commodities markets in
recent weeks. Breaks in oil and other key materials would make
the Fed's job easier.

Just A Thought....

Well, the gold munchkins will not be calling Mr. Bernanke
"helicopter Ben", at least for a couple of weeks. And, Maria
Bartiromo, CNBC's sensuous, langorous reportress, may even
be having second thoughts about getting Ben all riled up
with her scoop about his feeling misunderstood concerning
the implications of monetary policy. The aftermath, of
course, has been the "Maria bears all" episode for the
markets.

Wait, there was a thought here. I got it. I suspect the main
target for all the tough Fed talk about inflation is the price
of crude oil. It is a primary capital input for many businesses
and when it inflates, the effects are infectious. The boys at
the NYMEX were planning a glorious run for crude this summer,
what with the hurricane season and Iran tripped out on its
show of power. Good for the NYMEX guys and the oil producers,
not so good for most of the rest of us. And so the Fed, knowing
the market is currently awash in crude, may have taken aim at
this market, hoping to scare folks away and induce a sell-off.
That would also help a little to unsettle Pres. Ahmgonnabebad of
Iran. Just a thought....

Gold -- $608 oz.

Gold macro fundamentals turned up sharply as early as 1998
and were strong through 2005, save for the 2001-2002
recession period. The main factor has been the inflationary
growth of central bank credit, followed by the price of oil
which rose an unexpectedly strong 65% since the end of 2004.
I believe a temporary sharp jump in Federal Reserve Credit in
the wake of Hurricanes Katrina and Rita helped spark the recent
gold mania. Without good productivity growth in the US, China
and Japan during the current global economic expansion, US
CPI readings could be steady at 4.5% instead of the 3.5%
average.

My gold macro indicators have started slowing in 2006, and
have not had anywhere near the momentum to support the parabolic
run in the gold price up to $732 oz. in May. As expected over a
$100 per oz has come off the gold price since then. The Fed
presently plans rather moderate liquidity growth, and global
system liquidity growth could be further constrained by
evidently growing liquidity tightness in Japan and the ECU.
Moreover, the US trade deficit has recently flattened out, which
crimps liquidity flows in emerging economies especially.

A major issue in the US concerns the continuing strong growth of
real estate lending. It should start slowing soon as housing, the
major sector, has been weakening. BUT, it has not shown up yet.
This keeps credit driven liquidity strong. The Fed has been allowing
basic monetary liquidity to inch up to counter an expected slowing
of the broader credit driven liquidity. This may be smart policy as
it will allow a smoother transition to a milder Fed policy once
private sector credit reacts to a slowing US economy. The growth of
the broad money supply has supported gold, but this may end as the
economy loses some more momentum.

On balance, the macro fundamentals suggest an eventual further retreat
for gold, perhaps down to the $525 - 550 oz. range. This may not
come immediately as gold has found trend support at $608 and is
heavily oversold short term. Moreover the hurricane season is here and
resolution of the course of Iran's nuclear fuels program remains
unresolved. Under circumstances of damaging storms and/or a decision
by the UN Security Council to reject Iran's position and impose a
program of economic sanctions, we could easily see spikes in oil
and petrol which might entice the gold players to run the market up
again. Finally, my macro indicators are cyclical and do not cover the
large grain markets. It's quiet there now, but you never know.

A short term bounce in gold is growing overdue. Since the metal has
not tended to make gradual tops or bottoms in this cycle, I have been
using the 5 day M/A against the 10 to tell me when a turn may be at hand.

Fedblitz

Over the past week or so, Fed governors have painted the
news tape with speeches focused on the economy, inflation
and the US dollar. Analysts and pundits have had to scramble
from one speech to the next to look for nuggets of info and
hints about monetary policy. By design, the speeches have
featured different shades of emphasis and perspective. This
is an old Fed tactic which they deploy to tell people to
lay off them and start doing their own homework. What prompts it?

> Scrutiny by analysts becomes so intense, it is intrusive.

> The Street, the media and financial pundits shift from analysis
to trying to shape the Fed's agenda and manage them via pointed
editorializing.

> The chairman comes under personal attack for not telling analysts
what most might want to hear.

When the governors pop off and seem to be all over the map, their
intent is to wear out the horde that is reading the semantic tea leaves
to elicit policy info.

This device often works because so many Fed watchers do not have a clear
understanding of how the Fed actually develops and implements policy.

Fedblitz

Fed governors have been painting the tape over the past
week or so with a variety of comments about inflation, the
economy and the US dollar. In some cases, perspectives and
conclusions differ.

This is an old Fed tactic. It grows out of resentment that the
Street, financial pundits and investment managers lately have been
on their necks like white on rice, following every word, exploring
every nuance and, sin of sins, have been trying to manage
Them by continually setting the stage and trying to lay down
the rules of engagement. It is a transitional economic environment
yet the players want the definitive word. So, the Fed puts out
lots of views instead. The message? Back off and do your own damn
homework.

The Fed is also running another little caper here. On balance,
their remarks have been hawkish on inflation, especially Bernanke's.
The game here is to intimidate the commodities markets by talking
tough and keeping them off balance. The Fed wants to verbally
squeeze the speculators for added effect to compliment a slowing
economy.

Stock Market -- Fundamental

S&P 500: 1275

The fundamental models I use continue to put fair value
for the "500" at 1290 - 1320.

The models point to rising value. At the same time the
gauges of market risk are also on the rise, although not
yet at critical levels. So, the reward vs risk profile
is deteriorating although still positive.

Both short and longer term economic indicators point to a
return to more moderate growth. My profits indicators likely
made an interim peak in April, but still look solid. What
I do not like here is that analysts are raising estimates
for company earnings for both 2006 and 2007. Up earnings
are still indicated, but I suspect this is not a good time
to be raising estimates.

The case for a cyclical rise of interest rates has been
unabashedly strong since mid-2004 (Unlike Uncle Al, I would
have pushed up rates faster, but so be it). Now however, the
case is starting to weaken some. Manufacturing new order rates
are losing steam, and the yr./yr. growth of commercial and
industrial loans, although still strong, may well have rolled
over. The indicators still point to a 25 basis point upmove
in the FFR% for late this month, but the case for an additional
push beyond that is getting a bit "iffy."

Most disturbing near term is the upturn in the shorter term
inflation measure reflecting the recent rises in oil, petrol
and base metals prices. The longer term read on the indicators
is still tilted toward less inflation, but with atlantic hurricane
season here and Hurricane Khameini whirling in Iran, the outlook
is, shall we say, open.

This is not an easy time for investors in stocks to keep their
confidence levels up. Economic growth is going to slow, it is
a little early to be calling for a pause in the short rate uptrend
and there is uncertainty regarding the outlook for inflation in
the weeks ahead. Expect more volatility as investors struggle
to master this transition period.

Stock Market Update: S&P 500 -- 1278

Short term, the SP500 has been stabilizing in a range 1260- 1280
following the sharp drop from the early May interim high. Now at
the high end of this tight range, the market has moved up from
moderate oversold levels. My favorite indicators are headed toward
positive, and a break and hold above 1280 would turn the standard
MACD positive. That, in turn, might invite in some more money.

In quick review, the cyclical bull remains intact, reflecting trend
and the direction of the 40 and 69 week M/As. Six week measures of
the NYSE A/D line and market momentum are down but both have held
important support on a daily basis. The six week measure of internal
supply/demand is even-steven, but may tilt up some this week. The
market has been below its 13 week M/A for two weeks, and it could
easily stay down for another two based on experience in the current
bull campaign. The 14 week stochastic -- a good measure of bottoms --
is close to registering a full oversold. My 13 week momentum
oscillator has turned down, but it shows no break away yet. In sum,
there has been intermediate term damage, but no decisive break.

I had been expecting a sharper downward break in the "500" to the
1180 - 1200 area reflecting very strong overbought readings in the
leadership of the broad market and the period of extended breadth
and momentum compression that preceded the recent correction. The
market has failed to comply so far and is near a short term move
to the upside. I will likely wait a few days for confirming signs
before I would initiate a long position.

I plan to update on fundamentals in the next post.

Stock Market Update -- S&P 500: 1250

In the prior two stock market posts (4/13 and 5/20), I
opined that a weak market might be at hand, with the S&P 500
vulnerable down to 1200.

I have been looking at various technical and "black box" sites
and I have noticed that warnings and "crash alerts" seem to be
cropping up just below 1250 for the 500. Whoops. Did I miss
something? Here I thought a nice 10% price correction or haircut
following a decent period for the big caps and a spectacular
twelve month run for the small and midcaps seemed reasonable.
'Tis the season for a little weakness and most stocks were
extended to the upside. I do not know whether the "500" will
fall to 1200, but if it did, I would not find it particularly
troubling. Folks have to be allowed to take good money off the
table from time to time.

I have included a weekly chart of the S&P 500. It shows a
developing intermediate term oversold (RSI and Stochastic) and
it shows the market against its 40 and 69 week M/Avs. Click here.

Note that the 69 wk M/Av has provided excellent trend support for
the market in recent years. A firm hold at or a little above
this average would be an encouraging short term sign.

Stock Market -- Technical & Psychology

S&P 500: 1267

As discussed in prior posts, I thought we would be turning a new
page for the market as breadth and momentum compression was so
intense in recent months. In the 4/13 post I opined a signicant move
was in order come May. My strong hunch was that it would be to the
downside. The sharp breakdown of the market since May 9, leaves it clearly
oversold, but also in a no man's land. To reward the bears valiant
battle since Jan. '06, which produced such tight compression, the
market should move down at least another 5%, leaving the SP500
lower at around 1200.

I was concerned we could get a spring time correction not only
for seasonal reasons but also because the powerful + 35 - 50%
moves of the small and mid cap groups over the past year was an
insouciant advance to high levels of valuation in an evironment
of rising risk. These stocks are correcting, but it does not seem
like justice has quite been done yet.

I am cautious about making any predictions in here, because I do not
know if I have much of a handle on market psychology. I do not have
a bearish macroview as many have expressed so suddenly. I just thought
many stocks were too extended and needed a good hit and that May
was a dandy month for it on a seasonal basis.

The economy is entering a transition period to lower growth and, I
trust, more moderate inflation. With these sorts of fine tuned
scenarios, the markets can be very jittery if the ball does not
stay right in the middle of the fairway as it rolls to the cup.

I would like to see the market lower, especially the small and midcaps,
but I do not not want to miss a positive swing in psychology should
one be shaping up quickly. So I may follow the trend for a few weeks
until I have a better handle on the market's intentions.

Stock Market -- Fundamental

S&P 500 : 1280

Based on my fundamental models, I have the S&P 500 as currently
fairly valued in a range of 1290 - 1320.

The October '05 - May '06 rally reflected a significant net
liquidity injection by the Fed, continued double digit profits
AND dividend growth and a recovery in the market multiple
following the autumn spike of inflation. I also like to look
to see if there is "excess liquidity" in the system. This
occurs when the growth of the broad money supply exceeds that
of the growth of output plus pricing, when both are measured
yr / yr. Excess liqudity does provide fuel to support the
market, and it was in place until April '06, when the economy
surged.

The sharp sell off of stocks in recent days reflects a shift of
investor focus away from earnings and dividend growth toward
concern that inflation has strengthened which may result in
short term interest rates that could run higher than previously
anticipated. Players see that the higher fuel costs of recent
years are working their way through the system and, of course,
there may be concerns about whether oil and petrol could
surge further later this year, what with the hurricane season
ahead and with Iran trying to kite the oil price up with a
continuum of incendiary chatter.

At this point, my longer term economic indicators are pointing
toward slower economic growth ahead, and my inflation thrust
indicators suggest moderation of inflation going forward.
I am still projecting the S&P 500 to wind up '06 in a range of
1385 - 1415.

Basically, I look for a slowing of earnings growth momentum,
but a boost to the market multiple to reflect a moderation of
inflation. The housing industry is slowing, and I look for
the growth of consumer spending to moderate significantly as
the higher cost of credit curbs the appetite for borrowing.
On the inflation side, I look for development of a better
balance between supply and demand in fuels and throughout
the industrial sector. My major concern at this time concerns
the prospect for a reduction of private sector credit growth. To
counter that, the Fed will need to cap rates and add liquidity
directly to the system, and it will have to do so with alacrity.

The next post will focus on technical dimension and the short term
side of the market.

Gold Price

Gold: $712oz.

By the end of next week, gold will have finished a very well
defined parabolic up move that could, but not need not,
culminate at $730oz.(It traded that high today.) After next
week a new pattern will be set into motion. Normally, when a
commodity comes off a parabolic, there is a correction with
a subsequent retest of the high.

I am leaving go of further comment on gold for a month or so since
I think I have said all the sensible things I can say about it. We are
in a gold-friendly inflationary milieu, there is a well defined longer
term bull market in gold and it is receiving wider sponsorship and
interest. But gold is extremely overpriced by well founded technical
rules of thumb, and is fundamentally overvalued as well.

We have witnessed development of a gold mania since last autumn, and
manias, being what they are, can end abruptly or continue. Chart
wise, this is the right time for this one to end, but only a fool
would try to rule definitively.

The 5/10/06 FOMC Meeting

Well, they meet tomorrow. Most all observers expect the
FOMC will push up the FFR% by another 25 bp and are reserving
their curiousity for the wording of the statement.

The cyclical pressures are there -- fast rising shorter term
business loans, strong purchasing manager reports, rising
factory orders and the uptrend of capacity utilization.

Moreover, the Fed has not followed through in the injection
of liquidity that came in the wake of Katrina/Rita. The FOMC
has been very measured on the liquidity front since January.

Gold -- Parabolic Upswing

Gold: $678 0z.

Parabolic price moves are most easily seen on a linear
chart. The price of gold is on a happy upward curve.
This parabolic would complete at the end of May with gold
at $700-710oz.

Gold likes an inflationary milieu: economic expansion, rising
operating rates, cyclical inflation pressure, and as often
happens in such an environment, a rising oil price. We have
the proper milieu in spades, plus a growing geopolitical dispute
between the West and Iran over the development of the latter's
nuclear fuels. Iran has kited the oil price with success, and
there is no shortage of observers who see economic and/or military
conflict which could result in a shortfall of Iran's large oil
output.

So, the gold bugs and buggettes have run the price of their beloved
up and through the roof. There are several rules of thumb in the
commodities futures markets for measuring when gold might truly
be overbought and at risk and the price is there. However, since
feeding frenzies can often exceed expectations, there's little
that can be said about when an interim top might be struck.

At this point, I cannot argue with the basics of the gold case.
Economic supply/demand measures show continuing cyclical pressure.
Moreover, I doubt the Fed is ready to purposely squeeze the
economy to the point of recession. That type of action could
actually be several years away. And, it is still early to say
that continued economic expansion will involve growing imbalance
between economic supply and demand.

So, I would simply say that although gold may be in a high return
environment over the next few years, the metal is also in a high
risk one as well. An economic slowdown, oil price weakness,
reduced geopolitical belligerency, all could conspire to blow
$100 oz. of foam off that gold brew in short order.

A word about the situation with Iran. The easy worst case scenario
here is that either the US or Israel or both could launch a military
assault on Iran to impair or destroy its nuclear programs. My
guess is that this kind of action, should it come at all, could
easily be several years out in time. After all, Iran has
been muddling along with its programs for years. My concern
centers around another possibility, which is that Iran, grown
tired of taunting the West and unable to solve pressing economic
and social issues at home, might commit the first act
of war. Should Iran lead off, the response from the US could be
much larger and more devastating. Thank goodness I do not take
myself too seriously on such matters. Whew!

Monetary Liquidity

Both the monetary base and Federal Reserve Credit continue to
run flat with late Jan. '06 levels. Thus, the Fed is tightening
the monetary string, its words notwithstanding. For now, players
in the capital and commodities markets remain smitten with the
idea that the Fed is very close to ending the current round of
boosts to the Fed Funds rate. Chair Bernanke's testimony to
Congress last week that the Fed might consider pausing the hiking
of the FFR to determine the responses of the economy to the
foregoing rate hikes is regarded in some quarters as further
evidence of a growing desire by the Fed to wind up the current
round.

The recent Fedspeak has provided cover for the fact that They have
been in a tightening mode. Plus, the idea of a pause in raising
rates, however sensible from an economic perspective, gives the
Fed "room" to stop raising rates as the off-year election draws nigh.
As I have previously mentioned, this promises to be an important and
nasty campaign for control of the Congress, and the Fed would be wise
not to have itself become a political football that partisans can kick
all around the field. After all, Bernanke is a Bush appointee.

This mismatch between the Fed's expression of its future intent and
its present course of action hardly means that bets based in the
markets which are discounting a soon-to-occur leveling off of
short rates must fail. After all, the markets are discounting
mechanisms. But, recognize the increasing risk levels as well.

Oil Market

Oil rose to a record $75+ a barrel late last week. That is
close to 86% above its economic value in a balanced environment
with 3 million bd of capacity cushion. Cushion is negligible
reflecting contingency building of larger cover stocks by
processors, market participants seeking inventory profits and
non-oil market speculators.

The recent spurt in the price set off a political hullabaloo
in the US, and has set drivers again thinking of conservation,
as gasoline affordability has deteriorated rapidly. The crude
price has backed off to about $71.50.

In using industry fundamentals, I have not done badly at all on
guessing direction of the crude price, but the upswings have
been stronger than anticipated and the downswings have been weaker.

We are entering a brief seasonally weak period, and crude must
hold $64-65bl to keep the very sharp upturn underway since the
autumn of 2003 intact. The trend band for this May is $81-64bl
using late 2003 as a base and the longer term band is $70-38bl.

At my tender age, I am a conservative player and am effectively
priced out of this market on the long side above $45 a bl.,
just as I am priced out of gold above $450.

For a slightly different chart take on this market, click here.

Interesting Profits Picture

My top down corporate profits model indicates strong S&P
500 operating profits for Q1 '06. Yr/yr sales growth
accelerated significantly from late 2005, reflecting a
rebound in output in the wake of the storms plus a
continued broadening of pricing power. Sales were easily
strong enough relative to costs to allow a number of
companies to show higher pretax profit margins. In
addition, oil price realizations also accelerated,
likely producung strong inventory profits for the
integrated producers. About one third of the SP500
companies have reported quarterly results so far, and
surprise has been positive by far.

Varied sets of leading indicators point to a slower
economy in the current quarter. Moreover, profits in
last year's Q2 were strong. So, I'd be a little
reluctant to jack up the estimates for the current
quarter even though The Street may do so. The oil
price will remain difficult to project. Over the
past eighteen months the yr/yr price change has
varied from 15% to 60%.

Credit Driven Liquidity

The Federal Reserve has achieved some success in slowing the
growth of its prime focus monetary aggregates M-1 and M-2.
Part of the reason growth of these aggregates has slowed is
that banks have simply changed emphasis in how credit growth
is being funded.

Bank lending and leasing has been growing far faster than the
economy over the past eighteen months reflecting a sharp
acceleration of commercial and industrial loan growth as well
as a continued strong real estate loan book (mortgages and
development loans). Although growth of home equity loans has
slowed sharply, yr/yr growth of the real estate loan portfolio
tops 12.0% and has been trending higher so far this year.

Of interest now is that evidence of a slowdown in the housing
market has begun to accumulate. Should this continue as is
now widely expected, the real estate component of credit
demand at the banks will begin to slow, and this will reduce
the growth of bank funding, since the real estate portfolio
is by far the major component of the banking system's loan
book.

The Fed has to be on this like white on rice, because a slowing
of bank funding growth without a corresponding easing of
basic monetary liquidity can establish conditions that may well
lead to a liquidity squeeze and consequent damage to the
economy and the stock market.

Most real estate loans are still longer term, and it is the C&I
loan book that the Fed watches most closely in setting the Fed
Funds rate. The book of shorter term business loans is still
zipping along, and when momentum in this category rolls over,
the Fed normally stops tightening. Now, the Fed has to watch
both categories closely, because too rapid a slowing of the
growth of the real estate book could produce an unwanted
drag on liquidity. Time to watch all of this more closely.

A primary funding vehicle for banks is commercial paper issuance.
This category, which includes collateralized or asset backed
paper has grown rapidly over the past two years. The Fed
regularly releases data for the commercial paper markets on its
web site, and for a nice update from Haver Analytics click here.

Monetary Liquidity

The two precursors of basic monetary liquidity in the
US are the Adjusted Monetary base and Federal Reserve Credit.
As you know, they are both very close in content. Both have
flattened out since late January, 2006.

These series are fallible indicators of the markets. They work
best when interest in monetary policy is intense, as it has been
since mid-2004. It is not easy to trade this data, as the
primary dealers on the Street experience the data as order flow
and can act on it the fastest.

Interestingly, the big cap stock averages have returned to mid-
Jan. ' 06 levels. One plausible interpretation is that players
are getting a little edgy about monetary policy following the
major liquidity infusion which ran from late Oct. '05 through
early Jan. '06. In short, some players are now less enthused
the Fed will stop raising short rates right ahead.

The US Dollar has also fared a little better since the Fed took
its foot off the gas in Jan. In fact, $USD fundamentals are
currently nicely positive although there is concern that
the dollar will prove vulnerable once the Fed stops raising
rates.

The gold market normally gets jittery when the Fed steps back
and lets its own portfolio flatten out in $ terms. Both gold
and oil did sell off sharply after then chairman Uncle Al
pared back Fed Credit as January unwound. But both have
been on a tear recently, with the Iran - US trash talking
contest in full swing ( Note that Iran likes high oil
prices as does GWB's and The Shooter's Texas oil buddies).

Next couple of weeks will be interesting regarding these
liquidity forerunners as this data will further clarify
Fed intent.

Stock Market Technical

S&P 500:1288

Well, it's spring break for school kids this week and it is
quiet.My work shows another extended period of compression in
the market based on my momentum and A/D indicators, with the
latter adjusted daily for TRIN. The compression period extends
back to mid - December, '05. This suggests to me that the market
is setting up for another significant move, although the current
period of frustration could last until the end of this month.

It is so tempting to say that we'll see a sharp break to the
downside this time, especially since a traditionally weak seasonal
period lies ahead. Moreover, the broader market still looks
overbought to me. One measure I like is the Value Line Arithmetic
Index ($VLE). It is not capitalization weighted
and besides the SP500 stocks includes the majority of popular
midcaps as well as top smaller caps. The weekly is here.
The trend is strong (ADX black line) but the MACD below is starting
to weaken. You will note the index has made a big move since last
spring.

But, happily, I find it easier to avoid certain temptations at my
tender age. So, I merely note that we seem due for some tradable action
up or down soon.

Bond Market -- Again

In the immediate prior post, I mentioned that the bond market
is in a cyclical bear phase but that the long Treasury was
oversold short term (April 4).

As I study it, I realize that the market is proving capable of
considerable volatility. I am thinking about the very sharp
and temporary run-ups in the $TYX yield that happened in the spring
seasons of both 2004 and 2005. So, the $TYX which crossed over and
closed above 5.00% today, could easily rise another 30-50 basis
points in a hurry if the players are in panic mode as they now
appear to be.

There's a long side trade coming on the Treasury price ($USB)
but I think I will make no attempt to catch the falling knife but will
wait instead for the makings of a positive turn in MACD and the stochastic.

I have been playing in the bond market as trader and investor since
early 1970. The behavoir of the market over the last two - three
years is a bit ditzy or dotty in my view, almost as if there's a new
generation of bulls coming in just as a major sea change is forming.

Bond Market

1. The bond market remains in a cyclical bear phase.

2. Note, however, that the long Treasury is now significantly
oversold. The chart of the $USB shows o/s on RSI and the stochastic, but observe as well how far the price is below its 200 day m/a.

3. To view the long Treasury yield in longer term perspective, click here.
The bond yield is moving up to test long term downtrend lines. Over the
past two decades, the tests have provided excellent buying opportunities.

4. The market is approaching an important crossroads. If the current
cyclical bear phase in the yield remains intact, the downtrend lines
may well be violated and this would be a prima facie warning that the
long term bull market in bonds could be coming to an end.

5. Since the current economic expansion began, the bond market has been
sensitive to the trend of commodity industrial raw materials prices and
less so to the CPI and energy feedstock prices. Spot industrials
remain in an uptrend, but have moderated recently. Even so, the bond
market has been weakening, suggesting a broadening out of focus,
perhaps to include the oil price as well as ongoing moderate economic
expansion in the face of rising short rates.

6. One continuing concern I have regarding the bond market is the
possibility that once the Fed is done raising rates, the FFR%
could be kept at a plateau level, as the economy might well
continue to expand with growth of economic demand and supply rounding
into decent balance. I suspect that in such an environment, players
might opt to put some risk premium back into bond yields.

7. I have stayed away from the bond market for the past year, primarily
because I think it is overvalued, with too little premium in Treasury
yields to reflect interest rate risk, supply risk and future long
term inflation potential.

8. If the market does show signs of bouncing from the current oversold
condition, I might go long for a fast trade, but that would be it.

Inflation Picture

For me, the primary stimulants of inflation are commodities
prices and a range of key cyclical sector operating rates.
My inflation stimulus pressure gauge is essentially flat
for the past six months, suggesting little forward momentum
for inflation. As I have argued, the "core" inflation rate,
or inflation excluding volatile commodities such as energy
and foodstuffs, is overdue to show some acceleration following
the dramatic run-up in fuels prices in recent years. Nevertheless,
the inflation vanguard has slowed. Moreover, productive capacity
overall is beginning to grow a little faster.

The inflation pressure gauge remains on a high plateau, and
the recent positive bounce in oil and refined products is
putting a little stress on the financial markets. Iran, with
help from an equally belligerent Bush admin. is doing a swell
job of kiting the oil price and keeping traders in the game.
There is plenty of supply, but an abundance of fear as well,
and traders are thankful as it is keeping the oil price
up ahead of the forthcoming US hurricane season. After the
last two years, you can bet that weather.com will get a big
play as the air warms in July and August.

There is even a growing buzz on the web that the US is planning
to try and take out Iran's nuclear capacity. Understandable
given the Bush Doctrine of pre-emptive strikes when He spots
peril. And there's the low approval rating, too. Patriotism
as the last refuge of a scoundrel and all that.

Interesting stuff all, but at quite an advance to the economics
on the ground. There is a message here too for the Fed as well,
which is not to overreact to the powerful scarcity fear psychology
gripping the petrol sector.

The FOMC Decision on Short Rates

The first FOMC policy meeting under new chair Bernanke is
winding up over lunch, and their decision on rates etc. will
be announced in a couple of hours.

Most everyone out there is looking for business as usual --
a 25 basis point hike in the FFR%. Since the Fed also has a
God given right not to be psychoanalyzed, I would not presume
to say what the gang will come up with.

The customary cyclical fundamentals that are usually front
and center for the Fed are vibrant enough -- broad cyclical
expansion, rising operating rates and strong and rising
short term credit demand. there's enough rolling out there
to support a FFR% of 5.00 - 5.25% in my view, and we should
have been there already, save for Uncle Al's baby step policy
inclination.

The Fed has eased on the liquidity front since this past
autumn, but not enough to signal a policy change.

The one item in the usual mix that is of interest to me is
the mild acceleration underway in the growth of production
capacity. Over the past several months, yr/yr capacity
growth has moved up from a paltry 1.1% to near 2.0%.
The longer term trend seems to be turning up and this is
very important because, should it continue, production
supply / demand growth will come into much better balance,
and this will undercut inflation stimulus within the system.

I am hoping that Benny The Banker will step right up and
put his fingerprints all over the FOMC decision and
consequent statement rather than toodle along like a Greenspan
acolyte. We'll all see shortly.

Gold -- Not For A Cheapskate Like Me

Well, there it is, trading in a range of $550-560 oz.
Some of the pundits tell me $600 is the next stop on
a glorious upward ride. Wow, and here I am thinking
that I could eke out a decent case for gold at $450
oz. based on commercial demand / supply/ extraction
costs. I even thought it would sell off sharply over
the first four or five months of 2006. I know there
are concerns that oil supplies could be disrupted, but
when I look at that market, I can make out a good case
for oil at $40-50 bl., not $60+. No comfort there either.
looks like the same guys are in that market, too.

When I look at the gold charts, I see a sitting duck,
with intermediate term weekly MACD rolling over from very
high levels, yr/yr price momentum very high, Wilder
ADX closing in favor of internal supply. But, a
big drop has not come.

So, for now, I am consigning gold to the "out of my
league" category, to be dusted off periodically.

I do get a kick out of the gold bug websites. Not
even the more voracious Wall Street Bankers can touch
these guys for hucksterism.

A Little Trouble In Big China

China is averaging about 200 protests / riots a day.
This is not spontaneous. China's political left is
recovering after years of quiet.

Well paid workers in the eastern part of China are
leaving their country cousins in the dust. Plus,
the new running dogs of capitalism are turning the
country into an environmental cesspool and are
swiping turf the peasants once claimed.

Leader Hu has spoken of developing a "golden harmony"
that brings the 800 million Chinese who are not
sharing in China's economic development into the tent.
A very tall order.

As the NY Times reported today, the Chinese left is
starting to get its voice back, sounding strong
criticism of the country's growing imbalances in
the wake of its economic development.

Hu now has to straddle the fatcats and the peasants'
slow burn which is heating up steadily. This guy is
going to be tested right down to his new Ferragamo's.

Beijing hosts the 2008 summer Olympiad. This is planned
as Beijing's coming out party as a world capital. Losing
face in China is bad business, so 2008 should be a quiet year.
But the left will be pressuring hard for goodies through
2007.

The Chinese excel in traumatic political upheaval, and now
that the old commies are hooking up with the peasants, the
small trouble in China may well become very big trouble in the
years ahead if China fails to rapidly shift its focus from
the fatcats ball to the downtrodden.

Just one more thing that's going to heat up in the years ahead.

The US Trade Account

The LDCs and the weaker OPEC countries experienced economic
depression in the early 1980s as oil and other commodity
prices collapsed. It was a stock Kondratieff downwave that
was eclipsed from going fully global by timely major
central bank intervention, large US income tax cuts and a
relaxing of regulations regarding the writeoffs of non-
performing LDC/OPEC credits.

The US had been the lender of last resort. Now it had to
become the buyer of last resort to stave off spreading depression.
The original global rescue plan called for three locomotives to
pull the world back from the abyss: The US, Germany and Japan.
Between 1983-87, Germany and Japan welched on the deal, leaving
the US to carry the load. The strong US $ policy of 1980-85
did the trick, but the US began to run a deep trade deficit.
A weak US $ from 1985-95 reversed this situation, and by 1991-
92, the US was running a modest surplus on current account.

Powerful US economic fundamentals over 1995-2000 produced a
dramatic rally in the dollar which actually ran until 2002.
At first, both imports and US exports were strong, but export
growth faded and the trade gap again accelerated. Moreover,
it continued to grow rapidly even as the dollar tumbled from
2002-2005. The elixir to eliminate the current account deficit,
namely a weak US $, failed. Many exporters, China notably and
much of the rest of East Asia tied their currencies to the dollar,
while Europe and Canada gave up profit margin to maintain market
share.

Strong US interest in "free" trade has a long term objective.
We know as the massive baby boomer cohort passes into the
retirement years, US consumer purchasing power will moderate
very substantially. The hope is that exports will pick up
a fair portion of that slack and that countries like China
and India will eventually focus on growing their own
consumer economies.

All the countries who export to the US know that the consumer
will soon be past his prime, spending wise, and it is
Katy bar the door to sell as much into the US as they can
before demand slackens.

Only time will tell whether our policy aim will prove effective.
However, it seems to me that the next 5-7 years are going to be
difficult and risky on the trade front. Big US companies like
Dell and The Gap have large offshore production which they
distribute here. So the open market concept benefits many major
US companies. But smaller companies -- the backbone of US job
creation -- will be at increased risk as more niche markets
come under attack from abroad. On the flip side, the US is
exporting $ liquidity to the tune of nearly $800 billion a year.
Foreign currency reserves are ballooning, and the risk of
all manner of speculative excess abroad is rising rapidly.
Japan went bananas with this liquidity in its real estate and
stock markets in the 1980s and it has only been recently that
it has regained a comfortable degree of equilibrium.

When an exporter to the US locks its currency to the dollar,
it is engaging in a form of mercantilism. The US should
hammer China and the other bandits that are keeping
currencies artificially low. But it has chosen to let it all
happen so large US corporate and banking interests can prosper
abroad. This is a dumb policy that will hurt smaller
domestic interests as well as the overconfident foreign
treasurers who think they can manage mushrooming liquidity
with ease.

So we have to keep eyes on the trade sector, particularly
throughout developing Asia as the central banks out there
have yet to show their mettle.

The more one watches major US business interests, the more one
is reminded of Ike's admonition to watch that military / industrial
complex.

Stock Market -- Fundamental

S&P 500: 1274

I use three different fundamentals - based models to track
the SP500. All imply that from an empirical perspective the
S&P is reasonably valued in the range of 1280 - 1300. I
do not put too much stock in the predictive value of any
of these approaches, but use them more as a diagnostic
reference. Even then, I would not make too much out of
divergences until they exceeded 6% or so. For me, the market
looks reasonable enough now.

To summarize the output of the models, the market's rally since
this past autumn reflects a continuation of above average
earnings growth and an expanding p/e ratio to reflect a moderation
of inflation pressure which in turn has been supported by a
moderate easing of liquidity policy by the Fed as well as
continued good growth of the SP500 dividend. The key changes in
the mix since last October or so have been a step up in the
growth of the monetary base and a reduction of inflation pressure
stemming from lower fuels prices.

The risk premium of the market (earnings/price yield - 91 day T-Bill
yield) is continuing to shrink from once very high levels. Thus,
risk continues to rise, and it will be interesting to see how
the market holds up if the Fed tacks on another 50 basis points
to the FFR% over the next few months. Could be a character builder
for investors.

Yield Curve Inversion

The yield curve inverts when short maturities sport yields
above those of longer dated maturities. We have seen yield
curve inversion in the US Treasury market on a day to day
basis since late in 2005.

Historically, an inverted yield curve has been a good
indicator of an impending sharp economic slowdown or
even recession. That's because yield curve inversion is
normally a symptom of either a liquidity squeeze or a
developing credit crunch wherein banks severely restrict
shorter term lending.

We have no squeeze or crunch now. Far from it. The
broad money aggregate M-3 is up 8.4% yr/yr, commercial
and industrial loans are up 15.5% yr/yr and trending higher,
and real estate loans continue to grow. In fact, the
financial sector is generating excess liquidity
now, or more liquidity than the economy actually needs.

Now, if the Fed Funds rate gets put up above 5.25% I'd wager
that banks will begin to take notice, and may well begin to start
to ration credit modestly. M-3 growth would slow because
funding requirements would slow, and the economy would
enter the very early stage of a liquidity squeeze. Bond
yields could even go lower in such an environment because
bond players would begin to anticipate eventual recession,
lower inflation and a flight to quality.

I'm strictly guessing the Fed may cut off the push on the
FFR at 5.0-5.25% in the months ahead, up from the current
4.5% posting. I doubt the Fed wants to become a centerpiece
political issue in a critical off-election year such as is
2006.

What might be of interest is how the bond market behaves
if the Fed goes to a FFR 5.0% and signals it may well
stay there for a while. That might send bond yields
sharply higher since some players would likely conclude
they may as well shorten maturities.

Note as well that following Uncle Al's silly roller coaster
ride with Fed credit post-Katrina, the FOMC is again adding
to holdongs, thereby signalling another bit of easing.