Gold Price "Heads Up"

Gold went out today around $927 0z. It failed to hold the strong
rally uptrend from 11/08 into 02/09, and now it is close to a
further breakdown on a more extended uptrend measured from
11/08 with an intermediate "touch" of the line around mid- April
' 09. This is a charitable read since the lengthier uptrend has yet
to fully confirm by taking out the Feb. high. Failure of gold to
rally over the next 5 trading days could set the metal up for a
deeper correction down to the $800 level. Time to pay a little
more attention.

The gold macro directional indicator has moved steadily higher in
2009 on expanded monetary liquidity, a rising oil price and a strong
rally in industrial commodities. But the indicator has also leveled
off over the past 2 weeks and its trend, like that of gold, is about to
be tested, especially as oil has flattened out and turned a little
wobbly around $70 bl.

Since gold led the rally back into riskier assets off its 11/08 low,
it's worth watching shorter term from a broader perspective.

Daily gold chart here.

The Fed Relies On Its "Gap Chart"

The FOMC finished up today. They left policy unchanged and
commented that the recession and price deflation are easing and
that sustained inflation is not in sight. they are relying on a tool --
the "Gap Chart" -- a tool that has been a cornerstone of monetary
policy for longer than most of you have lived. The chart compares
the trend of production and capacity and measures whether the gap
is growing or retreating. A growing gap means capacity is advancing
faster than production, which means the operating rate for the
economy is receding and that so should inflation pressure. The gap
is huge now, with the operating rate at a low 68% and still falling.
So, for now, the Fed sees no reason to expect a sustainable rise
of inflation pressure.

They have been dead wrong on this since late winter. Inflation
pressure -- measured without seasonal adjustment -- has been on
the rise even as the production / capacity "gap" has opened
wider. The FOMC did not acknowledge this fact today and has
opted to project that continued US and global economic slack will
kill off inflation pressure from rising commodities prices in the
weeks and months ahead.

Commodities players have an accomodative monetary policy at
their backs and are also armed with the knowledge that since the
recession in new order rates has been unwinding rapidly, prices
should improve with needed inventory restocking. When the
economy does come off deep recession, commodities can bounce
sharply on inventory pipeline refilling, only to settle back as
players realize that underlying demand, although set to recover,
must rise from very low levels. That is the Bernanke bet for the
time being. If commodities players, which now include the big
hedgies and long only funds, can keep the markets stoked, the
Fed will fall well behind the curve.

Commodities do exhibit a slight bias toward seasonal weakness
over the second half of the year, but not nearly enough to rescue
the bet. That will require a round or two of profit taking by
the speculators who have had the markets in play.

Inflation (Deflation) Pressure Gauges

12 Month Deflation
The CPI measured yr/yr showed deflation of 1.3% through May, and
the yr/yr CPI for June and July could well give deflation readings of
2.5%. No surprises here, and no surprise that the 2.5% deflation
mark may reflect the bottom on pricing pressure for 2009.

Inflation Potential
The inflation gauges I use appear to have made bottoms here in Half
1 '09. The CPI remains sensitive to the direction of commodities
prices, especially fuels. With a positive monetary liquidity cycle
underway and low short term interest rates, traders have been
running up the petrol sector and commodities broadly as they look
toward economic recovery. Right now we appear on track to see a
reversal of direction in the yr/yr CPI toward inflation on the order of
up to 2.5% by year's end 2009. Commodites are volatile indeed and
the current uptrends are running ahead of the economy. Whether
the action in the trading pits can sustain the direction of commodities
over the course of the year remains an open question. It will be
interesting to see if the Fed's FOMC addresses this issue in its
6/24 statement and at upcoming meetings.

Stock Market -- Long Term Technical

A broad variety of longer term indicators shows that the market has
turned up from one of its weakest periods in history. The one
exception is the Wilder ADX indicator, which has yet to flash a buy
outside of 20 weeks. It has signalled a change in the direction of
the trend to positive, but is moving very slowly toward a full scale
buy. Several indicators, and I have looked at over 10, show that
positive price momentum off the early Mar. '09 low has been very
strong, too strong perhaps for the longer term.

The SP 500 is also nearing a very important downtrend line that
extends from the May, '08 rally and catches the Aug. '08 interim
high. This line down is significant because the market rapidly fell
apart into a crash shortly thereafter. So this will be a big test of
trend out ahead. The market is now well through and past the crash
down lines.

The SP 500 13 wk. m/a is rising and is threatening to pop above
the 40 wk m/a. Some technicians call this eventuality a "golden
cross" which is seen as providing a confirmation of a durable
advance (providing the 40 wk m/a soon turns up, too). CHART.

Measured on a 40 wk. price oscillator, the market is but rather
mildly overbought. But, when I go out one derivative and look at
that oscillator against a 13 wk. average of itself, I see an
extremely overbought market. Here again, the momentum has
been uncharacteristically strong, even for the onset of a cyclical
bull market. To be to the point, the trajectory of this advance
is nearly twice normal, which suggests that at some point out there
in time, there will be a sharp price correction or extended period
of range bound consolidation or both. In short, when viewed long
term, we are contending with a price rocket.

Now, because the SP 500 took out its 2002-03 lows during the
crash late 2008 - early 2009, we not only ended a long term bull
market, but we have entered a bear market of indeterminate
length. We can see powerful cyclical advances during such a period
and we do not have to plunge to even fresher lows at some point.
But we have to recognize the possibility.

From a short term perspective, resolution of the price rocket
issue is not necessarily a worry. We could see a moderate
correction and a tradable rally in the interim. However, looking
out a month or more, resolution of the price rocket saga could
become more pressing.

Coincident Economic Indicators & Liquidity

Measures which coincide with the level of economic activity showed
that the US economy declined for the 12th consecutive month
through May 2009. Measured yr/yr, the two sets of indicators I
use were down about 6.5%. The big declines are in retail sales and
production which were down 11.1% and 13.4% respectively. The
lone positive has been the real wage which is up 4.4% yr/yr.
Inventories were still likeley being run off through May, and
productivity -- by any sensible measure -- is down as output has
been falling more sharply than employment and hours worked.

My profits indicators for nonfinancials show yr/yr weakness. This
reflects both lower sales and profit margins in the US as well as
abroad. Net revenues for financials have been holding up, but
loan and securities losses likely continue large.

A broad array of indicators suggest that the US economy may hit
bottom in July '09. A very rough guess at this point suggests the
economy could be up by 2.5% by year's end or early 2010.

Viewed historically, consumer spending should already be running
much stronger given the very large yr/yr growth of the real wage.
Householders are obviously continuing to build a savings cushion
and trim their debt. This development should keep everyone
hoping for recovery edgy.

With output down sharply yr/yr, the velocity or turn over of money
has fallen, providing excess liquidity relative to the real needs of the
economy. This is quite a development given that my broad measure
of financial liquidity is running flat yr/yr. Traditionally, excess
liquidity of this sort provides a strong tailwind for the stock market,
although this is not always the case.

I am watching the production data carefully. It has been badly
punished not only by the downturns in autos, other durables and
housing, but by a large decline in export sales as well. Should there
be further significant weakness in production, I would be willing
to call this downturn an economic depression given how far the
production composite has fallen below trend and how long it will
take to recover to new high levels.

Financial Regulation

Ultimately, you cannot legislate away the pernicious effects of
stupidity and greed and their profound influence on the stability
of the financial markets and systems. The US and other economies
are littered with past financial crises, most of which could have been
avoided by prudent foresight and courageous action. But, every so
often, emotion like greed and fear combine with ignorance and
outright stupidity to overwhelm the system.

We could all benefit greatly from a more stable monetary policy and
less monetary tinkering. Consumers would all benefit if they had
exposure to finance, banking and economics in their student days,
and regulators could benefit greatly from keen and diligent
gathering of financial and market intelligence so that they at least
know what we could be getting ourselves into during heady
financial times.

However, investors and lenders who do not do their homework
thoroughly and maintain sensible disciplines will avoid getting
burned in the markets only if they are lucky. Caveat Emptor!

Stock Market -- Technical Warning Lights

Back on 6/2, with the SP500 at 945, I mentioned in a post that I
thought the market was due for a correction. After failing to break
out top side last week, the market has headed down so far this
week, and some technical damage is evident. The SP500 has
fallen through its 10 and 25 day m/a's, and both of the m/a's in
question have turned down. Moreover, the ADX tool shows
that +D1 has just fallen below a rising -D1 on declining momentum.
Note though that the 10 day m/a has yet to confirm a downtrend
by falling through the 25 day m/a CHART.

I know full well how short term technicals can whipsaw you, but
I think enough of this type of analysis to say the amber light is on.

IF a correction is finally underway, my best guess now is that if the
SP500, now 911, is contained in a range of 865 - 880, then it would
remain plausible to argue that the powerful bull leg in evidence
since Mar. '09 could well run further before it confronts more
substantive headwinds. IF there is a break below 865, then the
argument for a cyclical bull from a technical perspective becomes
more problematic, although not necessarily fatally flawed.

With the downdraft this week, the market has turned ever so
slightly oversold, and I plan to keep an eagle eye on it, which I
have not done for a few weeks. It might also be wise to look at
some of the longer term issues in an upcoming post to come
shortly.

Financial Liquidity & Monetary Policy

On balance US financial system liquidity has changed little since early
in the year. My broad measure of credit driven liquidity remains
flattish as further contraction of the commercial paper market and
shadow banking system are offset by rising personal and business
savings via money markets and CDs. The Fed has drawn authority
to increase its balance sheet by nearly $1 tril. more, but has not used
it. In fact, Fed bank credit has contracted since the 2008 holiday
season.

Banking system equity capital has increased by 9.5% yr/yr, as
TARP money and new offerings by larger banks have dwarfed
miniscule internal growth for the system. Liquidity is still tight
at the margin as C&I loans remain in the early stage of a cyclical
run-off. Total loan exposure remains flat, which is not atypical in
a major economic downturn.

On a global basis, the breadth of new manufacturing orders has
increased sharply in 2009, with the US and China leading the way.
There have been numerous reports that China is stocking basic
materials, including bunker crude. With some inventory speculation
underway, petro prices have jumped as have commodities, as traders
get on the recovery anticipation bandwagon. The CPI in the US,
excluding seasonal adjustment, has been rising this year so far. The
Fed has maintained a ZIRP policy and has fallen behind the seasonal
increase of inflation. Basic economic benchmarks for Fed policy are
giving readings well below what would normally trigger rate increases
as the economy has yet to move into an expansion phase. The
continuation of a ZIRP with commodities on the upswing has probably
contributed somewhat to a steepening yield curve and a weaker US
dollar.

The Fed would prefer not to jeopardize the now fabled "green shoots"
with tighter monetary policy, and probably does not now mind a
weaker $. However, persistence of fuel and commodities price rises
over the remainder of 2009 would put the Fed well behind the curve,
as inflation pressures would increase.

Ideally the Fed would like to wait for economic recovery to take hold.
With short rates near zero, the central bank would have ample leeway
to move rates toward more normal levels as the economy expands as
well as contract a Its very large balance sheet.

For the moment however, it is in a less comfortable position than it
was just a few months back, and it will be interesting to see how it
balances the prospects for the economy against higher materials
prices at its upcoming FOMC meeting, Jun. 23-24.

Long Treasury Bond

The bond is sharply oversold and advisory sentiment -- usually
wrong at key turning points -- has dropped into the upper
reaches of "too many bears" territory. The bond price is hovering
just above important support. Conditions continue to fall into
place for what could be a sharp counter-trend rally.

The long Treasury remains very sensitive to the trend of industrial
commodities prices, which are in a clear uptrend now. So, what is
needed now is a spot of negative news on economic recovery
prospects to shake the industrials market into a round of profit
taking. That would serve to rally the T-bond.

Long bond chart here.

The Commodities Market

The availability of commodities ETFs and long position mutual funds
coupled with a large bull market in commodities from 2001 - 2008
has lead to a substantial increase of interest in this area and has
re-positioned commodities from consummables to an asset class.

Over the long term, commodities have been a poor investment. The
famed CRB composite has appreciated by just 2.5% per annum since
1970. Commodities prices have tended to move in 6 year cycles, but
there have been 2 longer term bull markets in recent years: 1970 -
1980, and 2001 - 2008. There are pundits out there who maintain
that a long term or secular bull market is in place, but such claims
sorely test credulity. However, a multi year bull run in commodities
as occured over 2001 -2008 can be highly profitable for an investor
with rigorous discipline.

History shows commodities are most sensitive to interest rates and
the liquidity cycle. Now with short rates low around the world and a
new liquidity cycle underway to reflect easier monetary policy,
commodities have been moving up since Feb. '09, with this move
aided by a positive bounce in the leading economic indicators.

Since 1980, most advances in the CRB index, which closed today at
258, have been constrained in a range of 260 - 280. Breaks above that
level in 1979 and again in 2003, heralded sharp advances. So the
market is approaching important resistance, and with this test thought
near even before the global economy breaks into expansion, you can
appreciate the enthusiasm of commodites bulls as they anticipate
economic growth with the added fillip of inventory rebuilding.

I will do more on commodities going forward. Relative to the long
term trend of the CPI, commodities are indeed cheap as a class.
Below, I have linked to the CRB index chart. I would put resistance
in two close together spots -- 260 / 280 and again at 300. I would
also point out that commodities are crash prone when evidence of a
tough credit crunch emerges, as happened in 1980 and again in 2008.

CRB CHART.

Economic Indicators

The weekly and monthly leading indicators continue to move up
sharply, signaling that the US economy is setting up to recover
from deep recession. The indicators have surged from very
depressed levels, so it remains a little foggy to tell just how
imminent expansion may be. The Economic Power Index remains
positive but the index is being carried entirely by lower tax
witholding rates, unemployment insurance and the large increase
in Social Security payout. The real wage remains strong, but the
continued deterioration of employment has flattend the US
payroll pretax. Straight ahead, there will be pressure in DC to
make sure the spending stimulus dollars are being pumped out. The
very large inventory liquidation underway since late 2008 puts
the economy in a position to benefit from pipeline refilling as final
demand continues to stabilize. Continuing constraints to growth in
the short term remain strong private sector liquidity preference and
the large inventory of unsold homes ( A measure of pending home
sales is showing recovery.)

Capital slack continues to increase and is quite large with
employment, capacity utilization and business credit demand at low
levels. The Obama spending program has been designed to take up
some of this slack. If private sector interest in building liquid assets
up does not ease off some with improved confidence, then Team
Obama may look to enlarge the scope of fiscal stimulus.

No shortage of issues and worries here, but the indicators are
pointing northward, which what is needed most.

On a global basis, total output and new orders measures continue to
recover from exceptinally low levels registered around the end of
2008. these measures are a little more than half way to expansion
readings.

Stock Market

Technical
The strong rally underway since early Mar. remains intact. There
is another short term overbought in place now and the market
remains o-bought out through 13 weeks as well. The trajectory of
the rally is now verging on unusually strong. The SP500 closed
today at 945, and I would be happy if it was down somewhere
around 865-885. So, I think it is nearing a point where it is overdue
for a pull back, even though there are no indications yet of
difficulties with trend. I have linked to a chart which features an
intermediate term MACD and a 40 day RSI. Note that the RSI is
moving toward an intermediate term o-bought at 60%. CHART.

Fundamental
As readers know, I am on the hook for a cyclical bull market call.
Now, it is normal for a cyclical advance in stocks to pre-date a
positive turn in earnings (6.5 months on average). Still, the SP500
is now running about 45% above very depressed 12 months net per
share. Granted that the 12 month figure contains one unprecedented
red ink quarter -- Dec. '08 -- when companies wrote off everything
they could get away with, the 45% premium is a whopper -- large
by historic standards. In short, this baby is counting on the green
shoots to turn into stronger fibre soon. A pause in the upward
trajectory of the market for a month or two would not bother me at
all.