Gold Price

My view on the gold price has been that there would be a decent long side trade off the late
2013 price of $1200 oz. The figuring here was that strong global liquidity growth especially
from the US would foster faster real economic gains in this year and that an acceleration of
inflation would not be far behind in time. It was a good idea for the first half of the year, but
has run into trouble in recent months as economic progress in the EU and China diverged
negatively from the US, and operating rates failed to rise enough to generate some cyclical
inflation pressure. This was the case for one commodity near and dear to gold bugz, namely
the price of crude oil. Since mid-year it has weakened also failed to rebound here in Sep.,
a normally strong seasonal period.

the EU is under greater pressure to re-inflate the economy monetarily and folks have mis-
read China where monetary policy has been easy through the bulk of the year. With US
liquidity still strong, the potential for inflation down the road remains. But first there has
to be a firming in the balance of global economic / supply demand, which has yet to take
shape. Even in the US, where production growth has been stronger this year, the operating
rate is still a little shy of 80%, a kick off point for inflation pressure.

Meanwhile, the gold price has fallen enough to begin piercing long term trend support
and is a bit above intermediate term trend support at $1200. Weekly Gold

The metal is fast approaching a significant oversold on weekly RSI and may need to have
the oil price stabilize in the next few weeks to hold its ground. If gold can hold support at the
$1200 level there should be a bounce but more cautious traders may consider watching
global demand measures such as the forthcoming Markit global mfg. PMI due next week.

Stock Market -- Yet Another Technical Note

The current nasty little sell off is threatening to change the pattern of the SPX. The SPX
closed at 1983 today, and it will break the uptrend line in place since late 2012 if it breaks
and closes below 1980. To conform to the bullish pattern set since late 2012, the SPX should
have developed stronger positive momentum off the recent early Aug. low and be moving
toward the upper band of the trading range, now above 2050. It has not and instead is headed
for another test of trend support. The market is not yet at a classic oversold, and intermediate
term downtrends in MACD and RSI suggest there may be more negative chop ahead.

If the SPX does break below 1980, then there is "fail safe" support at the 100 day m/a. The
100 day m/a has been breached a few times since late 2012, but never by much and has served
as a springboard for the next up leg. We may see this play out once again but the recent
stumbles leading up to this possible crucial test of support suggest careful observation.
SPX Daily

Stock Market -- Technical Note

Ms. Yellen's latest attempt to 'kite' the market shows some of the magic has been lost. The SPX
has been on the flat side here in Sept., and the NYSE adv. / dec. line has turned down noticeably
this month to diverge negatively with the SPX. The chart I've set up to accompany this post
includes the cumulative NYAD line, the relative strength of the SP 500 on an unweighted basis,
the relative strength of the Russell 200 Small Cap., and the relative strength of the utilities sector.
NYAD Chart

As most know, the breadth of the advance in the broad market has become more exclusive as the
year has worn on. Small cap. indices like the Russell are down on the year and are trailing
significantly in relative performance (3rd. panel of chart). Now, with Sep., the SP 500 on an
unweighted basis has broken down in relative strength as has the NYAD (top 2 panels).

The bottom panel of the chart shows the relative strength of the utilities sector vs. the broad
market. Portfolio managers often use this group as a place to hide cash and earn some
current return. It is often a maneuver that managers resort to when they wish to become
more defensive but remain relatively full invested. The recent rise in bond yields has dimmed
interest in utilities somewhat, but interest has been reasonably well maintained since late last
year when it was announced that QE would eventually be terminated.

I think the downturn in market breadth and the decline in relative strength for the unweighted
SP 500 have recently begun to bother investors just a little bit so far. As we learned over 1998-
2000, market breadth can diverge negatively and substantially from the broader market before
a more substantial and far-reaching break comes. But that might have been the exception, and
it may well be that players would like to see the oversold medium sized and smaller cap. issues
regain some positive footing before the bull market moves up solidly from around the SPX 2000
level.

Economic Indicators

Coincident Economic Indicator -- August, 2014
Measured yr/yr, my version of the CEI rose by 2.3%. This represents the strongest improvement
in two years, but remains shy of what would count as vigorous, well-balanced economic growth.
The sales / production side of the indicator rose a solid 3.7%, but the income side increased by
only 1.9%. Within the income portion, civilian employment growth rose by 1.5% and the real
wage by 0.4%. The real wage has started to benefit form a slight increase in wage rates as well
as  from a recent deceleration of the inflation rate. With the benefits of productivity gains
continuing to accrue primarily to capital and not to labor, households must expand borrowing
to finance an increased level of spending. Scrooge lives on and so does widening income inequality.

Business Profits Model
Top line growth was about 6% for the year through Aug. Looking back at my projections for
2014, unit volume growth has been faster than I expected, but pricing power has lagged and
broadly so. Progress in advancing profit margin from productivity gains has been partially
offset by slower growth in pricing with my price / cost ratio now under some pressure. Without
stronger pricing power, a number of businesses may step back from more full blooded hiring.

Liquidity Situation
Over the past few months, liquidity generated by the private sector has matched the progress
of business sales. There has been excess liquidity in the system generated by the Fed's QE 3
program and this has helped power the stock market to some some extent in 2014. However,
with QE expected to wind down to zero later this year, investors are likely to find themselves
in stronger competition with the demands of the real economy if business sales growth can
hold around or exceed 6%.

Monetary Policy

The Fed is keeping Its focus on the Phillips Curve -- falling unemployment leads to rising
inflation and rising unemployment leads to falling inflation. Currently, the US is experiencing
moderate real economic growth with falling unemployment and low and relatively static
inflation with the CPI averaging below 2%. Significant slack remains in the economy and with
little inflation pressure, the Fed appears content to continue unwinding the QE program but
keep its ZIRP until the Phillips curve aligns properly with strong enough jobs growth to foster
faster inflation. With plant capacity growing at 2.8%, there is enough supply / demand balance
for the monetary authorities to not hasten to raise interest rates and see how the economy
responds to the wind up of the QE program. On certain fundamental measures the Fed can be
seen as suppressing short term interest rates and hawkish sentiment is clearly growing on the
Board. But Ms. Yellen is not yet under duress.

US Stock Market

Fundamentals
There was some profit taking this week. Continuing strong monthly economic data is worrying
some players that the Fed may end its ZIRP sooner, and begin a series of hikes to short rates
not long after QE3 ends next month. Bond prices also weakened as a result. Evidence from
recent Fed governors comments on the economy reveal that Ms. Yellen will have to fight harder
to keep the ZIRP in play in support of the labor market. Also, there are no doubt some players
who want to raise a little cash ahead of the snuffing out of QE3 which is down to a pilot light.

The weekly forward looking economic indicators have come in on the flat side since Jul. 25
with a lack of progress in weekly jobless claims and sensitive materials prices looming as
important.These indicators are volatile, but there is enough of a pattern to wonder whether
the stronger monthly data may soften some ahead. The liquidity cycle is still running strong
but is fading from peak yr/yr readings suggesting a period of growth moderation lies ahead
eventually.

Technical issues surrounding the close - out of QE and the need for the Fed to provide an
extra measure of liquidity around the holidays may preclude action on ending the ZIRP until
after the beginning of the new year. And, if there is evidence of a more moderate tone to the
economy by then, Fed Chair Yellen may have a stronger hand to confront the policy hawks if
she chooses.

The larger issue here still remains: Whether private sector credit generation will continue
vibrant enough to pick up the slack created by the cessation of QE. If such happens, and
private sector lenders have not just been piggybacking the QE program, then Ms. Yellen
will find her back at the wall if she demurs on raising short rates as the economy would
likely be strong enough to warrant further calls to end the ZIRP. Since I regard this
transition in liquidity sourcing to be a major experiment with little empirical backing, I
would suggest keeping enthusiasm tempered.

Technical
The sell off this week has turned the short term indicators negative but did not do enough
damage to trend to signal worry yet. The intermediate term overbought alluded to in the
prior post has eased a little. Major trend support is around the 1970 level  with crucial
backstop support at the 100 day m/a.

the market has traders' attention now because of the possibility that the recent highs in the
SPX just above 2000 might constitute a possible secondary and bearish top. This is due
diligence only now as there have been several such patterns in the long run up since late 2012.
SPX Daily Chart

US Stock Market

Fundamentals
Core fundamentals continue positive. Important liquidity growth factors are past their peak
yr/yr, but momentum is declining gracefully. Corporate profits gains have accelerated recently
with strong growth indicated in the current quarter. Monthly business new order data has
trended strong too, but weekly data has started to flatten out, a cautionary sign regarding
earnings momentum down the road.

As QE 3 winds up next month, liquidity growth will decelerate more. Business sales and earns.
progress should slacken as we move toward and into 2015. With milder liquidity expansion on
tap for 2015, competition within the capital markets for funds will intensify.

the coming end of QE 3 has so far had a significant but hardly fatal impact on stocks. SPX
positive momentum has shrunk from last year's barn burner level but is decent. Smaller cap
stocks have not fared nearly as well. This sector is flat after having sharply outperformed the
SPX last year. Portfolio beta is being reduced.

The mantle of greater monetary policy accomodativeness is passing from the US to the EU.
The EU stocks have underformed the SPX pretty steadily since the end of 2012, but relative
performance for the STOXX 600 has picked up recently and may challenge the downtrend
line against the SPX going forward (See SPX chart bottom panel below).

With slow global economic demand growth in place since the end of the deep recession of
2008 - 09, more geopolitical turmoil should be expected. The are millions upon millions of
younger people out in the world with deepened struggles to find their way. Risk has been
contained regarding the capital markets, but that can change. Also, UKR vs. Russia has
entered a new and less easily predictable phase.

Valuation
The SPX is not overvalued yet, but investors are paying a premium multiple for cyclically
elevated earnings. The risk / return profile is thus deteriorating as the market rises with
cyclically advanced earnings. The SPX is now trading at 22.3 times long term trend net
per share of $90. This is not a record by any means, but the high valuation suggests that
players who want to stay in the market review their liquidity requirements carefully.

Technical
The SPX continues in its third and longest upwave since the cyclical low of Mar. 2009.
It is mildly overbought in the intermediate term (3 -6 mos.) on the indicators. SPX Weekly
The consistency of trend since late 2012 remains astounding.

Inflation Potential

One very probable eventual outcome of a strong liquidity cycle such as the US has been
experiencing is an acceleration of cyclical inflation. QE's 1 and 2 helped push the CPI from
a deflationary reading of -2.1% yr/yr in Jul. 2009 up to +3.9% inflation for Sep. 2011. In
the absence of strong QE until early 2013, the CPI dropped back below 2.0% yr/yr in Apr.
2012 and did not rise above 2.0% again until this spring and then only barely.

The US has experienced a continuing long term decline of Its inflation rate since the early
1980s. There have been periodic cyclical surges that have come when the CRB Commodities
Index rises 10% or more on a yr/yr basis. The mini - surge in the CRB earlier this year
helped boost the CPI from 1% to 2%. CRB Chart

There are a number of factors that have reduced US inflation over the years such as slower
 real economic growth, sharply rising lower cost imports and a progressive but sizable decline
in the growth of wage costs. Even so, the low pass through of higher commodities costs
to the CPI this year has been a surprise. I have been thinking that the CPI could rise to at
least 3% by the end of 2014, but this may be a tough go now.

If you return to The CRB chart, you will see a horizontal green line set at 335 for the index.
That is my educated guess of where supply and demand in the aggregate for this group of
commodities would come into balance. So, from my view there is still excess capacity in these
markets, particularly for grains and fuels. If there is not further firming in global economic
demand, the excess will likely continue, and the sort of sustained upward pressure on pricing
that is needed now to underwrite a further sharp cyclical rise of the CPI % is not likely to
eventuate.