December 14, 2002 --Hard to believe, but one of my brilliant...

December 14, 2002 --Hard to believe, but one of my brilliant subscribers picked up the site that I lost on December 13. I've included it on today's site, so it's there if you want to read it. It reviews Friday's action. Just click on to Dec. 13.


I just went through the latest issue of Forbes magazine, and three columns were outstanding. The first was David Dreman's in which he complains that nothing or at least very little has changed. Corporations continue to put out "pro forma" earnings reports or "operating earnings" reports. These damnable reports leave out little things like certain expenses or expenses that are listed as "one time" but are "every time." He says that of the S&P 500, about 400 of their reports could use some changes. You wonder whether corporate America will ever get honest.

Old friend Jim Grant writes his usual excellent column, and Jim talks about the fact that stocks just aren't cheap at all. I note that S&P now has something they call "core" earnings, and these are earnings which allow for pension and option expenses, which in many cases are huge expenses that are generally not accounted for. S&P core earnings give us a P/E of around 48 although Barron's gives us a trailing P/E of an equally outrageous 29. Any way you look at it, trailing P/Es for the S&P are sky-high. Of course the analysts love to deal with estimated earnings. The only trouble with estimated earnings in a bear market is that they are invariably far too optimistic. You can bring the P/E down to bargain levels if you make your estimates bullish enough.

Let me put it this way -- in a bear market (and by the way, we are in one) analysts' estimated earnings are always overstated. Period.

Then there is Gary Shilling's column in Forbes. My friend Gary (he also produces delicious honey via his own bees) was one of the very first to warn of deflation. Gary talks about the sub-prime loans that are out, and he sees bankruptcies rising and the mountains of sub-prime loans running into increasing trouble, particularly in housing and autos. Actually, Gary sees world deflation, and if he's right (and I suspect he is) then the dirtiest word in the English and every other language is going to be DEBT.

Which is one reason why gold is breaking out and gold shares are rising. You see, gold is the only money that isn't someone else's liability. Actually, I should smile when I say "the only money" because it's almost a lie to call a dollar or a euro or a yen "'money." These are simply "legal tender" pieces of paper that the central banks of the world insist are legal for the payments of all debts.

I've gone through this many times before, but it still makes my blood boil when I think that I can work my ass off and be paid in something that Greenie and the gang can generate by doing nothing at all.

Maybe what we should do is get all the central bankers of the world together and force them to do some real work like digging up weeds on a road gang for minimum wage. Then they would know what real work is like -- but the catch is that we pay them with junk paper "money" which we produce in front of them on a Hewlett Packard printer. Then we'd see how they like working for nothing.

Anyway, what I see now is the beginning of competitive devaluations with the dollar now breaking down, and the euro now selling well above par (par being the price of the dollar). As gold climbs, almost all paper currencies are being devalued. Which, of course, is why central bankers hate to see gold rising. I guess you could come up with a ratio -- gold rising divided by the rising blood pressure of the average central banker. The ratio might well be one-to-one.

Turning to gold (I'm rambling now), the gold shares are starting to bring in some volume. Yesterday Newmont was on the NYSE most active list (I think it was number 20), and if I remember correctly 8.7 million shares changed hands. NEM is the world's largest producer of gold, and the company has top-flight management. It's a key stock which should be watched.

Newmont believes the price of gold is going higher, and for this reason it is actively getting rid of its hedge book (which it inherited when it took over the Normandy Mine out of Australia). Newmont said last month that it had reduced its forward sales by 928,000 ounces to 5.8 million ounces, and that it expects to reduce its hedge book by at least 279,000 ounces in the current quarter.

Interestingly, according to the US mint, sales of Gold Eagle one-ounce coins has averaged 38,200 since July, more than triple the average of 11,920 ounces during the first six months of this year.

By the way, a huge battle is going on behind the scenes in the gold area. The latest figures show that Commercials increased their gold short position from 109,000 to 128,000 while they reduced their long position from 41,000 to 37,000. At the same time large speculators increased their long position from 48,000 contracts to 73,000 (wow!) while increasing their short position from 15,000 to 20,000. Those are huge changes. It seems clear that the Commercials are flooding the gold market with additional supply (shorts) while at the same time the big speculators have increased their long positions hugely.

So watch for gold to get erratic and volatile. There's a mighty battle going on. Gold bulls should take their positions and not be leveraged (or margined) to the point where they will be easily knocked out of the game. I almost never go on margin in anything I buy. Even in a bull market, when you're on margin the odds are that the "smart boys" will get you, and you'll be sent home crying. I've almost never seen it to fail, and I've seen a lot of markets, and I've seen a lot of margined players pressed to the wall.

I've said this many times but I'll repeat it. The hardest thing in investing is to load up at the beginning of a bull market, and then ride the bull to somewhere near the end. You can do it with a small position, but then you're not going to make that much. You can try with a large position, but after a while that position may get "too hot for you to handle."

What's the best strategy? Take a medium-sized position that you can live with -- and then have faith in the primary trend. Somewhere ahead gold will go parabolic, and then what do we do? Do you sell real money for more paper? Do you just sit with your gold no matter what? Gold (and I'm probably talking about the metal) is probably something you should will to your kids. Why sell your gold? Why sell your diamonds? Why sell your Picassos and Modiglianis? They're intrinsic. They're true value. Keep 'em as long as there are counterfeiters who run the world's central banks (steady Russell, you're starting to go overboard).

Oh yes, there was the market action or really inaction last week. The stock market is suffering from two diseases, "lack of buyers," and "lack of sellers." Neither side has wanted to make the big move. Thus, we have a market that has been wavering on low volume with option-writers watching and worrying and keeping the VIX fairly high.

The option crowd knows from experience that out of sluggishness comes activity, and they're afraid that the next activity could be to the downside. At least, they're making you pay for that protection, which is why the VIX closed at 32 on Friday instead of 22.

We've got 11 trading days left between now and the end of the year, and it would be quite surprising (and bearish) if the market doesn't get a good rally going between now and December 31.

The December low is always important, and particularly important in a bear market. I say this because in a continuing bear market if the December low is broken any time during the first quarter of the new year, the odds are that the new year (2003) is going to be a poor one.

I am guessing that a lot of investors are betting that next year will be an up-year simply because only one time before in history has the market been down four years in a row. That was during 1929 to 1932 as the stock market was discounting the worst depression in US history. I'll be writing a lot more about this whole situation in the next Dow Theory Letters. But believe me, if next year is down, well, run for the hills.

Friday's action was not particularly appetizing. The dollar broke to a new low, my Big Money Breadth Index looks lousy, but my PTI is still in its bullish mode. The McClellan Oscillator is in bearish territory, and the stock market just looked "undecided."

Gold broke out above the 330 barrier, and watching the tape I saw large volume coming into many of the "cheapie" gold shares. Gold is starting to make the news, and maybe the Fed likes that since I'm sure the Fed takes the gold action as a sign of success in their battle against deflation. But it's not going to be that easy, Greenie, the battle is still in high gear. And it's going to be a long one.

As for Bush and Iraq, it almost seems as if it's written in stone. The US will attack. The US will win. It will all be so easy. Until the complications hit. And then what? Bush is a man obsessed. Right behind him stand Cheney and Rumsfeld. The secretive three against the mustachioed mass murderer. It promises to be quite a show. And an expensive one, in more ways than one.

Comments -- I note a number of analysts are drawing attention to the fact that the US market seems to be following closely the path of the Japanese market. My take -- yeah, they're both big bear markets, but forget using the Nikkei as a guide to the future path of the US market. Each bear market has its own path, and it's hopeless to keep trying to use a crystal ball or some other index to show us the way ahead. It won't work. The best way to go is to figure that before the US bear market is over, stocks will sell at great values, and then we take the technicals at any given time and with them we try to identify where we are.

One item I've always kept an eye on is the discount in the closed-end funds. When investors are bullish during a bull market the closed-end funds will sell at no discount or actually at a premium. When investors are bearish near a bear market bottom they will turn very bearish on closed-end funds. I remember the oldest closed-end fund, Tri-Continental, selling in 1974 at a discount of over 40% from actual net asset value.

Right now the discount from net asset value of closed-end funds is around 3.75%. This is still a very small discount from net asset value, showing that investors are still quite bullish. Before this bear market is over, I expect the discount to be 35% to even 45% below actual net asset value.

The true (common stocks only) A-D ratio for last week runs as follows -- Dec. 9 minus 4.46; Dec. 10 minus 4.06; Dec. 11 minus 3.98; Dec. 12 minus 3.92; Dec. 13 minus 4.30.

For the year 2002 so far, the broad Value-line Geometric Average was down 27.85%. The very broad Wilshire was down 21.31%. My guess based on the Merrill figures and the IBD Mutual Fund Index is that the average retail investor is down around 30% for the year, and that's probably an optimistic figure.

Barron's shows the P/E for the S&P (trailing figures) at 29.32. The dividend yield for the S&P is 1.78%. More like the statistics you'd expect at a bull market top than anything even vaguely close to a bear market bottom.

That's it from your older but (hopefully wiser) man from the Great American West,

Russell