January 16, 2008 -- (Bloomberg) -- The dollar fell to a 2...

January 16, 2008 -- (Bloomberg) -- The dollar fell to a 2 1/2-year low against the yen as losses in credit markets widened and the U.S. economy showed more signs of sinking into recession.
The U.S. currency also dropped to a record low against the Swiss franc on analysts' expectations. Merrill Lynch & Co. and JP Morgan Chase & Co. will follow Citigroup Inc. in writing down the value of investments linked to U.S. mortgages. The yen climbed against higher-yielding currencies such as the South African rand and the New Zealand dollar as a slump in global stocks prompted investors to reduce carry trades funded with cheap loans from Japan.

Russell Comment -- So much for what's left of the "carry trade."


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Writing about the stock market or the economy is not a pleasant task at this time. The reason, of course, is losses, losses and more losses. When, on November 21, I wrote that we had witnessed a Dow Theory bear signal, I had no set idea as to what that bear signal portended or even the reasons the primary trend of the market had turned down.

At the time, nothing seemed terribly out-of-kilter in the US economy. Sure, housing was a mess, but that had been well-publicized weeks, even months, in advance. And that's the strange and damnable thing about the stock market. It speaks, it gives its rather rare Dow Theory "signals," but at the time we never know exactly what it is that the market is telling us. But we don't have to know -- all we do have to know is UP from DOWN. At the time I didn't know how important or how far "down" was. And I'm still not sure about the full meaning of "down" in the current situation.

But it's becoming rather clear to me that "down" in this bear market means "down and dirty." It's "Katie bar the door." In other words, this bear market is not shaping up as anything vaguely pleasant. No, it's shaping up as an angry grizzly bear. And this bear has been sinking his claws into the throats of investors, not only in the US, but around the world.

I do want to bring up one rather esoteric thesis. Bill Gross, managing director of the giant PIMCO bond fund, wrote about it on his current site. It's the "shadow banking system." This so-called system consists of off-balance sheet conduits, which are designed to get around the Basel Accord rules. Gross estimates that there are $43 trillion in derivatives at risk, which represent this shadow banking system. There are no reserves behind these instruments as there are in the regular banking system. Furthermore, the shadow banking system is totally non-transparent, nobody really knows what or where the risks may reside.

Here is Bill Gross' description of the shadow banking system --

"But today’s banking system, as pointed out in recent Investment Outlooks, has morphed into something entirely different and inherently more risky. Our modern shadow banking system craftily dodges the reserve requirements of traditional institutions and promotes a chain letter, pyramid scheme of leverage, based in many cases on no reserve cushion whatsoever. Financial derivatives of all descriptions are involved but credit default swaps (CDS) are perhaps the most egregious offenders. While margin does flow periodically to balance both party’s accounts, the conduits that hold CDS contracts are in effect non-regulated banks, much like their hedge fund brethren, with no requirements to hold reserves against a significant 'black swan' run that might break them.

"According to the Bank for International Settlements (BIS), CDS totaling $43 trillion were outstanding at year end 2007, more than half the size of the entire asset base of the global banking system. Total derivatives amount to over $500 trillion, many of them finding their way onto the balance sheets of SIVs, CDOs and other conduits of their ilk comprising the Frankensteinian levered body of shadow banks."

So the risks remain large, and the hardest part of the whole situation is this -- it's not clear where to hide. The immediate thought of most investors is to "get into cash," and by cash they mean dollars, T-bill, T-notes, foreign currencies, anything outside of the stock market. But then I ask myself, how safe is fiat money? What is fiat paper but the figment of some central bank's computer system? In other words, in the long run how good is cash? And the answer is, "Who knows?"

But right now cash is wanted. Cash is not common stocks and cash is not commodities and cash is not real estate. Cash is -- well, cash is just plain cash. And remember -- cash, dollars, are legal tender for the payment of all debts. If you're a bank and you're under water due to a lot of stupid investments, you need cash. Thus the headline in today's Financial Times, "US Banks Get $21 Billion Foreign Bail-Out." Our foreign creditors know a good deal when they see one. And when they pay cash, you can be sure they're getting an excellent deal.

One thing we know -- the Federal Reserve must treat what's happening as a first-class emergency. The operative thought on Fed Chairman Bernanke's mind, his great fear, must be DEFLATION. To counter-act deflation, the Fed will want to keep consumers in a buying mood. That means getting cash into the hands of consumers. How to do it? A tax cut, tax refunds, special "bonuses," one-shot payments, you name it. As President Bush recently announced, "Nothing is off the table." Two things we may be sure of -- a flood of fiat currency is going to hit the markets, and short interest rates will be heading down.

But fear is the strongest of all human emotions, fear conquers all. If the great American consumer becomes afraid, if the specter of fear envelopes the nation, then no amount of government-sponsored "inflating" is going to bring consumers back to the stores. America's consumers have done too much buying already. They've "been there and done that." And that's a present and huge danger. The danger is that America's consumers are at the stage where they may want to "hunker down and wait for the emergency to pass."

Meanwhile, I want to go back and refer to this monthly chart of the Dow once again. Yes, I've included this chart a few times on recent sites. And it's still valid. RSI momentum is breaking down. Monthly histograms are negative. The Dow is still holding above its 40-month moving average -- but for how long? It's not a pretty picture. But it's reality, and reality is what we deal with on these sites.



All that liquidity that the Fed is forcing into the system, where's it going? It hasn't been going into the stock market. It's not going into the wallets of America's consumers. Then where is it going? Evidently, it's going into special sectors of the commodity spectrum. Corn, wheat, soy beans, agriculturals. Liquidity has been going into items that create higher costs for consumers -- in other words, inflation in living expenses for Americans. Below, a daily chart of the CRB Commodities Index.



How about oil, the life blood of the economies of the world, the reason we're in Iraq, the reason we're in the Middle East at all? This is a daily chart of oil, and oil has just sunk below its low rising trendline. Is this the beginning of lower-priced oil? I don't know. It's too early to know.



I talked about the so-called "softs" above -- wheat, corn, soy, sugar. Here is Goldman's index of agriculturals. Buy your bread now, because the price of bread is heading higher. And how big is your freezer, because bread doesn't last that long sitting on the kitchen shelf.



Is gold better than fiat paper? Over the long run it is. In the short term, gold is a commodity and a currency. Over the long term, gold is a tangible asset. But over the short term gold like any other item will rise, it will fall, and it will correct.

Over a one-year period gold is up 256 points or 41%. Last night gold was down 18 dollars (I'm writing this at 3AM on Wednesday morning). It was one of those sneaky after-market corrections. At the same time, silver was down 37 cents. We'll see how the precious metals open on Wednesday, and more importantly, we'll see how they close on Wednesday. But a correction was way overdue, and now maybe those gold-philes who sold out will have a chance to buy in again. That is, if they dare.

Yesterday was another 90% down-day. There have been three 90% down-days in the past six weeks.. What's the meaning of a 90% down-day? The meaning is that such days show us that the market continues to be in potential panic mode. As long as 90% down-days continue to appear, we know that investors are periodically willing to throw stocks onto the market willy-nilly regardless of their price or value.

Somewhere ahead, be it a week or a month or a year, this bear market will hit bottom. At that time, the market will have discounted the worst that can be seen ahead. There should be a number of symptoms and signs when that time arrives. The actual turn to the upside may be signaled by a 90% up-side day. That will signify a rush to the upside by large investment interests. That will be the happy day when the stock market, having hit its ultimate bottom, turns up with a vengeance.

TODAY'S MARKET ACTION -- My PTI was down 4 to 5943. Moving average was 5947, so my PTI ended down 4 and is bearish.

The Dow, after being all over the map, closed down 34.95 to 12466.16. Four movers in the Dow today -- BA up 2.01, XOM down 2.49, JPM up 2.26, and INTC down 2.81.

Feb. crude was down 1.06 to 90.84.

Transports were down 31.61 to 4249.28.

Utilities were down 8.26 to 531.24.

There were 1681 advances on the NYSE and 1678 declines. DOWN volume was 54.2% up + down volume.

There were 29 new highs on the NYSE and 385 new lows. My 5-day high-low differentials improved from yesterday's minus 1328 to today's minus 1081.

Total NYSE volume was a big 5.41 billion shares.

S&P was down 7.75 to 1373.20.

NASDAQ was down 23 .00 to 2394.59.

My Big Money Breadth Index was down 2 to 848.

Dollar Index was up .69 to 76.26. Euro was down 1.73 to 146.59. Yen was down .46 to 92.95.

Bonds were slightly lower. Yield on the 10 year T-note was 3.71%. Yield on the long T-bond was 4.32%. Yield on the 91-day T-bill was 3.04%.

CRB Commodity Index was down 5.59 to 489.34.

Feb. gold was down 20.60 to 882.00. Mar. silver was down 40 to 15.89. Jan. platinum was down 18.40 to 1567.10.

GDX down 2.38 to 48.83. HUI down 20.96 to 441.33.

ABX down 2.94, AEM down 3.09, ASA down 4.34, NEM down 2.20.

Rumor is that gold is being sold to raise money to cover losses on other stocks. My guess -- gold and silver are just over-bought -- and that together with the higher dollar has brought on the selling.

STOCKS -- My Most Active Stocks Index was up 3 to 426.

The five most active stocks on the NYSE were -- C down .70, F down .11, JPM up 2.26, EMC up .12, GE up .03.

The VIX was up 1.04 to 24.38, and traders are raising their fear quotient, which is a negative for the market.

CONCLUSION -- The stock market is whipping around like a snake with its head cut off. It's a dangerous market presenting a lot of ways of losing money. Today cash (dollars) was the winner. Proving the wisdom of the old saying, "When in doubt, stay out." Stay out in what? Today stay out in dollars, dummy -- loveable old Yankee dollars.

You know what dollars are -- the Fed manufactures them by the thousands of millions. On each dollar it says, "In God We Trust." Hey, don't blame inflation on God. When last I heard, God was in favor of stability and honest money.

Talk to you tomorrow --

Russell