Volume I, Issue 37

MARKET BOTTOMS CAN BE VIOLENT AFFAIRS AS THE TSX, COMMODITIES, RESOURCE STOCKS, AND THE EURO TUMBLE TO EXTREMELY OVERSOLD LEVELS. THE GOOD NEWS IS THAT FINANCIAL AND US HOMEBUILDING STOCKS ARE MORE THAN 40% ABOVE THE JULY 15 LOWS. THIS SUGGESTS THAT WE HAVE SEEN THE WORST IN MARKET ACTION FOR THESE SECTORS EVEN THOUGH THERE WILL STILL BE NEGATIVE ECONOMIC DATA FOR MONTHS TO COME. THE US FINANCIALS HAVE ALMOST ALWAYS LEAD THE US MARKETS AND THEREBY GLOBAL MARKETS. GLOBAL MARKETS FOLLOWED THE FINANCIALS DOWN SINCES LAST SUMMER AND SHOULD FOLLOW THEM HIGHER SOON.

The S&P/TSX fell 954 points, or 6.9% last week, as speculators and hedge funds sold resource stocks and purchased shares in financial companies to cover their short positions. Just as liquidity injected into the global financial system to offset potential problems with Y2K in 2000 ended up pushing technology stocks to high levels, part of the liquidity injected into the US economy during this crisis gravitated into the sectors with strong growth - resource stocks and commodities. Conversely, the problems US real estate mortgages and financial companies were so serious, it seemed like a sure thing for investors and hedge funds to sell them short and thereby profit from the collapsing share prices. With the US dollar in a free fall for years, it only made sense for investors and the oil rich countries to favor the euro instead of the greenback.

By the middle of July, these trends had reached an extreme. Short selling of financials became so pervasive the US regulators temporarily changed the rules for short selling. In the days after July 15, oil prices plummeted from $147 a barrel to $130 and the US financial and homebuilding sectors rose over 40%! Even though the temporary rules for short selling were lifted and news of an all-time high in US home foreclosures persist, the financials and homebuilders held on  to these gains and have risen to new recovery highs today, with the US Banking Index (BKX) now up 58% since July 15. In fact, Ambac Financial and MBIA Inc., the two major US mortgage insurance companies that most investors had given up on, have risen 739% and 375% respectively during the same time frame. On July 18, I wrote a special update with the headline, "Indicators Suggest Oil is Peaking and Equities Bottoming." While that was very accurate for oil and US equities, this time the Canadian market did not follow the US turnaround as soon as it usually does.

After July 15, signs of an economic slowdown in Europe and a speculative blow-off in oil prices took the bloom off of the euro, commodities and resource stocks, which had experienced a long, strong advance. In July, the TSX was approximately 10% below its all-time highs while US markets were down 20%. The sharp decline in resource stocks and the TSX last week seems to be the type of selling that occurs at the end of a decline, not the beginning, since the long-term oscillators were already very low and oversold. The oscillators issued a buy signal for the TSX and energy stocks on Aug. 25, but they were premature this time. Just as financial stocks sold off too far before they rebounded in July, the indicators suggest that the resource sector and commodities have sold off far enough to rebound anytime. However, some areas of the commodity and resource sectors, which have had major advances, will likely have to consolidate for a while, just as the Canadian dollar has been in a trading range after a major advance that peaked last fall. The US financials lead the US markets, and major global markets eventually follow long. Stock prices lead the economy by six to twelve months. It seems like we have turned the corner in the current financial crisis. That will be positive for the TSX and global markets in due course.

Bonds - Bonds appear to be overbought.

Commodities - Indicators for gold and oil appear to be on the verge of giving a buy signal.

Currencies - The CAD$ and euro are on the verge of a buy signal versus the USD.

The US Banking Index and Financial Services Index have reached higher highs for the first time in a year. The long-term oscillator for the BKX is also stronger than it has been since early 2007. The July low could represent a significant turning point in this sector, the US bear market and the current financial crisis.

The long-term oscillator for the TSX is still very oversold. Usually it makes a V bottom as you can see. No indicator is perfect. Although the Buy Signal was premature when it turned up on Aug. 25, time will tell if it will still be accurate in the longer term.

The same comments can be applied to the TSX Energy Index. The indicator is still positive, in spite of last week’s setback.

After a sharp decline, gold stocks are still in the bottoming process. See the gold bullion chart below.

Government of Canada (GOC) bonds are overbought in the short term. This does not necessarily imply a decline. However, the best buying point for any asset is when it is very oversold like it was a few months ago or in mid 2007 when they were fully oversold just before the subprime mess was revealed.

The Indicator will likely issue a buy signal by the end of this week if gold can hold at these levels or higher. This would be positive for gold stocks and the TSX. It has not turned up for silver yet.

The oscillator is just on the verge of issuing a buy signal for oil and natural gas too.

The trend chart for gold turned negative five weeks ago.

The long term trend chart for oil turned red well after the July 18 special update stating that oil was peaking at a price of $130.

The long-term oscillator for the euro vs. USD is on the verge of issuing a buy signal too. However, the oscillator for the euro vs. yen has not started to turn up yet. The oscillators indicate that the CAD should rise against the USD.