A rerun washout?

Once again, fasten your seat belts. We still need a washout to set us up for a lasting thaw. Adam at goldversuspaper noticed the striking similarity between the pattern of the last few months with that of the 1937-1938 “second dip” crash in the Great Depression:

At first I did a double take and thought I was looking at recent history (with a projection of the next few months).

Just read his post for all of the technical reasons for this prognosis. He does a great job covering them. Basically, we are looking for a bottom of the wave 1 of C that started in July or October 2007. This should be the largest bottom to date in the bear market, yet we have not yet had the panic conditions necessary to scare away the premature bottom feeders and permabulls. Watch the volatility index (VIX) and the put/call ratio. When they spike, we are nearing an important bottom.

My candidate for the meaningless but newsworthy explaination/catalyst for this phase of panic is the trouble that western european banks have created for themselves with eastern european debt. I actually just returned from a visit to Kiev this week, where all of the restaurants and cafes suddenly became empty just a few weeks ago. Steel production is down by half this year, and apartment prices are down by 40% in just six months. Things have come to a standstill, the people are talking about revolution, and there is even the fear of another major war, but all is still calm for now. As elsewhere in eastern europe, the currency has crashed, but the housing, auto and credit card debt is denominated in euros or swiss francs. Ugly.

**Note: This post originaly stated that housing prices and steel production were each down by 2/3. A friend in the Ukraine sent me references for the revised figures.

The Dow:Gold ratio broke 9 today.

It just broke 10 yesterday. By the end of this bear market, one ounce of gold will buy the Dow, just as it did in 1932 and 1980. In the short-lived Panic of ’07, it only dropped to 2 ounces.

Gold is money, and in deflation, that’s what you want. I still think gold should fall to $600 or lower after this panic buying subsides and people need to sell it just to pay their bills and debts. Also, the reality of deflation hasn’t begun to set in yet — people are still looking in the rear-view mirror at inflation. A lot of gold bugs are going to bug out when their hyperinflation scenario doesn’t pan out soon. Their timing will be awful, because we will eventually (I’m talking years) get hard-core inflation after the new New Deal kicks in.

Real bear markets last at least three years

Is this a bear market? Are we in a recession? Let’s assume everyone can finally agree on those points. In that case, nobody should be looking for a bottom for at least another two years.

This is not 1987, nor 1998, nor 2004. Those short-term corrections did not entail full-blown global recessions and debt liquidations. They were mere technical blips, statistical noise to anyone but short-term traders. Today, with the credit markets frozen, home prices down worldwide, unemployment taking off, weekly bank failures, and corporate bankruptcies left and right, we can be pretty sure that there are some real reasons for the global decline in stock prices.

Historical precedents

The aftermath of a society-wide credit binge and speculative mania across all asset classes is best compared to the Great Depression of the 1930s, the earlier depression of the 1830s and ’40s, or the bursting of the South Seas and Mississippi bubbles in the early 1700s. Those respective bear markets lasted roughly 3, 6 and 60 years, so given the circumstances, we should hope for another quick and dirty depression like the 1930s. The most recent run-of-the-mill bear market, the dot-com bust, lasted from March 2000 to October 2002, a mere 31 months, and it was associated with only the mildest of recessions. Prior to that, we had the entire recession-filled period from 1966 to 1982, when the Dow swung wildly in a range for 16 years while inflation raged, resulting in a 75% real loss.

If you measure its age from the nominal peak, the current bear is all of 11 months old, an adolescent or young adult. I actually prefer to think of this as just the next phase down in the bear that started in 2000, since if you measure your assets in gold or a basket of currencies, US stocks never came close to regaining those highs. But then, I think the West is in for a long decline in standard of living, so even 8 years is early in this bear. It takes generations for a society to relearn the lessons of prudence, personal responsibility and laissez-faire that are necessary for sustained growth. Just ask the Chinese.

Here’s a century of the Dow in gold. Look like a bottom yet?

Click chart for sharper view. Source: chartsrus.com

Panic, hope, repeat

On a month-to-month scale, bear markets alternate between periods of panic and hope, appearing on a chart as a series of waterfalls and dead-cat bounces. We have been through two of each since October 2007, and the bounce out of the July lows appears to be rolling over, likely into the deepest sell-off yet (Dow 9000 by Christmas?). Early in the game as it is, after this plunge to new lows, the bottom-callers will emerge and the shorts will scramble to cover, and we could have a mighty rally, maybe 25% over several months, which would just serve to further demoralize buyers during the next leg down.

Real bottoms are lonely

When the bottom-calling stops and the market doesn’t snap back up from a plunge, but just drifts along in a climate of disgust with little volume or public interest, it will be time to think about going long again.