Larry Pesavento – Something Wicked This Way Comes!!!!!!

Markets around the world are getting hammered on a daily basis. This did not start in the USA. This week I want to review the other three major powers in the world i.e. China, Japan, and Germany. The Germans stock market has lost 28% in the month of August making it the worst August ever. Over the long weekend stocks all across Europe and Asia lost anywhere from 1% to 4%. Of particular interest on the European front were losses in the banking section. This is similar to what’s been happening in the USA. We do not know what is happening but something behind the scenes is very sinister. Believe me it is not the proposed lawsuit brought by the US government to recoup bad lending practices in the mortgage market. The good thing about technical analysis is that when prices are going down more people are selling and when prices are going up more people are buying. China and the rest of Asia were close to bringing us out of this quagmire but have also been in very strong downtrends since 2007. We have completed Gartley’s in the Japanese and Chinese markets, but if these fail i.e. go below the August 8th lows, we are looking at something similar to October and November 2008 when we lost Bear Stearns and Lehman Brothers. Remember Lehman Brothers was the largest bankruptcy ever up to that point. Should Bank of America not make it I think it would hold that record. I don’t want to be an alarmist but something is really scaring me when I look at these charts. The rally that we just had occur going into the new moon of August 29th was a perfect AB=CD pattern that could easily be seen on the charts and it existed on almost all of the indices that are watched worldwide.

Our next full moon occurs on September 12th one day after one of the most dark days in our nation’s history, the World Trade Center disaster. Let us never forget that day.

S&P 500 v Nikkei Lagged over 10 years

Treasury Bonds

This week I’ve included the 30 year chart on treasury bonds showing the dropping of yields over that timeframe. Personally I believe this is one of the best charts that you could possibly look at as it is perfect technically. We are coming to a top in treasury bonds i.e. higher yields should be on the way. There is a distinct possibility that we could make the final butterfly pattern at the 150 level of the 30 year treasury bond. As you can see from the weekly chart on treasury bonds we have already completed the major patterns and are just waiting for a turn. The fact that they view this market as a flight to quality is an absolute mystery to me. We cannot keep printing paper in the form of notes and bonds and expect the rest the world to take them. The only out is an instruction to the US dollar or a default on these bonds or possibly both. Don’t be lulled into the complacency of buying these bonds. I know they have gone up somewhat over this lack of quality issue but that’s also becoming a bubble. Please print out this chart over the 30 year time frame because it will eventually turn into one of the best investments i.e. short bonds and notes of the next decade. If I had a trade of the decade i.e. 2010 to 2020 this would be the one.

Precious Metals

It appears now that gold is going to try with, relatively ease it seems, to make new highs above $1925 per ounce. Technically it could make a three drive pattern near the $2000 per ounce level. Silver on the other hand is still lagging badly behind gold but it could play catch up if it gets above $44 an ounce, and that would mean an assault on the old highs at near $50 per ounce. Copper has completed a Gartley pattern we talked about recently and is ready to head down once again.

Foreign Currencies

The US Dollar despite the fact that many people have been predicting its abrupt end has been able to hold the critical 73 level which is the .786% Fibonacci retracement that we have been talking about for weeks. It’s not out of the woods yet but at least it’s looking a little better than it did just a few weeks ago. The Euro stopped exactly at the 1.45 level, as we mentioned in last week’s letter, and The Pound just barely missed our profit objective of 1.65 stopping short of that by just a few pips. Trouble is in Europe folks and it’s going to remain that way for some time. There are just too many fractions in the European countries that want to have their own agendas. What is most troubling is the fact that Germany, the fourth largest economy in the world, is dropping precipitously by the stock market. Remember that the financial pundits have been telling us that it was going to be Germany which held the European Union together and this is certainly not the case. It was the same folks that were telling us that Asia and China were going to bail us out of this economic predicament worldwide and that is also not the case. Something big is happening. If we do get some type of a crash scenario it will most probably start in the foreign currency markets. One of the things to watch are the spreads that occur between the major cross rates. For example the usual bedspread for the euro is one to two pips at most during normal times. This thread can move up to 10 pips or more quickly, and when that happens all hell breaks loose everywhere because money starts to panic. And we keep score with money.

Crude Oil

Crude oil came within a few cents of our target and has now sold off over 8% in a matter of a few days. Should crude oil drop below $75 per barrel it would mean it would be in an extended bear market and would take it into the mid-50s in my opinion which would be nothing more than a large correction from the move from $33 a barrel to $114 a barrel. On the other side of the coin if crude oil can get above $92 a barrel it has a chance to challenge the $100 level probably in a very short time. But as it stands now the market is in the bearish mode as we have had lower tops and lower bottoms which is the exact description of a bear market.

Technical Corner

This week’s focus will be on the contract for December corn which is growing as we speak. It is also referred to as new crop corn as it will be harvested sometime in late October. Corn is a perfect example of the valuable insights that can be gleaned from technical analysis. First, by using the formations tool in the ensign program you can easily see the AB=CD patterns that are formed over the past nine months. What is interesting is that they have the same characteristics in time as they do in price. Secondly, there also is a 75 day cycle that is repeated twice and has peaked at the exact time of the previous two cycles. When cycles peak at the right hand side of the cycle i.e. going longer to the upside it is referred to as right translation and is invariably bullish to the market. As you can see from this chart the third peak is forming as we speak and is due sometime in mid-September. By using the Fibonacci tool it is easy to say that the retracement’s entities cycles were 50% and 78.6% respectively. Finally we can look at the repetition in the corn market by watching previous retracements in the corn market as shown by the yellow boxes. The first three retracement’s were perfectly equal and the last retracement, that finished with a Gartley pattern in early July, was exactly twice the other retracements and stopped at the 786 retracement.

Other charts exhibit the same types and characteristics but this particular one in corn is a textbook example. Anyone unfamiliar with technical analysis are skeptical of its ability to help make good trading decisions, they should take some time and study these principles and then use them on other charts. The software we have available presently enables us to look inside the market and see the secrets it is trying to tell us.

Trade of the Week

We are still trying to buy the TBT which is the ETF for the long-term short 30 year bonds. However, this week we should stand aside as early indications look like we are going to start to the downside and possibly take out the August lows in the stock market. Because it is a short week the risk will be increased a little bit as we will have one less day see the pattern form. We are going to get aboard this when it’s ready, and it will be ready so let’s be patient and find what we feel is an ideal opportunity. Review the long-term i.e. 30 year chart on treasury bonds and you can see why this can be an exciting trade.

Final Thoughts

It is now universally accepted it seems that markets are going lower. And they are going lower all around the world as we stated in the early part of this letter. Remember that we will get short covering rallies along the way and hopefully they will match patterns that allow us to fit pretty good spots to get short. One thing to remember in bear markets is that when they gap up dramatically overnight and early in the morning in the USA they are nearly always short sale candidates. The reason for that is the Bulls are so beaten that they are searching for bottoms that last only a short period of time. It is also a known fact that bear markets open higher usually and bull markets open lower. So don’t be afraid of higher openings along the way. However, you must be aware that sometimes these bottoms can last several days or weeks.

We are going lower, in my opinion, into at least mid October where we have some very nice cycles nesting that are usually associated with bearish formations. October happens to be one of the more predictive months for lows, the other being September.

On my trip to Asia in October 2010, I was interviewed by the Hong Kong Financial Press, the topic was the bearish butterfly pattern in the Hang Seng index at that time, as it turned out it was the high day. The moral of the story is that the patterns work but it is also helpful to be lucky rather than being smart. This was published in the Sunday Issue.

Uncharted Water!

As most of you are now aware Standard & Poor’s downgraded U.S. Treasury debt rating from AAA to AA! The other two agencies Fitch and Moody’s did not follow through as yet. This has never happened in our 200+ year history of our country. How the markets react to this will be interesting to watch but no one really knows how the rest of the world is going to react to this. Mr. Buffet from his home in Omaha said that government debt was still AAA in his opinion and Standard & Poor’s have made a bad mistake. Japan also downgraded their debt several years ago and although it caused short-term gyrations in the market nothing really came of it. Keep in mind it is a long way from AA to junk bonds. However, if we keep going in the direction we’re going it won’t be long until they will be considered junk. I’ve enclosed a mock front-page cover of Time Magazine showing the 200 day moving average and how it has been broken.

The lunar cycles have been looking very good since February 21st but have not worked over the last two cycles. There are some Astro points coming in on Monday, August 8 and Tuesday, August 9. But the big one to look for is “combust” on August 17th. In addition there are six other aspects around the state that should cause for a major trend change at that point! It is too early to determine whether it will be a high or low at this time. Most of the price objectives have not been met on a short-term basis from the head and shoulders pattern we’ve been talking about for the past several weeks. Markets are grossly oversold and are looking for any positive news to rally around. We must watch this rally very closely because the markets are screaming that they want to go lower in the longer run of things. This market is beginning to look more and more like 2008. There are major cycles occurring in the third week of October of this year that make it one of the more important turning dates and October is typically the strongest month for bottom.

Treasury Bonds

Downgrading in treasury bonds will be interesting to say the least. Martin Armstrong the famous economist from Princeton econometrics says that the bonds have nowhere to go but up. His reasoning is that the world is awash in cash and they have to put it somewhere and since the Bond volume is ten to one to that of stocks, bonds will continue to rally. That certainly doesn’t make any sense to me because bad money chasing bad money is still bad money. Sunday night on August 7th treasury bonds are down about one half after the downgrade. The S&P is down about 30 points i.e. equivalent to 200 points. Where will the flight to quality be next? Must be in gold as it is more than $25 higher Sunday night.

Foreign Currencies

The US Dollar is still trying to hold the 73 level. If there was ever a reason for it to fail it has it now due to the fact of our downgraded treasury debt. Remember if we PAY our debt back with deflated dollars it is still being repaid. It is only the holders of our debt that are damaged. The $64 question here is how China is going to react to the massive amounts of debt they are holding. One thing to me seems obvious, and that is that they will not panic. They have already been planning for this or will plan for it in the future. I do not think this will cause a surprise in the market. But believing the old Chinese adage “may we live in interesting times” is certainly present now. By the way that is a Chinese curse in case you didn’t know.

Precious Metals

Gold appears to have a target of $1700 per ounce. Its step-sister silver is still lagging the market badly and cannot make higher highs on Friday and Sunday night trading. Open interest and volume is not telling us that we are looking at a new swing high in silver for some time. Copper sold off from the 786 level following stocks down last week. Copper held up relatively well during the first few weeks of the decline but the selling of stocks overwhelmed the copper market and down it went. Copper is very oversold but still looks like it has a long way to go to the downside. What’s interesting about the gold and silver market is the fact that the XAU (gold/silver index) is extremely bearish and has come off the 786 retracement with a vengeance. This is a bearish pattern and certainly looks like it has far to go to the downside, however at this time it is very oversold. We will be watching for a rally to get short this index should one develop.

Crude Oil

Once the crude oil market broke the $94 per barrel level it collapsed. Price objectives in the low 70s can easily be seen from the charts. This is a deflationary scenario for the economy. What is amazing is the lack of correlation between crude oil i.e. black gold and the yellow metal, as they usually have a strong correlation due to inflation. This is another indication that we might be looking at deflation as opposed to inflation.

Trade of the week

Given the uncertainty of what’s going to happen this week it is best to wait to see what unfolds the first few days. We are currently long the SDS double short S&P ETF, have a put on the butterfly pattern in IBM for October, and are short Ryder Systems because of the three drive pattern of the transportation index. These are showing profit so I would suggest holding on because they look like they could turn even more profit down the road especially into October.

Technical Corner

This week I featured a chart of the Kondratieff Wave Structure. This explains economic theory over a period of 60 year cycles. As you can see it has been relatively accurate through 2000. Since 2000 our start marker has gone nowhere. We are basically at the same price we were in January of 2000 as we are now. That is zero return. That is not a good sign of economic activity. My personal opinion is that we are getting ready for another leg down in a stock market that will be as bad if not worse than 2008. The Federal Reserve put $2 trillion to stimulate the economy and nothing happened aside from them helping the banks. Unemployment is still very bad and shows no sign of getting any better. The recent volatility in the stock market is also reminiscent of what happened in October of 2008 shortly after the bankruptcy of Lehman Brothers and the fall of Bear Stearns. Remember the market did not bottom until five months later in March of 2009. The banking index and financial index had horrible looking charts and it’s hard to believe that we can have a bull market with charts looking this bad.

This is a shorter edition of the letter due to travel back to the greatest country in the World — The US of A!!
Stocks around the world are setting at critical levels in nearly every major country, notice the patterns and Fibonacci levels on the charts. What is most troubling to being bullish is the rate of recent down coming out of Europe and Asia. It is actually must faster than in 2008! Keep in mind the markets around the world have been in bear markets since 2007. The key low to watch, in my opinion, for the U.S. markets is August 27th, 2010. On this date stocks began one of their strongest bull runs in 7 decades. If this low is taken out it is LOOK OUT BELOW for stocks. As we prepare for next week’s trading the eyes of the world will be watching the August 9th low but it is Europe and Asia where the eyes should be focused as this is where the problem started for the bulls. Asia was supposed to bail the world out of recession (along with helicopter BEN) however it has not happened. If markets are sharply lower today then they have the potential for a meltdown. They must go below the August 9th bottom for this to happen.

Treasury Bonds

This market has been a bull market longer than anything I can remember in my 50 year career. As you can see by the 30 year chart from 1981 each low i.e. interest rates has been lower than the previous one. Interest rates are ready to move higher but given the fear around the world another high is possible. We must be very close because I am frustrated by being stopped out twice in the TBT, so reluctantly I will stand aside for a week. The most amazing chart to me in the treasury arena is the ETF for treasury notes, TLT. If you examine the t-note chart and compare it to the TLT chart you see 2 entirely different pictures as the ETF has barely rallied to the 618 whereas the notes have all time historic low yields (higher note prices). I have tried to rationalize this discrepancy but have been unable to do so.

Foreign Currencies

The U.S. Dollar reached a historic low against the Japanese Yen this past week by going below the 76.50 level. The U.S. Dollar Index continues to hold above the 786 level of 73.00 but could easily drop below and set a move to 68.00. The odds favor a drop in the EUR/USD and GBP/USD which would mean a higher dollar.

Precious Metals

Silver made a 618 rally high to $42.90 this week and could easily make $46/oz if gold continues its parabolic rise. One thing is certain from a technician’s point of view – PARABOLIC MOVES END LIKE THEY START IN EVERY SITUATION! (the only exception is Hong Kong real estate, so far!)
I will send a special updated letter on August 25th, the anniversary of the high in 1987 which led to the crash in October 1987. The U.S. stock market dropped 16% on that fateful day of the 19th of October now know as BLACK MONDAY!