Buy natural resource and gold stocks for long term

by Larry Edelson on August 31, 2009 at 8:30 am

In my July 2008 Real Wealth Report, just 13 months ago, I warned my subscribers that the Dow Jones Industrials (DJI) — in real terms — had already lost 72 percent of its value when measured from its real, inflation-adjusted high of 14,198 in October 2007.

I also warned that … “The U.S. dollar is on the edge of the abyss.”

And that …

“The only way to truly understand the U.S. economy — what’s happening, why, and where it’s headed — is to look at asset prices in terms of gold, the world’s only real form of money.”

It is absolutely CRITICAL that you understand that last point, because I believe that concept is the most crucial information you need to know to financially survive and prosper — now and in the years ahead.

It’s also something maybe only 1 out of every 100 economists even considers.

As the U.S. dollar continues to crash and burn, the price of gold – the only true money – will increase in value.

But the simple fact of the matter is this: Ever since U.S. politicians severed the link between the dollar and gold, the only truly accurate way to analyze any asset price is to consider its historical cost in terms of gold.

That’s because, before President Nixon dissolved the gold standard in 1971, anything and everything you did in your business, in investing, even in your personal finances — could be converted into or exchanged for physical gold by simply requesting the gold from your bank or the U.S. Treasury.

That’s no longer the case. And that’s also why since 1971, asset values have exhibited much more volatility and wild price swings than they did before the United States went completely off the gold standard.

Don’t get me wrong. The gold standard had to go for a variety of reasons.

But understanding the impact that abandoning the gold standard has made on the world — ushering in an entirely new era of finance and economics — is so poorly understood, it simply amazes me.

Consider the following: The “real” value of the Dow Jones Industrials in terms of GOLD — TRUE MONEY, or what I like to call REAL WEALTH.

Suppose you had $10,000 of paper dollars (or digital dollars in your brokerage account) to invest in the DJI at the beginning of 2001 …

At the end of 2001, while your original $10,000 investment in the Dow was worth $10,021 — a gain of 0.21 percent — that paper money would have only bought you 38.5 ounces of gold.

At the end of 2002, your original $10k investment in the Dow would have been worth only $8,341.64 – a loss of $1,679.36, or 16.78 percent — and it would have only bought you 21.8 ounces of gold, 43.4 percent LESS gold.

Compared to 2002, in 2003 and 2004, the Dow actually slightly outperformed real money (gold), and would have bought you 25.9 and 24.9 ounces, respectively.

But then, look what happened to the real value of the Dow from 2004 on …

At year-end 2005, you would have been able to buy only 19.5 ounces of gold with your money invested in the Dow …

At year-end 2006, only 15.8 ounces …

At the end of 2007, only 13 ounces of gold …

At the end of 2008, only 10.4 ounces …

At the March 2009 low of 6,440 in the Dow, your investment would buy you only 7.08 ounces of gold, an amazing loss of 79.77 percent of the Dow’s purchasing power!

And if you think that’s bad, then consider this: At that March low, the Dow had lost a FULL 87 percent of its value since its all-time peak purchasing power of 54 ounces of gold.

You can check out the “real value” of the Dow in this bar chart that I have for you:

Pretty amazing, eh?

A few questions I’m already anticipating …

Question #1: Where does the Dow stand in terms of gold today, Larry?

A. As this column goes to press, the Dow Industrials-to-gold ratio stands at just over 10, meaning the Dow right now would buy about 10 ounces of gold.

That’s up from 7.08 ounces at the March low in the Dow, a gain of 41.24 percent, a pretty big gain.

Question #2: In your opinion then, has the Dow in terms of “real money” bottomed?

A. Before I answer that question, I want to digress a bit and take a look at the individual components: The Dow, in nominal values, has gained 48.7 percent since the March low, while gold has gained about 7 percent.

Why is this breakdown analysis important? Because it shows you that since March, the Dow has outperformed gold. Dramatically.

I expected that. Indeed, it’s one of the many reasons I turned bullish on the Dow in the middle of March, nailing the Dow’s bottom virtually to the tee.

My reasoning at the time: The median low point for the Dow/gold ratio since the world went off the gold standard in 1971 is a ratio of 5 to 1.

So I calculated that at 7 to 1, the Dow would have lost nearly 90 percent of its real value from its high on the ratio of 54 to 1, fulfilling the 1932 Depression style collapse, which was also a loss of 90 percent for the Dow.

The big difference between then and now: Back then, the world was on a gold standard. So the decline had to occur in nominal values which were the same as real values — since every dollar was fixed to a specific exchange rate with gold.

Today, we no longer have that fixed measuring stick. Today, we live in a world of oscillating values, floating exchange rates, and no fixed values for anything. We live in a world of relative values.

So any comparisons to the stock market of the 1930’s Depression has to be made not in terms of nominal values but in terms of real values, and namely, in terms of gold — the one asset that has always held its purchasing power, throughout the ages.

In fact, my long-standing theory has always been — coming full circle — that unless you understand that the assets can no longer be measured accurately in terms of nominal values, and that in a world of floating exchange rates, gold is the only true way to value assets — you are virtually doomed to being on the wrong side of major trends, time and time again.

So has the Dow bottomed in terms of gold, in terms of real values?

My answer, and uncommon forecast: Yes, it has. We have likely already seen the major low in the Dow in terms of its purchasing power, it having lost almost 90 percent of its value back at the March lows.

Does that preclude any further moves down in stocks? No, it does not.

But from a long-term investor’s point of view, I would no longer be shorting the Dow. Instead, I would be buying both select stocks — especially other tangible asset stocks like shares in natural resource companies — and gold, for the long term.

Best wishes,

Larry

P.S. Assessing real estate values in terms of gold is another very interesting analysis. At the peak of the housing market in March 2007, the median U.S. home price was $262,600, equivalent to 346.4 ounces of gold.

Today’s median home price is $178,400, or 188.4 ounces of gold. So in terms of nominal values, the U.S. median home price has shed 32.0 percent. But in terms of real money, gold, it’s lost a whopping 45.7 percent.

Even more interesting, since 1971, the average of the annual median home price in the U.S. is $73,333 (the annual median home price from 1971 to 2008, totaled, then averaged).

For the same period, the average annual price of gold is $349.

So for that entire period of 37 years (1971 to 2008) the average of the median home price compared to the average price of gold means that the median home price would have bought you 210.12 ounces of gold.

That ratio today is now 188.4, fully 10.3 percent below the average of the ratio for the last 37 years.

This is one of the reasons I forecasted a bottom in real estate prices in my June 29 column, a month ahead of just about everyone else.

Housing Market Stabilization on Track

by Mike Larson 08-28-09

Almost four months ago, I made one of the most dramatic shifts in my investment outlook ever. After warning — in advance — that we would experience a devastating housing and mortgage market crash … and after repeatedly refuting all the early — and wrong — bottom callers during the four-year collapse, I wrote the following in my Money and Markets column four months ago:

“It’s time to signal another important shift in my thoughts on the housing market. Namely, that the nexus of the real estate downturn is shifting and that the residential market is poised to stabilize in the coming quarters.”

I went on to say the market wouldn’t turn on a dime. My forecast: Home prices would continue to fall, but at a more gradual pace, while sales would gradually stabilize and inventory for sale would gradually come down.

So where do things stand? Do I deserve a passing grade?

Sales … Starts … Home Builder Sentiment?
It’s All Telling the Same Story …

Here’s a brief recap:

• New home sales rose 9.6 percent in July to a seasonally adjusted annual rate (SAAR) of 433,000. There were gains in three out of four regions in the country. Meanwhile, the raw number of homes for sale dropped to 271,000 — the lowest level going all the way back to 1993. And yet, median home prices were STILL down 11.5 percent year-over-year.
• What about the existing, or “used,” home market? Sales gained 7.2 percent to a 5.24 million SAAR. That was the highest since August 2007. The number of homes on the market is still way too high, but it did fall almost 11 percent from a year ago. Prices were off 15.1 percent.

Construction of single-family homes is trending upwards.

• S&P/Case-Shiller home price index? Prices are down 15.4 percent from a year earlier in June. But that was an improvement from the 19 percent rate of decline seen a few months ago.
• Housing construction? Everybody flipped over the fact that “headline” housing starts missed expectations in July. But the weakness was all in the multifamily (apartment, condo, etc.) segment. Construction of “core” single-family homes rose for the fifth month in a row, while permit activity shot up by almost 6 percent.
• Home builder sentiment? Another good number. The National Association of Home Builders index rose another point to 18 in August, the highest since June 2008. We saw gains in three out of four regions of the country.

I’d call that a pretty decent fit with my May 8 forecast. Most importantly, for investors like you, I said you simply had to get out of the way if you were “short” the sector. The easy money, as they say, had been made.

The Philadelphia Housing Index (HGX), which consists of 19 home builders, construction suppliers, and mortgage-services firms, closed at 93.97 the day my piece was published. It’s up about 16 percent since then.

That’s all history. But it leads naturally to the NEXT question …

Where Do We Go From Here?

I think in the short term, a lot of the good news has been priced into the housing sector. So I wouldn’t be surprised to see industry stocks stall. We may even be in for another bout of weakness.

Why? Near-term home sales have been “juiced” by the $8,000 first-time buyer tax credit. That credit is set to expire November 30, unless Congress extends it.

Buyers have been running ahead of it and snapping up more homes than they otherwise would. It’s just like what we saw with auto sales as a result of the popular “Cash for Clunkers” program. We’ll likely see a “hangover” effect once the government-fueled sugar high fades.

As for the underlying market itself, I expect to see continued pressure on home prices — though again, the declines will be more gradual than we had in the past. The most important factor is still distressed inventory. We still have too much of it, and we’re going to get even more because borrowers are falling behind on their loans at record rates.

According to the Mortgage Bankers Association …

The overall mortgage delinquency rate jumped to 9.24 percent in the second quarter of this year from 6.41 percent in the same period of 2008. That’s the highest delinquency rate ever recorded (the MBA data goes back to 1972).

More than one in four subprime borrowers is now at least 30 days behind on payments. But it’s not just the crummy mortgages that are going bad. More than 6.4 percent of prime borrowers are also falling into delinquency.

Another 4.3 percent of U.S. mortgages were in some stage of foreclosure. In plain English, that means more than 13 percent of U.S. loans are in some stage of distress (either being paid late or already defaulted on). That’s the worst this country has ever seen!

There was something else noteworthy in the MBA numbers. In its … er … infinite wisdom, the government has NOT tightened the screws on Federal Housing Administration, or FHA, lending standards. You can still sneak into a home with weaker credit and a down payment of just 3.5 percent using FHA, even as private lenders have abandoned such generous terms. That’s driving FHA’s share of the mortgage market through the roof.

FHA delinquencies continue to rise. So will Washington force taxpayers to dip into their wallets again?

Unfortunately, it appears that FHA delinquencies are now starting to rise. The delinquency rate jumped to 14.4 percent in the second quarter from 12.6 percent a year earlier. Are we as taxpayers going to be asked to cough up even MORE money to bail out the FHA insurance program a year, two, or three down the road? I suppose only time will tell. But I’m not exactly brimming with confidence.

Bottom line: The housing market appears to have put in a longer-term bottom when it comes to sales and a longer-term top when it comes to inventory. Prices? Not so much, at least not yet.

As for any recovery, don’t expect a rip-roaring rebound. This is going to be more of a gradual process that will take a long time, kind of like turning a battleship.

Until next time,

Mike

Market update Dow, S&P500, US Dollar and Asia Stocks

by Larry Edelson on August 17, 2009

I am now going to lay out my profit roadmaps for three key markets for the rest of the year.

But before I do, a short review is in order. So, let’s get started …

First, back in my mid-March column titled, “Early-bird Profits: Grab Your Share Now,” I made it clear — in no uncertain terms that …

A powerful, multi-month rally in the Dow Jones Industrials, the S&P 500, the Nasdaq, and the Hong Kong and Shanghai stock markets was about to begin

The U.S. dollar was topping out and headed back down in a long-term bear market

I reiterated my forecasts again in my March 30 column, “Your Next Profits.” Then, on April 6, I told you about another opportunity in my column, “Big Asia Rally
Coming.”

Most importantly, in those three columns I gave you multiple ways to get set up to profit from what I saw unfolding — a total of 12 suggestions, including U.S. stocks, foreign stocks, and a slew of ETFs.

End result: We‘ve closed out four of the recommendations — all winners, with gains of as much as 68.31 percent. The eight remaining open positions are all in positive territory, with gains as high as 53.34 percent.

Indeed, I figure if you had invested just a modest $2,000 in each of those positions, you would now be sitting on gains of as much as $7095.27, a return of 29.56 percent — in just five months!

That’s sweet, but is it sustainable? Are there more profits like that to be made in the months ahead? Specifically, through the rest of this year?

My answer: Of course! If you’re well-positioned, there are a lot more profits to be grabbed!

Now, let’s check out the profit potential by turning our attention to the cycle charts I showed you last March and April to see how they panned out, and then we’ll take a look at the updated cycle charts for each of the three markets I want to focus on today.

First …

The Dow

This is the cycle chart of the Dow I published back in March, which nailed the major March low right on the head.

Also notice how that chart projected a strong subsequent rally.

Now consider the updated cycle chart of the Dow (data date: August 12). I’ve expanded it so that you can see the March low, the market action since then, and the latest cycle projections.

Notice how the rally has tracked the cycle projection almost to the tee. Also notice that the blue cycle projection line indicates that the current rally should continue into mid-September, followed by a pullback into mid-October, and then a renewed rally thereafter.

A couple of additional observations …

The red line on the chart, called “a half-cycle” projection, is based on methods refined by cycle analyst J.M. Hurst. I use these half-cycle projections to either validate, or invalidate, the full cycle projections. In this case, the half-cycle projection nicely confirms a continued rally into mid-September.

The green dotted line you see is not cyclically-based. I merely drew it in to tie together the lows of the cycle projection going forward. The rising upward angle to this line indicates that any pullbacks should be shallow and within the context of an overall rally.

My view on this chart: Everything remains in place for higher stock prices into mid-September. Other technical indicators I use to gauge price levels suggest the Dow Jones Industrials should easily exceed the 10,000 level by then.­

I’ll get to how to play the continued rally in a minute. But before I do, and before moving on to the next market, the all-important U.S. dollar, let me pose a question: “What does the current projection for the Dow mean for the economy?”

Since my view is that stock prices lead the economy, it tells me we should continue to see improvement in the economy’s underlying fundamentals, including retail sales, consumer confidence, durable goods orders, real estate, and more.

That does NOT mean you should go out and bet the farm on the economy either in your business or your investments.

Far from it. All of the above simply means the economy and the stock market should be out of the woods, so to speak, for a while longer.

In fact, more intermediate-term research suggests the economy will be in relief mode and hence, so will stocks, until early next year.

Indeed, please refer back to my comments in my July 20 column, especially the section titled “Surprise: Unemployment Should Be Peaking“ — another forecast which seems to have come to pass with the recent tick down in the unemployment rate, the first downtick in 16 months.

Now …

The U.S. Dollar

Here’s the Dollar Index chart
I published in my March 30 column, when I warned everyone that the dollar was still in a long-term bear market and headed much lower.

This was NOT a cycle chart, but merely my interpretation of the technical chart action in the buck.

Now, here’s an update of the above chart. Notice how overhead technical chart resistance in the Dollar Index repelled the rally back in March, and how the dollar has tumbled almost 13 percent since then.

That’s quite a steep drop in barely five months, and is characteristic of a market in a long-term bearish trend.

Now, here’s an updated cycle chart of the U.S. dollar. You’ll see that the dollar is likely at, or near, a short-term low.

But notice that going into September, the half-cycle and cycle projection lines seem to conflict with each other, before hooking back into synch in late September.

What kind of action does this portray for the dollar?

Likely that the dollar is not going be doing much over the next few months, except trading back and forth in a rather tight range, but within the confines of a longer-term, bear market, which will accelerate lower again in late September.

Next …

Asia

Here’s the chart of the FTSE Xinhua China 25 ETF (FXI) that
I published on April 6 and where I stated emphatically that “… my system signals point to a very large rally in Asian stock markets.”

Below is an updated chart of the FXI, showing the very powerful rally that has occurred since late March/early April.

My view based on this chart: Although China (Asian) markets are likely to pull back in the short term, massive technical support is building under the market, indicating Asian markets remain very healthy on a long-term basis.

Furthermore, once a pullback is out of the way, a renewed rally should begin in most Asian stock markets, especially China.

Here too, the cycle projection for the FXI confirms a pullback, some sideways trading, then yet another powerful leg to the upside.

So How To Profit From All This?

My suggestions, based on all of the foregoing …

A. Use pullbacks in the Dow to buy an ETF like the Dow Jones Diamonds (DIA). Or, if you already own it, consider adding to your position on a pullback.

B. If you haven’t done so already, use rallies in the dollar to get short the buck and/or hedge your dollar exposure.

A good vehicle for this is the PowerShares DB U.S. Dollar Index Bearish Fund (UDN) — an ETF that replicates the performance of effectively being short the U.S. dollar by investing in currencies such as the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.

C. Use the next pullback in Asian markets, which is likely occurring now, to position yourself for the next rally via an ETF like my favorite China play, the iShares FTSE/Xinhua China 25 (FXI). If you already own FXI, consider using the pullback to add to your position.

Next week, updated projections for gold and oil!

Best wishes for your health and wealth,

Larry

Economic Cycles

by Larry Edelson on August 3, 2009

Wow, what great markets we now have, eh? Many are in the best trending modes they’ve been in months, while others are in well-defined trading ranges, swinging nicely back and forth.

Either way, they’re handing you numerous profit opportunities and opening up loads of new ones to boot.

Consider, for instance, the big gains you should have grabbed per my Uncommon Wisdom column last week — where I suggested you to take your profits off the table on the Chinese and Asian stock picks I recommended back in March and April of this year.

The gains turned out even larger, like …

68.31 percent in Aluminum Corp. of China (ACH)

57.51 percent in iShares FTSE/Xinhua China 25 ETF (FXI)

39.71 percent in PetroChina (PTR)

34.46 percent in Posco (PKX)

30.56 percent in US Global China Region Opportunity Fund (USCOX)

28.52 percent in Korea Electric Power (KEP)

27.17 percent in CNOOC Ltd. (CEO)

10.11 percent in Huaneng Power (HNP)

All grabbed last Monday, just two days before the Shanghai Composite CSI 300 plunged nearly 7 percent. Now that was great timing!

Or, consider gold, which is starting to follow my short-term forecast unable to bust through overhead resistance at $959 — and instead, starting to slide in a potentially sharp, swift decline that could see gold fall as low as $808 over the next couple of months.

Or, consider the U.S. stock markets, which are also on track with my forecasts — the Dow now having reached as high as 9,246, and despite an occasional pullback, on track to rally even higher.

How have I been able to get such forecasting and timing uncannily accurate?

Mind you, I’m not always this accurate. No one has a perfect track record, a crystal-clear crystal ball. In fact, no one has a crystal ball, period. There is no such thing. And I make no presumptions that I have one either.

Even so, let’s have some fun and use the crystal ball analogy.

Suppose you wanted to create a crystal ball for your investments and trading.

Suppose you want, like all of us do, to acquire a better understanding of the markets, and especially, better timing for your investments.

Then where would you begin in building your crystal ball?

I propose that your crystal ball is made up of three crystal balls (alternatively, you can call them “Rules” if you like) …

Crystal Ball #1: A completely empty crystal ball, devoid of all preconceived notions about the markets.

To truly understand the markets, and, to acquire better timing, it is absolutely essential that you clear your mind of all preconceived notions about the economy and markets.

Put another way, be completely and thoroughly open-minded.

For instance, just because the Dow has not plunged to 1,000 — or soared to 100,000 — doesn’t mean it can’t happen. It can. In fact, it’s entirely possible the Dow can do both — plunge to 1,000, and then soar to 100,000.

Likely? No. And it’s not a forecast I’m making. I am merely pointing out that when it comes to the markets, the best way to approach them is with a completely open mind, with no presumptions about what they can and can’t do.

If you implement this rule, or use this crystal ball, you can start listening, truly listening to what the markets are saying, with zero biases.

Crystal Ball #2: This one is loaded with question marks floating around in it. Meaning, you should question everything you read or hear about the markets.

After all, if you want a sure way to lose money, then listen to CNBC, or any other business/market news and media out there. They are as poorly educated when it comes to economics and the markets as the majority of brokers and analysts on Wall Street.

For example, consider all the recent talk in the media about how rising interest rates would kill the economy and the stock market. As if it’s etched in stone or some sort of biblical rule about the relationship between interest rates and stocks.

But question it, and you’ll find out something entirely different: MOST BULL MARKETS IN THE ECONOMY AND IN STOCKS OCCUR WITH RISING INTEREST RATES, NOT FALLING RATES.

Exactly the opposite of what Wall Street likes to pound into your head.

Or consider an equally common but also incorrect premise that gold, and other commodities, only do well when the dollar is falling. Not true, at all. Just look at the period from January to April of this year, when both the dollar and gold were rising together!

There are many market myths out there, perpetuated by the media and largely inexperienced analysts.

Bottom line: Question the market analysis you’re hearing from the mainstream media. And, to the extent possible, do your own homework.

Otherwise, you are almost certain to lose your shirt.

Crystal Ball #3: This crystal ball takes a scientific and truly unbiased historical approach to the markets and your investments.

If there is anything remotely close to a crystal ball for market forecasting, and for timing both short- and long-term trades, in my opinion, it’s the science and study of cycles.

A discipline that’s largely been ignored by Wall Street yet is certainly one of the most scientific, objective, and tried and true forecasting methods of all.

As I told you a couple of weeks ago, I’ve been studying trading and economic cycles for more than 30 years, and have frequently worked with data from the pre-eminent think tank on cycles — the Foundation for the Study of Cycles, a non-profit organization.

The Foundation’s roots date back to 1931 when President Hoover asked Edward R. Dewey, the Dept. of Commerce’s Chief Economist Analyst, to determine the causes of the Great Depression.

And because this is the most important of the crystal balls, I want to give you a primer on the science of cycles — to make sure you have an understanding of the broad concepts of economic cycles.

In future issues, I’ll give you a more in-depth look, bringing the science down to the trading level, showing you how cycles can even fine-tune short-term trading.

What Are Economic Cycles,
And Why Are They So Important?

We’re all aware that cycles exist. We can easily see cycles in the physical world — just by observing the tides, the seasons, weather patterns, and more.

And in our business lives, we often talk of intangible cycles such as the sales cycle, the inventory cycle, or on a broader plane, the business cycle as it relates to an industry you might be involved in.

But what exactly are economic cycles and how valid are they? Are they true rhythms of human behavior driven by mysterious forces that are real and bigger than all of us?

My view: Long-term economic cycles — periodic and often predictable rhythms in the history of civilizations — are the result of collective human behavior, mass psychology if you will.

They are part and parcel of society and the history of civilization. And they are the driving force behind all economies, markets, and changes — especially the tidal wave shifts that can occur — in society.

Broad economic cycles are also often as concrete and measurable as the changing of the tides or the seasons in a year. And without having at least a basic understanding of cycles, society is often doomed to repeat the mistakes of the past.

Indeed, we all know the expression “history repeats itself.” To be sure, there are loads of historians devoted to the study of particular countries and periods in the past.

However, there are very few economists who take their studies to the next level, seeking to understand the cycles — the mysterious forces that seemingly cause history to repeat itself.

But given the times we are in, understanding the basics of cyclical analysis as it relates to society, to the history of civilization, to the markets, and to the timing of investment decisions couldn’t be more important.

Before I go into the actual cycles themselves, let’s start with the three basic technical terms you need to know about cycles; and to make it easier for you, I’ve constructed a chart so you can visualize them.

The terms are …

1. Periodicity: Often referred to as frequency, periodicity refers to the timing of cycles, quantified as their duration from a high point in a series of economic data to a subsequent high, or the trough of economic activity to the next trough. (You can think of this like the cresting of ocean waves, which occurs at regular, periodic time frames.)

2. Amplitude: Essentially a mathematical measure of the magnitude of change in the data of an oscillating variable, above or below its trend line. Put simply, it’s the strength, or power, of a cycle.

3. Phasing: Indicates whether a cycle is arriving on time based on its periodicity and a beginning reference point in a time series.

Of course, there’s much more to cycles than these three basic terms. In fact, there is a whole field of elaborate mathematical and econometric analyses that are performed on large volumes of data to isolate and confirm cycles, including measures of statistical probability, such as Fourier analysis and the Bartels score for a set of data.

But there’s no need to go into all of that here. It’s way beyond the scope of what I want to accomplish in this issue.

Now, here’s the premise behind economic cycles: They are more than just mere fluctuations in economic activity; they are statistically significant oscillations of human behavior consistent and powerful enough to impact an economy in its entirety.

With that said, we’re ready to move on to the most important cycles you should become familiar with …

The Short-Term Business Cycle:
The Kitchin Cycle

First uncovered in 1923 by economist Joseph Kitchin and published in a Harvard University Press article titled “Review of Economic Statistics” — what is understood today as a typical business cycle is a predictable and statistically significant cycle of 42 to 54 months in duration, comprised of a pattern of alternating periods of economic growth (recovery) and decline (recession). It is typically characterized by four basic phases:

1. Economic peak

2. Contraction (recession)

3. Trough

4. Renewed expansion

Graphically depicted below, the time frame for each period varies depending on underlying market variables, such as consumer sentiment.

The rise and fall of each period within the business cycle is generally measured via a country’s gross domestic product (GDP) and is quite obvious to most. In the United States, the National Bureau of Economic Research (NBER) is the final arbiter of the dates of the peaks and troughs of the business cycle.

The next two cycles to become familiar with are …

The Juglar and Kuznets Cycles

In 1860, French economist Clement Juglar identified an economic cycle of eight to 11 years long, distinguished by three phases: prosperity, crisis, and inventory liquidation. The crisis phase showed the highest “amplitude.”

The Juglar Cycle is a major reliable economic cycle, comprised largely of several smaller business cycles, such as the aforementioned Kitchin Cycle.

More recent research has tied the Juglar Cycle into another cycle, discovered by Simon Kuznets in 1930.

The Kuznets Cycle is an infrastructural investment cycle of 15 to 20 years in duration and tends to help identify significant buildup and liquidation phases in the capital expenditures of businesses, including “panic bottoms” in a market.

Next …

The Long-Term Kondratieff Wave

Immensely popular, the Kondratieff wave — also called the long wave or K-wave — is an amazingly consistent long-term economic cycle of the modern world economy.

Russian economist Nikolai Kondratieff (also spelled Kondratiev) was the first to discover this cycle, publishing his research in his 1925 book The Major Economic Cycles.

Unfortunately, Kondratieff was banished to the Russian Gulag by Stalin in 1930 and later received the death penalty. Kondratieff’s crime: His view that capitalism and communism often vacillated and morphed from one to another, and importantly, that political leadership often had no powers to alter the cycle.

The Kondratieff wave averages 50 years in duration, but can range anywhere from 40 to 60 years in length. It consists of alternating periods of high economic growth and slower economic growth.

Unlike the shorter term Kitchin, Juglar, and Kuznets business cycles, the Kondratieff wave has repeatedly proven its regularity with major political changes in society.

The Kondratieff wave is generally divided into four “seasons” — the Kondratieff Spring (economic improvement) and Summer (acceleration into prosperity) … and the Kondratieff Fall (plateau, slide into recession) and Winter (acceleration downwards, depression).

The first stage of expansion and growth — the “Spring” stage — encompasses a social shift in which the present wealth, accumulation, and innovation create positive developments and advancements in society, accompanied by peaceful and steady economic growth.

In the next phase — the “Summer” stage — economic growth accelerates and begins to widen the gap between the haves and the have nots, creating production inefficiencies and tensions in society at large.

After this stage comes the plateau period of the Kondratieff wave — the “Fall” season of deflation. This period is generally characterized by recession and contraction.

Finally, the “Winter” stage arrives, indicated by the drop-off into a severe recession and eventually depression. Correspondingly, this sets off high volatility in markets and society at large.

The important turning points in the K-wave — and how they tie into changes in markets and industry sectors — can be seen in this chart I have for you.

Take a look …

1790-1849: Characterized largely by the Industrial Revolution

1850-1896: The age of transportation (steam and railways)

1897-1949: The age of steel, electricity, heavy engineering, and mass production (autos)

1950-current: Coincides with the beginning of the Cold War, but ironically characterized by the Information Age and telecommunications, peaking in 2000-2001 with a recession and a depression phase (or the “Winter” stage) beginning in late 2008

Another important long-wave cycle you should become familiar with …

The Schumpeterian Cycle of Innovation

Though not as widely known, Joseph Schumpeter is perhaps one of the most important cycle-based economists.

Writing in his 1927 paper, “The Explanation of the Business Cycle,” and in his seminal work Capitalism, Socialism and Democracy, Schumpeter is responsible for developing a business cycle theory that emphasizes innovation and entrepreneurship.

His cycle work was also the first to combine into a single model the four main cycles discussed above (the Kitchin, Juglar, Kuznets, and Kondratieff cycles).

Schumpeter contended that the cycles could often meld together based on their periodicity. As such, they would form a large composite wave that, at key times, could produce extraordinary amplitude in the composite cycle, resulting in major economic events of epic proportions.

In particular, he wrote that if the shorter cycles came into phasing with each other and in conjunction with the Kondratieff wave, disastrous slumps and consequent depressions could be explained, anticipated, and timed with a fair degree of accuracy.

Interestingly, Schumpeter not only foresaw the importance of the individual and of technological innovation in advancing an economy, he also recognized that in advanced capitalist economies, once a wave is over, entrepreneurship will cease to exist and will come to be replaced by socialism.

His reasoning: In advanced economies, when innovation and entrepreneurship has led to massive wealth creation, the less fortunate begin to despise the wealthier classes (even though the wealthy may have created the jobs that helped drive the economy forward). In other words, class warfare eventually emerges.

Capitalism’s collapse, argued Schumpeter, would come from within as social democratic forces usher in a welfare state … a heavy regulatory environment … and restrictions on entrepreneurship that burden and destroy the capitalist structure. This would eventually flatten both society and the economy.

Hmm. Pretty interesting theory, eh? I’d say so. And obviously, Schumpeter’s work is extremely relevant to what’s happening in the current economic environment.

We are seeing exactly what Schumpeter foresaw some 80 years ago: class warfare, socialist policies, a heavy government regulatory environment, and more.

According to Schumpeter’s model, we can expect depression, more socialism, and a flattening of society to continue for at least another 10 years, into the beginning of a Sixth Schumpeter Wave around 2020.

The Armstrong Cycle of
Economic Confidence

Perhaps one of the greatest living cycle theorists, Martin Armstrong, former Chairman of Princeton Economics International, has further refined long-term cycles, discovering what he calls the “Economic Confidence Model.”

Armstrong’s work is widely respected amongst researchers, despite the fact that he is currently incarcerated for matters unrelated to his research work and economic models, which have been widely sought after for use by governments around the world and even the CIA, due to their accuracy.

Armstrong’s work has accurately forecasted — often to the day — many of the major moves and shifts in markets, including …

The 1980 high in gold

The stock market crash of 1987

The 1989 peak in Japan’s stock market

Both the Asian financial crisis and the peak in broad U.S. stock markets in 1998

Plus, he’s made several uncannily accurate calls in the currency, commodity, and bond markets.

His “Economic Confidence Model” is a long-term cycle of 309.6 years, comprised of six sub-cycles of 51.6 years each, which can be subdivided into six shorter waves of 8.6 years.

Armstrong’s model is unique not only in its structure and remarkable accuracy, but also because of Armstrong’s interpretation of the model’s cyclical behavior.

For instance, Armstrong believes the cycles are symptomatic of great shifts between waves of confidence in the public vs. private sectors of an economy.

At times when a public confidence wave is on the rise, for example, investors, businesses, and individuals tend to believe in the power of the government to “fix” things … and, in essence, to direct and guide society.

During such waves, investments in sovereign bonds, municipal bonds, and virtually all investments tied to the government tend to do well.

Conversely, in waves where confidence shifts away from the public sector and back into the private sector, bull markets are seen in riskier assets, namely stocks and commodities.

At extreme points in the 51.6-year cycle, one can expect tidal wave shifts in the markets as well as in the size, shape, and form that governments take or evolve into.

Armstrong’s model is right on target: Years in advance, it predicted the peak in the real estate market would occur in February 2007.

Also well in advance, Armstrong’s model called for a major turning point in the markets to arrive in April of this year, which saw the kick-off of the current rally in global stock markets.

My Own Work On Cycles …

For more than three decades, I’ve immersed myself in the study of economic cycles, specifically the works of Dewey, Kitchin, Juglar, Kuznets, Kondratieff, Schumpeter, Armstrong, and others.

I’ve run extremely complex mathematical models and developed computer programs tracking literally thousands of years of economic data. This includes the analysis of individual markets — such as gold and silver — where a rich history of data exists. So I understand the significance of economic cycles on markets and investments.

And now, with these three crystal balls, you have the tools to better understand the markets. I also hope I’ve started you down the path of viewing the world in terms of cycles — to help you understand, cope, and even profit from the times we live in.

In future Uncommon Wisdom columns, you can expect more detailed cycle analysis, including shorter-term analysis as it relates to precise market timing and even entry and exit signals.

In the meantime, if you’ve taken advantage of any of the recommendations I’ve suggested in this column, hold them. And stay tuned for lots more action … profit opportunities … and more educational material on how to better understand — and time — the markets.

Best wishes,

Larry