Get Ready For A U.S. Double Dip Recession

In my view, it's becoming increasingly likely that we're rapidly heading towards a double dip recession.  It won't be tomorrow or this week or even next month, but many warning flags point towards significant deterioration in the U.S. and global economy going forward and so I think that by the end of the year or early 2011, we could very well be facing a new leg down in the world's economic situation.

We'll take a look at some of the factors at work but first let's take a look at the past week and where we stand at Wall Street Sector Selector.

Looking at My Screens

Obviously the volatility that has come back into the markets in recent weeks was in play last week as the Dow experienced its third worst drop of the year on Friday, fast on the heels of Wednesday's rocket ride up.

This week's action took our Standard, 2X and Option Master Portfolios to 100% cash as we took profits and cut losses during the week.

Currently our portfolios look like this year to date:

Sector Selector Standard:                  +7.5%

Sector Selector 2X:                              -17.8%

Sector Selector Option Master:      +47.1%

This week's positions were closed for the following gains/losses:

VXX:                    +50.3%

EFZ:                     +2.8%

YXI:                      -8.5%

PSQ:                    -5.3%

EEV:                    +5.9%

SKF:                    -12.9%

DecemberS&P Put Option:   +29.7%

We remain in the "Red Flag Flying" mode, expecting lower prices ahead.  However, almost incredibly, our indicators are moving towards a new "buy" signal that we might see confirmed within the next days or weeks.

A quite likely scenario is a relief, short term rally through August-September, followed by further declines into 4th Quarter and next year.

Whatever happens, we will continue working both the "long" and "short" side of this market that remains unbelievably volatile and challenging.

The View from 35,000 Feet

This week's action was driven by conflicting forces but ended largely negative, with the S&P 500 unable to break through its 200 Day Moving Average.  As we've said before, this average is widely viewed as the demarcation line between bull and bear markets, and until or if the major indexes are able to sustain positive momentum above this line, we can consider that we are in a bear market, at least for the short term.

The big catalyst for Friday's sell off, of course, was the Non Farm Payrolls report that came in far weaker than expected at 431,000 versus a whisper number of 500,000.  Adding to the worries was the fact that only 41,000 of these new jobs were "real" private sector jobs, with most of the rest coming from temporary census workers.

Further worries were the Euro hitting a four year low, Hungary saying that their situation was "very grave," and less than robust reports in consumer spending, pending home sales and factory orders.

More troubling in my opinion was the ECRI (Economic Cycle Research Institute) report of its weekly index hitting a 43 week low and its annualized index hitting a 50 week low.  This is a highly accurate leading indicator of U.S. economic activity and points ominously towards the double dip recession that we've been considering.

Also at this week's G-20 meeting, Treasury Secretary Geithner called on the Europeans to adopt the "American fix" to current problems by increasing government spending and quantitative easing to stimulate growth but he was firmly rebuffed by European leaders who are going instead for deficit reduction and austerity programs over fiscal stimulus.

What It All Means

Looking over the past year's growth and stock market rally, we see a liquidity rally fueled by stimulus and various bailouts, and as those draw to a close, the question of the hour is whether or not this economic growth has become self sustaining or not.

Many experts expect a natural slowing as these programs are removed from the system and the situation in Europe can only be a tremendous drag on the global economy as the Eurozone retrenches and cuts their spending and consumption.

It seems that, unlike us, the Europeans are willing to take their medicine now and resolve their problems rather than "kicking the can down the road" as we've done in America.  Of course kicking the can sidesteps current pain but will only serve to make the "day of reckoning" worse because the piper will still demand to be paid.

The Week Ahead

Economic Reports:

Monday: April Consumer Credit

Wednesday: April Wholesale Inventories, June Fed Beige Book

Thursday: Initial Unemployment Claims, Continuing Unemployment Claims

Friday: May Retail Sales, June Michigan Sentiment Survey, April Business Inventories

Sector Spotlight:

Leaders: Short Financials, Short Europe, Short Small Caps

The Problem With Markets

Although I'm a long-time market-watcher, that doesn't mean I always believe what I see. In fact, one problem with relying on price trends and trading activity to try and gauge what's going on in the world and what might happen next is that "the crowd" is occasionally dead wrong, especially at major turning points.

That was the case back in the spring of 2007, when credit markets were priced to perfection — just as the financial world was poised to fall apart. Something similar happened in October 2007, when clueless equity traders ramped share prices to record highs even though it was clear that the economy and the banking system were spiraling into a dark abyss.

Another reason why market trends need to be assessed in light of other factors is because they can be affected by a variety of occasionally contradictory forces. For instance, sometimes foreigners will acquire goods or investments that locals believe are overpriced because the net cost in their own currency is less than they might pay at home.

People may also believe, as a great many apparently do nowadays, that those currencies and foreign assets that are risky in their own right are nevertheless a better bet than any of the alternatives — that is, they are the best of the worst.

That's one reason why the U.S. Treasury market has remained buoyant even though Washington is spending and borrowing money like a drunken sailor and wrecking the nation's long-term creditworthiness in the process. From the perspective, say, of a European who is worried about the burgeoning debt crisis in his own backyard, our market might appear to be a safe haven.

But as The Economist's U.S. business editor suggests in a Yahoo! Finance Tech Ticker story (and video report), "'Longer-term Issues for America Are Really, Really Serious,' Bishop Says," such a perspective is dangerously short-sighted.

While the U.S. dollar and Treasuries are benefiting near-term from Europe's fiscal problems, Bishop anticipates tough times ahead for both America and Europe. "It's going to be a horrible roller coaster in Europe. There's going to be a lot of political stresses and strains," he says.

Meanwhile, Bishop remains skeptical a new Congress after the November mid-term elections will yield a return to fiscal discipline in the U.S. "The longer-term issues for America are really, really serious," adds Bishop, co-author of The Road from Ruin: How to Revive Capitalism and Put America Back on Top.

 

Unicom’s UniStore Coming Soon

The second-largest Chinese carrier, China Unicom (CHU: 11.59 -0.36 -3.01%), is set to launch its online mobile application store "UniStore" in June 2010, according to a company official. The store will feature applications based on the carrier's "Uphone" Android handsets which were introduced in January 2010.
China Unicom began trial operations of UniStore in February 2010. The online store has been designed to resemble Apple Inc's (AAPL: 255.965 -7.155 -2.72%) App Store in China. UniStore currently has more than 780 mobile applications (including mobile themes, games and entertainment and system tools) which are categorized into two groups, namely, freeware and paid applications. Besides Android, the store's applications support other leading mobile operating platforms such as Windows Mobile, JAVA, Linux and Symbian.
While UniStore has been able to pile up a vast pool of applications, it still lags China Mobile's (CHL: 46.4225 -1.2075 -2.54%) "Mobile Market" and China Telecom's (CHA: 44.47 -1.18 -2.58%) "eStore" online stores, which boast roughly 18,000 and 1,250 mobile applications, respectively.
The recent buzz on online application stores follows the success of Apple's App Store. Following a similar model, Chinese carriers are aiming to profit from premium value-added services and data services enabled by the 3G networking.
The maturing vanilla voice market has become less significant for the carriers due to the emergence of lucrative data and information services. However, given the availability of free applications on the Internet, it will be a tough task for the Chinese operators to convince customers to buy from their stores. So, it will take some time to develop a comprehensive ecosystem in which carriers, application developers, device makers and subscribers realize the significance and growth potential of the online mobile application marketplace in China.  
UniStore will largely support the adoption of Uphones, which represent China Unicom's second biggest opportunity (besides iPhone) in the 3G handset market. Uphone, which has been designated as a major national project by the Chinese government, competes head-to-head with China Mobile's Ophone Android smartphones. The three big Chinese carriers are banking heavily on the booming market for Android smartphones to boost their respective market shares.
While China Unicom will initially offer customers free downloads through UniStore, it plans for a smooth transition to a paid download model for select applications later. To entice application developers, the carrier plans to offer them a 30% share of profits from UniStore.

From The Archives: Lessons From Coach Wooden

I can not properly express how much I truly admire John Wooden. I cherish his approach to life. With his passing yesterday, my respect for him as a man dictates that I rerun this commentary and video which I originally posted last November. The world and our country need more men like Coach Wooden. May he rest in peace as he is reconnected with the love of his life, his beloved Nell. I hope you will ponder John Wooden's message in the embedded video and incorporate his principles on life into your lives. The greatness of John Wooden will live forever. LD

The measure of real value is whether something can stand the test of time. While certain individuals, products, or principles appreciate over time, others dim as time passes. Society also has a funny way of embracing new and valued concepts in an attempt to market and materialize definitions of happiness.

In the midst of the noise and volatility of our current financial market and economic landscape, I treasure those principles which are often overlooked and under-appreciated. These principles include: discipline, simplicity, selflessness, loyalty, drive, humility, relationships, integrity, love. While without being judgmental it is not difficult to identify individuals or situations lacking these timeless traits, how often are we able to identify individuals or situations embracing these characteristics?

This morning, I witnessed just such an individual. Who might that be? My favorite coach of all-time, John Wooden. I have not only read most of Coach Wooden's works, but I have had the good fortune of chatting with one of his former players, Gail Goodrich  (UCLA '65, 14 year NBA career, Basketball Hall of Fame inductee '96), about Coach Wooden. While I wish I knew Coach Wooden personally, I cherish the character of the man. In fact, in this day and age of immediate gratification, John Wooden's lessons should be highlighted as a path to long-term success and happiness.

As we collectively navigate the economic landscape and look for examples and exemplars of 'how then shall we live,' John Wooden is a great model. I welcome sharing a video clip recently produced of this 99 year old marvel. I hope you enjoy it as much as I did. In reviewing it, I hope you can see that Wooden's love story is not merely a sweet tale of an elderly man. Look deeper and see that Wooden is providing insights and lessons on life itself.

If you care to learn more about the greatest coach ever, check out Wooden's book, They Call Me Coach, which I have highlighted here at Sense on Cents from the very first day I started this blog. That's how highly I think of Coach Wooden.

A Look At Deflationary Forces And Historical Market Corrections

With a weak employment report on Friday, problems in Europe, and financial markets in a precarious technical condition, it is helpful to review similar historical stock market corrections. From a fundamental perspective, our present day concerns relate to deflationary forces in the global economy. Unlike the U.S., which can expand the supply of dollars relatively easily, printing euros is more difficult since each member of the European Union has its own tax and spending policies. Printing euros may help the people of Greece in some ways while diminishing the purchasing power of German savers. The situation and possible longer-term outcomes in Europe lean toward the deflationary camp, which is not good for asset prices. Continued high unemployment in the U.S. is also contributing to deflationary forces. Diminished demand for goods and services leads to lower pricing power for those selling goods and services. Asset markets want and need positive inflation in the current environment; recent events have increased the probability of longer-term deflation. The question of the day is will these deflationary forces derail the current bull market? A review of current market internals vs. history may give us some insight.

 

As shown in the table below, corrections of similar magnitude to what we have seen thus far in 2010 have been followed by rallies of some significance.

 

The CCM Bull Market Sustainability Index (BMSI) was developed to help better discern between a correction within a bull market and the possible onset of a new bear market. CCM BMSI scores are shown for the historical periods and current period in the table above. Current CCM BMSI scores continue to correspond to corrections within the context of an ongoing bull market, rather than those associated with the onset of a new bear market. Further market deterioration could occur, but for now the condition of the market's internals remain bullish for the longer-term from a probability perspective.

As all the historical examples shown here illustrate, there is a difficult and fine line between selling to protect principal and selling just before a substantial rally. Like 2010, in 1989 the slope of the 200-day MA was positive.

 

In 1996, the slope of the 200-day MA was positive during the correction.

In 1997, the slope of the 200-day MA was positive during the correction.

In 1999, the slope of the 200-day MA was positive during the correction.

In 2000, the slope of the 200-day MA was positive during the initial correction off the bull market high, which allowed patient investors to reassess risk at higher levels.

 

In 2004, the slope of the 200-day MA was positive during the correction.

The Slope Of The 200-Day Can Be Significant

Our models and research align well with some interesting facts about when the market crosses below its 200-day moving average (which occured recently in May 2010). Conventional wisdom is that a break of the 200-day MA is bearish, but that is not the case if the slope of the 200-day moving average is positive (line is rising - as it is now in 2010). Some good stats were presented in an article posted on istockanalyst.com

:

Ned Davis Research tells us that since 1946, there have been 64 cases in which the S&P 500 has crossed below its 200-day moving average when the MA was rising. But instead of the market going to heck in a hand basket as most investors would probably expect, two weeks later, the S&P has been higher by an average of +1.0%. The key point here is that this is actually BETTER than the buy-and-hold results for all 10-day periods of +0.5%. After crossing below a rising 200-day moving average, the S&P has been higher by +1.7%, which again is better than the +1.0% average for all the one-month periods since 1946. Even three months later, the market performs BETTER after it has crossed below its rising moving average as the S&P has posted gains of +3.6% versus the buy-and-hold returns of +2.2%.

While our long-term market models still remain bullish, it is prudent to have a detailed exit strategy in place should the markets deteriorate further. High debt levels in Europe and high unemployment in the U.S. are deflationary forces that need to be respected and closely monitored.

 

Why Gold Could Soon Go Above $5,000, And How You Can Profit From It

The gold bull is unstoppable.

Gold prices are up fourfold since 2001 and hit a new record high near $1,250 an ounce on May 14. But they're still nowhere close to finished.

In fact, another four-fold increase could be in the cards.

It sounds like a gold bug's dream. But looking back to the last inflation-adjusted peak price in 1980, it's far from impossible that the gold price could soon go above $5,000.

Increased demand for gold along with dwindling supplies (there's a reason it's a "precious" metal - there isn't much of it!) are creating a perfect storm: a storm that could send gold to unprecedented highs. Read on to learn the case for $5,000 gold… and for four specific ways to profit.

Forecasting Skyrocketing Gold Prices

A recent survey of more than 75 gold market experts by David Bradshaw, editor of the brokerage newsletter Real Money Perspectives, found that most see gold topping $1,500 an ounce in the not-too-distant future, with $2,000 not far behind.

Even a few who are cautiously pessimistic, like Goldman Sachs Group, Inc (GS: 142.25 -1.79 -1.24%), which last month cut its 2011 gold price outlook, still foresee higher prices - Goldman's new estimate is $1,350 an ounce, down from $1,425.

It's easy to see why so many analysts anticipate higher prices. The European debt contagion that's being driven by Greece, Spain, Portugal, Ireland, and Italy - collectively referred to as the PIIGS - has weighed the euro and undermined confidence in the European banking system.

In fact, the euro - which has fallen below $1.25 - could be in danger of failing as a currency.

Investors are rushing into gold to hedge against the Eurozone's financial turmoil. And because that the euro is the reserve currency for many nations, its drop in value translates to a higher price for gold purchases made in euros. Both these catalysts will continue to bolster gold prices until the underlying issues are resolved.

However, several other factors also contribute to gold's price movements, and most appear biased to the upside for the near future…

Supply and Demand

The earth has a finite supply of gold, and the increasing difficulty involved with retrieving the yellow metal is making it steadily harder to keep up with demand - especially since some long-time production leaders are now exhausting their reserves. South Africa, for example, produced 74% of the world's new gold at the turn of the century, but that has now dropped to 19%.

Estimates put the world's existing stock of processed gold at 160,000 metric tons, with about 2,400 tons being added each year. That amounts to a growth rate of just 1.75%, well below the worldwide increase in demand (though recycling of "used" gold, which accounts for about 30% of new supply each year, helps offset some of the imbalance).

Cumulatively, recent demand has outstripped supply by more than 1% a year, and that rate is accelerating - in part due to the introduction of exchange-traded funds (ETFs) that back their shares with stores of physical gold. The three largest - SPDR Gold Trust (GLD: 119.19 +1.23 +1.04%), iShares Gold Trust (IAU: 119.29 +1.28 +1.08%) and ETFS Physical Swiss Gold Shares (SGOL: 121.41 +1.17 +0.97%) - now hold nearly 1,400 tons of gold, or more than half of annual production.

That will not only provide a basis for future gold price increases, but also provide a foot to put the brakes on any corrections.

One other demand consideration is also worth noting. Because of the weak economy and tightened personal finances, individual consumer demand for physical gold - both as an investment and in jewelry - still lags levels of a decade ago. However, that's starting to change - the World Gold Council reported recently that consumer demand in India surged to 193.5 tons during the first quarter of 2010, up nearly 700% from the same period a year ago.

As consumer demand for gold rises - both for hedging and jewelry - it feeds on itself. With financial uncertainty topping the daily news, ways to deal with it move to the front in both investment planning and cocktail party chatter. Nearly every financial advisor is now suggesting investors put some of their assets - usually 5% to 20% ­ - into gold, which supports prices.

Inflation on the Horizon

As already noted, the euro has taken a beating recently - but it's not the only currency that's suffering. What's more, many analysts believe the ill-advised and poorly executed efforts by governments to "stimulate" the global economy out of recession will ultimately debase all of the world's paper currencies.

Just as an example, the United States is now $13 trillion in debt and, even with the artificially low rates still being mandated by the Federal Reserve, will have to pay $224 billion in interest this year - and even more in the future as spending and rates increase.

That situation is leading many economic pessimists - and nearly all gold bugs - to argue that the dollar will eventually be worthless, leaving gold as the only accepted form of exchange.

Turn the currency-devaluation issue around, and it becomes inflation - always a justification for higher gold prices.

Based on (the rate of) consumer price inflation, the peak of $875 an ounce for gold in 1980 is equivalent to about $2,300 today.

And, if you scale up gold's price to the rate of growth in economic output, which has increased six-fold since 1980, it could justifiably top out around $5,300 an ounce.

Central Banks Stock Up

Central banks - the monetary authorities for the world's nations - are the largest traders of gold, buying and selling as needed to support their currencies and fund global trade. For the past two decades, central banks have been net sellers of bullion - but that has reversed in the past year.

Since early 2009, banks from emerging nations have turned into net buyers of gold. India, for example, bought 200 tons of gold from the International Monetary Fund (IMF) late last year, boosting its holdings to 6% of its total foreign exchange reserves. India's gold holdings peaked in 1994 at 20% of its foreign exchange reserves.

Meanwhile, China has been a huge net buyer of gold over the past five years, reportedly increasing its bullion reserves from 600 tons to 1,054 tons, and it will have to continue building reserves if it hopes to encourage global acceptance of the yuan in international trade.

So, there are plenty of arguments underlying the overwhelmingly bullish outlook for gold in the near future. Given the current levels of global uncertainty - economic, political and otherwise - it would be foolish not to include some form of hedge in your portfolio.

And, gold remains the classic choice in filling that role.

Getting Your Hands on Gold

Other than the obvious method - physically buying gold bullion or coins - here are four ways to add some glitter to your holdings:

ProShares Ultra Gold ETF (UGL: 53.70 +0.93 +1.76%) - With current assets of $180.1 million, UGL is considerably smaller than the ETFs mentioned earlier. But this fund takes a different approach. Rather than investing entirely in bullion, it uses leverage and invests in derivatives and other assets with the goal of doubling the return of physical gold, as measured by the London p.m. fixing price in U.S. dollars. As such, it's more speculative than other gold ETFs - but may also do better in the event of a correction in bullion prices.

Gabelli Global Gold, Natural Resources & Income Trust (GGN: 15.50 -0.23 -1.46%) - Similar to an ETF, this closed-end mutual fund invests in gold and other natural resources stocks in markets around the world. It focuses on companies engaged in exploration, mining, fabrication, processing, distribution, and trading of gold, as well as financing and managing gold-related activities. For investors concerned with income, it also pays a dividend, though the current yield is just 0.90%.

Newmont Mining Corp. (NEM: 53.715 -0.605 -1.11%) - For those who prefer to cut out the middle man and go straight to the source, Newmont is one of the world's oldest, largest and most profitable gold-mining companies, with an additional focus on copper. It has assets or operations in the United States, Australia, Peru, Indonesia, Ghana, Canada, New Zealand and Mexico. At the start of 2010, NEM had proven and probable gold reserves of approximately 91.8 million ounces. With trailing-12-month earnings per share of $3.36, the stock also pays a 40-cent dividend.

Aurizon Mines, Ltd. (AZK: 4.74 -0.06 -1.25%) - Another straight-to-the-source play, Aurizon is smaller and far more speculative than Newmont. The company, based in Vancouver, B.C., has mining operations in the Abitibi region of northern Quebec, and is engaged in exploration in other areas of Canada. The company beat production goals in 2009 and posted record revenues, cash flow and earnings ($9.9 million, or 20 cents per share), which it used to pay down debt. That means the bulk of any added revenue from higher gold prices should go straight to the bottom line after accounting for production expenses.

 

S&P Futures Hang Below 1100

The S&P futures sold off on Friday after Fitch lowered Spain's credit rating.  However, losses in the EUR/USD and Cable were somewhat limited and both dollar pairs are still trading comfortable above their May lows.  Hence, despite nervousness in the markets, U.S. equities and major dollar pairs have some near-term supports in play.  The EU news wire is already getting active this week after France warned that keeping its AAA credit rating will be a tough task and require aggressive budget repairs.

Additionally, Germany said it is considering raising the VAT from 7% to 19% on some goods.  Therefore, the theme of fiscal austerity continues and investors should keep in mind that the situation in the EU is still unstable.  Meanwhile, markets have gotten off to a relatively quiet start the week, although the SCI did drop by 2.4% after rumors spread that the Chinese government wants to test some property taxes. Although it's unlikely this drop in the SCI will be mirrored by U.S. equities, the development is still noteworthy.

The U.S. has a banking holiday today, meaning the U.S. session could be choppy.  However, markets should get more active during tomorrow's trading session with key Australia data on tap followed by and RBA rate decision.  China will also print manufacturing PMI data and it will be interesting to see whether recent tightening in the property markets has had an impact on broad-based economic fundamentals.  If so, we could expect U.S. markets to react negatively.

The UK and U.S. will also print their own manufacturing PMIs later in the day, meaning Tuesday could end up being a volatile session.

For the time being it seems 1100 will prove to be a key battleground as investors debate where to take their next leg.

Price: 1093

Resistances: 1098.22, 1103.46, 1115.42, 1122.15, 1131.12

Supports: 1084.76, 1078.78, 1070.56, 1061.59, 1054.86

Psychological: 1050, 1100, 1000