HERE

In this issue:

• The Second Wave – The old ways are obsolete. Fresh thinking is required.
• Inventory and Credit Recessions may appear to be the same at first. They’re not.
• The Chart Pages
• To Sell or Not to Sell
• An Outlook for the Canadian Dollar

….read the 7 page report HERE

I’ve covered some of the market myths I’m about to tell you about on occasion in the past. And I’ve wanted to consolidate them into a single article for quite some time now.

But my colleague and internationally-respected analyst Robert Precther beat me to the punch, in an article he recently published for his subscribers.

Fortunately, I know Bob well, and I’m sure he won’t mind if I review the lessons he voices in his article with you, borrowing from his excellent research to help make the arguments. As I’ve often cited in the past, many of these market myths, if not all of them, are critical to your success as an investor.

So let’s get right to what I consider are the top five market myths of all time!

Myth #1: Interest rates are the principal driver behind stock prices.

How many times have you heard that rising interest rates are bad for the stock market, and that declining rates are good for stocks?

If you’re like any average investor, you’ve heard that theory literally hundreds, if not thousands, of times before. Tune into any media show today, and I’m sure you’ll hear it at least once, if not more.

Most stock brokers, and the majority of analysts and newsletter editors, espouse the same causal relationship between interest rates and stock prices.

But the fact of the matter, the plain truth, is that there is no “standard relationship” between interest rates and stock prices. Period.

Consider the last 10 years of market action …

• From March 2000 to October 2002, the Federal Funds rate declined from 5.85% to 1.75%, and the Nasdaq plunged 78%.

Put simply, stocks and interest rates went down together!

• From March 2003 to October 2007, the Federal Funds rate rose from 1.25% to 4.75% … and the Dow exploded higher, launching from 7,992 to 13,930 — a 74.2% gain!

In this case, stocks and interest rates went higher together!

Think those are oddball, freak occurrences? Think again …

• From August 1929 to July 1932, the Fed’s discount rate fell from 6% to 2.5%, and the Dow industrials plunged a whopping 87%.

• In Japan, from December 1989 to March 2003, the Bank of Japan’s discount rate fell from 4.25% all the way down to 0.10%. And Japan’s Nikkei 225 Index?

It plunged from nearly 40,000 in 1989 to 7,824 in March 2003, a loss of 80%.

The fact of the matter is that the relationship between interest rates and stock prices is exactly the opposite of what almost everyone, even the pros, preach: That they are positively correlated, not negatively correlated.

A little uncommon wisdom teaches you why. Just think about it for a moment …

When an economy is growing, the demand for money and credit is increasing. Naturally, so is the cost of money.

And in a growing economy, stock prices should also do well. So the two — interest rates and stock prices — should be rising together.

Conversely, when an economy is sliding, the cost of money is also falling, as demand for credit contracts. Makes sense then that stock prices should also be weak, right along with the deflating cost of credit.

Very logical, right? But oh, how so very wrong almost all analysts and investors are when it comes to interest rates and stock prices!

Right now, for instance, almost everyone is telling you that if interest rates go up, that spells the death knell for stocks.

Maybe so, but also, maybe not.

I, for one, think that rising interest rates right now would be bullish for stocks. Reason: It would be symptomatic of demand coming back into the credit markets, of a heartbeat so to speak, and signs of life in the economy. Ergo, that would be a bullish sign for stocks.

Next …

Myth #2: Rising oil and energy prices are bearish for stocks.

Just like the myth about interest rates, we’ve all heard this one before, many times too.

The claim: The increasing cost of energy is a tax on consumers and squeezes corporate profits as well. Therefore, rising energy prices are bearish for stocks.

Makes sense, right?

But consider this: There is no consistent relationship between energy prices and stock prices.

Sometimes energy prices are rising along with stock prices, and sometimes they decline together.

The myth exists simply because the oil crisis of the 1970s still remains fresh in many investors’ minds, and, for those who were too young at the time, because that’s what’s (wrongly) taught to them: That rising oil and energy prices kill stock prices.

The relationship between energy prices and stock prices, if anything at all, historically tends to lean more towards a positive correlation. Like we’ve seen in the last year, for instance …

Since its low in March 2009 at 6,440, the Dow is up more than 65%. Simultaneously, the price of oil rose from a low of $44.58 to today’s $79.61, a 78.5% rise.

Strong demand for energy emanates from an economy that is either doing well, or, is recovering. So shouldn’t that be a positive harbinger for stock prices?

You bet it should. Another market myth exposed!

Myth #3: A widening trade deficit is bad for an economy, and conversely, a narrowing trade deficit is good.

Personally, this is one of my all-time favorites. And truth be told, I used to be guilty of misinterpreting this one as well.

The claim: That a widening trade deficit is terrible for stock prices.

The argument goes like this: A country is importing more than it’s exporting, hence, it’s shipping more capital offshore than it’s bringing onshore. Therefore, domestic stock prices must go down.

Sounds reasonable, doesn’t it? Appeals to the emotions, right?

But history proves that it is entirely wrong, and nothing more than a myth.

Fact: From 1976 to 1998, the U.S. trade deficit ballooned from $6.08 billion to $166.14 billion, and guess what? The Dow Jones Industrials went from 848.63 to 9,343.64!

In truth, the relationship between the trade deficit or surplus and stock prices is exactly the opposite of what the pundits claim.

In other words, a rising trade deficit is related to rising stock prices, and a narrowing trade deficit with recessions and falling stock prices.

Want more proof? Consider what’s happened to the trade deficit since the Dow peaked in July 2007 at 14,239: 

The trade deficit narrowed from a deficit of roughly $701 billion to $378 billion, or 46%!

Myth #4: Corporate earnings drive stock prices.

Another great, giant myth, perhaps even the biggest of them all.

The argument: That if a company’s earnings are rising, the company must be growing, therefore, its coffers must be filling up with cash to pay dividends, or acquire new products or other companies, and good times are here to stay.

So the company’s stock price must go up.

Conversely, if earnings are falling, stock prices must go down.

Well, have you ever seen a company announce better-than-expected earnings, and its share price gets clobbered?

I’m sure you have, probably oodles of times.

Conversely, you’ve also seen plenty of companies announce lower-than-expected earnings, and their share prices move up.

The same thing can happen to the broad markets, taken as a whole.

For example, 1973 to 1975: The combined earnings of the S&P 500 companies rose strongly for six consecutive quarters, yet the S&P 500 Index fell more than 24%.

And according to research conducted by analyst Paul Kedrosky, since 1960, the average annual return on the S&P 500 was greatest when earnings were falling at a clip of 10% or more …

While the smallest returns on the S&P 500 occurred when earnings were growing at up to 10% per annum.

Bottom line: Rising corporate earnings does not guarantee rising stock prices, by any means. Nor does falling corporate earnings guarantee falling stock prices!

Myth #5: An economy’s GDP drives stock prices.

Most investors and most analysts agree: Stock market prices as a whole, especially in terms of total market capitalization, should reflect a country’s gross domestic product (GDP), the sum total of a country’s overall economic output.

Logical, right?

But consider the following: From the quarter ending June 30, 1976 to the quarter ending March 31, 1980, GDP rose in 15 of 16 quarters. Yet the Dow Industrials fell 22%!

And from April 1, 1980 to September 30, 1980, quarterly GDP contracted, yet the Dow Industrials rose almost 19%!

Direct positive relationship between GDP and broad stock market prices? There is none. Certainly none reliable enough to make investment timing decisions.

Bottom line to the above five major market myths (and more to come in future columns)?

Actually, I have three bottom lines:

1. Never assume anything when it comes to the markets …

2. Question everything, and most of all …

3. Think independently, and exercise uncommon, not common, wisdom!

Stay tuned. There are some major surprises dead ahead in the markets.

Best wishes,

Larry

P.S. Time is running out for major recos! Today is your absolute LAST day to join us while we use a time-honored, scientific approach to build a Rapid Growth Portfolio that not only has huge profit potential, but also will help protect the wealth you’ve already worked so hard to grow. Click here to learn more.

Larry Edelson: With nearly three decades of experience in precious metals and natural resource markets, Larry Edelson has played a pivotal role in training Weiss Research staff and in guiding Weiss Research’s customers to prudent investments in these sectors.

His Resource Windfall Trader and Real Wealth Report provide a continuing education on natural resource investments, with recommendations aiming for both profit and risk management. His team of technical analysts helps enhance the timing of investment recommendations with the aim of continually improving performance results for investors.

This investment news is brought to you by Uncommon Wisdom. Uncommon Wisdom is a free daily investment newsletter from Weiss Research analysts offering the latest investing news and financial insights for the stock market, precious metals, natural resources, Asian and South American markets. From time to time, the authors of Uncommon Wisdom also cover other topics they feel can contribute to making you healthy, wealthy and wise. To view archives or subscribe, visit http://www.uncommonwisdomdaily.com.

The 30th Anniversary of Silver Thursday

Unless you are a real silver bug or a much studied gold bug, the concept of Silver Thursday will have little meaning for you. Silver Thursday took place on March 27, 1980, and this-coming Saturday marks the thirtieth anniversary of that event.

Generally, the take on Silver Thursday is explained by Wikipedia as follows:

“The Hunt brothers had invested heavily in futures contracts through the brokerage firm Bache Halsey Stuart Shields, now Prudential-Bache Securities. When the price of silver dropped below their minimum margin requirement, they were issued a margin call for $100 million. The Hunts were unable to meet the margin call, and facing a potential $1.7 billion loss, the ensuing panic was felt in the financial markets in general, as well as commodities and futures. Many Government officials feared that if the Hunts were unable to meet their debts, some large Wall Street brokerage firms and banks might collapse.[2]

“To save the situation, a consortium of US banks provided a $1.1 billion line of credit to the brothers which allowed them to pay Bache which, in turn, survived the ordeal. The U.S. Securities and Exchange Commission (SEC) later launched an investigation into the Hunt brothers, who had failed to disclose that they in fact held a 6.5% stake in Bache.”

This is the generally accepted version and basically correct, but the story is much more involved. Most of what will be penned below is from the book Silver Bulls, by Paul Sarnoff. Mr. Sarnoff’s account cannot be verified as to every detail, and my quick synopsis will hardly do this historic silver event justice. Those who are truly interested in the “long” version (pun intended) will have to find a copy of the book.

If we go back a bit, we can find some interesting points leading up to this event. On January 7, 1980, the Comex board held a meeting and adopted “Silver Rule 7,” which specified any account with more than 100 contracts a reportable account. No individual could carry more than 2,000 contracts, or more than 500 for any one delivery month. “Bona fide” hedgers were, as usual, exempted from Silver Rule 7!

As Paul Sarnoff expresses on pages 81 and 82 of Silver Bulls, there was clear evidence that some of the larger longs were apparently buying January and February up to the monthly position limit—thus creating the possibility of a squeeze on the shorts. After noting this, one of the board members suggested that both these months be limited to 50 contracts per account, and thus, on January 9, 1980, Silver Rule 7 was amended to reflect this change.

According to Sarnoff, the Hunts and their corporate allies controlled about 192 million ounces of silver.

The Hunts were aware of the rules being manipulated and there was a way out; it was to “simply switch their futures into physicals, hock the physicals abroad at interest rates, which were of course tax deductions, and shift their forward buying, if any, to the London Metal Exchange” (page 95).

As if enough wasn’t taking place, one of the main firms that the Hunts were doing business with needed some help to stave off a takeover bid and thus did Bache a favor by purchasing Bache stock.

The Hunts had purchased a substantial position in Bache Halsey Stuart Shields, over 5%, and were therefore insiders. This prevented them from selling a substantial amount of this stock when the margin call was issued. In other words there was no way the Hunts could use their Bache stock to finance part of the call.

When things started to unravel on March 27, Nelson Bunker Hunt was in Europe, announcing the idea of a silver-backed bond. The proposal was to issue a bond in various denominations and distribute it through large European banks to investors.

As the news spread of the silver bond proposal, the Bache $100 million margin call, and the rumor that the Hunts might not be able to meet the margin call, a Comex member started selling silver, and panic hit the silver pits. The reaction was rapid—the Dow Jones Industrial Average began tumbling, and trading was halted in Bache stock.

Bache, Merrill Lynch, and the New York Stock Exchange sent a message to the CFTC, asking the Commission to halt trading in silver to quell the panic. This request was denied and silver dropped about $4.00 from the previous day to stop at $10.80.

Paul Volcker was brought in and “arrangements” were made to solve the problems that were rippling through the financial markets. Later, the $1.1 billion “bailout” loan caused then Senator Proxmire to hold a hearing of the Senate Banking Committee, due to a great deal of resentment about the loan being issued.

So for some time, the Hunts accumulated their frequent flyer miles between Dallas and D.C. As Sarnoff notes, “It is ironical that the investigations focused only on the actions of the silver longs rather than the silver shorts. Only in Senator Proxmire’s hearings did inkling emerge of the role the shorts had played in the rise and fall of the silver price. At that hearing it became evident that the congestion in silver happened to be not just on the long side, but even more on the short side.”

Finally, he writes:

“Whether or not such frank journalism will lead federal agencies to investigate the accounts and the activities of the short-sellers in silver, who were members of the boards of directors of the involved silver exchanges, is a moot subject.”

So, it seems we “silver bulls” have seen the investigation into probably the most notable story about silver, played from the long side only. As we approach the upcoming hearing with the CFTC on March 25 to discuss position limits in gold and silver, we can keep hopes high, but let’s also keep them realistic. Even though there are two sides to every story, it seems the long version gets more attention from the big players.

David Morgan
Founder: Silver-Investor.com

Mr. Morgan has followed the silver market for more than thirty years. A unique silver saver program is available here. Much of his Web site, Silver-Investor.com, is devoted to education about the precious metals. It is both a membership site and does post and tweet articles to the public. To receive full access to The Morgan Report, click the hyperlink.

Have a good one.

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