Thursday, October 8, 2009

The Head Fake

As a young boy we had an empty lot two doors down that provided a field for many sporting activities. The lot owner didn't live in the neighborhood, but let us use it as long as we mowed and maintained it. Without any trees, it was the perfect football field. We even built a goal post out of 2x4's.

My dad used to throw passes to us for hours. My favorite pass route was the down-out-and-up. My dad used to emphasize that there were two keys to making it a success. First, you had to run a few successful "out routes" to get the cornerback's attention. Secondly, when running the "out and up" you had to make a strong "head fake" to "the out" to get the cornerback to come up and commit. Without the head fake, the corner would hang back in anticipation of the "up route".

Financial markets, especially in times like this, can present many "head fakes". These "false moves" can sucker in the best of us. With the Federal Reserve Bank manipulating the system, it is even more challenging. A review of the last two contraction cycles from the perspective of the DJIA/Gold Ratio reveal an interesting consistency. I call it the "head fake". The head fake is that uptick in the market that convinces everyone that the "bottom has been reached" and the "Kool Aid Bar" is back open for business. Let the party begin! But, history appears to show that that uptick is short lived and it "suckers in" the masses to buy back in just before it proceeds to its real final bottom. This is the stage when many get totally "wiped out". I believe that the head fake will come sometime within the next year. We may be there now. With the recent uptick, the media has quickly jumped on the "buy everything" mantra and the Democrats are starting to do a victory dance and state that the stimulus plan is working. This is another euphoric moment, but I believe that it will be shortlived. Keep your eyes open and lets see what transpires.

I once again provide an updated chart of the Dow Gold Ratio back to 1890. The creation of the Federal Reserve System in 1913 set off a wild rollercoaster ride. If the ratio aligns symmetrically, we have a ways to go to reach a ratio of 0.5-2.0. A ratio of 1.0 means that the Dow Jones Industrials equates to the price of one ounce of gold. The DJIA closed Friday at 9487. Gold is hovering around $1000 per ounce resulting in a ratio of 9.5. While it seems uncomprehensible that the two could come close to equating, we only have to look back over the last century to see that it occurred twice. Also note the head fakes in 1932 and 1976.

For a zoomed in look of the ratio (1980-Present), see the chart below. My October 1 post on "the rhyme" illustrates how the media along with the politico's, keep you heading for a big head fake.

Are we currently at the "head fake"? It's been an amazing run since March 6 and The Confession.

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