Yet the futures markets were telling us otherwise. The SFE Target Rate Tracker had a 1% cut fully priced in and was even pricing in a small chance of a 1.25% cut. But that was never really going to happen.

The RBA cash rate is now down to 4.25%. That’s the lowest point that rates got to while John Howard and Peter Costello were trying to run things. Only time will tell if Rudd and Swan decide to make any capital out of the low interest rates.

But that isn’t enough. Now the market wants another 1% cut as evidenced by the futures markets. As of yesterday, the futures prices have already built in a 98% chance of a cut to 3.25%. But they’ve got a long time to wait as the next RBA meeting isn’t until February.

We won’t go into detail on the rate cuts. Quite frankly there isn’t much more to add. Apart from the amusement of seeing politicians and the mainstream media urging consumers to spend, spend, spend. Obviously they have quickly forgotten the reason for the recent credit nightmare.

Either that, or in typical fashion they are only interested in the short term benefits of a spending spree against the longer term benefits of moderation.

Oil - $30 or $150?

So, instead of that, this. What is going to happen to the price of oil?

As of this morning, the price of crude oil has dropped below USD$50 a barrel. Not that long ago it was trading at nearly USD$150 a barrel.

OPEC is trying its best to cut production so that the price remains elevated. It’s been talking about that for a few months now. Even so, it hasn’t stopped oil from nearly halving in that time.

With global economies moving into recession, forecasts are for oil demand to wane. For the time being. Don’t forget that the margin between supply and demand is still very tight at only a few hundred thousand barrels per day. That’s out of a global demand of about 85 million barrels per day.

John Kilduff at MF Global told Agence France Presse (AFP), “if they [OPEC] expect to have any chance of halting the current price slide and reaching their goal of maintaining anywhere near a 75-dollar price level, a clear demonstration of unity is necessary. They must take more oil off world markets. Stockpiles are clearly at very high levels.”

That’s a tough task. The reaction from OPEC nations to the falling oil price is just like the stampede to exit the stock market when prices are falling. They know that pumping out more oil at these prices is going to drive the price down, but they also know that if they don’t then other nations will and the price will fall anyway.

Now the price has broken through the USD$50 a barrel mark, and with negative economic headlines for the world economy, there is a very real chance that crude could head towards USD$30. That would be a price level not seen since 2003.

We aren’t game to predict that, because we just don’t know. To be honest, the fall from USD$150 down to the current level has happened a lot quicker than we expected.

But. As we know, markets tend to over-react to the upside and the downside. The fundamentals of oil supply have barely changed. Apart from the hopeless activities of OPEC.

The issue of Peak Oil has not gone away, and alternative energy sources still need to be considered. The question is whether there will still be the same urgency with oil at USD$40.

Some would argue that there was only marginal urgency when it was three times that price, and that nothing will change.

Stay tuned for another upturn in oil prices once global economies start to recover.

Many of us will be sitting on the sideline with our heads in our palms. Shaking our heads, crying to ourselves and worrying about the future. The poor-house will be much more crowded than it was before…and it won’t be easy for anybody. Some will have to adjust their retirement plans, take less vacations, not buy that beach-house to retire in. Some will even have to come out of retirement…and into one of the worst job markets in a lifetime.

All because they didn’t move their feet fast enough.

So I’m going to be painfully clear, because I don’t want anyone who’s wise enough to keep up with my weekly commentary (and that’s you) to be a part of that crowd. What’s happening out there in the world should be seen as nothing less than a mass extinction…a changing of the guard.

Don’t believe me?

And I don’t need to tell you that the picture is outdated. Now you can add Citigroup, several European institutions, the whole country of Iceland, pension funds, mutual funds, possibly every sub-par auto manufacturer in Detroit, and several American cities who’ve gone from metropolis to lowly beggar in a matter of months.

This is not a bad thing. Not at all. To the contrary, it’s a wonderful confirmation.

You never believed that the guy wearing the tie in the corner office and making millions a year was any smarter than you. Well guess what? You were right! It turns out that - if anything - he wasn’t nearly as smart as you are.

But it can be disconcerting too…no longer can you take your life savings and hand it to some guy in a posh office with “Lehman Brothers” tattooed on the wall in gold. No longer can you simply assume that he knows best and he can make all the decisions. No longer can you see steady returns trickle in from dividends and stock price appreciation.

It’s just not that easy anymore.

But wasn’t it all an illusion anyway? Adjusted for inflation - and at today’s levels - the S&P 500 has gained less than 25% in the last 40 years! That works out to annualized returns of about .5%…pitiful if you ask me.

Where have all the Profits Gone?

Meanwhile…the individual thinkers…the diamonds in the rough, the truly Sovereign Individuals were busy elsewhere. Busy with real opportunities. Not with brokers who memorized all of Gordon Gekko’s lines from Wall Street.

Their strategies have never depended on being part of an “old boys’ club,” and their propensity for telling the truth has made them unpopular in some circles…but their intelligence has stood the test of recession, and proven itself not to be a part of Wall Street’s “Grand Illusion.” I want to show you one more picture…

Have a look at those dates if you will. Most of these trades have been closed out in the interim, and this particular portfolio stands at a 1,800% gain with zero losers.

Make no mistake, these guys are the real deal, and they’re not messing around. The follies and failures of the rest of the world’s “investment experts” have opened huge windows of opportunity and these stand-alone traders are making a fortune.

The market can be boring and sideways, with traders taking a break over Christmas, or it can give you a really strong move heading into January.

WD Gann wrote that early January was an important time to watch for turns in the market. If you look back over any market, you will often see major moves start or finish early in January. This can be a great way to finish the year, with a nice Christmas bonus from the market!

How do you know whether you will get a good move or a boring, sideways market?

The answer lies with time analysis, which is beyond the scope of this article. However, those of you who have studied Gann would know that if your time analysis is showing you an early January date, you can be pretty confident you will see a turn.

My time analysis is telling me to watch for a turn in the first week of December on the US Dollar/Japanese Yen (FXUSJY in ProfitSource), running into another turn around the 5th or 6th of January, 2009.

Chart 1 below shows the current market action on the Dollar/Yen.

Chart 1

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After a very tradable move down from the August 15 high, the Dollar is trading in somewhat of a violent sideways pattern.

With moves like these, it can be difficult to know whether to expect a top or a bottom if we have a turning date approaching.

In this case, I am watching for a top around the 100.80 level. This was the 50% Retracement Level of the run down, and would give us a double top with the November 4 swing high, as shown in Chart 2 below.

Chart 2

click to enlarge

I am yet to meet anyone who can call every turn in the market, every time. Sometimes, it just doesn’t work out. David Bowden once said “when it comes to trading, the only thing you need to know about God is that you’re not him!” It’s important to remember that – if the market doesn’t give us a tradable signal on our pressure date, we simply wait for the next date.

Many people would prefer not to hold positions over Christmas, as this is traditionally a period of rest, and that’s fine – you can always come back early in the New Year and look to trade OUT of the early January date.

However if we see a Double Top come in early December, there is a very good chance we will see a 1000+ point fall in the Dollar/Yen, into a January low. With the exciting leverage of the FX market, a 1000 point fall equates to $US1000 for every $US100 US margin tied up in the trade.

It is an easy proposition for any retail trader to model this style of investment and trading strategy. By using technical and fundamental analysis it is possible to profit from the higher probability opportunities top down analysis reveals. A sprinkling of additional economic and seasonal analysis of markets can help massively in order to produce solid trading results. If we review an example, it is easier to put the current context into perspective.

Through the latter parts of 2007 it was evident that the Sub Prime issues in the US were spreading to global markets and that the financial sector in Australia was starting to suffer. Comparing a sector to the overall market is easy using the Relative Strength Comparison (RSC) tool in your software and can demonstrate which sector is displaying strength or weakness, regardless of the overall market direction.

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Although the top 200 shares in the ASX were falling, the rising red line in the lower chart clearly displays that this particular index was massively outperforming the XFJ (the financial sector). Over this period and in this circumstance it becomes a simple case of running scans for short trading opportunities over individual companies that lie within that sector. Hence it is possible to identify those that are most likely to drop from a technical perspective.

If we move to the same charts over the current period there is a different story playing out. Of course, you can also do this to assess the strength of any sector (e.g. the materials or energy sector the XMJ or XEJ respectively).

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Evidently, the most recent price changes would suggest evidence that the XFJ is beginning to outperform the ASX top 200 shares. This signifies a reversal of the predominant share market action of 2008.

Now would be a perfect time to look for short term reversal trades (such as those supported by Elliott Wave 5 set ups) on shares of companies that are involved in this sector or are perceived to benefit from a rise in this part of the economy. Profits from any potential run up into Christmas period in line with the potential Santa Claus rally seem to be on offer over the next few weeks.

That is quite some feat. We write of course, on the subject of the BHP Billiton/Rio Tinto story.

Aside from all the benefits that a takeover would have brought to BHP, the big point to take from it is that even mega companies are reluctant to add debt to their books at the moment. And it also gives an indication that if it is troublesome for the likes of BHP and Rio to raise money in this market, think about the smaller companies and how they must be faring.

An example of this is one of the companies in our Australian Small Cap Investigator (ASI) portfolio. Last week it released details of a new joint venture deal it had entered into. Three days later the window closed for shareholders to pick up more stock in a capital raising.

The result was that the company raised less than 40% of the capital is was hoping for. If it was twelve months ago we are sure they would have raised the full amount. Fortunately, the company in question does have a Plan B. But many small companies out there don’t. If they can’t borrow from banks and can’t raise additional capital from shareholders, it makes it very hard for smaller companies to invest in growing their business.

On the other hand, that is one of the reasons why rather than stepping back from looking at new investments for ASI, we are actually ramping up the coverage in the New Year.

The credit markets will eventually recover, but it may be slow. However, even before this becomes obvious to the market many small cap companies will have already taken advantage and should surge ahead in price.

In our view, we believe the next six months will be the best time in years to pick up undervalued small cap companies.

But honestly, that’s only part of it. The other reason there is always at least one currency rising is because of capital flows. As a currency trader, you’re constantly watching where capital is flowing, so you know where traders are dumping their money.

Every time markets suffer around the world, there’s always a line-up of investors ready to sell-off their positions.

Each time, those investment funds have to go somewhere. Even if that’s just back to cash – which pushes a handful of currencies higher. That’s exactly what happened in 2008. As investors ran from stocks, bonds and even CDs, certain currencies rose.

However, not all currencies (or markets) are created equal.

We live in a world made up entirely of fiat currencies. “Fiat” means “an arbitrary order or decree.” In other words, our money doesn’t derive its value from a particular good or basket of goods, but from the government decree that brings it into law.

So the value of these currencies isn’t fixed. Instead, it tends to fluctuate and vary, depending on everything from interest rates and policy decisions to exports and civil unrest. So if you want to know what a currency is worth at any given time, you just have to ask yourself, “What could it buy?”
 
A soda, a half-gallon of gas, a big mac etc. And we do the same thing in the Forex world when comparing currencies. A particular currency can only buy so many yen, so many Swiss francs, etc. 

So it stands to reason that if a currency’s exchange rate is falling, then another’s is rising. That’s the law of relativity when it comes to currencies. If the dollar’s exchange rate against the yen is declining, then you can buy less and less yen with your dollar. But at the same time, you’re able to buy more and more dollars with your yen.

This is where the idea of an eternal bull market comes from.

We have climbed down from our soapbox today, in order to take a look at the banks. Or, more precisely, the dividends on bank shares.

Today’s Age reports that “Australian banks pressured to lower dividends.” It’s a touchy subject for the four major banks. If there are two things Australian income investors like it’s a nice juicy dividend and 100% franking.

With interest rates falling, investors will naturally be looking for other sources of income. And with bank share dividends offering yields of about 9% it is a pretty attractive investment.

For instance, take a look at the four major banks:

ANZ Bank - yields 9.7%
National Australia Bank - yields 10.2%
Commonwealth Bank - 8.1%
Westpac Bank - 8.5%

And Queensland based Suncorp can offer a dividend even better than that. It is yielding 11.7%.

Add in the franking credits and the yield gets another boost.

For those that rely on income streams from their investments, falling interest rates can make a big difference. Supposing an investor has $500k in their account to live on in retirement, a cut in interest rates from 6% to 5% results in an income reduction of $5,000 per year.

For that reason bank shares should look attractive. $500k could potentially provide an income of about $45,000, compared to only $25,000 if held in cash at 5%.

But it is a big, big risk. Especially for those in retirement. Many will have seen a drastic reduction in the value of their share portfolios. They would be the same people who assumed investing in the banks was safe and reliable. They would have convinced themselves that banks shares couldn’t fall - not by 50% anyway.

The big question for them is, has the market discounted the price of bank shares in the belief that dividends will be cut? You would think it has. So far the Australian banks have weathered the global credit problems quite well.

Not that they have got off completely. But unless something really bad comes out of the woodwork it seems likely that all the ‘bad debt’ risk is already built into the share price.

So it can only really mean that expectations are high for a dividend cut. As Bell Potter research director Peter Quinton points out in The Age article, “It’s increasingly untenable to be paying out 90% of profits as dividends when all banks around the world are rebuilding their capital.”

If we assume a reduction in the yield to about 7% then the banks are now trading around that level. That should reduce the chances of them falling much further in the event that dividends are cut.

Considering that if banks do reduce dividends there is little incentive for investors to jump in as they won’t benefit from the current yield anyway. Therefore it would seem probable that despite the appearance of being good value, bank shares will remain low until there is an indication on the next round of dividends.

And so we arrive at the modern-day. The Dollar is the world’s reserve currency, making us in some sense the world’s goldsmith. And we have a Federal Reserve System - composed of privately owned member banks - that represents how cloudy and convoluted the relationship between governments and banks has become in the last half-millennium.

But somehow, the world economy keeps falling for the same scam.

You see, the Federal Reserve controls not only the interest rate at which banks are allowed to lend, but the fractional reserve ratios they’re required to keep (as a percentage of their reserves).

Let’s backpedal for a second here…make it even simpler. An institution composed of banks and their representatives is in control of not only our money supply, but the amount of new money (in the form of loans issued) that banks are allowed to ‘counterfeit’ and the interest they’re required to charge on those conjured-from-nowhere dollars.

Interest rates - when the decision is left to the borrower and the lender - represent the time preferences and assumed risk of borrower and lender. Like the price of any other good, the interest rate of a loan ideally represents a compromise for both parties in terms of time and risk.

But when the government intervenes with a mandated interest rate (like Greenspan’s sub-zero “liquidity experiment”) those decisions to lend and borrow are often made with little or no consideration to time and risk. Since the money is cheap, free, or the government might even be paying you to take it, incentives are changed across the board.

And then fractional reserve banking comes in. Since the banks only have to keep a percentage of their reserves - a ratio set by an institution they own…making them essentially self-governing - these ridiculously low interest rates spur the banks into a lending frenzy.

Lending to and from each other, commercial interests and private parties, the banks go hog-wild. Without the restraint of reasonable lending costs, they lend as much credit against your money as humanly possible, flooding the economy with fresh dollars that never existed before.

Euphoria takes over. Of course housing prices will continue to go up when the pool of dollars chasing those houses is growing so rapidly…that’s just common sense. But many of us bought into it, in some way or another. And that’s what makes the coming correction so painful.

So here we have the goldsmiths…guardians of bullion and protectors of everyone’s wealth. I’ve personally always seen this as the primary function of a bank.

But just guarding money and issuing certificates for it…I suppose it just didn’t pay as well as it could. That and you always end up with a huge pile of cash (gold) that’s just sitting around and not really doing anything other than backing promissory notes. So the goldsmiths got crafty, and at this point they became the bankers we know today.

They started issuing more certificates than they could back in gold, allowing them to collect interest on the physical gold collecting dust in their shop…gold that already belonged to someone else. But weren’t there already certificates attached to that gold? Of course. But the bankers believed those certificates wouldn’t all be cashed in at the exact same time, so they could get by and no one would ever be the wiser.

This is the critical point in our story, and at few points in history has the difference between right and wrong been so very clear.

The value of goldsmith’s notes was in the gold behind them. So when they issue a new note backed by…well backed by nothing other than the supposition that they’d have enough inventory to pay it off if it fell through…they were engaging in wishful thinking, at best. Ladies and gentlemen, I give you irrational exuberance. At the very core of our banking system.

But how could the goldsmiths get away with such blatant counterfeiting? Didn’t anyone realize that they were pulling wealth from thin air, that they were trading worthless notes for valuable goods? Well, the governments knew. Why didn’t they do anything to stop the goldsmiths?

Put clearly; it wasn’t in the interest of the world’s ruling monarchs to stop them. King Charles II of England had his own con game going with the bankers…one where they traded him physical gold for sticks of wood (I’m not kidding at all…we’ll be covering government debt next week.)

So by complying with the government’s con games and ponzi schemes, the goldsmiths earned themselves a back-scratching from the world’s monarchs, received in the form of Fractional Reserve Banking.

Click To Enlarge

This long-term bearish trend (between points A and B on the weekly chart) drove the Dollar Index roughly from 125 to 72 therefore a loss in value of more than 42%. On the medium-term, the target is likely to be the resistance line plot just below the 38.2% Fibonacci retracement. It’s a previous high level where a “double-top” occurred (points C and D) that generated the second phase of the bearish trend, between 2006 and July 2008.

On the short-term, let’s use a system based a on multi-dimension oscillator to anticipate the price action. We use the Chande Momentum Oscillator (CMO).

Click To Enlarge

The CMO can be used to measure several conditions.

Overbought/oversold: the primary method of interpreting the CMO is looking for extreme overbought and oversold conditions. As a general rule, overbought levels are quantified at +50 and the oversold levels at -50. At +50, up-day momentum is three times the down-day momentum. Likewise, at -50, down-day momentum is three times the up-day momentum. Basically, these levels correspond to the 70/30 levels on the RSI indicator.

Trendiness: the CMO can also be used to measure the degree to which a security is trending. The higher the CMO, the stronger the trend. Low values of the CMO show a security in a sideways trading range.

Divergence: as is often done with other momentum indicators, divergences occur when the indicator does not confirm new highs or new lows posted by the price action.

Other: although not specifically dedicated to patterns recognition, the CMO may be also used to identify chart formations, failure swings, and support/resistance levels.

If we establish overbought/oversold entry and exit rules by plotting a moving average trigger line on the CMO, therefore alerts are triggered when the CMO crosses its 9-period moving average after being in an overbought or oversold condition.

It’s a short-term basic system that typically well identifies inflexion points.