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Jeff Saut Presents: Me, Lord Marlboro and the Dow!?


Clearly, where you stand is a function of where you sit.


Reminding us of the current equity market is an anecdote about the Sport of Kings that took place in London :

"An American race horse owner, while parading his entry in the paddock just before the event, fed the horse what appeared to be a white tablet. Noticed and challenged by an English track official, Lord Marlboro, the American was informed that his horse would have to be disqualified. Protesting vehemently that he only gave the horse a sugar cube, the owner popped one into his mouth and offered Lord Marlboro a cube as proof. The English official tasted and swallowed the cube. He agreed with the owner that it was a harmless sugar cube and waived the disqualification. Just before the race horse was to enter the gate, the American signaled his jockey, instructing him to keep his horse clear of trouble near the start and try for the lead early since his horse was sure to win. 'In fact,' he told the jockey, 'Only two have a chance to beat our horse.' 'What two?' asked the jockey. Replied the American owner… 'Me and Lord Marlboro!'"

. . . Anonymous

We recalled "Me and Lord Marlboro" as we watched the running of the Kentucky Derby over the weekend. Evidently, someone fed Barbaro the proverbial "sugar cube" in said race as he won by a monstrous 6½ lengths. Likewise, the media fed the Dow Jones Industrial Average (DJIA) a similar "sugar cube" last Friday driven by the softening employment report that resurrected the cry, "One more and done." Plainly, the shared belief was the Federal Reserve will cease its rate-ratchets after this week's anticipated move to 5% (Fed Funds). As previously stated, however, with everyone asking the same question (when will the Fed stop), history suggests this is likely not the right question! Nevertheless, in our business price is reality and the reality of the situation is that stock prices (as measured by the DJIA) are going "up." In all of our verbal strategy comments last week we repeatedly stated that while we don't understand it, and don't trust it, the equity markets felt to us like they were about to go into a "melt up." Indeed, for the past two months the bears have had every opportunity to put things away to the downside and have just not been able to capitalize on those opportunities. Subsequently, we purchased some out-of-the-money call options on the indices in our trading account in an attempt to capitalize on the envisioned potential melt-up. As a sidebar, it is worth noting that we RARELY buy options since over the long-cycle that strategy is a losing strategy. Verily, better to make time your ally, not your enemy, and adopt a strategy of selling options to hedge some of the risk in the portfolio, but that is a topic for another time.

So, a melt-up was the short-term "call" and a melt-up is what it looked like last Friday. How far it can carry is unknowable. Indeed, we have seen parabolic rises before and have always been amazed at how far they can extend. Take gold for example. In December of 1979 our notes show that gold began a parabolic rise from $432 per ounce. By January 1980 that parabolic rise left the yellow metal trading at more than $850 an ounce, a price that has not been seen since. It is worth noting, however, that every secular bull market we can find has seen the peak-price of the previous secular bull market exceeded. Since we have been steadfastly bullish on gold, and other "stuff stocks," for the past five years, believing that gold is in a secular bull market, gold should therefore exceed $850/ounce before the current gold bull market ends. Yet, secular bull markets are very complex, as stated in last week's report.

Consider this: in August 2005 the DJIA was selling around 10463 measured in U.S. dollars. Therefore, in dollar terms, as of last Friday's close (11578), the Dow has gained roughly 10% since last August. But, using gold as our "measuring stick" yields a different result. To wit, it took 24 ounces of gold to "buy" the DJIA in August of 2005, now it only takes 17 ounces. So in gold terms, the Dow has declined by more than 29% since August 2005. Measured in silver, nickel, or copper, the Dow's decline has been even worse. Clearly, where you stand is a function of where you sit.

Speaking of gold, hedge fund manager and Minyanville Professor Bill Fleckenstein intrigued us last week with his comments regarding the gold stock Newmont Mining (NEM). His back of the envelope analysis goes like this, "By my way of looking at it, if you assume Newmont has 100 million ounces, which is fairly conservative, before today's decline it was trading as though gold fetched $538 an ounce. Of course, that gives no credit to its (Newmont's) Canadian oil-sands investment, which, depending on the value we ascribe to it, would mean that Newmont would be discounting gold at something less than that price. Obviously, that's a far cry from the price that gold was trading at this morning." In addition to Bill's comments, we would note that in 1987 Newmont's shares rallied to $82 when gold was only at $435/ounce. Or as one Wall Street Wag opined, "The difference between perception and reality is where our opportunities lie."

Obviously, we remain bullish on gold and "stuff stocks" in general (energy, timber, base metals, fertilizer, agriculture, cement, etc.). Yet, even here many of those stuff-stocks are pretty extended in the short-term (read: overbought). For example, we have been bullish on the drilling stocks for quite some time. And, particularly bullish on some of the higher yielding oil/gas drilling trusts. Yet even here the drillers are pretty extended. As our technical analyst Art Huprich pointed out to us last week, "The drillers, as measured by the Oil Services Index (OSX) is nearly three standard deviations above its 200-day moving average, or about as overbought as it gets." The same can be said about many of the stuff-stocks in our portfolio, which is why we continue to rebalance them to keep their weightings in-line with our portfolio's objectives. Longerterm, we remain extremely bullish on the stuff stocks.

Other gleanings from last week's action include: new reaction highs by many of the indices; no confirmation of those highs by any of the advance/decline indicators we monitor; a new all-time high in the Dow Jones Transportation Average; Lowry's Buying Power Index remains near its lows and is 190 points below its July 2005 peak; a statement from Iran that it wants euros as payment for crude oil; a short-term sell signal for crude oil; a new reaction low in the U.S. dollar (basis: The Dollar Index) leaving the "buck" down 7% year-to-date and us thinking the dollar had BETTER hold these levels (sidebar: we are very bullish on the Japanese yen); the nationalization of certain oil companies' properties in Bolivia; the revelation that our government keeps two sets of books, the OMB's books that show last year's deficit at $319 billion while the Treasury Department's books show it to be $760 billion (obviously the Treasury doesn't use the Social Security surplus as an "offset" since it is a future liability); continuing stronger than expected economic reports save Friday's "soft" employment report that is likely to be revised higher; more geopolitical consternations; a loose lips sink ships conversation between Ben Bernanke and Maria; and things get curiouser and curiouser.

The call for this week: Renowned economist and political thinker John Kenneth Galbraith passed away a week ago at the ripe age of 97. Famous for the writing of many books, as well as numerous bon mots like, "If all else fails, immortality can always be assured by a spectacular error;" the quote that stuck with us was, "To speak out against the madness may be to ruin those who have succumbed to it. So the wise on Wall Street nearly always remain silent. The foolish (therefore) have the field to themselves, and none rebukes them." Those words clearly resonate with us because we have often "spoken out against the masses" and found ourselves looking foolish. And, that was the case again last week as our cautious trading stance looked foolish. Indeed, when you can be measured to the second decimal point every morning it is a very humbling business! Fortunately, our long-standing investments in mid/small-cap mutual funds, stuff-stocks, and non-dollar investments continues to leave our accounts outperforming the major market averages. Meanwhile, our Focus List is up 9.2% versus the S&P 500's 6.2% year-to-date gain as we ponder the possibility of a continuation of the stock "melt-up."


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