Best Financial Markets Analysis Article Friday will mark the 20th anniversary of the crash of '87 (Saturday will mark the 10th anniversary of the crash of '97 – see an issue here?). We are not calling for an anniversary crash, but the media is (and will be throughout the week) playing up the day and noting some of the similarities to that bleak Monday not so long ago. To be sure, there are major differences, key among them is inflation running half of that in '87 and interest rates are not soaring to 10% as they were then. The main linkage between the two periods is the dollar, falling during both periods and well below historical ranges today.

Economically speaking, the reports of the past week indicated that the economy continues to grow at a modest pace without high “core” inflation. However, when food and energy get added back, year to year producer price growth is uncomfortably above 4%. The price of oil has not dropped as it has in the past once the main driving season is done, and although the growing season was good, agricultural prices continue to rise. Thankfully the foreign economies continue to grow – so keep an eye on the economies of Europe and China, for if they slow down, we could be in for a big surprise.

It is said that bottoms in the markets are events and tops are processes. If so, then the bottom following the 500-point decline in August would be the event, and today's struggle to push higher may be the process that puts in “the” market top for the year. Volume figures for the week have not been spectacular and once again rose as the markets fell, indicating many more willing sellers than buyers. Many of our other indicators, from a simple advance decline line (showing the net number of advancing stocks) to more momentum based indicators are all showing signs of diverging with the records reached by the Dow and SP500. By not “confirming” the highs in the market, these indicators are showing that all is not well below the surface of the markets – more stocks are not participating in the advance, volume figures remain weak and valuation/sentiment reading still point to high expectations by investors. Disasters can ensue from these kinds of readings, but more likely is that returns on stocks going forward are likely to be poor. As we get into the meat of the earnings season, it will be very interesting to see what and how companies couch their outlooks on both the economy and business prospects.

While our bond model continues at a positive reading, we are beginning to see “excessive” excitement in the metals markets that may point to a near-term top in gold (that in turn, would support interest rates). We look at the ratio between gold stock prices and the price of the metal. Historically gold stocks have traded within a range of roughly 1.4 to 1.8 times the price of bullion. From 1994 to well into 1997, gold stocks traded nearly 2x the price of bullion, gold stocks subsequently fell by 60%.

During the tech bubble, gold stocks were selling for less than the price of bullion and have since tripled in price, recovering all that was lost from 1996 to 2000. Today, the ratio is at its highest level since 1996. A few things can happen here, either bullion prices rise (and stocks remain steady) or bullion prices are stable while stock prices decline. Bulls are betting both bullion and stock prices rise.

By Paul J. Nolte CFA
http://www.hinsdaleassociates.com
mailto:pnolte@hinsdaleassociates.com

Copyright © 2007 Paul J. Nolte - All Rights Reserved.
Paul J Nolte is Director of Investments at Hinsdale Associates of Hinsdale. His qualifications include : Chartered Financial Analyst (CFA) , and a Member Investment Analyst Society of Chicago.

Disclaimer - The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.

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