by Kevin Klombies, Senior Analyst,

It may take a few years but we fully expect that the euro will decline back to parity with the U.S. dollar while the Swiss franc moves back to .70.

We mention this because it is also our view- one that we will go into in some detail tomorrow- that the equity
bear’ market is not going to end until the U.S. Dollar Index breaks to new recovery highs above 81 which means, of course, that eventually- hopefully sooner rather than later- the Swiss franc is going to move below September’s lows which, as the chart at right attests, is going to put a considerable amount of pressure on gold prices.

Many will argue that the dollar has no where to go but down but it is our very firm contention that the opposite is true. Many will argue that sheer cost of bailing out the banks makes a weaker dollar a given but we will counter by arguing that the dollar tends to rise when the U.S. fiscal deficit balloons.

Aside from that the banks are obviously in a mess with no end in sight. Or… is that light we keep moving towards the end of the tunnel instead of yet another near-death experience?

Sept. 23 (Bloomberg) — Goldman Sachs
Group Inc., seeking to quell investor concerns that have lifted the firm’s borrowingcosts and hurt its stock, is raising at least $7.5 billion by selling stakes to Berkshire Hathaway Inc. and public investors.

Goldman Sachs is the closest thing to a ‘market’ stock in the U.S. and it was higherin trading
yesterday and higher yet again in late trading after the news was released that Warren Buffett’s Berkshire Hathaway was investing $5 billion.

Yet… obviously the euro has to rise because European interest rates are higher than U.S. rates.

Sept. 23 (Bloomberg) — French consumer spending on manufactured goods fell more than expected in August after the euro region’s second-largest economy shrank and shed jobs.

The chart below shows that the French stock marketdoes better when euro is falling against the dollar and much worse when the euro is rising. The point is that eventually economic conditions in countries other than Germany are going to deteriorate to the point where the ECB is forced to start the long process of cutting interest rates. The CAC 40 Indice will start to rise relative to the S&P 500 Index after the euro breaks nicely below September’s lows near 1.39.



Equity/Bond Markets

We will and have argued that when the Fed attempts to slow the U.S. economy it succeeds and when it works to accelerate the economy it also succeeds. The problem is that monetary policy works with such a lag that economic slow downs and recoveries always seem to catch investors by surprise.

In mid-2000 the yield curve inverted as 3-month TBill yields moved above 10-year U.S. Treasury yields. The negative yield spread- shown on the chart at right through the decline below the ‘0’ line- marked the beginning of an equity bear trend in the financials (i.e. Citigroup- C). The negative trend lasted for very close to 9 quarters (2 1/4 years) before turning positive once again early in October of 2002.

Belowwe have lined up a comparison between C and the 10-year minus 3-month yield spread from 2000 through 2002 with the same comparison running from 2006 to the present day. The argument is that the yield spread moved negative as yield curve inverted in mid-2006 so in terms of ‘time’ the negative pressures on the financials has now run for almost exactly the same duration as 2000- 2002. In other words it has been very close to 9 quarters since the yield spread fell below the ‘0’ line in 2006.

Below we show the U.S. Dollar Index (DXY) futures and a ratio between the Philadelphia Semiconductor Index (SOX) and copper futures.

The simple point here is that the semiconductors tend to bottom relative to base metals prices when the dollar is at a major cycle low. The trend has favored the base metals for the past 7 or so years but if the dollar has bottomed then the semiconductors will spend the next number of years rising relative to copper prices.