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October 19, 2007
October Thrills Not Over Yet

While the Dow didn’t mark the 20th anniversary of Black Monday by crashing again by 22.6%, it did drop by more than 300-points for only the fourth time this year. Leading the charge lower was a collection of cyclical stocks, three of which released quarterly earnings/forecasts (MMM, CAT, and HON).  On the plus side, Caterpillar – which gave a lot of attention to the word ‘recession’ in its earnings release – managed to bounce off of its 200-dma, perhaps helping forestall another wave of selling. Reflecting the newfound fear in the marketplace, the VIX closed at its highest level in more than a month.


With credit crunch fears being rekindled and a bleaker corporate earnings outlook taking shape in recent sessions, today’s sharp sell off could set the stage for what could be an interesting end to October. However, before painting too negative a picture it may be worth remembering that Bernanke and company take the stage at the end of October and we are near what is historically a seasonally strong period for the markets. In other words, while the outlook for U.S. equities remains fundamentally weak, investors may elect (as they have done in recent weeks) to simply ignore the fundamentals.

Turning to gold, the commercials padded their record net short position (
futures and options) by 14,285 contracts last week. Despite repeated calls for a massive short covering rally from the usual gold bugs, the commercials seem content and financially capable of accumulating shorts ahead of a correction. As is the case with a lot of commodities today, there is growing mob of investors expecting a major correction in precious metals.


The outlook for the remainder of October is as follows: If the U.S. dollar doesn’t crash equities and gold could be in for a weak spell but if Bernanke surprises again we could be off to the races. What complicates this outlook is the fact that if the Fed keeps cutting interest rates as the U.S. economy slows equities will – eventually – be unable to move higher.

As for the contention that the Fed will inflate no matter what the cost to keep the credit bubble going and stock prices moving higher, there may come a point when even the mighty U.S. Fed loses the ability to prod investors into risky assets. For that matter, there may even come a point when the Fed temporarily loses their stomach for devaluing the dollar.  The gold commercials certainly hope so…

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