The dollar is going to be the key to virtually all markets. If it continues down it’s going to act to support asset prices. Well at least initially. At some point we are going to see the decline become unruly and the Fed’s efforts to prop up asset prices will have serious unintended consequences. Namely, surging inflation. Which is already starting to show up in China, India and many emerging markets.

On a cyclical basis if the dollar drops below 81.88 it will mark a failed daily cycle.

Lately we’ve been hearing a lot of talk about Kondratieff cycles, Elliot Wave super cycle, end of the world, deflation, deflation, deflation.

What the deflationists fail to acknowledge is that in a purely fiat monetary system deflation is a choice not an inevitability. To put it in simple terms, if a government is willing to sacrifice its currency there is absolutely no way deflation can take hold in a modern monetary system.

It doesn’t matter how large the debt contraction is, 10 trillion, 100 or 1000 trillion, any government with a purely fiat currency can, with the stroke of a computer key, print enough money to wipe out the debt. Granted they will destroy the currency by doing so, but at some point we are going to be faced with the choice of print or deflate. I have little doubt Bernanke will choose to throw the dollar on the sacrificial alter.

Consumer credit isn’t growing you say. Consumers are deleveraging. Not possible to have inflation unless consumers are borrowing and wages are rising. Pure nonsense!

Let me point out one indisputable fact and then I will delve deeper into the deflation/inflation argument and where investors need to put their capital to protect themselves from the coming inflationary storm. In a purely fiat monetary system a government that is willing to sacrifice its currency can, if they so desire, print enough money to mail every man, woman, and child a check for $1,000, $100,000 or a million dollars. To do so would halt any deflationary force right in its tracks. It would for most practical purposes wipe out all consumer debt. Impossible you say? Well the US has already done it twice. (It was called a tax rebate, in case you forgot.)

Here’s the thing, where the inflationary forces show up is determined by who gets first use of the money. So far that has been the banking system. Through the myriad bailout programs the Fed has created money out of thin air and forced into the insolvent financial system. That has resulted in selective inflationary forces being unleashed. Instead of loaning credit to consumers or businesses who don’t really want it, the financial system has plowed the money back into financial marketss. It’s the reason the stock market rallied 80% despite flawed fundamentals. It’s why oil rallied from $35 to over $80 despite impaired fundamentals. It’s why gold is threatening to break out again to new historic highs.

If instead of forcing the liquidity into the financial system it had instead been mailed to the average consumer, we would now be seeing real estate prices rising rapidly again, food prices and gasoline would be going through the roof. Wages would be rising out of control.

Where inflation shows up is a direct result of who gets first use of the freshly minted dollars. I can assure you we don’t have an impending deflation problem; we have a rapidly approaching inflation problem and currency crisis.

I’ve said for a long time now that eventually the market is going to make Bernanke pay a terrible price for his insane monetary policy. That price is going to be a currency crisis in the dollar and I think it’s already begun.

While everyone was busy watching the Euro crack during the first part of this year what no one foresaw was that eventually the cancer that began in Europe would at some point spread into the dollar. It began 3 months, ago although no one has noticed yet.

Next I’m going to illustrate the long term cyclical nature of the dollar as the cycles are now lining up perfectly to bring on a major currency crisis in the US dollar, much worse than what just transpired in the Euro.

First let me show you a chart of the largest cycle, the three year cycle.

I’ve marked the last six 3 year cycle lows. These have tended to bottom about every 3 to 3 1/2 years with most running 3 years and 3 months. The consideration here is that the next major three year cycle low is due next year sometime around the March to June time frame.

As they say, the doody is going to hit the fan when the dollar moves down into this major cycle low, and Bernanke’s foolish attempt to print away the credit crisis is going to blow up in our face. By spring of next year we are going to be mired in a full-fledged dollar collapse.

The first warning is going to come when the dollar breaks back below 80. That will signal that the current intermediate cycle has failed. As soon as that happens we can close the door on the dollar.

We should first see a test of the all time lows by late this year when the next larger yearly cycle is due to bottom. After that we should have one more leg down into late spring or early summer that I expect will send the dollar to new all time lows

The only way to abort this from happening is for Bernanke to immediately start withdrawing massive amounts of liquidity from the market. That won’t stop the 3 year cycle from coming but we might have hope that the dollar could hold above the all time lows and we might avert or at least reduce the damage that will be caused by the impending currency collapse.

I can assure you he will do no such thing though. For one he has no idea the crisis is brewing. (This is the same man who assured us in ’07 that the credit problems were contained in the sub-prime markets and in ’06 that real estate was not in a bubble.)

And second, if he were to withdraw liquidity the country, and world, would quickly sink back into recession and then depression. No, I don’t think we have to worry about Uncle Ben turning off the presses.

So what should investors do to prepare themselves for the approaching conflagration? They must be invested in real stuff, commodities. There is a reason virtually the entire commodity complex was showing relative strength as the market put in the intermediate cycle low in early July. Smart money was and still is positioning to weather the coming storm.

I would point out that the beginning phase of the crisis isn’t going to feel like a crisis at all. A falling dollar will act to support all asset prices. We may even see nominal new highs in the stock market.

But eventually too much of a good thing will turn deadly and the true scope of the mess we are in will dawn on the market. At that point the collapsing dollar will no longer support stocks and we can expect the market to roll over and begin the next leg down in the ongoing secular bear market. Unlike stocks, commodities will thrive in a currency crisis with one in particular shining above all the rest.

That one of course is the only remaining secular bull market…Gold!

I had been expecting the daily cycle to bottom on last Friday’s revision to GDP or possibly with Friday’s jobs report. Yesterday’s big rally more than likely confirmed the daily cycle low did come last Friday.

Now we have a test coming. If the market can break above the August highs it will complete a 1-2-3 reversal. That will confirm the trend change from down to up and the odds will be good that we will test the April highs.

Actually I expect we will probably test and at least marginally break to new highs even if we have entered another leg down in the secular bear market. I’ll explain why.

Back in July I posted an article showing how big money runs technical levels in order to trick technical traders into puking up their shares. That allows big money to accumulate large positions without moving the market against themselves. Well the same thing happens at market tops and bottoms.

Both the `02 bottom and the `07 top occurred with a slight break of a significant technical level that immediately reversed.

My expectation is that if the market can complete the 1-2-3 reversal by rallying above the August highs we will probably see the April highs marginally broken. Now if that break is immediately sold there is pretty good odds that big money used the technical break to unload positions onto technical traders in preparation for the next leg down in the secular bear market.

In a word, not a chance in hell.

Folks we’ve had three real crashes in the last 100 years. The odds of a 4th crash following right on the heels of the 3rd is minuscule.

In the fall of `08 the financial system needed to roll over 700 billion in debt. Unfortunately the credit markets were imploding at that time which made it virtually impossible to refinance that debt. Many of the big banks were on the verge of going under. That was the trigger for the crash we saw in the fall of `08. 

Those conditions don’t exist at this time and they aren’t going to exist anytime again in the near future. Governments the world over turned on the printing presses and made sure that scenario will never happen again.

Granted it’s human nature to experience an event like that and then be constantly looking around every corner for the next one, but it simply isn’t going to happen again. All these calls for a crash are either simply people who have no understanding of what causes a crash or people trying to shock and awe wide eyed bears into buying their bearishly biased newsletter service.

When the bear does return, and he will return eventually (he may have already), it will be because the economy is sinking back into recession. Those kind of bear markets are slow grinding affairs that creep lower interspersed with violent bear market rallies as governments throw unbelievable amounts of liquidity at the markets and economy in a futile attempt to halt the bear.

Not only that but one can expect the government to change the rules as we go along. At some point we can expect bans on short sales, more bailouts, more stimulus, etc. etc. It is the kind of environment that is a traders nightmare, especially if you are on the short side. In order to make money you will have to time the counter trend rally tops almost exactly and be prepared to cover on a slight break to new lows before the next violent rally takes off.

Moves to new lows will continuously fail to follow thru only to explode higher in the next counter trend rally. In other words not only a bulls nightmare but a bears too.

Now do you see why I have no desire to get tangled up in the stock market? This just isn’t the kind of environment conducive to making any consistent profits and it’s very likely both bulls and bears alike are going to lose lots and lots of money.

The easy money and big money will be made by just riding the gold bull. It is the only secular bull market left and very soon an event is going to happen that will transform this mild mannered bull into a rampaging monster.

Subs know what I’m talking about 🙂

The strong move above $1240 pretty much negated the coil and eliminated any doubt that Aug. 24th was in fact the cycle low. Gold is now on day 5 of the current daily cycle with potentially 10-15 days before the next significant short term top.