Scoreboard year to date: Dow up 16.76%, S&P up 21.01%, gold up 24.7%

Try a fun experiment: ask everyone you know when you next see them if they own any gold coins and watch their faces go blank.

We sit at a critical fork in the road regarding the stock market now (remember, what happens in the stock market affects everything right down to consumer attitudes).

So far, this market has recaptured approximately half of what it lost from the peak in 2007 to the bottom last March. This 50% rebound is a significant number because it’s an historical precedent that was expected. Most market crashes are followed by a rebound of 30-50% as sure as it snows in Alaska in winter.

This happened in 1930 after the great crash of 1929 but then stocks slid into a deceptive, grinding downwards cycle which culminated 3 years later with an overall 80% drop from the 1929 peak (yes, 80%). If you apply the exact example to today, the Dow would be at 2,840 in 2012.

That would be a nice send off for comrade Obama, wouldn’t it? But I really hope it doesn’t happen. It’ll be bad enough for the poor guy to be a one-term president, let alone going out on such a humiliating note where all he’s remembered for is burning the savings of our grandchildren to fight a natural economic cycle. Don’t think he’ll be a one-termer? I’ll take that bet when you’re ready (and any Democrats reading this, please, I’m not a Republican either. I just want to be left alone.)

So we’re at the upper limit of the expected rebound and one would now presume the grinding down to start if history is any guide. So we all go short the market now and then retire happily ever after, right?

Not so fast…

This scenario playing out is based on the assumption that this is in fact a bear market rally and not a new bull market. There are many respected analysts who believe the latter to be the case. If it’s true, then the market will instead be off to the races leaving a wake of dead bears in its path and we can all go back to normal.

So who to believe?

As usual, we must listen to the market itself when it’s at a critical point like this with lots of conflicting opinion. Long-time subscribers will know I’m talking about using Dow Theory (new subscribers may want to look at past issues to learn more).

Dow Theory drowns out all the ‘noise’ and pays attention only to the market, namely two markets: the Dow Jones Industrials and the Dow Jones Transportation index. As one index reaches a new high (or low) it must be confirmed by the other index also reaching a new high (or low) within a reasonable period of time. What’s a reasonable period of time? Good question, but the longer time passes without a confirmation, the less valid and strong such a confirmation would be if and when it does happen (anymore than a month would be weak).

So let’s apply this to the current situation and read between the lines of what the market itself is telling us…

The Dow Jones INDUSTRIAL hit a recent high of 10,291 BUT it has not yet been confirmed by the TRANSPORTS doing the same. The Dow Transports need to CLOSE at above 4,045 for that to happen. If this occurs and Dow Theory isn’t sending a false signal (through market manipulation), the bull market may well be back on.

You can view the daily action of the Dow Transports at http://money.cnn.com/data/markets/dowtrans/

As I write, Transports are about 90 points below 4,045. And remember, the numbers only apply at the market CLOSE, not intraday highs or lows.

I believe the time has come where bulls and bears alike will have to ‘put up or shut up’.

And this is no normal market turning point; I believe we’re at the most critical market turning point of this generation.

Another turning point I’m closely watching for you is what we discussed last time- how the Fed maintaining its independence is the difference between the critical investment question facing us all now: inflation or deflation?

This from Bloomberg…

“The Federal Reserve faces the biggest blows to its authority and independence in five decades under legislation championed by its lead overseer in the U.S. Senate.

The financial-regulation overhaul proposed yesterday by Senator Christopher Dodd would strip the Fed of its role as a bank supervisor and give Congress a greater voice in naming the officials who set interest rates. The measure opens the door to interference from politicians who might disagree with any move by the Fed to raise rates from record lows, former central bank officials said.

Dodd’s measure would also curb the Fed’s ability to make emergency loans to individual companies. The Fed’s response to the financial crisis prompted increased scrutiny of the central bank, especially after it used its emergency powers to bail out Bear Stearns Cos. and American International Group Inc.

The proposal comes as Fed Chairman Ben S. Bernanke, 55, awaits confirmation to a second term. The hearings will be held some time between the Nov. 26 Thanksgiving holiday and year’s end by Dodd, the Connecticut Democrat who chairs the banking committee.

Dodd said in a Bloomberg Television interview today that he “tends to be supportive” of Bernanke. Yesterday Dodd said his proposal is “not about individuals and personalities. It’s about putting together an architecture that makes sense.”

Under the 1,136-page proposal, the Fed would lose its bank- supervision role to a new Financial Institutions Regulatory Administration. Its consumer oversight duties would go to a new Consumer Financial Protection Agency. An Agency for Financial Stability would have broad powers to protect the economy from financial risks, with the Fed chairman holding one of nine seats.

The Fed’s regulation of banks has been an “abysmal failure,” Dodd said yesterday. He has blamed it for not preventing the practices that contributed to the financial crisis and led to taxpayer bailouts of firms including Bank of America Corp. and Citigroup Inc.”

This new agency (FIRA) would be a government arm and controlled by the whim of politicians, like any government agency.

Now, you may (rightly) argue that the Fed is an evil agent of Goldman Sachs et al in that its creation was to do nothing but cause inflation, they were the ones behind this mess, they only look after their banking buddies and no agency should have such power.

All perhaps true, but what’s the alternative?

The Fed may well be all those things but one thing it’s not, is as stupid as Congress- the people at the Fed may have their own agenda but they’re not idiots and they know that too much money-printing would cause hyper-inflation. The Fed is a much lesser of two evils. You’d better hope and pray that the Fed DOES keep its independence because if the public-pandering, vote-buying, sleaze-ball politicians get hold of the printing press, you’ll wish all your money had been in gold.

It’s interesting to hear about stories during the hyper-inflation that recently occurred in Argentina. Survivors will tell you that what was so shocking was how fast it happened and seemingly without warning. A packet of cigarettes was one price in the morning and another in the evening. Prices of even the most basic items would be announced on loud-speakers because the price was changing so fast, a bit like financial markets.

Could that happen here? Or is that only confined to banana-republics in South America and Africa?

One thing’s for sure, US politicians aren’t going to sit idly by while their precious voters walk up the Hill with pitchforks and scream out louder and louder for their ‘right’ to a job. Good luck to the Fed keeping hold of the printing press when that starts…

These two critical precipices we sit at- the inflation/deflation question and stock market turning point will define what happens in the next decade; a decade that will make or break you depending on your actions.

And of course, the two are linked. If the stock market turns decisively down from here and deflation sets in putting the economy in freefall again, public pressure will demand action and the politicians will respond (by stealing the printing press).

Wow, when I put it like that, an awful lot now seemingly rests in the hands of that Dow Transport index doesn’t it?!

Notice how various country’s central banks are now net BUYERS of gold rather than net SELLERS as they have been for the past years? What do they know that we don’t??

What I know is what history knows: he who has the gold has the power and that no paper currency has ever stood the test of time.

Please stay tuned. History is in the making and I’m your commentator.

Until next time,

Kevin Raymond