3076 Sir Francis Drake’s Highway

Road Town, Tortola, BVI

Website: www.madhatter.vg E-mail: info@madhatter.vg

September 15, 2002

Volume 17

SEPTEMBER EDITION

Who Runs The Fed And What Is Manipulation?

The Federal Reserve Bank of the United States is a very interesting subject and I bet it would surprise some of you to know that the “Fed” is really a privately owned company with individual shareholders. It would surprise even more people to know that most of these shareholders aren’t US citizens. This in and of itself raises several very interesting questions. First, how can foreigners be expected to look out for the best interest of the US and its citizens? Second, what happens when the interest of the United States conflicts with their individual interests or the interests of their own country? What guarantees do the people of the United States have that their interests will be protected? Third, why does the US government elect the head of a private corporation? And finally, is Mr. Greenspan responsible to his shareholders (as is the case with just about every other private company) or to the American people? Tough questions! Issues like these have perplexed other people too and some of them even decided to take action. For example, then President John F. Kennedy announced in early November 1963 that he saw no reason for the Federal Reserve to exist and he had every intention of closing it down.[1] Unfortunately he died two weeks later and one of President Johnson’s very first acts was to announce a reversal of that decision. What a different country we’d have today if that wouldn’t have happened.

Who are these shadowy figures that exercise such control over our everyday lives? It’s difficult to say but I do know that the French Dupont family was a shareholder for a long time and still may be. I also know that the Rothschild family was and still is a shareholder in the Federal Reserve and for those of you who may not be familiar with the name; they are by far and away the richest family in the world. The five Rothschild families control trillions of dollars and can easily make or break most, if not all, foreign countries. This is the oldest banking family in the world and they’ve made vast fortunes playing both sides against the middle. Quite often they, and not armies, decide the outcome of major conflicts. Their financial maneuverings did more damage to Napoleon than the English army or the Russian winter ever did.

I would be very interested to know how much each shareholder has invested in their “company”. My guess would be zero. If I’m correct then the government of the United States of America has allowed a group of foreigners to form a company in the US with little or no real investment, create trillions of dollars of debt out of nothing, and all in the name of the American people. This entity was then free to use these dollars to defraud the American people and interfere in financial markets for the betterment of a few. This has been going on for decades now but became truly corrupt when the government eliminated the gold standard, i.e., stopped issuing ‘silver certificates’ and began issuing Federal Reserve Notes. These Federal Reserve Notes are backed by the “full faith and credit” of the United States government. It always seemed strange to me that the government would want to fully guarantee the debt of a private entity with no assets. In my opinion, this guarantee allowed the US to go from a country capable of rebuilding Japan and Europe in 1946 to what is today, the largest debtor nation in the world. Don’t forget to send Sir Alan Greenspan and his predecessors a Christmas card and thank them for the wonderful service they’ve done for you.

Another interesting question comes to mind. Certain “quasi-government” institutions like Fannie Mae and Freddie Mac are not subject to all the balance sheet revisions of the SEC, etc. like other publicly traded companies. Does the same hold true for the Federal Reserve? Are they audited, and if so by who? Do these audits show shareholder capital? Are these audits available to the public? What is the purpose of auditing a company that doesn’t have any assets? I always thought that a company with debt and no assets was considered to be bankrupt. I guess there are exceptions to every rule.

Our previous commentary ties in nicely with the idea that markets can be manipulated. While it’s true that individuals, groups, and/or institutions can enter a specific market and influence price direction for a period of time, it is also true that they usually have little success over the long run. A perfect example is the currency market. How many times have we heard news reports over the last six months declaring that the Japanese, European, or US Federal Reserve Bank has intervened in the market in order to stop the decline in the US dollar? Smart investors know this won’t last, wait several days for the intervention to cease, and view the situation as a chance to short the dollar. Why? Simple: no amount of intervention, even by the Fed, can change the direction of the real market. A perfect case in point involves the Fed’s lowering of interest rates and increase in money supply. This has been going on for more than eighteen months and it just doesn’t turn the tide. Confusion sets in because we tend to view Wall Street, the NYSE, or the COMEX as the real market when in fact they are not. The real market consists of the millions of individuals in over a hundred countries who go about their daily business of drinking orange juice, eating corn flakes, driving to work, and paying bills. Contrary to popular belief, the real market is not The Money Girl, a/k/a Maria Bartiromo, on CNBC telling us that some clown like Abby Joseph Cohen over at Goldman Sachs “is pounding the table” with respect to some tech garbage they want to sell. This misunderstanding comes about when we turn on our TVs’. We have been programmed by CNN (similar to mass hypnosis) and others to believe that the real market is being passed live before our very eyes on a twenty-four hour a day basis. Fortunately, that’s just not the way it is. If you are going to watch, do what I do, put the mute on.

The Wall Street crowd would love for us to believe that the ticker we see every day is the real thing but that just isn’t so. The true market has its ebbs and flows, much like the tides in the ocean, but it always ends up where it’s suppose to be. And all the J. P. Morgan’s of the world can’t change that. Further bewilderment comes when we mistakenly apply the label “manipulation” to institutions making investments that propel a price along a certain path for prolonged periods of time, when in fact it was really the market force which gave the direction. I think that’s very much the case with gold from 1996 to 2000. Gold was headed down and guessing right, they were able to help it along. I understand that the gold market is small in comparison to other markets but you can’t suppress prices for years on end unless the price wants to follow that trend.

That doesn’t mean that the gold market isn’t being manipulated now, because I believe it is. In July, manipulation together with the overvaluation of mining shares all conspired to drive prices down in a violent fashion. And like all attempts at manipulation, this will fail too (if it already hasn’t). The Federal Reserve has conspired with the Bush Administration, through the Department of Treasury, to drive the price of gold down and it’s important to understand why. In the first place rising gold prices are a clear indication that we are entering an inflationary period and our government’s official position is that inflation doesn’t exist. Unfortunately for Bush and Sir Alan, inflation is like a cork in the water. You push it down here and it pops up over there. “Over there” turns out to be the Commodity Index (CRB) which has risen 15% year-to-date and more than 20% over the last twelve months. Second, several major banks find themselves on the wrong side of billions of dollars of gold contracts (they are short) and the government wants desperately to prevent their failure. Making their job more difficult is the fact that increasing demand from China, Japan, India, and the Arab world are serving to support gold prices. Finally, the gold producers are contributing to the rise in price as they unwind their own hedge positions.

With all this in mind, we have to ask ourselves just what it is that the Federal Reserve can do about the current situation. I’m convinced that the answer is a resounding nothing! The United States in drowning in debt, in the private sector as well as the public sector. As I point out above, the Federal Reserve does not have any assets so the only thing they can do is print money (they are doing this) or lower the interest rate (they’ve done this). Both are now counterproductive. Printing more paper money is inflationary by its very nature and a further lowering of the interest rate will have little or no effect because the real rate of interest is already negative. The US government is now out of traditional bullets and any continuance of present policy will only exacerbate the problem. What’s more, the ‘powers that be’ are now aware of this.

The only solutions open to the Bush Administration are unconventional ones. They floated a trial balloon last week when they accused Al Qaeda of converting all of its assets into gold. I believe they plan to outlaw the use of gold and thereby eliminate the major inflation gage while, at the same time, saving the bacon of the two biggest banks in the United States. Unfortunately for Mr. Bush, this won’t resolve the fact that the economy is in terrible shape and the government is bankrupt so Bush will have to resort to even more drastic measures. He will go to war with Iraq and he will do so by the end of the year. He knows such an action will serve to unite the entire Arab world and plunge the US into a war that will take years to resolve. There will be immediate reprisals against Americans on their own soil and this will be Bush’s justification for his next step. He will attempt a complete suspension of the Constitution as well as Congress. If successful he’ll rule by Marshal Law for an indefinite period of time. The end result will be an economic catastrophe and the US will be faced with a situation similar to that of post-WWI Germany: massive inflation together with a complete collapse of most modern systems including but not limited to transport, education, banking, insurance, production, and medicine. The public will eventually become outraged and react with civil disobedience. The government controlled press will try to hide this but eventually the problems will become too big for King George to sweep under the rug and he will go down in flames.

The question left for us to answer is how do we, as investors, prepare ourselves for the coming events? Currently, we hold no US stocks and are short the DEC S & P (SPZ2) from 920.00. I did not expect this index to surpass 905 so I raised the percentage invested from 10% to 20% on Friday September 6th, I sold the SPZ2 short at 899 and I put my stop/loss in at 910.5. Over the very short run, I saw two possible scenarios: first, we fail to exceed 910 in the DEC S & P on Monday and Tuesday (Sept. 9 and 10) and turn back down to test 825. Second, we exceed 910 on Tuesday and rally up to 970 over the two weeks or so and then turn down to test the July lows. As luck would have it, neither situation occurred. We hovered around 910 until Wednesday September 11th when we gapped up at the open. A gap up on the open can mean one of two things: exhaustion or strength. And you usually get your answer in the first two hours of trade. I had the feeling all week that the market lacked the strength to follow through in spite of the fact that we were stopped out so we took a chance and sold the SPZ2 at 920 and put our stop/loss in at 927 (the high of the day). A lot of our clients took the gap up as a sign of strength, went long, and paid the price. We covered all of our positions on Friday and went into the weekend flat. Why cover if the market looks weak? Because I feel that we’ll get one more run-up into the 920 range before we make the big move down. We closed out the week at 891 in the SPZ2 and we will look to sell the future at 917 early next week with a stop/loss at 924.50. Assuming I’m right and we go up early in the week and then turn down, this will be our third test of 870 and it will be an important one for the Bulls from a technical perspective. I believe that we must see a break of 870 (the old low) this week or we will head back up toward 924 (old high in the CASH S & P) and maybe even 965. Any break of 980 in the CASH S & P will lead to a test of 1,070.

Over the short run, I believe the Bulls are in trouble. We must begin a sustained move up Monday or Tuesday at the latest in order to have a shot at the August 22nd high (965.10 in the SPZ2) but I have some doubt this is going to happen now. Rather, I think we will have a test of 775 in the CASH S & P within two weeks and probably fall as low as 715. This will give us a chance to make a nice profit before we pull the plug. If we do manage to rally, I believe it will be over before the end of the month and we will be on our way back down. In any event, I now believe that we will head down to test the July lows by October 1st at the latest and the trip down should be short and violent. From a long-term perspective, this will be an important week as far as cycles are concerned. We will be two and a half years from the high and I believe this will mark the halfway point in a major five year cycle, i.e., a 60 month Bear Market. Finally, I will look to invest 2.5% of our portfolio in a short position in the DEC DJ (DJZ2) at 8540 and our stop/loss will be at 8625. As usual, I am avoiding the NASDAQ at all costs.

The precious metals market has finally perked up. DEC GOLD (GCZ2) closed on September 13th at $318.10, down $3.60/ounce for the week. Gold traded as high as $325.50/ounce on September 9th as it registered a new five day and twenty day high. The gold price has now risen eleven out of the last sixteen sessions. That doesn’t mean we are out of the woods by any stretch of the imagination but I believe we are going to test $333/ounce sooner rather than later. Currently, we own October and December 2002 gold as well as February 2003 gold and we are looking to accumulate more. I took the opportunity to repurchase several DEC GOLD contracts (that I was stopped out of that same day at a higher price) on September 11th at $316.70/ounce and I will continue to purchase on weakness. Likewise, I am aware that there are institutions with substantial short position and they will have to do something soon in order to save the day. I have tight stops in at $315.52/ounce in the December contracts. This equates to $314.30/ounce in the OCT GOLD (GCV2) and $317.10/ounce in the FEB03 GOLD. I will not give back my hard earned profits under any circumstances.

DEC SILVER (SIZ2) likewise has improved its performance and closed on Friday at 457.5 cents but did trade as high as 464.0. This is a new five day and twenty day high. I have stop/losses in at $4.47/ounce for DEC SILVER but I really doubt that we’ll see these levels again. If we do, it won’t be a good sign. Silver has lagged gold for almost three months now but I look for it to make up lost ground before the month ends. The last time gold was trading above $320/ounce, silver was above $5.00/ounce. With respect to both gold and silver, the more time we spend going sideways, the better it is for the both of them. Without dwelling on the subject too much, there are forces at work right now that would like nothing better than to destroy the metals market and they’re doing there best to make it happen. The more the metals can resist, the stronger will be the move up. Finally, I would like to point out that while I am cautiously optimistic on gold, I still have a nagging feeling that it did not complete its last move down. I really thought gold should have touched US $297.90/ounce. At the very least, it should have come closer than it did ($300.30 in the DEC GCZ2). That’s why I only have 20% of our futures portfolio invested in metals contracts right now.

As far as gold stocks are concerned, I sent an Update out to all of our clients on September 3rd asking them increase their holdings from 50% invested to 75% invested. Why? The CASH XAU was able to break out above its resistance at 67.70 and stay there. In an effort to capitalize on this we purchased Goldcorp (G), Kinross Gold (K), and Bema Gold (BGO) in the Canadian market as well as Gold Fields (GFI) on the Swiss Exchange thereby avoiding any exposure to US markets and the US dollar. Today I want to take the opportunity to tell you to add Harmony Gold and Iamgold to your portfolio. Both can be purchased in Canada. Make each holding 2.5% of your total stock portfolio. The CASH XAU was able to close above 75 on Friday September 13th and I am now looking for several days of consolidation and then another big move up. Likewise, any movement back down below 67.70 in the CASH XAU won’t be a good sign and I would recommend that you liquidate 50% of your existing portfolio if that were to happen.

The NOV CRB (CRX2) is a wonderful story. We have now watched it rise from 186.0 to its recent high of 231.0 on September 10th and it did so practically without interruption. We used Thursday’s action to exit all seven of our contracts at 230 and post significant profits. On Friday we went back into the market and purchased two CRX2 at 228.0 and we will hold here until we get some sort of pull back in price. When something goes up every day, you tend to loose sight of the fact that the market does have a downside as well. There will be a correction here just as there was in the precious metals market and that will give us our opportunity to reinvest. As most of you know by now, I use the CRB as a proxy for the grains. I exited all of my grain contracts one month ago and purchase more CRX2 contracts at that time. Some of you chose to do both so I would advise you to lighten up on the grains until we’ve had some sort of correction.

Currencies appear to by range bond for the moment but I don’t think they’ll stay that way for long. We were stopped out of our DEC US Dollar Index (DXZ2) at 108.75 on Friday September 13th and we will look to get back in this week. We’ve held these contracts since February and they’ve done well for us. We will post an entry price in the ‘Chat Room’ on Tuesday. As far as the DEC SWISS FRANC (SFZ2) is concerned, we went back to our original five contracts on September 5th and will hold onto these until the market bottoms. We will add onto the SFZ2 if and when the DXZ2 breaks down below its twenty day low of 106.06. I still believe that we will see parity between the US dollar and the Swiss Franc before we reach bottom in the equities markets.

Finally, let’s talk about Crude Oil. Until now I have avoided the petroleum markets because it was impossible for me to analyze the political risk. Well, I changed my mind a week ago and purchased several NOV CRUDE CLX2 contracts at US $27.85 and we will hold onto them as long as the price stays above $27.66/barril. We closed out the week at $29.75 and traded as high as $30.25 on Friday. I see a lot of political risk at this time and its all to the upside as far as price is concerned. If we enter into war with Iraq, we could easily see the price spike up three or four dollars. I want to sell on the news that war has broken out, I do not want to hold on hoping for $40/barril oil.

CONCLUSION

In order to prepare this Newsletter I spend twenty-five days a month researching and reading everything I can get my hands on. Admittedly, most of it isn’t worth the paper it’s written on but there are exceptions. For two years now I have been paying close attention to two gentlemen in Europe who really know what they are doing. Hugh Hendry and Chris Patton have been “Bears” for two years and both turned bullish on gold more than a year ago; more so Hendry than Patton. Hendry manages the top ranked Odey Continental European Fund while Patton runs Oystercatcher Management in the Netherlands. Both have regular time slots on CNBC Europe with Patton making an appearance every Wednesday morning for five minutes while Hendry is on every Friday for a half an hour (sometimes he’s on more than once a week). Patton does excellent work with respect to the S & P Index and, while being criticized by everyone, got on CNBC in March and said the CASH S & P would not exceed 1180 under any circumstances. He then went on to say that we would make new lows in the CASH S & P before the end of the year. That took guts because if he would have been wrong, in front of a worldwide audience, it would‘ve probably destroyed his business. Likewise, Hendry was originally on CNBC two years ago with two Bulls when he predicted the markets would decline sharply with the CASH S & P falling to 600 and the FTSE trading at 2,500 before it was all over. Now, a Bull won’t be caught dead on the same show with him. For the record, Patton believes gold will make new highs before the end of the year and Hendry could see gold as high as US $1,000/ounce before it’s all over and the Bull market comes to an end. It’s a shame that we can’t get CNBC Europe in the States because in my opinion it’s a lot better than its American counterpart.

For my own part, I have been telling investors for almost two years that the DJIA would go to 5,000 and I still maintain that belief. I also thought the market crash would manifest itself in four phases:

A sharp decrease in stock prices. An increase in commodity prices.
A decrease in the value of the US dollar. A decrease in real estate prices. I don’t think anyone can deny that the first two phases are well under way and most would admit that the dollar is in trouble as well. Real estate is another issue altogether. Every one from Alan Greenspan to the man on the street swears up and down that we don’t have a real estate bubble and values will continue to rise. As I’ve mentioned countless times before, “everyone” is always wrong! Real estate will fall and it will fall hard. I own real estate and I’m liquidating as fast as I can but I’m probably too late.

I thought that these four segments would be the whole story but now I would like to add a fifth and perhaps most important stage:

The crash of the bond market.
Bond prices will fall just like stocks shortly after the real estate market begins to crash. Current yields are close to a four-decade low of 3.97% and right at significant resistance. If this resistance holds, the bond market could be in serious trouble. Rising interest rates together with inflation will be the death blow for any remaining Bulls. Some argue that we never had inflation in the Great Depression and we won’t have it now either. There is only one flaw with this argument: we were on the gold standard in 1930 and that made all the difference. There is nothing to back the value of the greenback except “the full faith and credit” of the United States government and that won’t be good enough. There won’t be any port in the storm for the last remaining Bull and the US will finally get the economic and political cleansing that it so desperately needs[2].

One final pearl of wisdom before I close out this months Newsletter and it’s not really market related. Why do US soldiers need immunity before we go off to war? I went to Viet Nam, my father fought in Korea, and my uncle served during WW II and no one would have ever dared to think about immunity much less ask for it. What are we going to do in Iraq that’s so bad that we require immunity? Think about it!

PROJECTED PORTFOLIO (09/15/02)
TYPE STOP LOSE WHERE
S & P FUTURES = 00%(short) YES 000.00 DJ FUTURES = 0.00%(short) YES 0000.0 NASDAQ FUTURES = 0% (short) YES n/a METALS FUTURES =20%(long) YES AU = 315; SI = 447 CURRENCY FUTURES = 3% NO 108.25
CRUDE OIL = 2.5% n/a 27.75
GRAIN FUTURES = 0% NO n/a
COMMODITY INDEX = 3% YES 216.5 CASH = 71.5%

Please be aware that this Newsletter was actually written on September 15th and was not loaded into the website until September 16th. As usual, I will post any significant changes in my opinions in the Chat Room for all of you to see, so please pay attention.

Sincerely,

The Management

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[1] It’s my own personal opinion that the Kennedy assassination had nothing to do with Castro, the mafia, or Viet Nam; rather he was assassinated because of his decision to close the Fed.

[2] I’d like to say ‘moral’ but I don’t want to come off as some sort of religious fanatic because I’m not.