During the past several years, the Federal Reserve has engaged in a historic market intervention through its quantitative easing (QE) programs. Early on in the process, Federal Reserve Chairman Ben Bernanke indicated that the intent of the intervention was to inflate the stock market and thereby spur a “virtuous cycle” through which the economy would be reinvigorated. Predictably, the economy has failed to respond meaningfully to QE as it continues to be constrained by excessive debt. However, the stock market has responded to artificially low interest rates and the cyclical bull market from 2009 has accelerated into a highly speculative advance that exhibits the characteristics of a prototypical bubble.

As an academic, Chairman Bernanke has exhibited the tendency to expect markets to behave rationally throughout his career. For example, many years ago, he argued that excessive debt would almost certainly not become a problem in the US because allowing debt to reach excessive levels would be irrational. Yet, here we are. Similarly, he probably did not expect the recent QE programs to create a speculative bubble in the stock market, but that is precisely what has occurred. As with all such highly speculative advances, the inevitable correction will be equally violent in character. It is only a question of when.

Additionally, it is important to reflect upon the extremely difficult task that will face the Federal Reserve when the time comes to reverse the QE process. How will this historic amount of monetary stimulus be withdrawn from the system without engendering significant economic disruptions? In a recent weekly commentary, fund manager John Hussman reviewed the unpleasant consequences of Federal Reserve policy that will need to be addressed after QE ends.

Over the past three years, the U.S. economy has repeatedly approached levels that have historically marked the border between expansion and recession. There is little question that massive quantitative easing by the Federal Reserve has successfully nudged the economy away from this border for a few months at a time. But as I’ve noted before, the belief that monetary easing solved the 2008-2009 financial crisis is an artifact of timing. The Fed was easing monetary policy throughout 2008, and while it is tempting to view the recovery as a delayed effect, the more proximate factors were a) the change in FASB accounting rules to dispense with mark-to-market accounting, which relieved banks of insolvency concerns even if they were technically insolvent, and b) the move to government conservatorship and Treasury backstop of Fannie Mae and Freddie Mac, which reduced concerns about default risk among mortgage securities.

The Pavlovian response of investors to monetary easing – as if it has anything more than a transitory and indirect effect on the economy – fails to distinguish between liquidity and solvency; between economic activity and market speculation; and between investment value and artificially depressed risk premiums. The economy is not gaining anything durable from these policies, and the conditions for the next bear market are already established. Meanwhile, the chart below updates the extreme that monetary policy has already reached (data points since 1929).

The 3-month Treasury yield now stands at a single basis point. Unwinding this abomination to restore even 2% Treasury bill rates implies a return to less than 10 cents of monetary base per dollar of nominal GDP. To do this without a balance sheet reduction would require 12 years of 6% nominal growth (which is fairly incompatible with sub-2% yields), a more extended limbo of stagnant economic growth like Japan, or significant inflation pressures – most likely in the back half of this decade. The alternative is to conduct the largest monetary tightening in the history of the world.

In September 2011, our cycle analysis predicted the formation of a long-term top in the gold market. Following the development of a consolidation formation from late 2011 until early 2013, prices moved below congestion support in the 1,550 area. As expected, the breakdown was followed by a severe decline of 12 percent during the last six weeks.

Our Gold Currency Index (GCI), which tracks the intrinsic value of gold as an international currency, has moved sharply lower in a similar manner, reconfirming the long-term correction that began in 2011.

With respect to cycle analysis, the sharp decline this week has reconfirmed the bearish translation that has persisted since late 2012. However, violent declines such as the move that began in April often result in cycle compression and it is likely that the next intermediate-term cycle low (ITCL) will form earlier than usual. The initial best estimate for the next ITCL window was from June 28 to July 26, but it is now likely that the forthcoming low will form sometime between May 31 and June 28.

The long-term correction from 2011 has retraced 29 percent of the secular bull market advance that began in 2001. This is typical behavior for a cyclical downtrend within a secular uptrend.

However, the Gold Miners Index has declined 58 percent from its comparable high in 2011, returning to levels that were first attained by the secular uptrend in late 2003.

From a big picture perspective, the obvious question is: has a new secular downtrend begun in the gold market? Given the historic expansion in the monetary base engineered by the Federal Reserve, along with the resulting structural imbalances, it is highly likely that the secular bull market remains in progress. The size of the monetary base has nearly quadrupled during the last five years and there is no known process through which this excess liquidity can be removed from the system without causing significant economic disruptions.

While contained at the moment, price inflation will almost certainly become a very big problem later this decade, probably beginning sometime during the next 2 years. Therefore, the fundamental foundation for the secular bull market in gold remains intact and we are likely several years away from the terminal phase of the rally. Cyclical corrections such as this one are healthy developments as they serve to purge speculative excesses from the market, thereby preparing it for the next phase of the advance. Additionally, they provide long-term investors with opportunities to add to their positions. As always, those accumulation opportunities are best identified through the use of optimal entry points as defined by the judicious application of chart analysis and we will report those opportunities as they develop.

Our computer models analyze a large basket of fundamental, technical, internal and sentiment data in order to calculate our Secular Trend Score (STS) and our Cyclical Trend Score (CTS). The historical data used by our models extend back to the market crash in 1929 and have enabled our STS to correctly identify every secular inflection point and our CTS to correctly identify more than 90% of all cyclical inflection points during the last 84 years. Additionally, when analyzed together, these data identify extremes in the risk/reward profile of the stock market from an investment perspective. Since early February, stock market investment risk has remained in the highest 1 percentile of all historical observations, joining a select group of five time periods that include the long-term tops in 1929, 1973, 2000 and 2007.

As always, this particular measurement of investment risk is not a top call or an indication that a severe market decline is imminent. Overbought rallies such as this one can remain overbought for a long time as speculative momentum carries prices to higher and higher extremes. What the current investment risk/reward profile tells us is that a severe market decline will almost certainly occur after the current cyclical bull market terminates. At a current duration of 50 months, the bull market is long overdue for termination and the next cyclical top could form at any time. Additionally, the rally has taken the form of a prototypical speculative advance as modeled by a log periodic bubble. This mathematical formula replicates market behavior extremely well during unsustainable advances and the following chart from a recent weekly commentary at the Hussman Funds website displays the high degree to which the current stock market rally is exhibiting the classic characteristics of a bubble in its final stage.

The most recent uptrend from November has moved higher at an unsustainable rate, gaining nearly 22 percent during the past six months and becoming extremely overbought on a short-term basis.

Any breakdown could signal the development of the latest cyclical top, so it will be important to monitor price behavior closely during the next several weeks. Now remains a time for extreme caution and we remain fully defensive from an investment perspective.

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As we note often, context plays a vital role in the development of reliable market forecasts. Short-term price behavior only has meaning when analyzed in the proper context afforded by the long-term view, so all investing and trading strategies should begin with a thorough understanding of the current secular environment. There have been five secular trends in the stock market since the crash in 1929, three downtrends and two uptrends.

The current secular bear market began in 2000 following a speculative run-up during the second half of the 1990s. As usual, market behavior clearly signaled that a secular inflection point was approaching and our Secular Trend Score (STS), which analyzes a large basket of fundamental, internal, technical and sentiment data, issued a long-term sell signal in December 1999. At the time, our computer models predicted that stocks would enter a secular bear market that would last from 10 to 20 years. Following the topping process in 2000, a prototypical secular downtrend began that continues today.

Severe secular bear markets such as this one are nearly always accompanied by extremely weak economic activity and the first decade of this century was characterized by the lowest real GDP growth since the Great Depression.

Stock market secular trends typically last from 10 to 20 years, depending upon the nature of underlying structural economic trends. Since we are currently in the final stage of a debt expansion cycle that began 60 years ago, it is highly likely that the current secular bear market is still several years away from its terminal phase.

The STS supports the hypothesis that this secular downtrend is far from over as the score has yet to return to positive territory following the sell signal in 1999. Secular inflection points develop slowly, usually over the course of 6 to 12 months, so the STS will provide plenty of advance warning when the next true investment opportunity develops in the stock market.

Secular trends are themselves composed of cyclical subcomponents, and the current cyclical uptrend began in March 2009. When they occur during secular bear markets, cyclical rallies have an average duration of 33 months. At a current duration of 50 months, the bull market from 2009 is long overdue for termination and it will likely be followed by a violent overbought correction.

The final phase of the previous cyclical bull market from 2002 was easy to identify as it developed in 2007. The measured move higher from 2004 until 2006 was followed by speculative blow-off rally that terminated the advance in prototypical fashion. The historic amount of Federal Reserve stimulus introduced during the last four years, targeted directly at risk assets such as stocks, has created massive market distortions, causing the current cyclical bull to be characterized by violent moves in both directions. However, the last advance off of the low in 2011 is rising at an unsustainable rate, suggesting that the rally has entered its final phase.

Another way to model an unsustainable advance is via a log periodic bubble. This mathematical formula replicates market behavior extremely well during highly speculative uptrends and the following chart from a recent weekly commentary at the Hussman Funds website displays the high degree to which the current stock market rally is exhibiting the classic characteristics of a bubble. Therefore, the next cyclical top is almost certainly imminent and it could form at any time.

Additionally, it is important to remember that stock market investment risk continues to hold near the highest level ever recorded. Anything can happen over short-term time periods, but the key to having consistent success over the long run as an investor and a trader is to stay aligned with the most likely scenarios and protect yourself from the unlikely ones. There will come a time when the risk/reward profile of stocks is once again favorable and the judicious study of market data will signal when that next long opportunity develops, just as it did in March 2009. However, now is a time for extreme caution and we remain fully defensive from an investment perspective.

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As expected, the recent two-session crash in the gold market has been followed by a violent oversold reaction. Following the 13 percent decline in mid-April, gold has rebounded more than eight percent during the last eight sessions.

With respect to short-term cycle analysis, the strong advance today has caused a change to our preferred scenario and it is now likely that the beta phase rally is in progress. Additionally, the move well above the last alpha high (AH) during the beta phase rally signals the likely transition to a bullish translation.

As we noted two weeks ago, technical and cycle analyses produce reliable outlooks when price movements are well behaved, but abrupt crashes like the recent decline severely limit the usefulness of these techniques. Therefore, short-term forecasting will remain difficult until the market stabilizes and we will need to wait for renewed clarity to emerge from subsequent price behavior.

From an intermediate-term perspective, the breakdown of the consolidation formation that had been developing since 2011 was followed by a quick return to the next meaningful support level in the 1,400 area. The strong rebound this week suggests that the 1,400 level will hold during this initial test, but it is likely that the violent price behavior of the past three weeks will continue in May.

A weekly close above 1,481 tomorrow would generate a cycle low signal on the weekly chart, indicating that the half cycle low (HCL) of the intermediate-term cycle from March likely formed last week.

Extreme moves often result in cycle compression, so the formation of a very brief cycle from March would not be unusual following the recent crash. However, the recent breakdown of the long-term consolidation formation was a significant bearish signal and it is too soon to know if a meaningful intermediate-term low occurred last week. Therefore, it will be important to monitor price behavior closely heading into the forthcoming ITCL for the next assessment of gold market health.

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The S&P 500 index closed sharply higher today, moving up toward recent highs of the cyclical bull market from 2009. The uptrend from November has moved higher at an unsustainable rate and the confirmed break below uptrend support last week signals the likely development of a potentially violent overbought correction. However, the final phase of speculative advances are usually characterized by extreme price moves in both directions, so the violent market behavior of the last two weeks will likely continue.

With respect to cycle analysis, a cycle low signal was generated today, indicating that a short-term low likely formed on April 18. Only a quick move below the stop level at 1,541 would invalidate the signal and suggest that the alpha phase decline from mid-April is still in progress. Given the current assumption that the latest short-term cycle low (STCL) formed in early April, the formation of another short-term low on April 18 would result in the development of an extremely brief alpha phase of only 9 sessions in duration, which would be highly unusual. Therefore, the confirmed formation of a short-term low on April 18 would likely cause a change to our preferred scenario and shift the last few inflection points to new locations.

Regardless of which short-term scenario unfolds during the next several sessions, the development of a violent correction sometime during the next several weeks remains highly likely. The cyclical bull market from 2009 continues to exhibit behavior consistent with the terminal phase of a speculative advance as modeled by a log periodic bubble.

As always, it is nearly impossible to predict the timing of a bubble reversal with any useful degree of statistical confidence. However, recent market behavior suggests that the turn could occur at any time, so it will be important to monitor the development of each short-term cycle closely until a confirmed long-term top is in place.

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Over the past several years, we have spent a great deal of time discussing the excessive debt problem that continues to constrain structural economic growth. In their latest quarterly report, economists Van Hoisington and Lacy Hunt perform an excellent review of the current situation and outline the formidable challenges that we face on the road to restored economic health.

Printing Money

“The Federal Reserve is printing money.” No statement could be less truthful. The Federal Reserve (Fed) is not, and has not been, “printing money” as defined as an acceleration in M2 or money supply. Just check the facts. For the first quarter of 2013 the Fed purchased $277.5 billion in securities (net) as their security portfolio expanded from $2.660 trillion to $2.937 trillion. A review of post-war economic history would lead to a logical assumption that the money supply (M2) would respond upward to this massive infusion of reserves into the banking system. The reality is just the opposite. The last week of December, 2012 showed M2 at $10.505 trillion, but at the end of March, 2013 it totaled only $10.450 trillion which was an unexpected decline of $55 billion. Printing money? No.

This broad misconception of the Fed’s ability to print money has been widely embraced since the Fed began its massive balance sheet expansion near the end of 2008. It was then that the Fed expanded the monetary base from $840 billion to $1.7 trillion in a matter of months. Further, from the initiation of this misguided program to the end of March 2013, the Fed has expanded the monetary base from $840 billion to $2.93 trillion. The money supply indeed went up (35%) but not in proportion to the increase in the monetary base (249%). Presently, the year- over-year expansion of M2 is only 6.8%, which is nearly identical to its year-over-year growth rate in March of 2008 before the Fed decided to “help out the economy” (Chart 1). In other words, there is no evidence that the massive security purchases by the Fed have resulted in a sustained acceleration in monetary growth; nor is there evidence that economic conditions have improved.

The Fed’s Flaw

Not only does the Fed not control money, but it cannot determine velocity (V), the speed that money turns over, either. The great American economist, Irving Fisher, identified this connectivity between money and economic growth with a straightforward formula: Nominal GDP equals money (as defined by M2) times its turnover (GDP=MV). Two flaws exist in the belief that the Fed can create rising aggregate demand. First, they do not directly control M2. Second, velocity is almost entirely outside their control. In order to understand how these two variables prevent the Fed from increasing aggregate demand, it is necessary to become conversant with a few terms: monetary base, bank reserves, and money multiplier.

The monetary base, which is derived from a consolidated balance sheet of the Fed and Treasury, has an asset (source side), and a liability (use side). When the Fed purchases government securities, the asset side rises and the liability side, comprised of currency in circulation and bank reserves, increases commensurately. Bank reserves are funds that are held by banks on deposit at the Fed or in their own institution in the form of vault cash. These funds, or reserves, are available for lending. This process of lending reserves creates deposits and currency that constitute the definition of M2.

The monetary base is often referred to as “high-powered money” since the reserve component has the potential to expand deposits and therefore money. The operative word is potential, which may or may not be realized. The massive reserve injection since 2008 is therefore the primary reason why there has been an elevated fear of inflation since these funds could be loaned. However, the empirical evidence is clear that high-powered money is not causing an increase in M2. Why? A bank’s conversion of reserves into money is called the money multiplier (Chart 2, left scale). At the end of 2007, the money multiplier was 9.0. That meant that the monetary base of $825 billion (Chart 2, right scale) was multiplied nine times to create the level of M2 that stood at $7.4 trillion. At the end of March, 2013 the monetary base had exploded to $2.9 trillion, but the money multiplier had collapsed to only 3.6, creating an M2 balance of $10.4 trillion. The Central Bank has very little control over the movement of the money multiplier; the actions of the banks and their customers primarily control this variable. This lack of control was evident in the first quarter of 2013 when the monetary base rose by $264 billion and M2 fell because the money multiplier declined from 3.9 to 3.6. Therefore, the Fed’s balance sheet expansion was thwarted.

Velocity

Referring back to Fisher’s equation GDP=MV, the other constraint on the Fed’s ability to increase aggregate demand is velocity. If M2 actually expands, then velocity must remain stable in order for nominal GDP to be lifted in proportion to the rise of M2. While stable velocity was assumed in most of the post war academic work on monetary theory, clear empirical evidence is that velocity is woefully unstable (Chart 3). A host of factors influence velocity, but arguably the most important one is the type of borrowing and lending that occurs. For velocity to rise, any increase in debt needs to create a productive income stream. For the past several years, most of the borrowing and lending activities have related to daily consumptive needs, including borrowing by the federal government as well as much of the recent upturn in consumer lending. Borrowing to finance consumption does not generate a productive income stream nor does it create the resources to repay the borrowed funds. Consequently, velocity has collapsed and now stands at a six decade low.

No Inflation

Inflation cannot ignite in such an environment. Incomes will languish and growth in aggregate demand, as measured by nominal GDP, will slow except for brief, intermittent periods. Some inflationists point to the vast pool of reserves and conclude that if borrowing and lending begin to accelerate, money will surge and so will nominal GDP, but this argument is invalid. First, the money multiplier could continue to contract, just as the most recent figures confirm. Even if, contrary to the latest data, the money multiplier were to stabilize, an extended period would still transpire before any meaningful change in economic conditions. Second, no sign suggests that credit creation is turning more productive. Hence, velocity will continue to fall. Research further indicates that there is a considerable lag between monetary change and altered economic conditions.

In the current setting, those historically long lags should be even longer. The intersection of the aggregate demand curve (AD) with the aggregate supply curve (AS) determines the price level and real GDP. In today’s highly globalized markets, with services coming on-stream from all parts of the world, the AS curve could be in the process of continually shifting outward. Thus, the price level could fall even if there are small outward shifts in the aggregate demand curve. Additionally, the extreme level of indebtedness is a force entirely independent of the Fed, and it is restraining aggregate demand and serving to neutralize what minimal influence the Fed has on the economy. Moreover, this year’s tax hike will serve to shift the aggregate demand curve inward, reducing demand, providing a second powerful counter-force to the Fed’s feeble actions.

Perspective

Our present economic situation is nearly unparalleled in American history (Chart 4). An examination of the real economic growth rate of each decade in the United States from 1790 to 2012 reveals the unprecedented sluggishness of our present economic environment. The 1.8% average rise in the thirteen years of this century is less than half of the 3.8% growth rate since 1790. The only decade that witnessed worse economic conditions was, of course, the 1930s.

Debt Constrains Growth

Bad things happen when government debt exceeds 100% of GDP. Four studies published in just the past three years document this conclusion. These studies are highly relevant since OECD figures indicate that gross government debt exceeds 100% in the U.S., Europe, Japan as well as in other OECD member countries. Three of these studies were conducted by foreign scholars and published outside the United States thus avoiding attachment to the unfortunate domestic political debate. Here are the studies, starting with the one with the broadest implications:

1. In Government Size and Growth: A Survey and Interpretation of the Evidence, Swedish economists Andreas Bergh and Magnus Henrekson find a “significant negative correlation” between size of government and economic growth. Specifically, “an increase in government size by 10 percentage points is associated with a 0.5% to 1% lower annual growth rate.” (Journal of Economic Surveys, April, 2011)

2. In The Impact of High and Growing Government Debt on Economic Growth, An Empirical Investigation for The Euro Area, Cristina Checherita and Philipp Rother find that a government debt to GDP ratio above the turning point of 90-100% has a “deleterious” impact on long-term growth. Additionally, the impact of debt on growth is non-linear. This means that as the government debt rises to higher and higher levels, the adverse growth consequences accelerate. (European Central Bank, Working Paper 1237, August 2010)

3. In The Real Effects of Debt, Stephen G. Cecchetti, M.S. Mohanty and Fabrizio Zampolli determine “beyond a certain level, debt is bad for growth. For government debt, the number is about 85% of GDP.” (Bank for International Settlements (BIS) in Basel, Switzerland, September, 2011)

4. In Debt Overhangs: Past and Present – Post 1800 Episodes Characterized by Public Debt to GDP Levels Exceeding 90% for At Least Five Years, Carmen M. Reinhart, Vincent R. Reinhart and Kenneth S. Rogoff confirm that public debt overhang episodes are associated with growth over one percent lower than during other periods, and such episodes lasted an average of 23 years. They write “the long duration also implies that cumulative shortfall in output from debt overhang is potentially massive”. (National Bureau of Economic Research, Working Paper 18015, August 2012)

When private debt to GDP rises above 160% to 175% of GDP, growth is also stunted. This argument is also operative since private debt to GDP in the U.S. was 260% of GDP as of the fourth quarter of 2012. The point on private debt is a serious matter since it strikes at one of the core purposes of central banking – to promote private credit growth. But this is only valid for normal considerations and not when private debt is excessively high. When private debt is excessive, efforts to promote more private debt are counterproductive, thus the Fed is destabilizing rather than facilitating economic growth. The two major studies on private debt, both completed in the past two years and published outside the United States, bear directly on this issue. The first is the 2011 United Nations Conference on Trade and Development (UNCTAD) study, Too Much Finance, authored by Jean Louis Arcand, Enrico Berkes and Ugo Panizza. They find a negative effect on output growth when credit to private sector reaches 104% to 110% of GDP. The strongest adverse effects are for credit over 160% of GDP. The second is the 2011 BIS study referenced above. It finds that these negative consequences, or what the BIS economic advisor Cecchetti refers to as the point at which debt levels turn “cancerous”, start at 175% just slightly more than the UNCTAD study.

Is Deflation a Continuing Risk?

In their pioneering work, This Time is Different, Carmen Reinhardt and Kenneth Rogoff (R&R) found that “In Depression-era defaults, deflation was the norm.” They, however, observed situations where extreme over indebtedness was followed by high inflation. For all its valuable contributions, R&R’s sample in this best selling 2009 book included both advanced and emerging economies. In later studies other researchers also separated advanced from emerging economies because the latter have options that the former do not. The emerging markets and very small economies in general can resort to currency devaluation when they become over-indebted which creates domestic inflation. Such adversarial action may succeed because the individual countries are too small and insignificant to harm others and thus would not evoke immediate retaliation. But inflation is optional for these smaller countries only. If advanced economies choose currency devaluation (“economic warfare”) to deal with a debt overhang, this evokes retaliation and a “race to the bottom” that is globally deflationary (the 1927 to 1939 experience). As far as we know, all the debt studies of the past three years have confined statistical examination to the data on advanced economies, a procedure that is now widely supported.

Irrationality

Credible academic research indicates that economic growth deteriorates when debt to GDP reaches critical levels – a condition that has now been met in countries that represent 75% of global GDP. When this reality is coupled with the Fed’s inability to create money growth or inflation, the result will invariably be slow nominal GDP growth.

The financial and other markets do not seem to reflect this reality of subdued growth. Stock prices are high, or at least back to levels reached more than a decade ago, and bond yields contain a significant inflationary expectations premium. Stock and commodity prices have risen in concert with the announcement of QE1, QE2 and QE3. Theoretically, as well as from a long-term historical perspective, a mechanical link between an expansion of the Fed’s balance sheet and these markets is lacking. It is possible to conclude, therefore, that psychology typical of irrational market behavior is at play. This suggests that when expectations shift from inflation to deflation, irrational behavior might adjust risk asset prices significantly. Such signs that a shift is beginning can be viewed in the commodity markets. The CRB Commodity Index peaked about two years ago at 691, but now stands at 551, a 20% decline despite massive Fed balance sheet expansion. The ability of the Fed to arrest a downside irrational move in risk assets may be limited. Non-risk assets, such as long dated U.S. treasuries, should benefit from this shift in perception.

At a current duration of 49 months, the cyclical bull market from 2009 is long overdue for termination. Fueled by a historic amount of stimulus, the rally has taken on a highly speculative character during the last two years. Although it is nearly impossible to predict the timing of a cyclical top in advance, recent developments suggest that a long-term reversal will likely occur sometime during the next few months. From a monthly perspective, the rebound off of the low in 2011 has taken the form of a speculative blow-off move, indicating that the final phase of the bull market is likely in progress.

From an intermediate-term perspective, the advance off of the low in November marks the second time that the angle of ascent has increased following the formation of the low in 2011. The cyclical bull market is moving higher at an unsustainable rate and it will likely be followed by a violent overbought correction.

Another way to model an unsustainable advance is via a log periodic bubble. This mathematical formula replicates market behavior extremely well during highly speculative uptrends and the following chart from a recent weekly commentary at the Hussman Funds website displays the high degree to which the current stock market rally is exhibiting the classic characteristics of a bubble.

Again, it is nearly impossible to predict the timing of a bubble reversal with any useful degree of statistical confidence. However, market internals are beginning to show signs of fatigue. For example, a negative divergence has developed between breadth summation and price behavior, indicating that the bull market is losing strength even as it surges to new highs.

As always, there are no certainties when it comes to financial market forecasting, only possibilities and their associated probabilities. Driven by irrational hope and euphoria, the duration of a highly speculative advance can easily exceed all rational expectations. However, at some point, the music stops and the pendulum inevitably swings violently in the other direction. Current market behavior suggests that the overdue cyclical top will likely form sometime during the next few months, so we remain fully defensive from an investment perspective.

Since late March, gold prices have struggled to rebound off of the last intermediate-term cycle low (ITCL), favoring a continuation of the bearish translation that has persisted since October. This week, gold plunged 5 percent. The weekly close well below the ITCL in March reconfirms the current bearish translation and forecasts additional intermediate-term weakness heading into the next ITCL in late June or July.

The long-term correction from September 2011 developed into a consolidation formation in early 2012 and prices were confined to a trading range between 1,550 and 1,795 prior to the breakdown this week. The weekly close well below congestion support at the 1,550 level reconfirms the long-term correction and forecasts additional losses.

Our Gold Currency Index (GCI), which tracks the intrinsic value of gold as an international currency, closed sharply lower as well, breaking well below its comparable support level in the 40 area.

It is important to note that the secular bull market from 2001 remains healthy and the character of the correction from 2011 continues to favor an eventual resumption of the uptrend.

However, the breakdown on the weekly chart forecasts additional weakness during the next two to three months heading into the next intermediate-term low.

Yesterday, our cycle analysis identified the potential development of a short-term low in the stock market. Today, a cycle low signal was generated, confirming that a new short-term cycle has begun.

Although short-term cycle translation remains bullish, the uptrend from November has moved higher at an unsustainable rate and the rally is now extremely overbought.

Moves that occur in the direction of the primary trend, which in this case is up, often take the form of a five-phase wave. The advance off of the low in November is a typical example of this type of move and the fifth and final phase is nearly complete. Therefore, a meaningful reversal could occur at any time.

Moving out to the intermediate-term view, the rally off of the low in November marks the second time that the angle of ascent has increased following the low in late 2011. The cyclical bull market from 2009 is moving higher at an unsustainable rate and it will likely be followed by a violent overbought correction.

Additionally, the latest intermediate-term cycle high (ITCH) is long overdue and it could form at any time.

The formation of the overdue ITCH would be a potentially important long-term development because, given the extremely long duration of the current cyclical bull market, a confirmed intermediate-term high is also a potential cyclical high.

The character of the forthcoming correction will provide the next assessment of bull market health and determine if the latest ITCH is also a likely cyclical top. Therefore, it will be important to monitor price behavior closely during the next several weeks.

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