The credit markets signaled disaster a few months ago and commodities as well as currencies are just beginning to get the idea. However, Wall Street is still in denial and I am surprised that major US indices are still holding up pretty well. Nonetheless, given the fact that the world's fever chart (US Dollar Index) has recently broken out to a new recovery high and credit spreads are refusing to come down, it may only be a matter of time before Wall Street wakes up to the European reality.

Without massive intervention by the European Central Bank (ECB), the European debt crisis can't be solved. Unfortunately, the ECB's mandate does not allow the printing of trillions of euros, thus, a world-class financial crisis may be required before further monetary inflation is unleashed. As things stand today, it is clear that Italy and a host of other European nations cannot continue to service their debts - not with bond yields spiking and their GDP growth rates shrinking. Moreover, with European banks deleveraging their balance-sheets, I cannot help but think that the primary trend for risky assets remains down. Therefore, I believe that short-term counter trend rallies notwithstanding, the path of least resistance for stocks remains down and this is not the time to catch a falling knife! If and when the October lows are taken out, a more serious sell-off will probably follow and we may get a waterfall decline.

Over in the commodities complex, the crude price has dropped below its 200-day moving average and it appears as though the test of the recent channel breakdown is now complete. If this is the case, the price of oil should decline over the following months and the looming recession will certainly bring out the sellers. The Reuters-CCI Index has also declined to a new bear market low and this weakness in commodities does not bode well for the global economy. My view remains that most commodities will probably deflate over the following months.

Turning to precious metals, gold, silver and platinum are looking very weak. The price of platinum has dropped to a new bear market low and this suggests that the world's auto demand is weakening. Furthermore, gold took a big hit this week and its price has also dropped below the 200-day moving average. This development is extremely bearish for the risk trade and the recent weakness in gold suggests that the world is rapidly sinking into a deflationary spiral. In addition to platinum and gold, the price of silver is also declining and the recent lows are likely to be taken out soon. As long as the dollar is strengthening, precious metals will continue to face selling pressure.

In the world of currencies, the US dollar is strengthening and this is a hallmark of a severe credit contraction. For now, the Dollar Index is in a firmly established uptrend and by breaking above the 80 level, it has managed to clear overhead resistance. Conversely, the euro has recently broken down to a multi-month low and I expect further weakness over the following months. As this European drama unfolds, I expect most world currencies to decline against the US dollar and perhaps the yen may be the only currency to buck the downtrend.

Finally, looking at the world's debt markets, the story is playing out as expected. In simple terms, money is flowing towards safety, thus US Treasuries and German Bunds are outperforming all other forms of credit. Unsurprisingly, bond yields in peripheral Europe are spiking yet again and this is terrible news for the Europeans.

(HK Edition 12/17/2011 page2)