Robert R. Prechter

CEO, Elliot Wave International

"Conquer the Crash Revisited"

Transcription of Audio Interview, June 18, 2005

Editor's Note: We have edited the interview in this transcription for clarity and readability.
The original real audio interview may be heard on our Ask The Expert page.

Charts for Today's Interview

JIM PUPLAVA: Welcome back everyone, it’s time to introduce my special guest this week. It’s a real treat to have Robert Prechter, Jr. back on the program. Bob’s a chartered market technician. He began his professional career in 1975 as a technical market specialist with Merrill Lynch. He has also been publishing The Elliott Wave Theorist, a monthly forecast publication, since 1979. He is President of Elliott Wave International and he’s an executive director of the Socionomic Institute, a research group. He’s received various awards including winning the United States Trading Championship. He was also awarded “Guru of the Decade� by the Financial News Network in 1989. He has also been listed in Timer Digest. He’s been published in various magazines, and he’s the world’s leader in Elliott wave interpretation. He’s written 13 books or coauthored 13 books, starting with Elliott Wave Principle � Key to Market Behavior. His most recent successes have been Pioneering Studies in Socionomics and a book he wrote called Conquer The Crash.

Bob, I wanted to have you back on the program because you are one of the foremost Deflationists I can think of and one thing that I think has happened, which is a tribute to you I believe, is you have a lot of copycats. There are a lot of people who have taken your analysis and copied it as their own without the attribution. So I wanted to have you back on the program, and since our radio audience today is 4 to 5 times bigger than the last time we had you I want to start out with the premise of Conquer The Crash because many people may not yet have read it or may not be aware of it.

ROBERT PRECHTER: Well, the premise of Conquer The Crash is that a major turning point in the financial world was met in the first quarter of 2000. The bull market that began in December of 1974 ended at that time, in the blue chip averages, and we have turned the corner into a completely different environment, which is going to be a bear market environment very much like the 1930s and 40s. Nothing is ever exactly the same as it was in a previous time, but I think there are going to be quite a few similarities. Another time in history that we should be copying to some degree is 1835 to 1859. These were times when stock prices mostly went down and when commodities joined the trend ultimately as well. So when I put those two things together I think what we’re going to see is a deflationary environment, probably ending about 7-10 years from now.

JIM: Now Bob, one thing that has happened when the markets took off in March 2003, everybody’s calling this a new bull market. I would take it from your technical views you would disagree with this more in terms of, let’s say, a bear market rally in a continuing bear market trend.

BOB: Well, you’re exactly right and in fact I’m extremely bearish at the moment. We have a tremendous list of technical negatives in the market. But the important ones are that the retracement level in the S&P500, the main representative of stocks that we have, was about 58%. That’s a normal bear market retracement. I think it’s over. I think it ended in March. But whether you try to call the exact month is not that important. What matters is that the optimism that has been generated by these two up years has matched -- and in some indicators even exceeded -- the optimism we had at the all time high in the first quarter of 2000. Just to give you a perspective, or to give your listeners some perspective, on this absolutely amazing situation, ever since the October 1998 sell-off -- that’s when South East Asia had its meltdown -- the market came out of that low and the Investor’s Intelligence group, which reports on the percentage of advisors who are bullish and bearish, showed a plurality of bulls from that point onward. And despite the fact that the S&P lost 50% of its value and the Nasdaq lost over 75% of its value in the meantime, we’ve now gone 339 weeks since that point, 6 � years, and in only nine of those weeks were there more bears than bulls, despite the terrorist attack, the collapse in stock prices and everything else. It’s the biggest top formation that has ever existed, and it’s the flip-side of the bottom formation that occurred between 1974 and 1982, and I think this top is about over.

JIM: Now if we look at that recovery which begin March 2003, we had a nice upward move in stock prices, all the way into, let’s say, the first quarter of 2004. But from that point forward until really probably the last six weeks of 2004 this stock market spent most of its time digging in negative territory, until the last six weeks of the year and here we are again in the year 2005, and at least at this juncture you’ve got the Nasdaq down 5%, the Dow is down over 2, and we’ve got the S&P down.

BOB: You are absolutely correct. In fact the Dow -- and actually very few people realize this because of the bullish feelings out there -- the Dow is absolutely unchanged from January/February of 2004 to where it is right today.

JIM: It’s amazing because one area that has done well in the last couple of weeks has been technology stocks, especially the semiconductor stocks, but if you look at them fundamentally the sales are roughly where they were in 1998 and then also collectively as an industry the bulk of those sales are occurring overseas.

BOB: You point is obviously key: people are overvaluing stocks tremendously. What I focused on in the June issue in one section, just to show people that prices in stocks can be way, way out of whack with so-called fundamentals, is the Dow Jones Transportation Average. The companies collectively in that index have net losses. They don’t even have any earnings, and yet the index in 1998 had tremendous earnings, $300 a share, and oil was trading at $11 a barrel. Now oil’s at $55 a barrel. It’s gone up 5 times, the earnings are negative and yet the stocks went up 65% into the peak in March of this year! Now that is an amazing situation and tells you that people are in a dream world in terms of pricing stocks. We can’t necessarily call the exact turn of when this dream world will end. It’s already gone on longer than I thought it would, but some of the recent figures we have in just the last couple of weeks say that it’s hard to imagine an extremity greater than this, and that tells me this rally is over.

JIM: You’re also seeing some of the same type of characters play out in the market. Recently for example Google which has roughly an $80 billion market cap with only $3 billion in sales, less than $1 billion in profits, we have analysts saying Google was a $300 stock. Then, not to be outdone, another analyst came out and said it was $350, then another one came out and said, “Well, I’ll top that, $375.�

BOB: Does that remind you of anything?

JIM: Probably 97-99.

BOB: Exactly.

JIM: So we’re seeing the same kind of behavior. Let’s talk about something also that we’ve seen that has been somewhat odd, and that is the behavior of the bond market, Mr. Greenspan’s conundrum. We’ve had the Fed raise interest rates 8 times, possibly 9 this month, and yet long term rates have come down; we’ve got 30 year Treasuries below 4 �% and the 10 year Treasury roughly around the 4% level.

BOB: I think the answer to that is the time-honored -- although not honored by economists -- Kondratieff cycle. We are in the downward phase of this cycle. We have been for a while. The tremendous credit expansion -- what I call the Great Levitation -- has kept things floating here for the last 5 years. But the normal situation for this time of the cycle is for interest rates on strong bonds, that is bonds issued by someone people believe will pay them back, to go down. Japan was ahead of the curve on this, and its bonds went way down in yield to under 1% and have been staying there for quite a long time. I think the U.S. bond market is slowly catching up to what Japan has been doing on the leading edge. This is pretty normal but, and this is where most people are going to get in trouble, the vast majority of bond issues out there are not safe. The only bonds that are going to stay very low in their yields are those bonds that are going to pay off ultimately, and that is an extremely small percentage of the total amount of dollar denominated debt outstanding in the world. I think some of the worst investments you can make right now are corporate bonds and municipal bonds. I think people are making a mistake even when they are buying them cheap, for example the General Motors bonds. I mean, once we head into the next leg down we are going to have another economic contraction just as we did in 2001, and the issuers of these bonds are going to be hard pressed to pay them off.

JIM: Certainly if we take the case of General Motors where they have over $300 billion in debt and I think equity that doesn’t even come close to paying that, I don’t see how they survive. They continue to lose market share, and the area that they are making money, which is in the lending department, they’re making more money making loans than they are making cars. Same thing with Ford.

BOB: I agree. And I think the only reason that many of these companies are staying alive is this dream world that investors are living in, in terms of valuation. For example, if we were having a runaway inflation now, bonds would be getting crushed. If we were having a big bear market, stocks would be getting crushed. Yet investors have bulled up the price of absolutely everything. They’ve pushed up the price of bonds, they’ve pushed up the price of stocks, they’ve pushed up the price of commodities. It doesn’t make financial sense, except in the sense that this is all credit, and it’s going to come collapsing down at some point. So I think I know why this is happening. We were forecasting several years ago that the recoveries would be homogenous across the board. I didn’t think it would last this long, and I didn’t think they would go this high, but this is the kind of thing that happens late in the Kondratieff cycle: liquidity is driving everything. The Fed played a lot of cards in the last few years. I think they are pretty much out of ammunition. They claim they are not, but I think they are.

JIM: Has it surprised you in the sense that another assumption in your book Conquer the Crash is a deflationary depression? If we take a look at the downturn that came in 2000, the collapse of the Nasdaq bubble, the recession, the events of 9/11, what made what happened afterwards somewhat different is if we contrast the recession of 2001 to the recession of 91, people acted responsibly: when Greenspan brought interest rates down. People refinanced their homes; they took that extra cash flow, they paid down debt; they built up their savings; they stopped spending; there was pent up demand. That did not happen this time: we had runaway spending; a new bubble that developed in real estate; we had a mortgage bubble that developed, consumption fed off of that with equity takeouts. I mean this wasn’t responsible action if we compare this to previous recessions.

BOB: I agree completely, and I think ultimately Greenspan will be known as the guy who created all these bubbles, or at least nursed them along. Ultimately human beings are the ones who decide to go out and borrow the money, even when it’s cheap to do so. They don’t really have to.

But I think there is one big myth out there in terms of the 2001 recession, that is that it ended. If you look at the manufacturing jobs in this economy, they continue to collapse. There’s been no recovery to speak of. Three million jobs have been lost in the manufacturing area. We can’t survive as a producing country just doing each other’s laundry, providing services for each other. So I think this recession is worse. I think actually we started a depression in 2000 and 2001, but people don’t recognize that we’re in a depression because we’re not in the bottom. They say, “I don’t see any bread lines.� Well, as soon as you see the bread lines, it’s the low. That’s when you want to start buying stocks, commodities and precious metals and everything else because then the deflation will be over. But we are in the very early stages of a depression, and the country is basically falling apart. What hasn’t fallen apart yet is the optimism, the confidence and the dream world that people are in, but that is going to happen.

JIM: It’s amazing when you examine government statistics. I for one -- and I’ll go on record -- don’t believe the GDP numbers. They are massaged, we have imputations, we have a lot of things that go into the GDP figures that aren’t real. In other words they are dollars that are not created anywhere. Nobody creates them as a manufacturer or as a producer or pays them as a consumer. But you bring up something that is rather interesting because up till, let’s say 10-15 years ago when we began to massage these numbers, and you saw this in the 91 recession, they said it was a recovery in 92 but they were calling it a “jobless recovery� because we were losing jobs, we weren’t adding jobs. The same thing happened this time around.

BOB: Yes, that’s right. It sounds like an oxymoron doesn’t it?

I agree with you, Jim. I don’t trust the GDP numbers either, and I’m not a conspiracy theorist, but government always tries to massage numbers. I think this is the normal way they do business. But here is one reason why I seriously question the idea that we’ve had much of a recovery out of the low in 2001: In the past century, never has a recession ended before the stock market bottomed. And in this case they claimed the recession ended in late 2001 and yet the stock market went ahead and made a new low in 2002, a year later. That has never happened before. The stock market is a leading indicator of changes in the economy. To me the only way that can possibly be the case is if the numbers are being massaged. And it could be part of the fact that credit has grown so much that they’re just valuing things upward that actually, in terms of their real value, are worse off than they were before, like so many of these prices in dollar terms that we’ve experienced in the last couple of years.

JIM: You know another phenomenon that I think we’ve seen since 2001 that is unlike the previous recession in 1991. I’m just looking at, for example, the Flow of Funds at the Fed. Last year we had foreign central banks buy $262 billion worth of Treasuries. We had foreign institutions buy $96 billion worth of Treasuries, and we had the Fed monetizing over $42 billion. So collectively, foreign central banks and the Fed itself in essence monetized nearly $400 billion worth of securities, which was more than the government or Treasury issued in bonds last year.

BOB: Yes, and that’s the source of our tremendous credit expansion. And again, I think the purchasing of that debt is all due to confidence, and once that cracks, and the stock market is the signal of that, the whole world is going to look different.

One really interesting thing I’m sure you’ve experienced in your study of history: A lot of people when things change will say, “Oh my gosh! what a sudden change that was. Gee, just a couple of months ago we all thought this, and now look, everything is falling apart,� or sometimes vice versa, everybody’s worried and 3 months later things are fine. They don’t realize that the recognition point when people wake up and say “everything is changing� was the result of a long process. And this time the process has been outrageously long; it has taken many, many years. But the problem is not so much what the Fed and people are doing at the moment, it’s what they’ve been doing for the last 20 years, and that is reinforcing the credit bubble we’ve been in and all the bull markets that it has supported. I think it is going to turn turtle and go the other way, and when it does it’s going to be a breathtaking thing to watch, but it won’t be out of the blue.

JIM: Do you think it will be something like what happened to the stock market in 2000, because certainly the Fed began raising interest rates in the summer of 1999. They raised it all the way most of 2000 with the same kind of comments that you hear Mr. Greenspan say on Capitol Hill. He’s confident the economy is at a level of long term stability, sustainable growth, and all of a sudden, boom, things fall off a cliff very suddenly. And when you have the amount of debt we have in the US today, whether it’s government, whether it’s corporate, whether it’s municipal or individual, how far do you think they are going to get away, because at least as of last week Mr. Greenspan was confident that everything was rosy?

BOB: It’s a little bit like what happened in the 20s and 30s. The Fed raised rates in the late 20s and everything started to fall apart, and they were a little late in following it down by lowering rates. This time they were much more aggressive. From 1932-1937, the market finally rebounded. It was the most rapid bull market, actually, for its period of time in the last century. And then there were a couple of up-ticks in rates and the market suddenly crashed again in 1937 and 1938, and people blamed it on that. I think the Fed is pretty much a reactionary group and when it’s lowering interest rates you can tell they’re afraid, and when they’re raising them it just means their confidence is returning. I don’t think they are making things happen, generally speaking. So it tells you, yes, they are not worried any more; they really do think this recovery is sustainable. But last time they were able to lower rates from a very high level, 6%. This time they’ve got less than half that. So I think their quiver is low on arrows.

JIM: Let’s talk about the consequences of Conquer The Crash. The conclusion was that the U.S. would enter into a deflationary depression. That has not happened. Why?

BOB: Well, I think we are in it. We are in a depression. We haven’t begun deflation yet, that’s true, but you can also see a lot of signs that it is extremely difficult for manufacturers and other people selling their goods and services to do anything about it. Car prices keep going lower because of the competition from abroad. There’s a lot of what I call deflationary psychology because there are people who can barely make ends meet, and the reason they are surviving is something you alluded to earlier: So many foreigners are buying our bonds that people are borrowing their way into survival. Obviously that can’t go on forever.

Now instead of printing currency, what the Fed has mostly been doing is encouraging people to take on more debt, and the government has been taking on more debt right along with them. Debt is something that can contract and collapse, and I think that is what’s around the corner.

There has been a reprieve. I’d like to put it this way. In 1974, late 74 early 75, I was very bullish on the stock market. It took off for two years up into December of 1976, and then it spent a number of years testing the lows. It went down into 1978, it rallied, came back down in 1980, rallied again, and yet a third time in 1982 it came down and tested the low one more time. People were pretty disgusted by this point, they were pretty bearish, they were giving up on the great bull market idea, and that’s exactly when it took off. Well, we have the same situation now, but it’s inverted. We had the peak in 2000. I don’t think I was wrong by saying that from that point we were going to head into a depression, but what we’ve had now is a test of the highs. We’ve had some obscure indexes go to new highs, but the ones that are really representing most of what people own, like the S&P and so on, are not. They are below the highs, just as in 1978, 80 and 82 the Dow stayed above its low of 74 and didn’t go to a new low. I don’t think we are going to go to a new high. So it is a second attempt to go back towards the highs. It’s a top-building process, just as we went through a bottom-building process. This one has lasted five years. The bottom lasted eight years. I don’t think this can hang on for eight years, but who knows? It has already lasted longer than I thought. We’ll just have to see.

JIM: Let’s talk about this system we have today of fiat currencies, where money is basically backed by nothing, and when you have money and credit expand rapidly there always seem to be some sectors that inflate while others deflate, either in relative or absolute terms. For example if we look at between 2000 and 2003, at least the first part of it, we had a deflating stock market. Certainly you would call it that if you look at the Nasdaq, which lost over 70% of its value. But during that period of time from 2000, actually 1998, we had the beginnings of a real estate bubble. So as this money and credit was injected into the system, as the Fed pumped money furiously and also as foreign central banks came into the U.S., we got the mortgage consumption real estate bubble. Is it possible with central banks acting, and some would say, in unison -- Richard Duncan who wrote The Dollar Crisis said that in the first quarter of 2003 to the first quarter of 2004 Japan printed $323 billion, US dollars, and bought our debt. That was more than they did in the previous decades. Is it possible, Bob, in your opinion, that in this fiat currency world in which we live we could see some areas deflate, whether it’s real estate coming next or it was the stock market previous to that and other areas inflate.

BOB: What you are really asking is can prices in some sectors go up while others go down. And yes, I would say that’s true. When we’re talking about inflation and deflation, I think you’d agree that it’s a matter of the money and credit supply, and so far that hasn’t contracted, so we haven’t had any deflation in the true sense of the word. What I think is happening here is like an EKG of somebody having a heart attack, and it’s going crazy. We’re having the peak of this amazing expansion in credit from 1933 when the Fed finally decided, “We can’t live with this deflation stuff anymore and we’re going to make credit available no matter what.� We’ve had 72 years of it now, but we are in the topping area. They have saturated society with debt to the point that people can barely hang on, but they are trying to. So you are getting these surges in various areas. It peaked in the Nasdaq, as you say, in 2000. Now it’s the real estate market, and in between it has been everything from Beanie Babies to various commodities, and as soon as those things run up they tend to fall apart again. So people are losing money every time they bet on one of these things, and I think it is the flipside of what we lived through in 1974-1982. Every time people were bearish back then, they were wrong, and ultimately I think the people who were bullish on all these markets are going to be wrong as well. But living through it is no picnic.

JIM: Let’s talk about a different kind of phenomenon that we’ve seen operate elsewhere. Most people would agree that inflation is primarily a wartime phenomenon: Governments expand the money supply, we consume massive amounts of commodities, and we destroy massive amounts of things, but there were periods even recently where you had numerous countries especially in Latin America, Turkey, Russia, and parts of Asia, where inflation came about with actually the currencies of those countries falling faster than the price rise, and we saw this in the Weimar Republic. So what you saw in essence was a deflation even though nominal prices were going up, real prices were coming down. Could that happen here?

BOB: Yes, in fact in Conquer The Crash I say I think the ultimate workout of all this will be hyperinflation, but not until we get deflation first. What happened in Germany in the 20s, 1922-1923, was the printing of banknotes. Now mostly what the Fed does is make credit available, and they make it easy for banks to lend. So people are going to the banks and borrowing. Every one of these things is an IOU. It’s not a dollar in their pockets; in fact the number of greenbacks is very small. So hyperinflation would have to come after the collapse in credit. If the Fed or the government began to print greenbacks now as they did in the Weimar Republic, what would happen is the entire credit house of cards would fall apart because people would look at it and say, “We can’t hold these bonds, these trillions of dollars worth that are out there worldwide, anymore because the Fed is going to destroy them by printing bank notes.� I think the Fed is walking a tightrope 500 feet above the canyon. They can’t do what the Weimar Republic did. And of course there were also some extenuating circumstances back then in terms of the World War I debt that they were demanded to pay, the reparations, so they just decided, “Fine, we’ll give you what you want; we’ll just print it and you can have it.� We don’t have that situation today, and I think the integrity of the credit market is the most important thing that the Fed has going for it. As soon as that falls apart, which it eventually will, it’s going to lose its power around the world, but I think it’s going to want to fight to keep it alive. I absolutely do not think that they are going to begin printing banknotes, and even if they do it’s going to cause initially a deflationary crash. It may only last a year instead of the number of years I think it will because the credit market would have to basically fall apart completely as people realize all the Fed was doing was replacing debt with currency. That isn’t beginning, but as you were saying, is it possible? Yes. Ultimately, after the deflation, I think it is more than possible; I think it’s likely.

JIM: And is it possible in an interim period of time they can get somebody else to do their dirty work as a surrogate as one might argue, let’s say, the Bank of Japan, or the Bank of China serves today.

BOB: What do you mean, “do their dirty work�?

JIM: In other words, instead of the Feds printing money the Bank of Japan and the Bank of China prints money and buys our debt.

BOB: I don’t think that they have any different situation because their markets for credit are also very large, and they haven’t shown any desire to destroy them. So far it really hasn’t happened. What has happened is what has happened from the beginning, from 1933, and that is that the Fed is facilitating credit. Now if someone shows me someday that they have started the machine pumping the dollars out, then I guess I’d say they are changing their approach, but it still won’t change the fact that they have created these multi-trillion-dollar credit markets, and those credit markets are not going to take kindly to that kind of activity; they will have to collapse. So I don’t see how in the world we can avoid having deflation, and I think the fact that so many prices have stalled, for example, most of the agricultural commodities have had 30% declines sometime in the last year and a half, silver stalled out over a year ago, and gold stalled out six months ago. These markets are telling us that despite the increase in credit they smell something different. They are saying there is something else around the corner, “we’re not going up because we don’t think this is sustainable,� and I don’t think it is sustainable. Credit balloons, bubbles, always get deflated.

JIM: Let’s talk about something within commodities that is certainly standing out and is certainly is critical to Western industrialized society, which is energy. We’re looking at oil prices at $55/barrel. Last week a book was released by probably one of the foremost energy experts in the world, a gentleman by the name of Matthew Simmons. The name of the book is called Twilight in the Desert. It’s Simmons’ thesis in this book that Saudi Arabian oil [production] has peaked. If it hasn’t peaked already, it is close to peaking and when that happens world oil production will have peaked, and from that point it’s a decline curve and of course energy permeates just all sections of our industrialized society. What happens? Does that alter your forecast?

BOB: No. You’re just saying the price will go up because the supply went down. That wouldn’t have anything to do with inflation or deflation. So that doesn’t speak to anything we’ve been talking about. But I’m calling for one of the biggest depressions ever, and in those environments you get all kinds of disruptions, and I’m certain that cutoffs of fuel are going to be one of those disruptions. There’s probably no doubt about it. But also you have to realize where I come from when I do my analysis. I am mostly a market psychologist. I am looking at the kind of statements people are making, the kind of arguments they are making. We keep 25 or 30 different indicators on the psychology of the various markets we follow. It tells us what people are doing and what they are saying. Nobody was going apoplectic over the world running out of oil back when it was eleven dollars a barrel. You didn’t hear any of that. Everyone was complacent in 1998. So when you get near tops, you get all the wild forecasts and, just as with Google, everyone tries to outdo the other and one guy says we are going to run out of oil in 2060, and the other guy says no it’ll be 2030 and another guy says it will five years from now. So it’s the same kind of psychology going on at this peak. While I was attending the last couple of conferences I was really surprised to see how many people were opening up booths and making speeches about how to make money in the oil market. I haven’t seen that before, and it’s generally a sign of a top. Again, it doesn’t mean we are 5 minutes away from the peak in oil prices right now, but I would certainly say it’s much more likely from a psychological standpoint that oil’s going to go a lot lower than people think over the next 5 or 6 years.

JIM: I want to come back to something on this massive amount of credit. There’s been some criticism against the bond market, in fact some may argue that the bond market has been bought off with the carry trade. If we’re seeing inflation in the consumer price index, it’s certainly gone up even with the massaging. You really don’t care, if you’re a bond investor, if you can borrow at 2 or 3% if you can play market spreads and go in and get 8 or 9%, who cares about inflation when you’re making that kind of money on borrowed money?

BOB: Well, it depends. I think people trying to make money in anything yielding over 2% are taking a risk. The ultimate risk is the payback of principal, and that to me is the most amazing thing, that the overall bond market has held up as long as it has. We’ve seen this tremendous expansion in the credit supply, as you are pointing out, and continuing movements up every single year in the CPI, and yet the bond market stays robust. It’s an absolutely amazing situation. It is unsustainable. It’s this dream world psychology that “Everything is fine, it’ll continue to be fine and we’ll continue to have mild inflation bailing us all out, we can have our bull market and our slow moving prices at the same time,� but it can’t be sustained. I think that the issuers of these bonds aren’t going to pay off the people that have invested in them. It’s a hot potato game. They’re passing it around from one person to another, and when they finally realize that there is not enough production to pay all this debt off, it will be coincident with the next big wave down in stock prices. And the next wave down isn’t going to be like 2001 and 2002. This one should be much more relentless and cover much more territory on the downside.

JIM: Do you think that downside could be accelerated if at the same time we’re experiencing a deflating of the real estate bubble? Because one of the comments -- I know you follow a lot of the market psychology indicators -- but in talking to people, in talking to potential clients, the kind of emails we got here at Financial Sense, “Well, I know my 401K is down 40% but you know I’ve got 20 years to retirement, I’m into it for the long run, but you know, hey, my house is up 50%.�

BOB: You hardly know what to say to someone like that. He jumps out of one pot that has boiled his skin and he jumps into another one. This has been a rolling series of bubbles. Rather than learning from them, so many people are saying, “This one is the true uptrend that will never end,� and it’s not. As you point out, it’s a bubble, supported by credit. And that’s what bubble means in my opinion; it’s not just a market that is way up. Some people will call any rising market a bubble, and that’s not true, there has to be extensive credit supporting it and it has to permeate society, and that’s certainly true of the real estate market today. I think one of the signs of the fact that this is a terminal time for the real estate market is that people are no longer buying homes to live in; they are buying them to flip, they are buying them to speculate. It’s an incredible situation, and again, how long it can last we can’t be certain, but it’s very much as we saw in late 1999. It wasn’t just the blue chip stocks anymore, it was Internet stocks with absolutely no value going from $1 to $50, 60 or 70 and doing the whole round trip. It’s that kind of froth we are seeing right now in the real estate market. If there were a way to short it, I would do it, but the best you can do now is to sell some REITs, which I think is a great speculation.

JIM: Bob, let’s talk about the solution before we get to some conclusions. In Conquer The Crash, why don’t you go over for our listeners given what you see coming ultimately, which is a deflationary depression, followed by hyperinflation. How would you best prepare for that?

BOB: Here’s one interesting thing. Where I finished that book in March of 2002, the peak that month in the Dow was 10673, well it’s 10547 right now, so it’s virtually unchanged. I’m as surprised as anyone it’s had that kind of recovery, but there is absolutely no difference in the recommendations I am making for people to get out of the way of the danger that I see is coming. And it’s very, very simple. It’s to do virtually the opposite of what most financial advisors are recommending that people do. And what are they recommending? They are recommending that people take their hard earned money and put it in risky areas such as the stock market, which as you say lost 40% for the average investor in 2000 based on the hottest 50 mutual funds sold that year, and they are putting it into other things such as commodity funds, which I think have had a nice run in dollar terms, not in euro terms, but in dollar terms, I think that is already reversing, so they’re going to be in trouble. But the biggest area of all is real estate, and people think it won’t come down, and the banks that are lending money to people to buy these homes don’t think it can come down either, or they wouldn’t be lending 90 cents on the dollar. So it’s a tremendous accident waiting to happen, and I guess you and I are just getting tired of waiting, but you can’t change, I think, the inevitable weight of the credit bubble that we have. It’s so large and so pervasive that the ultimate outcome I think is virtually assured, and that is, it’s going to collapse.

JIM: Let’s talk about gold. You’re bearish on gold in the short term; longer term you are bullish on gold. There’s a difference between you and me on gold. I’m still bullish on gold. Explain your position on gold and why you would stay out of it now and when you would be in it?

BOB: I’ll tell you when I would be in it: February 2001. I put out a special page that month. Gold was trading at $255/oz, and I said it looks to me as if it’s going to rally about $100/oz. And that’s in the midst of what I was considering a bear market, so I was taking a very contrary stand. There were very few bulls around at the time. I underestimated how far it would go because when it got to $360, I got out. I don’t know if you remember ,but it edged up to $380 and fell immediately to $320, and we were short for that. So I made some money there, and then I said, “I’m out of it for now, I’m not bullish, I’m bearish, but we’re not taking a position.� What’s happened since then is that gold has continued to rally, but only in dollar terms, not in terms of the euro. So really what has happened since then -- that last $95 in gold, or most of it anyway -- was pretty much a reflection of the change, that is the decline, in the value of the dollar. So I decided this is a very interesting thing to look at. When you have extremely diverging trends in the dollar price and the euro price of gold, what does it mean? So in the June issue, which I just published, I’ve got a chart on page 6 tracing gold from 1979 all the way to the present, and it shows you that when the trends of gold in dollar terms and in euros, which used to be deutschmarks essentially, are moving in the same direction, you have a true move in gold. It’s either a bear market move or a bull market move. There are times, in fact there were two major times in that period, when they diverged from each other, and one of them was at the 1985 bottom. There’s an extreme divergence where gold was cheap in dollar terms and expensive in deutschmark terms, and what happened? Gold turned around and soared from that point up to its 1987 high. But then we had the opposite situation in 1995-96. It was going up in dollar terms and going down in terms of the deutschmark. What happened then? We had one of the biggest slides in gold, from $500 down to $250. It was cut in half. In the last year we have had the same thing that happened in 1995 and early 96, the extreme move up in dollar price and not responding in terms of the euro. So I think it’s the same set-up we had back then. And that’s just one of many things we could talk about if you want to keep going, I wouldn’t mind.

JIM: Please do, because one thing that I think is unusual right now is what’s happening with the euro. Why don’t we talk about the euro and its relation to gold because you are right, we have not seen until recently gold break out against the other currencies. It’s been mainly a dollar event.

BOB: Well there are some other really interesting things going on in the gold market. From the standpoint of the price forms, Elliott waves -- that’s what I use as my primary tool -- we had a recovery in gold from 1982 until 1987. It lasted 5 years and 6 months, and what we had from 1999-2004 was 5 years and 3 months. It was exactly the same move in percentage terms, and in fact in the last couple of months we finally figured out what was going on and anticipated that high in the $450s, and that’s so far where it’s topped out. So you’ve got two bear market rallies that are virtually identical. It’s been � what? -- six months almost since gold topped in December. Now if we go above that high then I’m probably going to have rethink things. But because of what I have just mentioned about the big spread between gold prices in dollars and gold prices in euros and also the tremendous divergence between gold and silver I don’t think that’s likely. And this is the third area that I think is very important. In 1987, for example, silver topped out in April of that year and had some more rallies but it was pretty much over. Gold kept going up until December, and that’s when it finally topped out and had that tremendous drop that we talked about earlier. Well, we had almost the same thing happen in 2004. Silver made its peak in March. It’s had several rallies since, but it has failed to make a new high. Gold continued higher and finally topped -- guess when -- in December. So you’ve got almost the identical situation in both of these bear market rallies. As long as silver continues to fail to take out its high of early 2004, I would say you’ve still, on that basis, got a set-up for a bear market, or at least one more wave down in a bear market. So I’m bearish from at least 3 different standpoints. Who knows? I don’t have to be right about it, but the evidence to me is overwhelming: you don’t want to be in the metals or in the metal stocks at this time.

JIM: Bob, as in any kind of forecast there are things that change, the world evolves, it changes. What are the things in your mind that would change or have to change to cause your view to change from a deflationary depression?

BOB: That’s a good question. I think one of the things that would have to happen is a confirmed new high in gold and silver together. That would wipe out much of the negative development that I see at the moment. You’d have to see gold going up in terms of all the currencies. If it doesn’t, then gold may get into a bull market in dollar terms, but then gold is not the only thing that you need to own. You’re welcome to be bullish on gold but you may as well hold Swiss francs. So the key here is, is it just a dollar fall, or is gold going to be in a great bull market? I guess that is the main thing that would make me change.

I’d like to add one other observation. This is on page 9 of the issue I just put out. Very few people know about this, and it is a fascinating connection -- in fact, if we can, I’d like to post this chart on the website along with this talk -- and that is how closely silver has actually been going up and down with the stock market and the economy. Most precious metal bugs say that gold and silver are contra-cyclical, but in fact silver has been trading as an industrial metal for a long, long time. It peaked in April 1987, and a couple months later in August the Dow topped out and had a crash. Silver collapsed throughout the entire period. It went from ten bucks down to $4. It bottomed in February 91 and, if you remember, that was right near the end of the recession of 90-91. So it bottomed in the middle of a recession. So that’s going with the cycle and not against. Silver then started going up along with the stock market and topped next time in April 1998. Do you remember what happened then? That was the high in the Value Line geometric stock average. It still hasn’t been taken out to this day. Then silver started down and bottomed in December 2001, which was one month after the recession of 2001 ended. So it’s almost identical to the February 1991 low. Then silver took off, the economy recovered and topped out at March-November 2004, while the stock market appears to have topped in March 2005. So I think again it’s pretty much on schedule again. If I’m right, we are heading into a depression. Then according to this oscillation silver should go down as well. So when you look at cycles, you look at the economy, you look at the non-confirmation against gold, the exclusivity of the dollar move as opposed to the euro or anything else, and to me it all adds up to a selective bull market that is likely to be reversed.

JIM: When I asked you previously what would have to change and you would have to say new highs for gold and silver. Is there a level in silver and gold you would like to see before you would have to say I need to go back and examine this?

BOB: Well, gold topped at $457/oz, so if it goes above there and silver goes above its high of early 2004 which was, what, $8.20-8.30, then I would have to say something is going on that is changing the technical situation. Sometimes the technical situation can change, and I am looking at data every single day to make sure that we are on track here. But I really think if your readers want to get a feel for it, I’ve got four whole pages discussing all this in the latest issue, and if they want to get a hold of it that will tell them exactly why I think what I think.

JIM: Bob, there are a couple of things that I would like to say here. Number one, I think you and I both agree on deflation. It’s just a matter of when it comes. You believe we get deflation first, then hyperinflation. I’m leaning more towards hyperinflation-deflation, so there’s agreement and I would say, or at least you would say that at least from both our perspectives at this point I can’t prove that we are in hyperinflation and we haven’t had deflation.

BOB: You know we might even agree on a reasonable -- even if it weren’t our favorite -- investment for either environment. I had recommended in Conquer The Crash the Swiss money-market claims, which are essentially Swiss Treasury bills, and they went way up. They soared 50% in value, and I did it for safety reasons, not to get rich. If the dollar is the currency that you feel is going to hyperinflate, then you’d probably be reasonably happen with that as an investment, maybe not your number one investment, and it’s not my number one investment because I turned bullish on the dollar late last year, and that has been great for us by the way. That was a very contrary opinion and had the same sort of bearishness out there as we see bullishness in oil today, but that’s a sideline at the moment. Now, if you’re thinking every currency will hyperinflate, then gold is your only choice.

JIM: You know we do agree on that because we’ve owned Swiss government bonds here for the last 2 � years. The only difference is if we hyperinflate then I think you are absolutely right and if all currencies go down then gold’s going to be that choice. But right now I think we agree on bonds. We agree on interest rates and also the stock market. It’s just that at this point we haven’t seen the hyperinflation yet. It hasn’t played out that way but I think it could, nor have we seen the deflation play out your way. I think it’s been frustrating for both of us.

Bob, anything else that you would like to call our listeners’ or our readers’ attention to that you think is significant over a three to six month time horizon, anything your charts or reading of psychology is telling you?

BOB: Oh man! There are a lot of things I’d like to say.

JIM: Say ’em.

BOB: I made a list in the recent Elliott Wave Theorist of all the technical negatives piling up in the stock market. They are just as exciting to me as they were in late 1999. I think the next leg down is probably going to be underway by the time you get this thing posted. It’s very, very exciting and we can hardly keep up with the amazing readings we are getting on so many indicators. But if there’s one thought I’d like to leave your listeners with, it’s that I’m a safety advocate right now. The people who wrote books saying you should own stocks for the long run because they will save you didn’t realize what people do when they are told buy stocks. They go out and buy the most popular mutual funds. Now the average mutual fund may be only down 15 or 20 percent, which I believe is about where it is after this recovery, but the funds that people went out and purchased in 1999 and 2000, a few weeks ago were down an average -- this is an average, as some of them were down much more -- an average of 43%! And this is after this tremendous recovery. You can only imagine what they are going to be like once we are in the middle of the next wave down. People are just blithely telling the average person who’s been trying to save money for retirement, who’s been trying to save money for his kid’s college education, that they should be investing in the stock market, “it’s as good as being in the bank, and actually better.� It’s not. It is very, very dangerous, and I think commodities for most people are very, very dangerous. You have to know what you’re doing to make money in these things. So I’m advocating safety. That means don’t keep your money in an unsafe bank. In Conquer The Crash, I’ve got a list of the two safest banks in every state. There’s no reason in the world to have your money in a bank rated C for solvency potential. You should be in an A-rated bank. There are a lot of things people can do to make their lives a lot better and make sure they survive the depression that’s coming. The people that got hurt in the Great Depression were not the people who got out at the top and saved their money; they were the people who didn’t get out and let everything go to nothing. And that’s what I’m trying to help people prevent. They’re a little gun shy. They don’t like looking at their 401K statements, and they’re hiding them away, but they really need to think what’s in there and realize the tremendous risk. Even though this may sound radical, I think stocks are overpriced by a factor of 10. They are way beyond where they ought to be priced, and you can tell that just by looking at the dividends that they’re not paying.

JIM: Well, it was amazing. We ran a database and we were trying to look at stocks that had reasonable earnings, reasonable quality, a good paying dividend higher than the S&P, higher than the Dow and a low PE ratio and we ran this with an institution today. We found two!

BOB: Listen Jim, you just said the secret word. The secret word is reasonable. What we have in today’s prices for investments is utterly unreasonable, and when you try to find something reasonably priced you can’t do it, and that’s why I’m saying the best thing that people can do, and I know this goes counter to your views, but I think the very best thing people can do is to find a safe cash equivalent, such as Swiss Money Market claims. Or recently, we’ve switched to the dollar. We’re riding this move for all its worth, and it’s not quite over yet; it’s about half way over. That is going to maintain your sanity, your purchasing power of goods and services as we head into this depression, but if you get caught into one of these fancy investments people talk you into, you can lose it all. So that’s the essence of my message.

JIM: And Bob, do you think we will see -- one thing that happened that was amazing with the events of 9/11, all of a sudden everybody woke up and said at least the financial press wasn’t saying this was simply a bull market correction, and all of a sudden the R-word, recession, got mentioned and the bear market got mentioned, but it was a precipitating event that all of a sudden suddenly changed psychology everywhere. Do you think that’s coming?

BOB: Absolutely. If you can predict the stock market to some degree, you can predict the changes in psychology. One of the things that’s coming up is not only another wrenching movement towards more bearish psychology, but also the third wave down is always when the worst news comes out. So we’re expecting news to be worse than it was in 2001. That means worse than the attack on the World Trade Center, for example, and worse than the recession we had in 2001. We’re going to have a deeper economic contraction and a lot more to worry about.

You know, it’s funny: If you call a bull market, people tend to remember. That was one of the things that helped my career back in 1978 when we wrote a book saying there’s a great bull market coming. But one of the ironies of being in this business is if you call a bear market, by the time it’s over people don’t remember who said it because they are too busy worrying about other things; the last thing on people’s minds then is finance. One of the most famous periods of course was the 1929-32 collapse, and in the late 1920s everyone -- well not everyone, but everyone involved in the stock market -- was talking about their mutual funds; they called them investment trusts back then. And do you know that by the time the 40s ended, I don’t think there was anybody left talking about their investment trusts. Many of them had gone to zero, and the ones that didn’t hadn’t recovered by substantial amounts. I think we are in one of those periods, but it’s bigger. People are enamored with finance; they’re enamored with the stock market and investments in general; there’s more money changing hands in this country over financial services than there is in manufacturing, which is an outrageous symptom of the peak of a Grand Supercycle in psychology and finance, and all of this is going to go away. It’s going to melt away, just as it did after 1929.

JIM: Well Bob, I want to compliment you. I wanted to have you back on the program because you really are, as you say, you are an original giraffe. You are always sticking your neck out, saying things that people don’t quite see at the time, and I promise even though we have different views on deflation -- I think hyperinflation comes first then deflation, you’re of the view it’s deflation then hyperinflation -- I have enough respect for your work, and believe me if you’re right I’ll be the first to come on this program and say it.

BOB: And let me return the compliment, Jim, because you are one of the very few people out there who has a well-thought out, strong opinion and yet is willing to open the forum to have an interesting discussion. And when things turn around and go your way instead of mine I’ll be happy to come on your show and try and figure out why in the world I got it wrong.

JIM: OK...Well, the name of the book is called Conquer The Crash: You Can Survive And Prosper In A Deflationary Depression. And Bob, as we close, why don’t you give out your website. In fact we have a link on the front page that people can get to, but give it out anyway.

BOB: OK, and I’d like to put out a little advertisement here. You can go to our website and get a lot of information absolutely free. We put out daily reports. We put out weekly reports. If you join something called Club EWI, that’s for “Elliott Wave International,� our company, you can participate in a lot of things we do, you can take a course to learn how to apply the Elliott wave principle in your own investing, and that sort of thing. And you can find all this wonderful stuff at www.elliottwave.com.

JIM: All right. And accompanying this webcast, Bob is going to send some charts and hopefully you can look at those charts of some of the topics we covered in this interview and we’ll also have a direct link that if you want to get to Bob’s site and find out all the wonderful things at Elliott Wave.

Bob, you’re a gentleman and a scholar, and I want to thank you so much for your pioneering work.

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