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TECHNICAL SCOOP

David Chapman of Union Securities Ltd.
www.davidchapman.com

February 23, 2005

War Jitters!

Last week jittery waves crawled through the markets when Iranian television reported that an explosion occurred near its only nuclear reactor. The stock markets briefly roiled and oil prices jumped. Initially it was feared that a missile had hit, fired either by Israel or the United States both of who are accusing the Iranian government of secretly developing nuclear arms. Washington denied knowledge of the blast and Iranian television later reported it was a fuel tank falling from a plane and then later said it was because of a blast linked to the construction of a nearby dam. Either way the message was clear to the markets. A real strike in Iran could shake the world.

A bomb of a different sort fell on Tuesday when South Korea announced that its Central Bank will diversify its currency reserves. There is talk that other central banks will back away from the US$ as well. Indeed there is evidence to suggest that this action is already underway and if that is correct then the demise of the US$ as the world’s reserve currency is already underway. This economic bomb hit the US$, then the stock markets and later oil markets soared over $51 and Gold soared $7 over $430. South Korea, who has one of the largest foreign exchange reserves in the world, has to be taken seriously.

Later South Korea issued a note that the plan to diversify their foreign exchange reserves was not new and didn’t say specifically that they would sell the US$. Certainly with $200 billion in US Treasuries they are not going to do that without seriously disrupting the bond market. Markets steadied on Wednesday so the message was effectively damage control.

Some other economic bombs lurking in the background are the Russians and possibly other oil producing nations demanding payment in Euros rather than US$ for oil and the birth of a nascent oil trading market in Tehran that could threaten the supremacy of London’s International Petroleum Exchange. In the case of the oil trading market the major oil producing countries are determined to take control of trading advising that the current markets in London and the NYMEX in New York do not work in their favour. Neither of these stories is new either.

The potential for war of either the real or economic kind is what makes markets roil and raises the stakes for the potential of a financial meltdown. For months now the rhetoric has been rising between Tehran and Washington over the potential for Iran’s nuclear industry to produce nuclear weapons. The Europeans have been trying to cut a deal with Iran now for some time in order to keep the problem under control. The Iranians deny that they are aiming to produce nuclear weapons. And on it goes. In 1981 Israel pre-emptively struck nuclear facilities in Iraq on the basis that the Iraqis were going to produce a nuclear weapon. A strike today in Iran could trigger a global conflict as both China and Russia have significant ties to Iran through oil agreements in the case of China and Russia supplying military assistance.

But Iran is seen by the US and Israel as supporting terrorism through Hezbollah and other groups. Iran has been accused of supporting the insurgents in Iraq. Tehran has close ties with groups who won the recent election in Iraq where numerous Iraqi Shiite clerics were in exile in Tehran. Conflict has existed for years between Israel and Iran and it is no secret that Israel would like to see Iran taken out. This also fits with the agenda in Washington who sees regime change as essential for the countries deemed to be anti-American or as they put it “countries of tyranny”. This includes Iran and Syria who is being accused of being behind the recent assassination of Rafik Harriri the former Lebanese Prime Minister. Iran and Syria have vowed to assist each other should they be invaded. Other countries in the Mid-East on the list include Saudi Arabia and Yemen. The Mid-East sits on the biggest oil reserves in the world and currently supplies the US with about 21% of its imports.

Amongst other countries on the US hit list for regime change is Venezuela where there is no love between the US and the Chavez government. Venezuela supplies about 11% of US oil. Recent indications are that Venezuela is signing contracts to provide more oil to China and less to the US. It has been surmised that the US was behind a failed coup d’etat in 2002. Chavez was elected as President of Venezuela and as well survived a recall vote with strong majorities following the failed coup d’etat.

Continuing to lurk in the background is the Israeli/Palestinian conflict. While efforts are being made to reach an accord with Yassir Arafat out of the way and the newly elected Mahmoud Abbas in charge many challenges remain that could derail the current shaky peace. Recall it was hard right Israeli settlers that derailed earlier peace efforts including the assassination of Yitzhak Rabin. As well Abbas has to deal with hard core groups such as Hamas. Any of these could derail the current process. Both Abbas and Sharon could face civil war and either could be target for assassins.

Despite the great claim that democracy is breaking out in Afghanistan and Iraq we are reminded that much of Afghanistan remains under the control of war lords and is effectively a narco state with one of the lowest standards of living in the world. The Iraqi election has not ended the Sunni insurgency. The party blessed by Shiite Ayatollah Sistani with close ties to Iran won the most seats in Iraq election. Al-Jaafari a former Iranian exile stands to become President. There have been calls to institute Islamic law which would be very problematic for the US. Other groups in the Iraqi coalition are unlikely to want Islamic law and the Shiite groups that won will have to compromise or there is the risk of civil war. Calls have been made by numerous groups that now that the election is over that US should leave. So election or not in Iraq there remain very high risks.

What all this is pointing to is that any incident that may have already occurred or one that has not occurred could trigger war, either of the real or economic kind. Markets do not like war. The thought of it or the outbreak of hostilities does trigger sharp drops in the markets. In this case a sharply falling US$ could also trigger a bond market collapse. This tells us that the odds of a financial accident in the upcoming months has now become real and very high. While it might not happen the question that needs to be asked is “do we feel lucky”? Given the high level of debts and leverage that exist in North America today coupled with the low level of savings this heightens the concern of a financial meltdown. We are potentially staring at a precipice or as Financial Sense (www.financialsense.com) would say “we are facing a potential perfect storm”.

We thought it would be interesting to provide a short summary of US wars in the 20th century and their impact on US stock markets (using the Dow Jones Industrials as the proxy). The general observation is that threats of war or a trigger event (i.e. Pearl Harbour, 9/11) are more likely to trigger market sell offs while invasions and an appearance that the war is going well triggers huge market rallies. An unexpected escalation of the war also triggers market sell offs. The 20th century and early part of the current century has seen the US involved directly in seven wars starting with the Spanish American War that got underway at the end of the 19th century. We did not count the long Cold War (1945-1989) as that involved no direct conflict but instead proxy wars. Nor did we count the Balkan Wars of the 1990’s where the US involvement was through NATO.

We follow the wars chart with a weekly chart of the S&P 500 and of Gold as we believe that Gold will be a major beneficiary of a market meltdown. We have placed some interpretations on the charts. Please keep in mind that these are interpretations only and there may be others as well. Elliott wave is subject to numerous interpretations even by serious devoted Elliott wave practioneers. We have only looked at big waves and made no attempt to interpret sub waves that can change the entire count.

War	Market Action
Spanish American War 1898-1902 - USS Maine explodes in Havana Harbour 2/15/1898 - US declares War on Spain 4/21/1898	- Market falls about 16% into March 1898. A report in March 1898 declared that the Maine explosion was caused by a mine. It was much later determined that it was a boiler room. - Market rises about 40% into August/September 1898 with a strong rise after the Spanish fleet was destroyed on July 3, 1898. - US gains Hawaii, Guam, Cuba, Wake Island and Philippines after vicious war in the Philippines that killed 4200 US soldiers, 20 thousand Filipino soldiers and 200 thousand civilians by 1902.
World War I 1914-1918 - Assassination of Archduke Ferdinand, Sarajevo 6/28/1914. - Germany declares war 8/1/1914 – US declares neutrality - US enters war April 1917 - War ends in November 1918	- Market falls about 16% into July 1914. - NYSE closes on fear that it will face an avalanche of selling from Europe. Market re-opens in December 1914 virtually unchanged. - Market rises strongly in 1915 as a “war boom” gets underway with US supplying. Market up about 83% on year. - Market falls about 33% over the balance of the year after US enters war. - Market rises about 19% from lows in early 1918 to cessation of war in November
World War II 1939-1945 - Germany invades Poland 9/1/1939. Britain and France declare war on 9/3/1939. - German blitz and Dunkirk May 1940 - French./German armistice June 1940 - Pearl Harbour 12/7/1941 US enters war.	- Market moves sideways to down into April 1940 losing about 7% at its worst. - Market falls about 25% into late May 1940. - Market rises for balance of year as US once again acts as a supply line gaining about 20% at its peak. - Market mixed to down throughout 1941 - After Pearl Harbour market falls about 10% but it had been drifting lower all year prior to that event. - As war progressed into 1942 market fell further 17% into the 1942 bear market bottom in May. Signs that things were turning around sent market up for the balance of the year. - War boom continues through 1943, 1944 and 1945 until war ends in August 1945 with market gaining 112% from the lows of 1992 to the highs of 1945.
Korean War 1950-1953 - House of Un-American activities in full force into late May/early June 1950, North Korean troops massing on border - North Korea invades South Korea 6/25/1950, US Troops in Korea 7/1/1950	- Market falls about 14% into the end of the June - Market begins steady rise into year end gaining roughly 19% - Over next two years of Korean War market generally trades with an upward bias. In 1953 market began a decline with steepest sell off after the Korean armistice on July 27 and triggered by the USSR exploding an H Bomb on August 12, 1953
Vietnam 1961-1975 - First US military arrives in South Vietnam with 4000 troops 12/11/1961 - Gulf of Tonkin incident August 1964. Incident later proves to have never happened. - US B52 bombing of North Vietnam begins in 1966. First major protest rallies take place. Bombing of Hanoi in June 1966 - February 1967 US begins major offensive in Vietnam - North Vietnam launches Tet offensive January 1968 - Secret bombing of Cambodia begins in early 1969. - Pentagon papers published in 1971 - 1972 troop levels cut but heavy bombing of North Vietnam and attempts at peace. - Cease fire in Paris January 1973 - 1974 Nixon resigns in August North Vietnam on offensive as US losing war. - 1975 last American troops leave Vietnam	- Market high close of DJI 735 on 12/13/1961. Market began long decline into June 1962 losing roughly 27%. Triggered more by Kennedy confrontation with Wall Street over steel price hikes rather than Vietnam. In August 1961 the Cuban missile crisis also caused a sell off. - Market rose through 1963 only interrupted by South Vietnam military coup and overthrow of Diem who was assassinated and the assassination of President Kennedy both in November 1963 - Market basically ignored the Gulf of Tonkin and continued rise through 1964/1965 with occasionally interruptions but not due to Vietnam. - Market tops in February 1966 at 995 and starts the 16 year bear market. Market loses 25% into October 1966. - Market climbed back throughout 1967 spurred largely for Wall Street by the expenditures required to supply the war. There were interruptions in the market in June 1967 with the 6 Day War in the Mid-East and interruptions due to protests of both the war and the growing civil rights movement under Martin Luther King. - Market falls about 8% into March 1968. Market rose throughout balance of 1968 despite assassinations of Martin Luther King and Robert Kennedy. - Market tops in May at 969 and begins a decline throughout 1969 losing about 21%. Mass protests and news of My Lai massacre. Market continues decline into 1970 bottoming in May losing another 18%. Market rises into April 1971. - Market falls again losing 16% into October 1971. - Market marks time throughout 1972 rising into the Nixon re-election in November. The break-in at the Watergate Hotel has not yet become front page news. - Market tops at 1051 and begins a decline into August 1973. After a respite into October a major drop occurs into November as the OPEC oil embargo starts. The Watergate scandal grows. American troops leave Vietnam. Market loses roughly 25% during year. - Devastating market decline throughout the year with US losing in Vietnam and Watergate scandal culminating in Nixon resignation. Market loses about 35%. - Market rises in 1975.
Gulf War I 1990 - Iraq invades Kuwait August 2, 1990 - UN sanctioned Desert Storm starts January 17, 1991	- Market had topped on July 17 at 3000 and invasion of Kuwait sparked a decline into October 1990 losing 21%. - Market begins rise on January 14 anticipating a short war. The 42 day war was over by March 1, 1991. The great 1990’s bull market is underway.
War on Terror and Gulf War II 2001-? - Alleged Al-Qaeda attack on the US in NYC and on the Pentagon September 11, 2001 - Air strikes commence against Afghanistan 10/7/2001 - US attempts to bring UN onside to invade Iraq – November 2002 - Invasion of Iraq Gulf War II 3/21/2003 without UN approval.	- The great tech bubble market of the 1990’s had topped in January/March 2000 with the DJI at 11,723 and began a long decline. By the time of the attacks on 9/11 the DJI had lost 18% and after a week’s closing of the NYSE the market lost a further 14% into 9/21/01. - Market recovered into February/March 2002 gaining about 28%. After that a long decline began into October 2002 losing 29% spurred by Enron and other financial scandals. - After the brief rise out of the low in October 2002 fear of the war in Iraq sinks the market into March 2003 losing about 15%. - Market bottomed on 3/12/2003 and began long rise for the rest of 2003 and into 2004 gaining roughly 44%.

David Chapman is a director of Bullion Management Services the manager of the Millennium BullionFund www.bmsinc.ca

Note: Chart created using Omega TradeStation or SuperCharts. Chart data supplied by Dial Data.

The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. Neither David Chapman nor Union Securities Ltd. take responsibility for errors or omissions which may be contained therein, nor accept responsibility for losses arising from any use or reliance on this report or its contents. Neither the information nor any opinion expressed constitutes a solicitation for the sale or purchase of securities. Union Securities Ltd. may act as a financial advisor and/or underwriter for certain of the corporations mentioned and may receive remuneration from them. David Chapman and Union Securities Ltd. and its respective officers or directors may acquire from time to time the securities mentioned herein as principal or agent. Union Securities Ltd. is an independent investment dealer and is a member of the Toronto Stock Exchange, the Canadian Venture Exchange, the Investment Dealers Association and the Canadian Investor Protection Fund.