The Rude Awakening
Wall Street, New York
Wednesday, May 10, 2006 ------------------------- - GOLD HITS $700,
- Putting your cash with the new underdogs,
- Steering clear of the 7-year itch...not the marriage
kind, all the markets this week and more...
------------------------- The Seven-Year Switch
By Eric J. Fry
Americans love an underdog. We love pulling for the little
guy. In fact, we've been pulling for the little guys for
seven straight years...and for seven straight years they've
been throttling the big guys. So maybe it's time to bet on
the new underdogs: the big guys. 
The nearby chart depicts the relative performance of the
Russell 2000 Index of small and mid-cap stocks, relative to
the S&P 500 Index. Over the last seven years, the Russell
has nearly doubled, while the S&P 500 has gained a mere 9%.
The Russell's remarkable performance over this time-frame
has elicited many oohs and ahs, as well as a number of
after-the-fact justifications from Wall Street. Small-cap stocks have been strong, the experts explain,
because small-cap earnings have been growing faster than
those of the big caps, or because investors have been
favoring growth stocks, or because interest rates have been
low, or because interest rates have been high, or because
the dollar has been steady, or because the dollar has been
unsteady, or because consumers have been spending, or
because consumers have been saving. 
The analysts here at Rude headquarters have no idea what
has caused the spectacular small-cap rally of the last
several years, but the we have some idea about the
resulting effects. Specifically, small-cap stocks have
become quite expensive, relative to their large-cap
counterparts. Yet, despite their lofty valuations, seven
years of straight-up price action has emboldened investors
to continue buying them. Both of these characteristics
suggest that small-caps are closer to a peak than a trough,
at least relative to large caps. We know of no precise reason why small-caps must now begin
to falter, but we can think of innumerable reasons why they
SHOULD. For starters, analyst Richard Rhodes, of the Rhodes Report,
observes that small-cap stocks tend to perform well over
seven-year cycles – or roughly as long as the average
spouse behaves him/herself. 
Since 1999, Rhodes notes, the Russell 2000/S&P 500 ratio
has been going straight up. "Generally," he asserts, "the
ratio runs in 7 year cycles, so given we are in the 8th
year, perhaps the time has arrived to consider readjusting
one's portfolio. In fact, we believe the winds of change
are forthcoming...Certainly, this [ratio] should be on
everyone's trading radar going forward." The seven-year cycle is not the only reason to consider
lightening up on small caps. Valuation differentials would
second the notion. At 41 times trailing annual earnings,
the Russell 2000 sells for more than twice the valuation of
the S&P 500. And even if we attempt to flatter the Russell
by relying on estimated earnings, this pricey index would
still sell for more than 26 times earnings, well above the
S&P's multiple of 17 times earnings. Perhaps year eight will prove to be another winner for the
small caps, but we'd rather bet on the underdogs. [Joel's Note: If the small-caps have had their glory, at
least for now, why not invest in something that is far from
running out of fuel. You would have noticed that yesterday
gold finally hit the magic $700 mark. If my colleague,
Justice Litle is right, we are in for a long-term march to
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-------------------------
Did you Notice? ~ Metal Mania
By Eric J. Fry We cannot say for certain what the chart below implies, but
we are quite certain what it does NOT imply: Commodities
are an ignored asset class.
 As long-time Rude readers will be well aware, your editors
have been long-time fans of commodities and resource
stocks...and so we remain. But we'd be lying if we did not
admit to viewing the chart above with some consternation.
Trading volumes in metals futures contracts are
skyrocketing on the Chicago Board of Trade. Specifically,
during the month of April, more than 40,000 metals futures
contracts were changing hands every day, on average. That's
double the volumes of the prior month and TEN times the
volumes of the prior year. Whenever an asset class becomes this popular this quickly,
bad things tend to happen...at least for a while. We
suspect that our beloved commodities will be no different. We suspect that bad things will happen to commodities and
resource stocks...at least for a while. But we'd welcome a
big, bad selloff...as the next big buying opportunity. [Joel's Note: And you can be right there, with your hand
out, just as readers of the Resource Trader Alert have been
on every big move of the past two years. By playing the
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