After a bang-up September, the markets continued their journey higher, but the looming elections kept things cool enough that the indices finished October without punching through the April highs. On Wednesday, November 3^rd, the Dow managed to take out that April high and finished at a level not seen since September of 2008 when it was headed down towards a bottom at around 6,600 six months later.

So...the much-anticipated mid-term elections came and went this week. Probably the best thing to come of them so far is the end of those unbearable campaign ads. Republicans rode a tidal wave of voter discontent to the biggest mid-term gains since World War II, but not as big as they'd have liked. Nancy Pelosi was unseated as speaker, but Harry Reid is still senate majority leader and Barbara Boxer was not thrown out.

The Tea Party had some big wins and some equally big losses, and all sides are furiously spinning the results as if some great, moral victory has been achieved. If I can take anything away from this election it's that our elected officials should have received one message loud and clear. The people like the system of checks and balances. A majority of seats in the house and senate does not mean you have the overwhelming support of the electorate to stifle debate, ignore dissent and advance an agenda that is unpopular with more than a small minority.

If the republicans believe this sweep was a mandate to return to the policies and practices that got them thrown out two years into G.W. Bush's presidency, they will most likely run headlong into some very motivated opposition at their next election cycle. There are strong differences in how each side proposes to attack the economic woes this country faces. If the president, house and senate cannot work together, and the next two years of potential recovery are sacrificed on the altar of gridlock and partisanship, we'll likely see another wave of incumbents being fired in two years.

The markets responded Wednesday morning with some apprehension. Markets usually like gridlock but a brief opening rally quickly lost support as investors shifted their focus to the Fed's announcement on QEII (that's Quantitative Easing - Take 2, not the second ship named after Queen Elizabeth.)

In Wednesday's statement, the Fed said it would buy $75 billion in long-term US Treasuries each month, up to a total of $600 billion by the middle of next year. This is in addition to $250-$300 billion in purchases it will make through reinvestments of proceeds from its mortgage portfolio. The Fed believes this will help keep interest rates low and encourage borrowing, spending and hiring.

With interest rates already at historic lows, most analysts don't believe the Fed's actions will have much of an effect on the economy, and some fear inflation could result from the bond purchases. Economic growth projections for 2011 are 2.7% with the Federal stimulus or 2.4% without it. Neither growth rate is expected to do much to turn the employment situation around.

How much further will the Fed allow the value of the dollar to fall? Will our trading partners follow suit in order to maintain a competitive trade balance? Will worldwide currency devaluation lead to worldwide inflation? Will the rush to gold continue or even expand, or is gold the next bubble to pop? When will employment turn around? When will interest rates start to rise and how far? What will the newly elected congress and the president do about the expiring tax cuts? Will they continue spending money we don't have or will they start exercising some fiscal restraint?

The answers to these questions or our beliefs as to what the most-likely answers will be and how the markets will react will determine how we position our clients' investments for the near term. Given continued uncertainty over taxes and economic growth, we believe caution is still in order, but there are always opportunities.

Some of our indicators are forecasting a continuation of this current rally. Others indicate this is a severely overbought market past due for a correction. If the markets indeed look six to nine months ahead, this doesn't yet appear to be a market brimming with enthusiasm about where the economy will be by the middle of next year.

October's employment numbers showed some improvement, but we still have a long way to go. Non-farm payrolls rose by 151,000 in October, but unemployment held steady at 9.6% for the third straight month. August and September jobs were both revised higher, but still netted a loss of 42,000 jobs. Keep in mind, the economy needs to create about 150,000 jobs per month just to keep unemployment steady. Most analysts are projecting it will be 4-5 years before we see unemployment levels back down around 5.5%-6%.

Investors responded to today's jobs numbers with a lot of activity, but not enough conviction to drive the indices decidedly one way or the other. Many saw it as a good time to take profits following Thursday's strong move past recent highs, driven mostly by a weaker dollar. Gold was pushed to a new high. The dollar bounced about 1% following the jobs report, but pulled back by the end of the day. Oil seems to be headed back towards $90/barrel.

Talk is now coming out of Washington about dealing with taxes before the current congress goes home. Extending Bush's tax cuts to all is back on the table as is discussion of fixing the Alternative Minimum Tax threshold to keep millions of households with incomes below $250,000 from paying the higher rates. The markets would most likely respond positively to both.

I'm going to wrap up with a summary of a recent article by Alex Dumortier on gold. I'll gladly send the article to any who reply to this e-mail and ask. Yes, I could paste it here, but sometimes I just like to know you're reading these commentaries.

While gold has outperformed just about every asset class over the past ten years, just how much risk are investors taking on by buying or holding gold at almost $1,400/ounce?  If gold is indeed a viable store of value and essentially a currency that no government can debase, that also means it does not inflate or deflate over the very-long term. It produces no cash flow on its own and has limited commercial/industrial applications to affect its inherent value.

Need proof? Inflation-adjusted gold prices going back to 1851 result in a return of 0.7% per year, and that is strongly influenced by the most-recent rally. We need only step back to 2005 to see that annual return drop to zero. The author considers this reason to believe that if gold simply reverts to its historical mean it will drop to $450/ounce (a 66% loss.)

Ten-year trailing returns over the same time period (1851-present) also indicate gold is currently well above historical levels, and that it has shown, at least in the past, a strong tendency to revert to the mean.

Up until the early 70s, in constant 2010 dollars, gold was showing a pattern of lower highs and lower lows, but in the early 1970s, gold bounced off a low of near $200 and shot up to over $1,600 (remember we're talking about inflation-adjusted 2010 dollars.)

Gold's price is in such a steep ascent at this time, it appears a price of over $1,600/ounce is not out of the realm of possibility, but keep in mind the last two price peaks in the late 1890s and mid 1930s were at roughly $600 in today's dollars. I'll also note the low prices reached in the mid 1860s, between 1920 and1930, and in the early 1970s all failed to break below $200 so a fairly solid floor also appears to be in place, but if you bought gold any time after about 1970, you probably don't want to see that tested.

All this is really to support my position that, at this time, gold is an extremely volatile and speculative investment. Several major gold mines have closed out their hedge positions indicating they believe a price drop will occur at some point. While current supply and demand dynamics, actions by the Fed and investors' likely responses support a near-term higher price, economic stabilization or inflation that doesn't materialize could mean some significant declines are also very likely.

If you're going to put all your eggs in one basket...watch that basket very closely. Stocks, bonds, real estate, precious metals, currencies, commodities...you name it. All markets are cyclical.