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Prior to the Fed rate increase last week, the markets over-reacted to the Fed’s tough talk on containing inflation. The Fed wants and needs inflation, so they deliberately “under-reacted.” Since last Wednesday, the markets have been unwinding the actions that happened in the weeks leading up to the Fed announcement. Also since last week we have seen a clear deterioration of economic data. You have to believe the Fed had a glimpse at the preliminary data indicating economic weakness and knew they could only afford the quarter-point increase. There is a huge global battle being waged right now between the forces of inflation (growing money supply/easy credit, plus lack of investment into commodity resource industries) and the forces of deflation (low labor costs globally, excess production capacity of finished goods, potential debt defaults and falling stock prices). It is imperative the Fed errs to the side of inflation to keep our current monetary system working. For now I operate on the premise that the U.S. economy is weakening, inflationary forces are gaining momentum, the rate of inflation will continue to be understated by official statistics, and finally the Federal Reserve will not be pro-active to contain inflation. Economic Factors In economic releases over the past week, retail sales have been declining, jobless claims were higher than expected and job creation for June was only half of what was anticipated, wage data came in weaker than expected, the manufacturing index fell and the ISM Services Index (85% of our economy) fell more than expected yesterday. We are seeing a loss of momentum from the stimulus of low interest rates, tax rebates and increased government spending. The weakening data has put downward pressure on the dollar and stocks, but the inflation is still out there supporting low interest rates (more money in bonds) high home prices and rising commodity prices. When looking at economic factors it becomes more complicated when we attempt to separate the U.S. economy from the global economy. I believe what we are seeing is a giant global economic boom due to pent-up demand from developing nations with HUGE populations such as India, Brazil, Argentina, and China. While we watch developing countries’ economies grow faster than the U.S., we see the U.S. economy expand with increasing amounts of economic stimulus; but take away the stimulus and we start contracting again. News reports were out today saying Japan’s Cabinet Office will raise its economic outlook which could easily move more investment capital to Japan, strengthening the yen and stock prices in Japan. In just over a year the Nikkei Average has gained over 50% by moving from below 8,000 to near 12,000. With regard to economic growth in China, I have heard analysts speculate that the GDP for the first half of this year could exceed the enormous level of 10% annualized growth. On the European front, Bloomberg reported today, “German manufacturing orders unexpectedly rose for the third month in four in May as a global economic recovery, led by the U.S. and Asia, boosted export demand for goods such as factory machinery.” From the Bloomberg quote, note they credit the global growth to “the U.S. and Asia.” On the demand side, both the U.S. and Asia have grown, but Asia has also grown in production whereas the U.S. is losing business to overseas producers. My big concern is that the U.S. will not participate in the global recovery as much as many other nations because we are not competitive internationally from a manufacturing perspective. Only 15% of our economy is based on manufacturing, with 85% of our GDP coming from “service industries.” If the rest of the world is growing and wants to buy “things,” what will we have to sell them? Our balance of trade indicates they don’t need to buy much from us. I guess we can provide consulting and financial services to the rest of the world and try to stay ahead on “intellectual capital,” but overall I see the U.S. losing ground from a global growth perspective. We have invested huge sums of money in our military…more than all the rest of the world combined. It’s too bad we can’t charge our foreign friends for military protection to recoup some of the expense to spend here at home. We still have well over eight million Americans without a job. The Dollar and Gold In order to become competitive globally, we will need to devalue the dollar thereby making U.S. goods more affordable overseas and imported goods more expensive here at home. The “strong dollar policy” of Clinton, Rubin, Summers, Snow, Bush and Greenspan that began in 1995 has come to an end, or at least the jig-is-up by letting the inflation cat out of the bag. What they have done in the last ten years is actually quite amazing. I don’t have the exact data, but try to envision all the many thousands of billions of dollars that have been created out of thin air in the last ten years. With the monetary expansion in mind, the dollar (based on the U.S. Dollar Index) is not far from where it was back in 1995. They increased the supply of dollars tremendously via credit expansion since then, but the dollar didn’t collapse in purchasing power and didn’t force the cost of credit higher…these forces are now coming home to roost. Today the U.S. Dollar Index closed at 87.90, down 0.45 for the day with the August gold contract closing at $402.7, up a huge $9.70 for the day!!! I can’t remember far enough back to know when we last saw a one-day increase close to $10.00! This is wonderful vindication for gold after what happened yesterday when it was hammered to a low of $389.00 with the release of the ISM data. Yesterday’s stocks, bonds and the dollar were all lower while grain prices, meats, oil and natural gas, lumber, sugar, and many other commodities were higher. Gold should not have been down for the day, but the sellers had the upper hand. Le Metropole Café cited Goldman Sachs as the big short seller that took gold down…I wonder if they were the ones doing much of the buying overseas and in the Access Market to reverse their shorts and go long for today. Any investors that sold gold with the sell-off yesterday got burned big time by the big money traders. Yesterday’s fund sellers would love to have those sell-orders rescinded. I actually like this kind of action, because it says something is happening (about time!). If we are going to get a significant move to the upside, the strong longs will try to shake-off the weak longs to take their contracts away before the big run. It looks like that is what happened yesterday. The golden bull does not want you to ride him. He will try to shake you off. One thing for certain since the Fed announcement to raise rates last week, is the volatility of the gold price has increased dramatically. Last Thursday was quiet, but Friday the gold price launched $8.00 higher in the first half-hour, Comex was closed on Monday, yesterday the shorts got the upper hand with a loss near $6.00 and today we closed $9.70 higher. So far in this gold bull market the gold price has been opposite the dollar and parallel to the euro, but I don’t think it will be too much longer before gold will break out on its own and become a bull market in all currencies. I’ll explain why in a minute when I cover the government debt sales for this week. For now the U.S. Dollar Index is testing the low from April 1st at 87.65. The next test for support should come at 85.50 (the low so far this year in mid-February). When 85.50 is broken to the downside, I will look for support in the 80-82 area which was the low going all the way back to 1995 and gold hovered around $400 for the year. A drop to 80 should be enough to push gold near $475 an ounce, or better yet, a gold move to $475 will push the dollar lower…by next year we probably see the yen at parity with the penny (both at 100 per dollar) and the euro in the $1.30-$1.35 range. For now I’m confident enough our officials would like to see a lower dollar and everything is in place to make it happen…a weakening economy, increased spending for war, trade deficits, government deficits and artificially low interest rates with a need to borrow increasing amounts of money to keep things rolling. The Perpetual Borrowing Machine The U.S. Treasury was forced to borrow more money today by selling $15 billion of five-year Treasury notes and tomorrow they plan to sell $10 billion of ten-year TIPS (inflation indexed notes). Treasury debt of all maturities was virtually unchanged today as is normal for most government auction days. I can still see some potential upside for bonds, especially if something ugly is brewing in the stock market…money will move to short-dated bonds in a flight to safety if stocks break down significantly. The next possible threat to the bond market could come next week when the data is released for both the CPI and PPI. If the Consumer and Producer Price Indices come in anywhere close to the increase we saw last week in the personal consumption expenditures deflator (an inflation measure closely watched by the Fed higher by 0.5% last week = highest in 14 years) we will see bond prices tumble. My gut feel says they will do everything possible to keep the inflation figures muted by taking as many adjustments necessary to keep the number under control. This week it wasn’t just the U.S. Treasury that needed to borrow some cash. Japan sold over $17 billion worth of yen yesterday and Germany was scheduled to borrow $10 billion worth of euros today. Governments around the globe can create money by simply borrowing it into existence. Who’s to say the Bank of Japan didn’t borrow the $17 billion in yen yesterday just so they could sell the yen to buy dollars which would be used to buy our Treasury debt today and tomorrow? Did Japan sell debt to turn around and buy our debt? All this digital money can be created at will, and it is being created thereby diluting all the money already in existence. They just can’t create gold and silver as easily as they create all these digitals. In fact, gold production is falling because there has been very little investment into mining over the last decade. As currencies continue in the battle of global devaluation to gain an upper hand with exports, investors will look for a safe haven to act as a store of value…we’re getting closer to that point where gold will really glitter! I say the same for silver, but to an even greater extent because there is less silver in the world and more places to use it commercially. The fundamentals are really good for both gold and silver; we just have to go through the politics of global currency debasement before we can realize the gains. On the brighter side of borrowing and interest rates, the Mortgage Bankers Association announced today that the Applications Index rose by 19.5% with the Purchase Index climbing 15% and the Re-finance Index higher by a very nice 27.6%. The rate on the 30-year fixed rate mortgage dropped from 6.21% to 5.96%. It looks like home borrowers jumped on the lower rates to lock-in for some fresh cash before rates move any higher. Stocks Look Dangerous Stocks have struggled all four trading days since the Fed announced the rate increase. After three days in the red, the broad stock indices barely made it into positive territory today. The Dow Industrials gained 20 points to 10,240, the NASDAQ Composite added two points to close at 1,966 and the S&P 500 rose two points to 1,118. The bad economic reports have investors concerned about prospects for the second half of the year. General Motors and Ford are being forced to increase their rebates to help pick-up sales, we’ve had a number of profit warnings from the software and semiconductor sectors, PeopleSoft missed their sales forecast and profits fell, Alcoa missed by a penny today and sold-off 3% in after-hours trading, and generally speaking…it doesn’t look good for stocks at this point. The markets have gone nowhere for six months now, and if this were not an election year with easy money flowing, I firmly believe stocks would reflect lower prices. I’m very close to break-even on my original short position from a few weeks ago, so I decided to increase the short stock position today. The HUI gold stock index was higher by 3.4% with a close of 197.34. Many of the individual mining stocks in the precious metals sector were up by 5%-10% today, so it looks like we’re finally ready to move higher. My next move will probably be a short bond position, but I want to confirm a near-term top for bond prices before I enter the position. I’ll cover more on bonds next week as we prepare to anticipate the direction of bond prices getting closer to the Treasuries’ next quarterly refunding with three big auctions the week of August 9th. Overall I’m long silver and gold, short the stock market and preparing to short some bonds…we’ll just have to see how it all plays out. In the meantime….I hope you have a Great Evening! Mike Hartman Charts courtesy of StockCharts.com
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Stock
prices reached their high for the day in the first hour of trading and
struggled the balance of today’s trading session, the U.S. dollar slid
lower with the weakening economic data so far this week, gold reacted
violently higher after yesterday’s unwarranted beating, and bond
prices were flat to slightly higher with today’s auction of $15
billion of five-year Treasury debt. I’m calling this the report card
for the Federal Reserve one week post interest rate increase, but it’s
actually a report on how the markets have reacted to the lack of
aggressiveness by the Fed to curb inflation and strengthen the dollar.
In last week’s commentary after the 25 basis point increase from the
Fed, I closed by saying, “I expect the dollar to resume its decline,
gold to start moving higher again, stocks to remain in a trading range
before resuming their primary bear market, and bond prices to bounce
slightly higher over the next week or two before resuming the long-term
downtrend.” Since Mr. Greenspan spoke, the dollar is down about two
percent, gold is almost $10 higher, the Dow Industrials are down by
almost 200 points and bond prices have moved up. It’s not every day I
hit four out of four with the near-term direction of multiple asset
groups, so I’ll attempt to cover each area to follow through from last
week.
