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U.S. STOCKS, TREASURIES, AND THE DOLLAR DOWN TODAY

The tone for the markets today was set with the disappointing news from Intel after the bell yesterday, more warnings from companies that don’t expect to meet their earnings expectations and the retail sales report for June showing a larger drop than expected. Intel reported a build of excess inventory and said their future gross margins will decline. Linens-N-Things announced yesterday that it is revising its guidance for earnings per share for the second quarter from $0.08 or $0.09 per share to $0.01 or $0.02 per share. Mr. Axelrod, the companies’ CEO attributed the poor results to “A decline in guest traffic.” Their reduced guidance is consistent with the report from the Commerce Department today showing a decline in retail sales of 1.1%, while expectations called for a decline of 0.8%. The big culprit was auto sales which were forecast to grow by 0.2%, but instead fell by 0.2%. The consumer is the driving force behind our economy and as a whole we are not in the “shop ‘till ya’ drop mode.” The consumer is pulling back without the stimulus from cash-out refinancing and tax rebates. I have to believe that many of the new cars purchased over the last year or two can be attributed to consumers extracting equity form their homes via refinancing.

The Mortgage Bankers Association announced today that the applications index fell 6.3% with the purchase component falling 6.4% and the refinancing index dropping 6.1%. The thirty-year fixed rate mortgage rate was virtually unchanged at 5.95%. Overall interest rates didn’t move much today as all eyes are looking toward the inflation numbers to be released tomorrow and Friday.

The markets aren’t closed yet as I write, but I do find one development in the Treasury market to be quite interesting. Though there hasn’t been much movement in percentage terms, the shorter dated maturities are down by a bigger percentage than the 30-year bond and the 10-year note. It looks like market forces are supporting the long end of the curve thereby holding down long-term interest rates. The yield on the 30-year bond FELL to 5.22%, the 10-year note yield INCREASED to 4.48% and the five-year note INCREASED to 3.68%. It is unusual to see money move into the 30-year bond, but move out of the shorter dated maturities…ponderous. My mind wanders to consider whether or not the Fed is quietly buying the longer dated maturities off the market…that thought goes all the way back to when Mr. Bernanke said the Federal Reserve would use “unconventional means” if necessary to support the markets. If they are actively monetizing the long bond (using newly created money to buy the debt) it will be highly inflationary. When long-term rates do spike higher, it could surely be the catalyst that pops the housing bubble. Richard Russell was “straight-up” in his commentary yesterday when he said, “Speculation has merely transferred from stocks to real estate. So far, nothing has been corrected.”

When he says “nothing has been corrected,” I believe Mr. Russell is referring to the excesses and the mis-allocation of capital due to excessive money creation over the last decade or so. Billions upon billions of dollars were invested in dot-coms and a huge overinvestment in technology as a whole. The growing global economy is hungry for more energy products, but there has been little investment. Our population has grown, but our oil refining capacity has not. Mr. Greenspan warned us a year ago that there has not been enough money invested in the development of infrastructure for natural gas. Copper prices have been on the move higher again hitting a five-week high because of inventory concerns. The world is using copper supplies faster than we can extract the metal from the earth. Over the last decade the money was flowing into stocks and bonds and very little was invested in infrastructure to harvest commodities. We are now paying the price of the speculative excesses and mis-allocation of resources during the Nineties.

To that very point, crude oil caught fire again today! At first it looked like it would be a quiet day in the oil patch. A Reuter’s article written before lunchtime today said, “U.S. oil prices held just below $40 on Wednesday as a weekly U.S. government report showed a fall in crude and gasoline stockpiles but a rise in heating oil inventories.” In a separate report, the American Petroleum Institute said crude inventories for the week ended July 9^th fell by 5.1 million barrels. The Energy Department reported a smaller 2.1 million-barrel decline. An ex-floor trader, now a CNBC commentator said floor traders rely on, call that “believe in,” the data presented by the API more than the Energy Department. Shortly after the inventories were released a floor trader was interviewed on CNBC saying that if the crude price would hold for a couple hours and not go down, he expected traders to jump in and start buying…how right he was. Crude closed at $40.97 for a gain of $1.53, or 3.7% reflecting the data reported by the API.

Silver, Gold and the U.S. Dollar

On a very similar note, gold and silver had a decent day with spot silver moving from $6.37 to $6.58 per ounce for a gain of $0.21 or 3.3% and spot gold moved from $401.70 to $405.00, a gain of nearly 1%. I don’t really expect to see much more in the way of big gains for this week in the precious metals because inflation will be under the microscope tomorrow with the PPI report and the CPI numbers due out on Friday. My low expectations for the next two days are confirmed by the action in precious metals mining stocks today with the HUI Gold Index closing unchanged at 195.73. Silver stocks acted about the same with the metal itself gaining over 3%, but all the primary silver miners had fractional losses for the day with the exception of Apex Silver.

What really concerns me was the sell-off in the last hour of trading. In the recent past, a late day sell-off usually leads to a drop the following day. With the release of the PPI tomorrow, some traders could just be getting out of the way in anticipation of muted inflation data. The only other explanation I can see is that gold and silver stock investors are reluctant to jump back in the market after the brutal losses back in April. I plan to stay the course in the PM sector. There is a good chance gold could backtrack to test support around $390 with silver re-testing support at $6.25. If that happens with the PPI tomorrow, it won’t change a thing for the long-term bull market in precious metals. If the metals prices hold, we could see a dramatic acceleration in PM stock prices as they catch up with bullion. I expect the PM’s to be strong next week. We shall see.

As I see it, the key to a rapidly rising gold price is when we see gold break out in euros and yen. The U.S. dollar should continue to be the weakest of the major currencies, so the price of gold should naturally rise in U.S. dollar terms. Have a look at the euro-gold and yen-gold charts and you’ll see what I mean. So far, as capital flows out of the dollar it finds its way to other fiat currencies. At some point in the near future I expect investors to run for safe haven of precious metals that work as a true store of value. With a potential banking crisis in Russia, you better believe they wished they had their money in gold rather than rubles.

Correct the Twin Deficits

The single most predictable thing I see in the financial markets is the continued fall of the dollar. Normally after a 20-year expansion in stock and bond prices, we should see deflationary forces at work to purge the excesses that were created during the long expansion. It appears the Fed will fight tooth and nail to inflate our way through the deflationary forces. Alan Greenspan identified the concern over deflation in 2002 and 2003, and began pumping the money supply accordingly. Remember that inflation and currency debasement (devaluation) is basically the same thing, just worded differently.

Yesterday Bloomberg posted an article about the government budget deficits in the European Union. In a nutshell, the EU’s highest court ruled that Germany and France broke the law by suspending the union rule that says they must keep their deficits below 3% of Gross Domestic Product. Germany’s deficit last year was 3.9% and France’s was 4.1%. The U.S. is currently running a government budget deficit that is more than 5% of our GDP. The European Union officials obviously think it’s a problem to run deficits over 3%, but we’re almost double that rate and nobody seems to make a big deal about it. Something to think about…it’s a big reason the dollar should continue to fall in purchasing power globally.

The next biggest reason the dollar should move lower is our VERY negative balance of trade. Yesterday the trade gap was reported to decline from a record $48.1 billion in April to only $46 billion in May. The dollar strengthened on the news, but the improvement in the trade numbers was attributed to a lower dollar making U.S. goods more affordable overseas. We have a long, long way to go to generate enough foreign sales to balance our trade numbers. The real issue here is over-spending for over-consumption…and doing it all by increasing our debts. The trade balance would have been worse if Boeing didn’t deliver 14 new aircraft to overseas buyers. Exports were up 2.9%, but it was fed by a 20% increase in civilian aircraft. We’ll see if they can repeat on next month’s report. To highlight the big deal about the improved $46 billion trade deficit, Bill Murphy summed it up the best with this. “A $46 billion trade deficit is heralded because it shrank. Numbers don’t seem to mean anything these days. Vet Café members have heard this one before. Six years ago the trade deficit was running around $12 billion. Goldman Sachs put out a report it could rise to $19 billion and Wall Street was horrified. A little more than half a decade later, a $46 billion number is cheered!” Are we losing our minds, or just losing our basic sense of economic fundamentals? They still need to devalue the dollar more.

Stocks Today and Reports Tomorrow

Stocks as a whole didn’t fare very well today. The Dow Industrials fell 38 points to 10,208, the NASDAQ Composite was tagged for 16 points to close at 1,914 and the S&P 500 fell three points to 1,111. By far the biggest sector loser for the day was the semiconductor group. The SOX Index was nailed for a loss of 4.5% dropping 19.7 points to 420.68. Intel was clobbered for a loss of 10.5% falling $2.76 per share to $23.38! Intel has roughly 6.5 billion shares outstanding, so today’s loss means their market capitalization fell by more than $17 billion…that’s a big hit for one stock in one day!

The big report for tomorrow is the Producer Price Index. In June the market was surprised with a higher than expected PPI at 0.8%, and tomorrow it is expected to show a modest gain of 0.2%. Federal Reserve officials have described the inflationary pressures as “transitory.” This week Federal Reserve officials Roger Ferguson and Robert McTeer have been out with hawkish speeches on inflation. Mr. Ferguson says, “Perhaps the inflation picture has deteriorated somewhat…We cannot be complacent about that, but some of those factors that have driven inflation do seem to be transitory.” Mr. McTeer says, “We’ve had two or three months where inflation has been higher than we expected it to be, and higher than we want it to be. It’s just too soon to know if that’s a blip, if it will go away almost on its own or if it’s the beginning of something more troublesome.” If it is really the beginning of something troublesome, we probably won’t be told that until after the elections. Until then I expect the inflation data to be as muted as they can “hedonically” report it to be.

In addition to the PPI numbers we will also get the Empire State manufacturing index, industrial production and capacity utilization, the Philly Fed index, business inventories and initial jobless claims. My best guess says inflation has tamed, and production numbers are weak. This would move more money into bonds and push the stock market even lower. I could go through lots of hypothetical scenarios, but instead I’ll just sleep on it and see what tomorrow brings. With the PPI and CPI out of the way, next week should be a better measure of where we are headed in the near term.

I hope you have a Great Evening!!

Mike Hartman

Charts courtesy of StockCharts.com

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