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TECHNOLOGY TUMBLES, INFLATION CONCERNS DEEPEN

Not even 24 hours have gone by and I wonder if Alan Greenspan is trying to figure out how to peel the five-egg omelet off his face. In his statement yesterday he said the economy appears poised to resume stronger growth, but the markets via stock prices are saying just the opposite. With regard to inflation he spoke out of both sides of his mouth. First he said, “Inflation has been somewhat elevated this year,” but later in the statement he said, “Underlying inflation is still expected to be relatively low.” It’s pretty vague to say somewhat elevated and relatively low…relative to what? Most of the Fed-speak analysts I have read suggest his firm stance on raising interest rates through the end of the year implies he is more concerned about inflation than the prospects for economic growth.

Reports from Cisco and National Semiconductor are saying the economy is not poised for stronger growth moving forward. (Bloomberg) “Cisco CEO John Chambers forecast slowing sales growth and said customers are less optimistic about the economy…Cisco said its inventories are rising, squeezing margins, and adding to worries that technology companies have overestimated demand.” Last month Intel also said their inventories were higher than expected and after the bell yesterday, National Semiconductor reduced their revenue estimate for the current quarter. National Semi gave guidance in June for revenues to be flat to up 3%, but yesterday they said revenue will probably decline 4% to 5%. By the end of the day Cisco took a big one-day hit of 10.6% by dropping $2.17 a share to $18.29 with enormous volume over 177 million shares and National Semi fell 14.1% to close at $13.48 also on huge volume of almost 26 million shares.

The Semiconductor Index was also tagged for a loss of 5.1% to close at 372.67. It’s important to remember the SOX Index tends to lead the overall trend for technology stocks, since manufacturers of cell phones, computers, flat-panel displays, and much, much more need to buy their chips before they can begin manufacturing their own products. In January the SOX Index had a closing high of 560, so with today’s close it’s down 34%. The NASDAQ Composite had a high close in January at 2,153 and after today it is down half as much as the SOX with a decline of 17%. In the last six weeks the SOX is down 23% and the NASDAQ Composite is down 13%. If technology as a whole follows suit with the semiconductor group, there are clearly lower stock prices to come.

By the closing bell the Dow Jones Industrial Average almost made it back to breakeven by only dropping six points to 9,938, the NASDAQ Composite came off the lows to close 26 points down at 1,782, and the SPX made it back to only losing three points to 1,075. Yesterday a “stick save,” today a “glove save,” and tomorrow we face off once again.

Interest Rates and Treasuries

The Mortgage Bankers Association announced its application index fell 0.7% with the purchase component dropping 2.7%, but refinancing activity actually increased 2.5% with the 30-year fixed rate mortgage falling from 6.0% to 5.8%. I will not be a bit surprised to see the 30-year rate fall to 5.5% or even lower. Mr. Greenspan is touting an increase in economic growth and it’s looking like it could happen if more consumers are able to extract home equity to pay off higher interest credit cards, buy another SUV, and head to the mall for more shopping. It will come just in time to kick-off the Holiday Shopping Season and everyone will smile again. If the stock market continues to get ugly, money will surely run from stocks to the relative safety of the bond market.

While inflation could well be a growing concern for the Fed, I believe there is another reason we will need to see higher interest rates in the long-term picture. It is becoming more and more difficult for the U.S. Treasury to finance the growing budget deficit. This week the Treasury is borrowing a total of $51 billion with $22 billion in 3-year notes sold Monday, $15 billion in 5-year notes auctioned today, and $14 billion of 10-year notes to be auctioned tomorrow. With the proceeds from the debt auctions the Treasury plans to pay off $29 billion of old debt and have $22 billion to keep the government solvent.

The concern for the Treasury auctions has come from declining demand for the debt paper. Auction demand is measured with the bid-to-cover ratio, which is simply the measure of total bids relative to the amount of debt sold. According to a recent Bloomberg article, the 5-year auction in June had a bid-to-cover of 2.91 and in July it declined to 2.33. On Monday the 3-year note auction had the weakest demand in the last year with a bid-to-cover of 2.0. Additionally, there has been concern about less participation from foreign central banks as measured by the “indirect bidders” category. In June indirect bidders bought 56.6% of the debt and in July their purchases declined to 38.5%.

As it turns out, the 5-year auction went fairly well today with a bid-to-cover of 2.64 with indirect bidders picking up 42.3% of the offering. From a quote by Mark MacQueen, who oversees $3.3 billion, “The market will need more of a concession to take down this auction,” we can see the market may need more incentive to invest in Treasuries. The Feds pulled it off today with decent demand, but in the future the market will probably demand lower prices (higher yields) to invest in Treasury Notes. Mr. Greenspan was probably signaling yesterday that they can only hold-off the bond vigilantes and keep them pacified with low inflation for a very short while. Why would investors want to buy Treasuries yielding 3-5% when the true inflation figure is much higher?

Dollar and Commodities

Since we’re still in the middle of Treasury auctions, foreign currency exchange rates barely budged today. The U.S. Dollar Index flip-flopped around breakeven most of the day with the September dollar futures contract closing down 0.36% at 88.98. Don’t get any crazy ideas and invest in precious metals when the dollar is lower, especially when market participants are supposed to be focused on buying Treasury debt on an auction day. The message was sent loud and clear to potential gold and silver investors to stay away.

It began yesterday after the close in New York when the Access Market opened and continued in overseas trading. Forty-five minutes after New York started trading this morning silver was hammered straight down by 16 cents with the September contract ending the day down 19 cents at $6.52 per ounce. In similar fashion gold was popped for $5.00 at the same time with the August contract finally settling $395.50, down $4.50 for the day. Unhedged gold stocks actually held up fairly well with the HUI Index dropping 1% to close at 181.58. I’ll be glad to see the auctions out of the way and see the end of the commercial traders forcing liquidations by the spec longs in the PM pits and access market. It looks like we’re getting closer…as usual, time will tell.

Crude oil and unleaded gasoline closed higher today on reports from both the Energy Department and the American Petroleum Institute of lower U.S. inventories. Crude closed higher by $0.30 to $44.82 and unleaded gas added 2% to $1.26. Of greater interest to me was the report from the International Energy Agency because they raised their estimates for world oil demand. Consumption for 2004 will average 82.2 million barrels per day and in 2005 demand is expected to grow to an estimated 84 million barrels per day.

With no end in sight for higher energy prices, it appears there is a concerted effort to knock down the cost of food items. In today’s trading oats were down 2.2%, soybeans were down 1.8% with soybean meal down 3.4%, wheat dropped 2.3%, pork bellies down 3.1%, live cattle down 1.8%, coffee down by 0.4% and cocoa was hit for 3.6%. The one commodity that really stands out is the absolute trashing wheat has endured since the beginning of April from $4.30 a bushel down to $3.04 today…almost a 30% dive in just a few months. One of these days some of the traders will realize they have to put diesel fuel in the tractors to harvest the wheat and then in trucks to transport it to market. I don’t trade grains because I don’t know the fundamentals of the grain business, but looking at the chart for wheat it sure looks tempting!

Change in Leadership

At the top of the WrapUp I show a chart of the Dow/Gold ratio that I still expect to bottom-out when the DJIA will buy somewhere around five ounces of gold. The last two times the cycle has bottomed the Dow could not buy more than two ounces of gold. You can see the ratio has been chopping sideways for over a year now, most likely due to 2004 being an election year and central banks around the world clinging desperately to the current global fiat money system.

To further demonstrate the change in leadership from paper assets to tangible assets please have a look at the charts of the S&P 500 to CRB ratio and the 30-year bond price to the CRB ratio. Both ratios have broken down below the long-term support trendlines, but have been reluctant to see paper assets capitulate to the rising commodity prices. The sideways chop for the last year has clearly been an exercise in patience for stock bears and those investing in precious metals and commodities. The change in leadership has already happened, but it can certainly be frustrating while we wait for the primary trends to reassert themselves. Hang in there gang…our day is the sun is close at hand!!

I hope you have a Great Evening!

Mike Hartman

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