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CHAIRMAN BERNANKE MAINTAINS CONTINUITY

Investors and market analysts have been waiting patiently for the new Chairman of the Federal Reserve, Ben Bernanke, to hear his testimony before Congress as they search for clues to determine the direction of interest rates and asset prices. Overall it appears Mr. Bernanke is demonstrating a continuation of the same policies we have seen by the Fed under Alan Greenspan. After two hours of testimony, stock prices are flat to slightly lower along with bond prices, the dollar is fractionally higher against most major currencies and commodity prices along with gold and silver are moving lower. The direction of asset prices is consistent with the expectation of higher interest rates to come.

Mr. Bernanke says the economic expansion in the U.S. remains on track, inflation expectation remain contained and he agrees with the last FOMC statement that some further firming of monetary policy may be necessary. The Fed mantra remains unchanged as they seek a smooth transition of leadership to create calm in the financial markets and reassure investors that everything is under control. Our new Fed Chairman cited the slowdown in the housing market as a potential problem for future economic expansion, but conditioned his remarks by saying that he expects a moderate softening in real estate to be more likely than a sharp contraction.

After earning the nickname “Helicopter Ben” by his comments of dropping money from helicopters to fight deflation, he came across today as more hawkish toward inflation. This is generally not what the markets wanted to hear; especially the bulls that would like to see stock prices continue higher. He identified high energy costs as a possible trigger to higher inflation along with elevated rates of resource utilization. The unemployment rate is calculated to be 4.7%, its lowest point in more than four years and a further decline in the rate could trigger wage inflation. While we would all like to see our paychecks get bigger, it will make the U.S. less competitive relative to global production costs.

Also with regard to resource utilization, Mr. Bernanke said, “The risk exists that, with aggregate demand exhibiting considerable momentum, output could overshoot its sustainable path, leading…to further upward pressure on inflation.” Indeed, aggregate demand shows considerable momentum when we look at the recent consumption data. On Friday it was reported our trade deficit surged to $65.7 billion, the third highest on record and yesterday we got a surprise increase in retail sales with a gain of 2.3% following expectations sales would increase less than 1%. Most analysts attribute the big sales to holiday gift cards and unseasonably warm weather.

The warm weather also accounted for the unexpected decline in U.S. January industrial production reported by the Federal Reserve today. Industrial production was expected to gain 0.2%, but instead fell by 0.2% due to the biggest decline ever for utility production of 10.1%. Capacity utilization was a bigger concern to the Fed with industrial capacity reported at 80.9%. In December capacity utilization came in at 81.2%, the highest in over five years. For now, Mr. Bernanke and the FOMC will be watching the data closely to see if the risks are more toward higher inflation or a slowdown in the economy. It looks like the Fed is being “re-active” rather than “pro-active.” I believe they should back-off the rate increases before they choke-off housing and the economy!

Let’s Hear It for the New Economy!

Mr. Bernanke continues with the same Fed mantra that the inverted yield curve (two-year Treasuries with a higher yield than ten-year Treasuries) does not indicate a near-term slowdown in the economy. He sounds like another new-waver economist that is saying “this time is different.” I don’t think so! There is a six to nine-month lag time of higher interest rates and a housing slowdown on the overall economy. In the fourth quarter our GDP growth was reported at the very low level of 1.1% growth, slower than the rate of inflation. The Fed is now saying their GDP forecast for this year should come in at the high end of the range. Last July they forecast GDP growth in the range of 3.25% to 3.5% and are reiterating their call for 3.5% GDP growth.

I just caught the tail-end of some commentary on CNBC by some of the Fed watchers, and I believe Mr. Bill Gross hits the nail on the head! I didn’t hear the whole thing, but I did hear Mr. Gross say that later this year we could see GDP growth slow to somewhere in the area of 2% and the Fed response at that time would be to actually CUT interest rates. With record debt levels in this country, consumers will be choked-off by higher interest rates. The “conundrum” of low long-term interest rates is explained away by the “global savings glut” and foreigners’ willingness to buy U.S. assets, most notably U.S. Treasury debt. To support our federal deficit and enormous trade deficit we are now borrowing roughly 70% of the entire world’s savings. How much longer will they continue loaning us money? We export our jobs to China and India, they loan us money, and we consume their exports. To loan us money they buy our debt which keeps long-term interest rates artificially low. China and other exporters will continue milking the USA for as long as they can!

The Treasury Department released data on capital flows today that should be sending up the warning flags. FxStreet.com reports, “Capital flows into the United States fell to $56.6 billion in December after hitting a revised $91.6 billion in November…Sherry Cooper of BMO Nesbitt Burns said the comparatively low interest in U.S. securities highlights ‘notable downside risks’ to the U.S. dollar.” It was also noteworthy to see the last sentence in the article. “Meanwhile, U.S. investors increased their purchases of foreign-issued securities in December, buying $17.6 billion in foreign bonds and equities, the Treasury said.” A couple important numbers to note are the U.S. trade deficit and foreign inflows. In December the trade deficit was $65.7 billion and foreign capital inflows were only $56.6 billion. If this trend continues the dollar will decline in purchasing power…you can call it competitive currency devaluation or inflation. But hey, that’s what the Fed is really looking for so we can pay our debts with cheaper dollars. The problem is that pesky Chinese yuan with its peg to the dollar. Look for more rhetoric to heat up by Congress and labor unions for another yuan revaluation.

Some Closing Prices

I just checked-in on a few of the closing numbers, and judging by the price of crude oil one would think that all of the political tensions with Iran have completely gone away. Inventories came in bigger than expected today which gave the shorts all the ammo they needed to whack oil solidly below $58 per barrel. By the close of the session in New York, crude finished down by $1.87 at $57.70. It’s getting notably colder across the U.S., but traders could care less. Heating oil closed almost a penny lower at $1.601 a gallon and natural gas dropped two cents to $7.09 per MBTU’s. Wholesale unleaded gasoline closed flat at $1.385, but I’ll bet you haven’t seen the price drop much at the pumps.

In similar fashion gold and silver were tagged for losses again today with gold down $6.10 at $542.80 and silver down $0.105 at $9.21 per ounce. I’m looking for silver somewhere in the range of $8.60 to $8.95 and gold possibly in the range of $495 to $515. It’s impossible to know exactly where support will come in for this correction; we just have to watch the character of the daily movements in the metals prices and corresponding mining shares to hopefully discern a resumption of the long-term bull market in precious metals. It wasn’t a big surprise for me to see gold and silver get whacked last week while the Treasury was busy selling $48 billion of new debt. The pattern has repeated many times.

From the five-year weekly chart of gold you can clearly see that gold broke-out from $450 to reach $575 in quick fashion which also created an overbought condition. Gold was ripe for a healthy correction that has obviously begun. There are many tools to use that might help to determine when this correction has run its course, but one that I like is watching the share prices relative to the metal itself. I’m expecting the HUI/Gold ratio to pullback and re-test the point of breakout before the bull resumes its upward trajectory. I believe we are in the beginning of stage two in gold and silver’s long-term bull market and I expect higher prices in both the metals and the shares as the year progresses. The corrections along the way will shake-out the weak hands that don’t believe the bull will resume.

The recent pullbacks in precious metals and energy prices are creating opportunity for good entry points, especially in the mining shares. When I heard wild man Kramer start to recommend gold stocks back in December along with mainstream brokers giving stock upgrades for the sector in December and January, it was a warning flag that a correction was near. They needed to create a “distribution” to hand-off the shares to the unsuspecting public. This is not an easy sector to trade so it’s not a bad idea to hold your core positions. Once the correction low is in place, the mining shares represent a great trading opportunity to make some money, and longer-term to protect your assets from a falling dollar. Problems with Iran and the possible opening of the Iranian Oil Bourse could be the next catalyst for gold and silver shares to take off.

I am still of the belief that the overall stock market is overvalued. The broad indices ended today’s session with the Dow Industrials higher by 30 points to 11,058, the NASDAQ Composite added 14 points to 2,276 and the broader S&P 500 gained four points to 1,280. Stocks are not moving higher on bad economic news and are not moving notably higher on good economic news because good news is being interpreted as the Fed needs to raise interest rates even more. Rather than being fully invested in stocks, this is probably a good time to increase cash in your portfolios to take advantage of the next good entry points for your favorite stocks. Once the market gets a clear signal the Fed is done with the current cycle of rate increases, the market should be ready to move higher. We all want to make money right now, but I believe investors that exercise patience over the next few weeks will be rewarded over the longer-term.

Have a Great Evening!

Mike Hartman

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