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BOOMING GLOBAL ECONOMY, DOLLAR TROUBLES AND CHINA

Stellar economic reports this morning sent stock prices higher and bonds lower as interest rates continue their rise to cool down the red-hot global economy. Metals prices continue their relentless march higher as global demand outstrips available supply and the finger pointing blame game continues to rage over oil and gasoline prices. The durable goods report came out before the opening bell for stocks and put traders in a frenzy by increasing more than three times higher than expectations followed by new home sales reported with the biggest increase in thirteen years. Today’s unexpectedly strong economic data comes on the heels of better than expected existing home sales and a four-year high in consumer confidence. Bonds and the dollar have been trashed recently as the global rush for tangible goods continues unabated.

Durable goods orders were expected to show an increase of 1.8%, but instead rose by 6.1%; excluding transportation items (call that Boeing) orders were higher by 2.8%. At the announcement, stock futures sold-off because the market is pricing-in more rate increases by the Federal Reserve, but by the opening bell stock futures reversed to push stock prices higher at the open. The U.S. dollar opened higher, flip-flopped around the neutral level, and now continues to sink lower as the day progresses.

The surprise to the big increase in durable goods should have been expected with the recent buying spree from China. Just two weeks ago I included the following paragraph in my commentary:

President Bush meets with the Chinese President next week while congressional pressure mounts for China to speed up its efforts to allow the yuan to appreciate against the dollar. In negotiations yesterday, China agreed to open up it’s mobile phone and medical devices market, lift it’s ban on beef imported from the U.S. and begin to police the piracy of music and software. The large order for 80 Boeing 737 jets was good news, but we will have to watch the situation to see how many aircraft they actually take for delivery. Look for a nice surprise to the upside in the next report for durable goods orders.

If you believe the spin from the popular press you will fall hook, line and sinker for today’s explanation from Bloomberg. I don’t consider this Bloomberg bashing; just know that they maintain constant “message discipline” along with the rest of the managed media that continues with propaganda in T.V., radio and print. They write:

'Gang-Busters'

American companies are using growing profits to replace outmoded equipment and add factory space. They are also likely to increase production and orders to replenish stockpiles that have dwindled to near-record lows, helping sustain economic growth as consumer spending moderates, economists said.

"It looks like second-quarter business spending will be gang-busters," said Chris Rupkey, senior financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York.

Boeing Co., the world's second-biggest maker of commercial aircraft, received orders for 112 planes in March, up from 25 the previous month. Boeing today said first-quarter earnings rose 29 percent, helped by the biggest jump in airliner deliveries in five years. 

Caterpillar Inc., the world's largest maker of earthmoving equipment, reported yesterday that profit jumped 45 percent in the first quarter compared with the same time last year as sales rose 17 percent in North America. The company has raised prices as much as 13 percent in the past two years as their plants ran at full capacity to keep up with orders.

The Real Deal

It could well be that some American companies are spending to increase production, but that is not the main driver of the explosion in durable goods orders. Two weeks ago I put two and two together when I read about the huge entourage that was here from China on a buying binge. They wanted to give U.S. business a good “warm and fuzzy” as a precursor to the visit by Chinese President Hu Jintao. On the surface it looks like China is putting their best foot forward to improve the balance of trade with the U.S., but this is a precursor to some much bigger problems down the road.

The Chinese realize that excessive U.S. consumption cannot continue forever. They are working feverishly behind the scenes to develop their own consumer base and also develop a consumer base aside from the USA. Bill Murphy has made a strong point recently about China working to stockpile commodities such as copper, silver, lumber, steel, and everything else they will need to continue as the global leader in manufacturing. They are stockpiling commodities and at the same time continuing their build of infrastructure. The big increase in durable goods orders is all about items that are going to China. We cut them off on the purchase of Unocal, so they are answering by buying everything else they can. Not only are they buying the metals, they are also buying soft commodities such as cotton and soybeans.

To highlight what I am saying, here are of few excerpts from an article dated April 20^th written by David Lynch of USA Today:

Building explosion in China pumps up exports from USA

All but unnoticed, however, is the steady expansion of U.S. exports. Companies prospering by exporting to China run the gamut from hardwood lumber suppliers to manufacturers of sophisticated coal-mining equipment. As a building boom remakes Chinese cities and towns, heavy equipment maker Caterpillar is thriving. Iowa soybean farmers and cotton growers in Georgia also number China as their top customer.

To underscore China's commercial prominence, Hu earlier this month dispatched a 200-member buying delegation, including more than 150 company presidents or chief executives. The trade mission, the largest China has ever fielded, resulted in $16.2 billion in orders and signing ceremonies for cotton contracts in Memphis and airplanes in Washington, D.C.

Still, future export growth is dependent on both China and the U.S. navigating a thicket of economic and political challenges. President Bush faces a drumbeat of congressional anger over the $201.7 billion U.S. trade deficit with China. Across the Pacific, after three years at China's helm, Hu and Premier Wen Jiabao are trying to spread prosperity by gradually shifting from an investment-heavy economy to one supported by greater domestic consumption.

China is working to develop their own consumer base, but they are not working to supply the new consumers with goods made here in the USA. They are buying the commodities and the know-how to do it all themselves. They are buying “specialty” items that require sophisticated proprietary knowledge along with things they are not able to make fast enough themselves such as aircraft and bulldozers. Here is an example of a few “specialty” items:

The impact of China's global shopping spree is being felt even in tiny Poca, W.Va., population 1,024. At Kanawha Scales & Systems, Chinese orders for the company's sophisticated coal-loading machines have grown to about one-third of the company's roughly $50 million in annual revenue.

It's not just giant multinationals that are tapping the China market. Since 1992, the number of small- and midsize exporters has grown 511% to 19,201 from 3,143, says the U.S. Commercial Service, which helps U.S. companies break into overseas markets.

Among them: Sharpe Mixers of Seattle, which makes specialized "absorber mixers" that strip sulfur dioxide from power plant emissions. Since securing its first order in 2004, Sharpe's China business has led to a doubling of the company's annual sales to an expected $10 million this year.

The 30-employee company has added 10 workers and a second shift, and has expanded physically to accommodate the influx of new orders. "China's been a huge boom to our small company," says Jay Dinnison, Sharpe's president.

Still, the export bonanza has done nothing to cool congressional ire over China's trade practices. As Sino-U.S. trade tensions have escalated in recent months, businesses with stakes in China have largely remained on the sidelines. In his March 22 speech, however, Caterpillar's Owens warned against letting China-bashing get out of hand.

"This anti-China sentiment could be extremely damaging if policymakers on either side of the Pacific make a mistake. Personally, I can think of no faster path to a worldwide recession than for the twin engines of the global economy — the United States and China — to turn against one another," he said.

Notice the article says, “Since 1992, the number of small and midsized exporters has grown 511%....” Notice that during the same time frame our trade imbalance with China has grown exponentially!! They continue to take the lion’s share of manufacturing away from the U.S. while we continue to pick up the crumbs. We export thousands of jobs and the small company mentioned above hires ten people. What will they be buying from us when the transfer of technology and know-how is complete and they have enough momentum to sustain their own economy? At that point in time do you really believe they will continue loaning us money by buying large chunks of our Treasury debt? I have said many times before that they will continue to milk us as long as they can.

If they are sincere about wanting to build better relations with us, why don’t they stop pirating our software and stop with the reverse engineering of our sophisticated products? The following excerpt from the Mercury News Editorial on April 19^th says a bunch:

The agreements won't put an end to the rampant theft of software and other intellectual property in China. But they should help narrow a telling gap: China is the world's second-largest buyer of personal computers but only the 25th-largest buyer of software.

The agreements, which were announced last week, include commitments by leading Chinese PC makers to sell computers with operating system software pre-installed, essentially requiring buyers to pay for it. Microsoft, which announced that three top Chinese computer makers agreed to buy about $420 million in Windows licenses over the next three years, is the big winner here. But the commitments could also pave the way for similar ones for other types of software.

The agreements also include a plan to deliver on earlier assurances by China to require local, state and national government agencies use only legal software. And China vowed to develop a similar plan to ensure that the private sector follows suit. In a country where an estimated 90 percent of software is pirated, these are significant steps.

Notice how they say, “The agreements also include a plan to deliver on earlier assurances by China…” It sounds to me like we are getting a great deal of rhetoric, but not a great deal of ACTION!! They don’t even have legally licensed software loaded on their computers in government! Well, enough on China…you get my point!

On the U.S. Dollar

I thought I was done with China, but it seems they came out of the recent G-7 conference and said they had concerns about the unsustainable current account deficit of the USA. The G-7 finance ministers are calling for the Asian countries that are currently dependent on exports to the U.S. to allow their currencies to appreciate and do something to stimulate domestic growth. Peoples Bank of China Governor Zhou Xiaochuan was asked about the G-7 comments and he responded by saying the revaluation of the yuan “probably can be a little bit faster.” When they are finished extracting all they can out of the U.S., they will pull the plug on loaning us money. The yuan will then strengthen and the dollar will sink, bringing on inflation like we have never seen! If China wants to be our buddy, they should probably tell their top-ranked military commanders to stop suggesting they want to drop a nuke on Los Angeles!

The G-7 warned about possible dollar problems and Russia says, “Dollar is no longer absolute international reference currency.” Russian Finance Minister Alexei Kudrin talked about the U.S. trade deficit and said it “causes concern with the dollar’s status as a reserve currency.” How about the headline from signs-of-the-times.org dated April 18^th that reads, “The Asian Development Bank warns of threatening monetary turmoil.” I found the following few paragraphs to be quite interesting:

Until now, official statements on this issue seemed to belong to the realm of psychological warfare between rival powers. As such, they were subject to question. But suddenly, on March 28th, 2006, the Asian Development Bank (ADB) chose to put its credibility at stake among its members by issuing a memo advising them to be ready for a collapse of the dollar.

In the same note, the ADB specifies that there is a certain degree of uncertainty as to whether this might happen or not, but that the immediate consequences would be severe if it were to happen [1]. The ADB is already in the process of working on the creation of a regional alternative to the dollar - the ACU, a basket of currencies modelled on the principles of the European ECU.

The ADB was founded as an institution by sixty-four national states. Contrary to what its name might otherwise suggest, its member states are not only countries from Asia and the Pacific Rim, but also countries from the South Sea Islands, North America and Europe (including France, Belgium and Switzerland). It is controlled in equal parts by Japan and the USA, owning 15% each. This makes the ADB's warning of an impending monetary turmoil all the more significant. (My emphasis with “bold” print.)

The above article on the Asian Development Bank is fully supported with facts, and footnotes on where the facts were obtained and goes on to say a great deal MORE……scary stuff if you like your dollars!

Back on the Home Front

The U.S. Treasury is borrowing another $22 billion today by selling two-year notes and tomorrow they plan to sell $14 billion in five-year notes. It’s a good thing the 22 primary bond dealers are obligated to buy the debt from the Treasury; if not, the Feds might have some problems moving the paper. Now let’s watch and see if bonds can bounce higher for a few days so the dealers will get a chance to “off” their newly acquired inventory. I suppose the Federal Reserve could also offer the bond dealers some permanent repos to buy the paper off their hands…monetization at its best!!

If we don’t see any overt shenanigans in the bond market in the next few days, keep an eye on Fed Chairman Bernanke tomorrow as he testifies before the Joint Economic Committee. I’m expecting dovish comments toward interest rates and inflation, otherwise the bond market will crater quickly. It is expected he will comment on the current high oil and gas prices. The debate continues as to whether the high cost of gasoline is inflationary or not. Some see it as a “tax” on the consumer and some see it as pure inflation. If you drive a car or have shipped anything recently, it’s pretty obvious we’re talking pure inflation. Plastic containers of all sorts, food packaging, toys, et al are made from oil products. Ultimately, the near-term direction of the dollar will dictate interest rates. If the dollar continues its decline, rates must move higher!

New home sales went through the roof in March with a gain of 13.8%, the biggest monthly jump in ten years. Most analysts I’m reading attribute the big gain to buyers locking-in before interest rates run higher. The other big reason is due to the incentives offered by builders. New home prices were reported lower by 2.2%, the first decline in nearly two-and-a-half years. Builders are forced to give up some margin, but it’s better than getting hung with excess inventory.

The Mortgage Bankers Association said their applications index fell 3.7% with the purchase index down 4.4% and the re-fi index down by 2.4%. Overall applications are down 23% from a year ago. The 30-year fixed rate mortgage fell four basis points to 6.53% and the average one-year ARM also fell four basis points to 5.96%.

A Few of the Closing Numbers

A year ago in April you could have bought copper at $1.15 a pound and today it closed at $3.398 per pound!! For rounding purposes we can call it a TRIPLE!! Gold moved $8.70 higher as it sniffs-out problems with fiat currencies around the globe. Crude oil was held in check today as most consumers and some in Congress get angry about high energy prices. One commentator on T.V. today said that some of the commercial refiners were angry about the postponement of having to blend ethanol into gasoline. They just finished buying what they need and most likely cancelled their MTBE orders for blending. With component inventories out of whack, they are screaming, “Make up your mind, Mr. Bush!” Mr. Bush also told the Environmental Protection Agency to be lenient on emissions so they can get the price down…lots of politics, and we just keep paying higher prices!

Silver is trying to gather itself technically since the trouncing last week. In today’s session silver added $.27 to close at $12.83 per ounce. I’ve read lots of commentary on the silver spanking when the spot price was nailed $2.42 lower last Thursday. Most commentators agree it was orchestrated by the commercials by pulling their bids. Check Rob Kirby’s and Ed Steer’s commentary on FSO if you’re looking for more detail. I have another separate comment to throw into the mix.

Last week before the take-down, I was looking at the open interest figures for both the put options and the call options that were due to expire yesterday. I noticed a VERY large number of calls (over 5,400) at the $13.00 strike price. On Wednesday the calls were worth $1.50 and ounce. With 5,400 contracts at 5,000 ounces per contract, it equals 27 million ounces at $1.50 per ounce or over $40 million in cash if the calls closed in the money. Once the silver price plummeted safely below $13 an ounce, I thought to myself about how the call writers just saved themselves a cool $40 million. There has been other speculation about George Soros making a deal with Barclay’s to provide the bullion for the soon to be launched ETF (then buy it back cheaper), but I still believe the answer is a simple $40 million options problem that got fixed in a day. Commodities can be a dirty business, even if you wear a white collar!

Currency exchange rates didn’t change much today, but the dollar did slip lower to 87 on the U.S. dollar index with the Swiss franc and the British pound slightly lower and the yen, euro, Australian dollar and Canadian dollar fractionally higher. Gold and silver outperformed all the paper currencies! Bond prices closed lower pushing rates higher, but like I said earlier, let’s wait until tomorrow to see if Big Ben Bernanke can talk a bid back into the bond market. Two-year yields stand at 4.99%, 10-year yields at 5.11% and the 30-year bond gets you 5.18%. The boys are managing the yield curve to near perfection so far.

The broad stock indexes showed a gain for the day with the Dow Industrials higher by 71 points to a fresh six-year closing high of 11,354. The NASDAQ Composite closed three points higher at 2,333 and the broader S&P 500 also closed three points higher at 1,305. I guess the stock players are not so concerned about the Fed raising rates…the spin seems to change on a daily basis. For now the market likes the way earnings season is going, great economic reports all over the place and lots of pent-up cash ready to buy stocks. Whenever stocks seem poised for a tumble, we see that mysterious hand (of the free market) jump into the futures pits and buy with abandon. Unfortunately, stock prices are not even keeping up with inflation for the past five years, unless you have owned commodity based companies and gold/silver stocks.

For me this is a good reason why Mr. Greenspan was so supportive of not regulating the derivatives market. With lots of leverage and an unlimited supply of cash, they can get the results they want…a modestly positive yield curve with interest rate derivatives and a stock market that refuses to go down in the futures pit, good news or bad. I believe firmly that we live in an era of managed markets…the financial system depends on it, but relentlessly rising commodity prices are telling the true story. You can play games with paper money, but buying tangible assets is another story. The global race to acquire needed commodities is alive and well!

Have a Great Evening!

Mike Hartman

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