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DOW TRANSPORTS & GLOBALIZATION CURVEBALLS
Four major reliable concepts have changed radically from the pervasive impact global trade, and no longer obey conventional rules. Each suffers a swing and miss as globalization tosses sharp curveballs. Analysts, even in the gold community, are slow to react in their thought process. Global trade has turned many widely subscribed beliefs on their ear. The fractured altered broken business cycle is but one casualty. The common denominator influence across the skewed conventional concepts is CHINA. They are:
A previous article Missing Parallels to the 1970 Decade developed the theme that China has prevented the “cost push” from resulting in price inflation and wage increases during the grand reflation initiative. The immediate effects are a lower USDollar, higher commodity prices, more financial speculation, but not enough price inflation to overtake debts, which are growing out of control. Higher production costs cannot easily be passed along. USGovt stimulus simply fails to work as it had in the past. Traction is difficult to find. The answer why is simpler than one might think. China is the biggest new kid on the global trade block. With its expansive import trade to the USA and emerging manufacturing offshore and service outsource from the USA, powerful limitations are placed upon finished product prices and domestic wages inside the US Economy. Prices for finished products might soon rise, but wages will be stuck in a long multi-year decline on an inflation adjusted basis. The Federal Reserve stimulates with its mammoth reflation, led by real interest rates held negative for almost two full years. However, the increase in new money matches in magnitude the increase in consumer debt extension, which also by the way matches the increase in the trade gap. So the Fed is actually stimulating Asian growth, not American. The second entity knocked askew is the FOREX currency market. With outsized trade surpluses, China has joined Japan in playing the currency suppression game, along with Taiwan and South Korea. The global trade pattern would be stopped in its tracks with smoothly operating currency corrections. Japan has established a pattern of routinely tossing a wrench in the currency adjustment correctional devices. Their yen currency is the only major world currency from Asia freely traded in the foreign exchange markets. The Japanese have a vested interest in keeping the yen currency exchange rate low, so as to support their export trade. Now they face higher energy costs and the threat of departing foreign investment capital, which might foster a change in their view toward blatant interference with currencies. A higher valued yen currency would reduce their cost of imported minerals and energy resources, and also satisfy foreign investors in their financial markets. Once upon a time, trade flows and matched capital flows would dictate a direct response from the FOREX. Not any longer, not in the age of globalization, which has its roots in the 1980 decade. China has only amplified the effects and interference. Perversely, a higher valued Chinese currency would render their import of commodities generally less expensive. Demand for an array (crude oil, copper, steel, cement, lumber) could actually rise in China, only to cause further stress to the US Economy from higher costs still. Many are the consequences from competing currency warfare. The third entity continues to confuse the analysts. A cross-section of economists actually hold firm and believe that service outsourcing carries a net benefit to the US Economy. They are short-sighted at best, inept at worst. Instead, such low-cost solutions impoverish our nation in the aggregate, while offering those who practice it a brief benefit. The practice does not create new jobs here, but it does save jobs here from being eliminated. In particular, management and executive jobs are preserved. A different article Absolute Labor Disadvantage elaborated on Ricardoian principles, which are thoroughly misquoted and misunderstood today. The catch phrase “comparative advantage” is spewed about without any seeming comprehension. If I am mugged and robbed, then sure, I maintain my comparative advantage over my assailant of inner awareness and pursuit of higher ideals. Many advantages are assumed, but illusory, in the service outsourcing game. A higher labor wage structure within the US Economy represents a debilitating universal disadvantage, which renders the entire service economy as exportable, provided the end product is information-based. When business investment takes place on foreign soil, the USA is not the ultimate beneficiary. When technology transfer accompanies the direct investment abroad, the USA gives away its only comparative advantage. When the delivered service comes face to face with the customer as in health, food, automotive, that service cannot be exported to India and Asia. As we have seen, X-Ray reading and other specific functions are being shipped to Asia.
As the essay title describes, transportation finance has also been thrown askew. Much attention has been given to the Dow Transportation index, and its recent rise. Neither the Dow nor the S&P confirm that rise. Or conversely, the Transport index does not confirm the sluggish stock indexes. Global trade requires the transportation of a wide assortment of commodities. At the same time, retail consumption has led to aggravating US trade gaps which have fostered Asian growth, and US indebtedness. The strong Transport index to a much greater extent reflects four things which bear little weight on the largest corporations in the US Economy:
The transportation phenomenon is aberrant, and has little to do with S&P profitability or the health of the US Economy. In my considered opinion, the Transport index confirms the rising Commodity price index (e.g. CRB) and the dynamic Asian export trade measures. Notice the common hitches in the chart for both the Transports and the CRB in the initial months of year 2003, and the initial months of 2004. In summary, the Transport index reflects the Asian boom, the commodity boom, the distortion toward US consumption, our housing boom, and cheap money. The disconnect is with the real economy foundation of the US Economy. The Dow Industrial index increasingly reflects financial enterprise, not manufacturing, where shipments take place. To argue a loose link exists between shippers and US multi-national corporations is a stretch. General Electric, Gillette, Proctor & Gamble, Coca Cola, Caterpillar, Microsoft, Cisco, these and other worldwide businesses are not as a group really very dependent upon the entire network of shipping. They each have foundation structures abroad.
The opposite is the case within the retail sector. To a greater extent, with their supply lines coming from Asia, Circuit City, Best Buy, Office Depot, Staples, Home Depot, Lowe’s, Sears, Target, and K-Mart ARE dependent on the shipment network. Wal-Mart certainly is, joined at the hip with China from 150 wholly owned mfg plants in the Middle Kingdom. Some strange and disturbing statistics can be recited from the California loading docks. Container vessels leaving empty from Los Angeles and Long Beach harbors surged by 24% from July 2003, now more than double the number which leave fully loaded. In no way is this typical commerce. It is entirely an aberration, symptomatic of a colossal migration of imported products. The US Economy has lost its manufacturing base, has gone haywire in consumption, and now sees evidence of neurotic statistics as a result. Notice the rise in imports (orange diamonds), which resembles the Dow Transport index.
In my opinion, as stated in previous essays, the S&P stock index is more and more a leading indicator for the world economy, with a strong bias toward the US Economy. If not for the significant business emphasis paid to Asia by US corporations, the S&P would be trending DOWN much more than it is lately. One can go further with the argument of divergence. As production costs rise from increased prices paid for raw materials and energy, the end user suffers while the shippers benefit. Higher commodity prices enable fatter profit margins for shippers in a tight market, which often have an inadequate fleet of vessels to handle the demand. Producers of finished products see an erosion in profit margins. The victim in the process is the independent trucker, who is caught without hedges in his fuel costs. Those fuel costs both vary in the middle of the life of the delivered contract, and are infrequently written carefully into the contract. Truckers are not sophisticated, and are squeezed. Instead of employing financial hedge contracts to protect themselves, they tend to become so frustrated that they block interstate highways outside Los Angeles. Truckers and commercial airlines are low men on the totem pole. Airlines feel pressures from highest fuel costs, high pilot labor costs, broad support costs (e.g. baggage, ticketing, mechanical, security), insistence to service the entire nation, and heavy fees to lock in airport hubs and concourses. China is behind the grand revolution of commodity and intermediate good shipments. On an incremental basis, their demand of world resources is incredible. China is behind most of its growth. This requires shipment of the raw goods. A magnificent explosion in construction of factories, cities, their infrastructure (e.g. highways, bridges, electricity generation), and residential real estate is underway in this emerging Asian powerhouse. Anyone who does serious economic analysis, or financial study, and ignores developments in East Asia is unspeakably insufficient, shallow, and bungling. The most amazing statistic in the following chart is that of steel demand, almost 90% at the margin originating from China. Much focus is given to their crude oil demand, and its base growth of approximately 50% annually. The less conspicuous items have detectable roots. The 65% marginal Chinese zinc demand owes to industrial output of galvanized products. The 53% marginal nickel demand is traced to growing stainless steel usage.
In all three charts, the months of July and August 2004 show a little droop. Could the Baltic Dry Index decline last spring have provided advanced warning of the slight comedown in both the Dow Transport index and the imports to the US Economy? Perhaps.
Dow Theory advocates wonder when the Dow Transports and Dow Industrials confirm each other. My analysis indicates that the “crack-up boom” is responsible for the non-confirmation. So we shall see a confirmation only when that highly disruptive, incredibly confusing, revolutionary movement changes course. The eventual confirmation will come when one of the following changes occur, each very much inter-related:
All three forces are subject to gravity, much like an aircraft which pursues too sharp a climb. The Dow Transport Index confirms the most important bull market in existence within the financial markets, THE COMMODITY BULL MARKET. NEWS TIDBITS Oil prices made fresh gains above $55 a barrel led by record-breaking heating oil prices on fears of a winter supply crunch. US light crude hit a new peak at $55.3 a barrel before easing back to the mid-$53 range. The Japanese Nikkei average edged down by its close, falling for the seventh session as record breaking oil prices cut demand for shares among investors. The Nikkei reached its lowest level in three week closing low. The Nikkei was down 17.33 points at 10,965, its lowest close since September 30. Doug Kass, of hedge fund Seabreeze Partners, is quoted in the latest edition of Barron's. Kass points to recent disappointing news from Pulte Homes as clear warning of trouble ahead for the entire housing industry. He also cited as a big negative the rise of speculation of the housing industry. He contended that the cracks in the housing market are apt to surface in a hurry, and likely to spread rapidly from one market to the next. The Fanny Mae accounting and legal probes can only worsen any trouble in the housing sector. South Africa's Harmony Gold has made an unsolicited $8.2 billion bid to acquire bigger domestic rival Gold Fields to create the world's biggest gold producer. Harmony, half the size by market capitalization of Gold Fields, offered 1.275 new shares for each Gold Fields share, which is at a 29% premium to the GFI closing price on October 14. The Houston Astros tied their championship baseball series with the St Louis Cardinals at two games each. Check out Beltran. The Boston RedSox finally won a game to avoid a sweep by the ugly and overpaid New York Yankees. Check out Matsui. The New England Patriots extended their streak to 20 consecutive pro football games. The Patriots, Philadelphia Eagles, and New York Jets each remain unbeaten. Animation flick “Shark Tale” led the weekend box office receipts with $22.1 million, followed by high school football story “Friday Night Lights” with $13.1M and political cartoon satire “Team America: World Police” with $12.3M. TODAY’S MARKET Today the Dow Jones Industrials wrapped up at 9956 (+23), S&P at 1114 (+5.8), Nasdaq at 1937 (+25), TENS yield 4.053% (unch). Currencies closed with Euro at 124.99 (+0.27), JYen at 91.77 (-0.09), Can$ at 79.52 (-0.25). Metals finished with gold at 417.6 (-2.2), silver at 698.7 (-12.0), copper at 128.40 (-2.40). Energy ended with crude oil at 53.60 (-1.33), natural gas at 680.5 (+9.6), unleaded gasoline at 134.60 (-6.34). Prices are at major futures contracts. Jim Willie CB
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