The Capital Spectator

Government sanctioned or not, gold just won't go away, finding a raison d'etre in poking its finger in the eye of paper money, which has long been promoted as a replacement for the metal that refuses to go away quietly. Indeed, some predicted in 1971 that freeing the dollar from gold would cause the metal to drop to $7 from its then-official price of $35. In fact, the opposite struck, with gold confounding the paper pushers by rising in price.

Today, of course, gold has again crossed above $500 of late, for the first time since the early 1980s. The cries still go out that gold isn't money; it's just another commodity. But defining money isn't necessarily cut and dry in the 21st century. In fact, it's a task that can be downright perplexing. We can't help but notice, for example, that the United States Mint openly advises that it produces "legal tender" gold coins with face values ranging up to $50 for the one-ounce American Eagle. Some might call this money. Legal tender? Gold? Say it ain't so. Alas, who are we to argue with the United States government on the definition of money?

In fact, the feds are a clever bunch when it comes to marketing, selling their legal tender $50 gold pieces at the going rate for (gasp!) gold and then som, which is to say at steep premiums over the face value of the legal tender coins. Lest any one think this is a great scam, rest assured, that no matter what you pay for the American Eagle, it will be accepted for payment by the good folks at Wal-Mart, 7-Eleven, and other fine merchants across the land. The law requires no less. Yes, dear readers, gold is in fact legal tender money by decree of the United States government, and must be received if given in exchange for Junior Mints and Chuckles candies. But in a not-so-surprising development, the coins' use as legal tender money amounts to a perfect record of failure as a means of exchange.

No one in their right mind would spend a $50 American Eagle as $50, given that the gold content is worth ten times that. You might think that the feds have stumbled when it comes to devising denominations of money that will find work for the employment at which the coins were intended. But don't be too hasty here. In fact, we suspect that all is going exactly as planned. As we noted, the government is a clever bunch, and the $50 American Eagle's face value is purposely assigned a value below what the gold content of the coin is worth in the open market. What's more, people are happily paying the premium. It's a win-win situation between government and adoring public. And since the U.S. sits atop the single-largest horde of gold in the world, it's a strategy with legs.

This government's current policy of minting gold coins with severely discounted face values stands in contrast to the past, when Washington stopped minting gold coins with face values that were severely discounted to the underlying gold's value. Minting of the original St. Gaudens $20 gold coins were suspended in 1933. But there too the government has a plan for purging past monetary demons by selling the old "Double Eagles" at prices well above face value.

So, let's review. The government used to mint legal tender gold coins for general circulation but ended the policy when it was clear that the face value didn't keep pace with the rising value of the underlying commodity. More recently, the government began minting gold coins again, this time embracing the strategy of severely underpricing the face value so as to insure (we're speculating here) that no one spend the legal tender gold. What's old is new…again.

The logic in all of this is debatable in discussions of the prudence of design and deployment of a national monetary system. But when it comes to the claim that gold isn't money, there's a large institution that suggests otherwise…sort of.

Posted by jp at 10:18 AM | Comments (2)

December 16, 2005

IT'S ALL ABOUT CORE AFTER ALL

Pointing out headline inflation's ascent of recent years has been a fruitless exercise in swaying opinion. The rise of annualized rate of increase in the monthly consumer price index had in September and October climbed above 4% for the first time in more than a decade. But the jump was effectively dismissed as largely irrelevant, the byproduct of the energy bull market of late and therefore unworthy of serious consideration as a sign that inflation threatened. Or so many reasoned.

The real action was in the core rate of inflation, otherwise celebrated as the true gauge of pricing trends. On that score, core depicted an inflation that was well-mannered, docile and generally unthreatening, delivering a sharp and soothing contrast to headline CPI's rude message.

There was no smoking gun in yesterday's report to materially change that view, at least when looking at the numbers. Core CPI (less food and energy) rose by 0.2% in November, unchanged from October's advance. On an annual basis, core inflation increased by 2.1%, also unchanged from the 12-month rate of advance logged in October.

Meanwhile, just for fun, headline inflation last month literally collapsed, thanks to falling energy prices. True, no one should expect that will continue. Still, even if it's a one-time event, the biggest monthly drop in CPI in more than 50 years isn't chopped liver.

But just when you thought the market would celebrate such a milestone, persistent or not, Mr. Market decides that it's time to start worrying about core inflation after all. The bond market registered its anxiety yesterday by moving the 10-year Treasury yield back above 4.5% at one point in the day before closing the session at around 4.47%. Fairly quiet stuff, to be sure, when it comes to bond trading, although the fact that the benchmark 10-year's yield didn't move much on a once-in-50-year-drop in monthly CPI tells you something.

The stock market, on the other hand, wasn't nearly as restrained. The S&P 500 shed 1.8% on Thursday. The buzz is that yesterday's industrial production report for November from the Fed reminds that the economy continues to bubble, keeping the inflationary fires smoldering. Industrial production advanced 0.7% last month, following a revised hike of 1.7% in October. Meanwhile, capacity utilization crept higher too, moving above the 80% mark for the fifth time this year. To the extent that the bond market thought sluggish industrial activity would help keep a lid on core CPI, such wishful thinking looks increasingly outdated.

"The manufacturing sector seems to be on the rebound, recovering much of the loss suffered during the hurricanes,'' Lynn Reaser, chief economist of the Investment Strategies Group at Bank of America in Boston, told Bloomberg News yesterday. "The overall economy is approaching a fuller level of capacity, both in terms of the labor market and in our industrial sector.''

Perhaps that's not reason to worry, but combined with a core rate of inflation that seems inclined to inch higher has inspired some to start worrying. "While this rate of 'core' consumer price inflation remains very low by historical standards, it is still roughly double the inflation rate of 2003 of 1.1 percent," said Brian Wesbury at Claymore Securities, via a story posted on Political Gateway yesterday. "While somewhat slow and unsteady, the acceleration in inflation is very real ... as 2006 unfolds we look for the 'core' CPI to push toward a 3.0 percent rate of increase."

What's so disturbing about a core rate that's running at 2.1% a year? Indeed, as Wesbury noted, it's up from the low-1% range that prevailed in 2003. No big deal, perhaps, although the upward trend is obvious. But perhaps more importantly, a 2.1% rate of increase is now slightly above the 1%-to-2% range for core inflation previously championed by Ben Bernanke, who'll take over the Fed from Alan Greenspan on January 31, 2006.

The new new game with inflation has become watching core CPI, and watching closely. It's already above Ben's comfort zone, and that's no aberrant trend. Core CPI's annual rate of change has been at or above 2.0% each and every month in 2005. The only question is what will Ben do, and when will he do it? Perhaps we'll hear the argument that the core CPI doesn't really reflect the "true" rate of inflation. Regardless, rest assured that helicopter references, as they relate to monetary policy, won't be returning any time soon.

Posted by jp at 10:40 AM | Comments (0)

December 15, 2005

IT'S BEGINNING TO LOOK A LOT LIKE CHRISTMAS

The economy giveth, and the economy taketh away. Today's update on consumer prices for November showed it clearly in the giveth mode, offering a refreshing volte-face from yesterday's disappointing news on the trade deficit.

Today is all about better-than-expected news of CPI dropping by the most in a month since July 1949. The consensus forecast was calling for a drop of 0.4% in last month's CPI, reflecting the pullback in energy prices. In fact, the decline in consumer prices was much steeper, registering a 0.6% fade. Energy led the retreat, shedding 8% in November, helping the energy-dependent price gauge for transportation to fall a hefty 4.9%. Whether this is sustainable is debatable, but for now there's only cheers.

The bond market hardly needs more incentive for predicting that the Fed's cycle of interest-rate hikes is nearing an end. Needed or not, that view of money markets got a large boost of momentum with this morning's CPI news. But if the Fed is tightening the price of money primarily to slow the housing market, central bankers may be inclined to keep on keeping on. Indeed, housing prices rose 0.5% in November, according to the CPI report--the second-highest monthly rise in 2005 after October's 0.9% jump.

To be sure, the government's measure of housing costs in the CPI report is driven by rental prices, which is flawed because it only captures of portion of what's going on in real estate generally, namely the buying of houses at higher prices. Nonetheless, higher rental costs feed into higher real estate costs.

But such sniping will be lost in today's celebration of a CPI update that, at least for one month, has given the markets a reprieve from the annoying talk of inflation. Indeed, the stock market, measured by the S&P 500, is pushing into new recent highs, and today's CPI report should help cement the trend for the remainder of the month and on into January. Meanwhile, the bond market seems inclined to pare rates, again, with the 10-year Treasury yield building downward momentum of late.

Christmas, in sum, may come early this year.

Posted by jp at 9:07 AM | Comments (2)

December 14, 2005

HOPES, DREAMS, AND INTEREST RATES

It's no longer "accommodative," and so the elevation may be nearing an end. But it's also a failure, if the two-and-a-half year tightening of monetary policy's intent was raising long rates and putting the fear of the central banking god into the hearts and minds of the fixed-income set.

The Federal Reserve raised its Fed funds rate 25 basis points yesterday to 4.25%. Gone from its accompanying statement was the word "accommodative," which has been present in previous statements and was widely considered to be a way of saying that further rate hikes were in the cards to bring the monetary policy closer to a neutral stance.

None of this matters much, if at all, to the bond market. The Fed's influence on trading in the 10-year Treasury looks virtually nil. Not only did the yield on the benchmark 10-year slip a bit yesterday, the closing ~4.54% yield on Tuesday was a bit lower than when the Fed began hiking rates back in June 2004.

Source: Barchart.com

What gives? There are, it seems, more pressing matters for the bond market. Such as? Take your pick. The choices, depending on your thinking, range from expectations of an approaching economic slowdown or recession; a global savings glut that's keeping long rates artificially low; to an export-driven mania in Asia that channels monies into American bonds regardless of fundamentals, to name but a few. Incoming Fed Ben Bernanke is partial to the global savings glut argument, and presumably that will inform his decisions when he takes the helm of monetary policy next year.

As to the suggestion by the Fed that it'll soon stop raising short rates, the pundits are buzzing with the possibilities. "Yesterday's FOMC meeting was a watershed in the sense that it was the first time the Fed left the window open for a pause in this 18-month tightening cycle," David Rosenberg, Merrill Lynch's chief North American economist, told MarketWatch.com today.

But before investors bet the ranch on the end of interest-rate hikes, there's more to digest. For starters, the economy's still rolling along. As Charles Dumas of Lombard Street Research wrote yesterday in a note to clients, "Psst! Ben: The economy's booming." Of course, we'll have to wait till next year to see if Mr. Bernanke takes the hint.

Meanwhile, yesterday's trade report for October reminds that there are more than a few hazards lurking in the global economy that may yet conspire to push up interest rates in spite of the best laid plans of central banking's finest. The consensus expectation called for a trade deficit of $62.8 billion in October, or down from September's $66.0 billion, according to
http://www.thestreet.com/markets/databank/10256427.html TheStreet.com. But the data surprised with a bigger-than-forecast mountain of red ink totaling a monthly record deficit of $68.9 billion. So much for Christmas gifts.

The news was greeted with shock and awe by forex traders, who've been selling the dollar today. The U.S. Dollar Index has dropped sharply since yesterday's close. The not-so-subtle implication: interest rates must rise to appease anxious currency traders and, more importantly, the large and far-flung club of foreign dollar holders.

Source: Barchart.com

"It's a genuinely bad number,'' Jason Daw, a currency strategist in New York at Merrill Lynch & Co., said of the trade report in Bloomberg News story today. "It's a negative situation for the dollar. We expect the current account widens out through the beginning part of next year.''

The reaction in the 10-year Treasury Note, by contrast, could hardly be more different, or more relaxed. The yield on the benchmark debt security, as we write around noon, is 4.44%, or about ten basis points below yesterday's close.

The bond market may be smoking what the Fed's handing out, but we'll stay on the wagon a while longer, thanks.

Posted by jp at 12:33 PM | Comments (0)

December 13, 2005

GOLD & RED

If you're scratching your head in search of a reason why gold prices surged again yesterday, reaching nearly $540 an ounce, try reading the latest Monthly Treasury Statement for inspiration. Among the numerical revelations imparted in this accounting of government finances is the news that the federal budget deficit last month was the largest ever for a November, David Resler, chief economist at Nomura Securities in New York, wrote in a research note to clients yesterday.

In fact, the longer you scan the Treasury Statement with data through November, which was released yesterday, the more it looks like the government's mountain of red ink is set to deepen. Again citing Resler's numbers, cumulative fiscal receipts for fiscal 2006, which begins in October, are up just a bit more than 6% this year vs. FY 2005--the slowest rise since October 2004.

But no one should have any illusions that a slowdown in receipts will easily translate into an epiphany of fiscal rectitude when it comes to the government's penchant for spending. As evidence, consider that cumulative government expenditures rose 8% in the first two months of FY 2006, the fastest pace since FY 2004. In the race between receipts an outlays, the latter are maintaining the lead of late.

As to reasons why, the usual suspects were again at work driving government spending skyward, including Social Security, Medicare and other non-defense items. Meanwhile, the prospect of more tax cuts are in the works, suggesting to some that red-ink momentum may still have legs. The House of Representatives last week passed an Alternative Minimum Tax relief measure that's estimated to add more than $30 billion to the federal budget deficit. In addition, the House gave the green light to a $56 billion tax cut spread out over five years.

Supporters of the tax cuts say such fiscal stimulation is needed to keep the economic expansion going. Warranted or not, the paring of taxes may add to the government's debt burden in the short term if for no other reason than Congress is no stranger to embracing more and bigger spending bills in the 21st century regardless of tax receipts. According to the Heritage Foundation, federal spending has been "accelerating" in recent years. "Federal spending has reached $20,000 per household, in constant dollars, for the first time since World War II," according to recent analysis published by the conservative think-tank.

Source: Heritage Foundation

Arguably, the gold market is paying close attention to such trends and, unsurprisingly, expects the worst. Gold bugs always see doom and gloom just around the corner, and that includes a jump in spending-induced inflation. They were largely wrong for a generation after gold reached an all-time high 25 years ago. Are they right this time?

Posted by jp at 9:37 AM | Comments (0)

December 12, 2005

'TIS THE SEASON

Let's call it a holiday gift. When investors unwrap the inflation reports scheduled for release later this week, hope and even joy may be the initial response.

Consumer prices for November are expected to fall by 0.4%, according to the consensus estimate, although Briefing.com advises that even that dose of cheer underestimates what's coming, and so forecasts a slightly steeper 0.5% decline.

Whatever the final number, Wall Street is comfortable with the view that the first monthly decline in CPI since June is upon us. The catalyst is energy, which delivered some holiday cheer in the form of price declines last month. The January 2006 contract for crude oil, for instance, extended a warm greeting with a 5% price retreat in November, putting the CPI on its presumed downward slope of late. And with Opec making all the right noises today at its current confab about keeping production at its current 25-year high, optimism may be able to thrive for at least another day.

Lower energy prices are expected to have kept core CPI in check last month, which in turn will trim headline inflation for November. But falling energy prices are a double-edged sword when it comes to inflation and interest rates. Indeed, when the Fed convenes tomorrow for assessing the price of money it's widely expected that the central bank will again raise Fed funds by 25 basis points, which would elevate the rate to 4.25%, based on the December Fed funds futures contract. Lower energy costs may very well inspire consumption confidence in Joe Sixpack, and so the Fed may be inclined to head off the renewed spending burst at the pass.

"With virtually every measure of economic activity surprising to the upside recently, and strong evidence of corporate pricing power, the Fed probably remains concerned that still-elevated energy prices are likely to bleed into core inflation over time,'' Michael Darda, chief economist at MKM Partners, told Bloomberg News yesterday.

Tomorrow's retail sales report for November may attract more-than-average scrutiny as the market assesses just how much renewed spending vigor is stirring. The consensus outlook calls for a 0.4% rise, which would be the highest since July's 1.7% climb. Adding to the warm and fuzzy feelings will be updates of regional economic activity from the Philly and New York Fed banks, which will probably show "moderate growth, with the industrial production data providing further evidence that key sectors such as building materials and chemicals are, respectively, responding to, and bouncing back from, last summer’s hurricanes," write the economists at Nomura Securities in New York in a research note published on Friday.

Ditto for the hopeful outlook on the update on last week's jobless claims, and the continued momentum in industrial production.

The economic buzz could very well juice stocks, but the question of the week is whether the Fed's fears will take the fizz out of buying equities.

Another potential fly in the ointment may be the October trade balance, which continues to bleed red in extraordinary amounts. Although expectations for a slightly retreat are in order when the figure's released on Wednesday, this volatile number increasingly holds the potential to surprise and therefore shed uninvited volatility on unsuspecting traders.

No matter--the fixed-income set is calm and feeling in a jaunty holiday mood. A bit of buying was evident in the 10-year Treasury in early trading today. This despite the fact that the economy continues to surprise on the upside. The bond market keeps the faith that its ancient bull market still has legs. The 10-year yield remains steady this morning: at around 4.52%, it remains well below its recent peak of roughly 4.68% set on November 4.

'Tis the season.

Posted by jp at 9:22 AM | Comments (0)

December 9, 2005

SLICING, DICING, AND OTHERWISE ACCUMULATING DEBT

Debt is in vogue these days. From the government budget to Joe Sixpack's personal finances, there's no shortage of red ink. The question, of course, is whether the mounting liabilities threaten or are merely a reflection of a wealthy nation indulging in what other economies can only dream of: borrowing to the hilt with no immediate consequences.

Yesterday's release of the Fed's third-quarter Flow of Funds report triggered the debate anew. On the surface, at least, all is obvious. Household debt, for instance, climbed by an annual 11.6% rate in the third quarter, the fastest pace since 1987. The Federal government's penchant for digging itself deeper paled by comparison, rising by a relatively modest 5.1%

For some, such trends are the latest smoking guns for expecting economic and financial turmoil. Joe can't keep racking up debt forever, goes such thinking. When he finally decides to save, the resulting parsimony will take its toll on the economy, thanks to the fact that the GDP relies on consumer spending to the tune of around 70%.

Of course, such warnings have long fallen on deaf ears, starting with the consumer, who shows a persistent inclination to spend now and pay off debt later. The piper never seems to get paid. But might that soon change?

If any of this talk is designed to conjure images of financial Armageddon, some dismal scientists aren't biting. Consider, for instance, William Conerly of Conerly Consulting. This economist recently penned an essay titled "What National Savings Crisis?" As he proclaimed in the piece, which he emailed to CS last month, "There is no national savings crisis in America."

A provocative statement in this day and age, to say the least, and all the more so in light of the updated Flow of Funds data. Wondering if perhaps Conerly's changed his mind, we called him up with an inquiring agenda. But this consultant wasn't budging, pointing out that consumer credit debt is actually rising at its slowest pace since 1993, according to another data series tracked by the Fed. "The 12-month growth rate for consumer credit is the lowest since 1993," Conerly told CS.

So, what accounts for the surge in household debt generally, as reported by the Flow of Funds report? The numbers reveal that mortgages account for the bulk of the ascending red ink among households. Whereas overall household debt jumped at an annual 11.6% rate in the third quarter, mortgage debt rose by 14%. Consumer credit, by contrast, rose by a relatively mild 5.4%. Real estate, in short, is driving the lion's share of the red ink. That's different than buy depreciating cars and TVs, of course. But servicing debt, any debt, gets harder if interest rates rise, which they seem to be doing of late.

What are we to make of all this? "We're paying off our car loans and doing more mortgage debt," Conerly observed, speaking on behalf of Joe Sixpack and his counterparts.

Conerly concludes that all the talk of crisis is overblown, specifically when it comes to the so-called savings crisis. The government, he asserts, has a less-than-perfect methodology for tracking savings. As he recently wrote in his essay,

The government does not count savings. The statisticians count income earned, and then they compute savings as whatever is left over after taxes and consumer spending. The theory is excellent, so long as income is accurately measured. In practice, however, income is woefully underestimated. We actually have more income than the official statistics show, so we have more savings as well.

Still, he conceded in today's interview that there's a "deterioration" in savings, even if it's miscalculated. But the deterioration isn't so great as to court disaster, he emphasized.

Conerly's not alone with that view. Susan Sterne, chief economist of Economic Analysis Associates, wrote an article for Business Economics in the summer that came to a similar conclusion. "Anomalies in the measurement of savings and growing wealth suggest that measured savings rates are not as big a problem as they appear to be," she opined.

Nonetheless, even an optimist can be excused for being a little wary these days. Conerly suggested to us that if the housing boom bursts, there could be trouble. He also said that businesses need to do more contingency planning in case of future short-term energy-price spikes. In addition, he added that Ben Bernanke, who'll take over the Fed next year, may not be as deft as Greenspan. "Bernanke's a good choice, but I don't expect him to be quite as good on judgment calls," he predicted, noting that Greenspan had experience in real-world economic consulting whereas Bernanke is a creature of academia. "That raises the risk of money policy errors."

Nonetheless, Conerly expects economic growth will stay above 3% in 2006. Still, the risk of recession will rise next year, he added, a forecast that probably doesn't surprise all that many people.

Posted by jp at 2:43 PM | Comments (0)

December 8, 2005

VIVE LA DIFFERENCE!

When we last discussed the pending demise of the M3 series of money supply, as per the Fed's announcement last month, there was suspicion swirling that a devious plot was underway to censor a monetary smoking gun. Several weeks hence, conspiracy theorists will find no reason to abandon the fear that the central bank's trying to pull a fast one on matters of money supply data.

For those who've just arrived to this soap opera, here's the quick update. The Fed recently decided to cease publishing M3, its broadest measure of money supply. The reason given: M2, a narrower gauge of U.S. money supply, is virtually the same, and eliminating M3 will pare redundancy.

Sounds fine, except for the fact that M2 and M3 aren't quite the twins the central bank suggests. As we earlier observed, M3's rate of increase is substantially higher than M2's, based on the rolling year-over-year change in weekly data. That was true in November, when we last wrote on the topic, and the difference has continued to grow.

Indeed, the disparity in growth rates in M3 vs. M2 has been widening. Based on the latest weekly data released by the Fed, M3 rose by 7.5% in the week ending November 21 vs. the weekly number for 52 weeks previous. That compares with a 3.6% growth rate for M2 over the same stretch. As a result, the spread in M3 over M2 is now 390 basis points, up from 280 basis points on October 31, and zero (no spread) at one point back in February 2004.

It seems reasonable to repeat the question that we posed earlier, namely: Why is the Fed killing the series of money supply that shows the fastest growth? The question is all the more pressing these days since the central bank is on a mission to convince the world that it's tightening the monetary strings by raising short-term interest rates. M3 arguably suggests something different. But M3's slated for the trash heap, and la difference is about to be snuffed out. To which we reply, Vive la difference!

Posted by jp at 10:40 AM | Comments (2)

December 7, 2005

GOLD OR STOCKS? HOW ABOUT BOTH?

Worker productivity rose at the fastest pace in two years in the U.S. in the third quarter while labor costs fell, the Labor Department said yesterday. For the dismal science, the trend suggests that inflationary pressures will stay contained.

The report is "great news on the inflation front," David Greenlaw, chief U.S. fixed-income economist at Morgan Stanley in New York, told Bloomberg News. "It will be very difficult for the economy to generate any sustained rise in core inflation, with unit labor costs showing such a high degree of restraint."

But the gold bugs, an ornery lot in the best of times, aren't necessarily inclined to listen. The price of the precious metal continued pushing higher in early trading on Wednesday, reaching over $513 an ounce at one point--a 24-year high--before pulling back. Inflation worries run amuck? Perhaps, although gold doesn't exist in a vacuum. Commodities generally are rising in price, gold being just one of them, and unspectacularly, as it turns out compared to, say, copper, which has climbed more than 40% this year vs. gold's 20% rise, as of yesterday.

Commodities overall, measured by the CRB Index, show a 14% year-to-date gain. Gold, which is part of the CRB and other commodity indices, may be rising as much as for traditional reasons (inflation hedging and jewelry buying) as it is for increased purchases of commodities in an expanding global economy.

Already, some are calling the run in gold prices above $500 an ounce a bubble, and one that's poised to burst. "When this sentiment-driven rally finally comes to an end, the pull-back we are going to see is going to be aggressive," Simon Weeks, director of precious metals at ScotiaMocatta, told Reuters today. "We are probably going to have a $25-$30 move on the downside when this sort of sentiment-bubble finally bursts."

Indeed, without throwing the gold market another inflationary bone to chew on it's hard to see the metal moving substantially higher from here without at least a correction. Of course, gold bugs can and do argue that inflation statistics are manipulated and so minimize the true rate of inflation, which they say is rising. Still, fresh confirmation is needed for the metal to see $600 any time soon.

What's more, with the stock market continuing its buoyant ride of late, the competition for assets remains intense, and that could put doomsday investing on the defensive in the coming days and weeks. Gold may be the ultimate store of value, but when equities are rising in a year-end rally even a dedicated gloomster can get distracted. Indeed, the S&P 500 climbed to a four-year high yesterday, and the rosy government labor report for the third quarter was no trivial factor. Higher productivity may not boost hiring, but it does wonders for corporate earnings.

Ed Yardeni, chief investment strategist for Oak Associates, posed the topical question of the moment and then resolved it in an email note to clients: "Is productivity great or what? The answer is: It's great." He then pointed out, "The trend growth rate has been roughly 3% a year for the past 10 years. During Q3, nonfarm productivity jumped 4.7% (seasonally adjusted annual rate), and was up 3.1% year over year. For nonfinancial corporations (NFC) the quarterly increase was less at 3.2%, but the year over year was more at 4.7%. NFC unit labor costs have been virtually flat for the past three years. No wonder inflation has remained so subdued and profits have been so strong."

With virtually all of the S&P 500 companies' third-quarter reports in, Zacks reports that the news is generally one of better-than-expected earnings results. For the third quarter, Zacks said that the median S&P 500 firm reported an earnings gain of 13.8% on a year-over-year basis. Energy led the way in terms of growth (+77%), but the earnings train was in force in various sectors. In fact, of the ten S&P 500 sectors, only materials posted a loss (-2.4%) for the third quarter in terms of an earnings comparison with a year ago.

More of the same is on tap for 2006, Zacks predicts, opining that a 12.2% earnings climb will come next year, or only slightly below the 13.9% pace it expects for 2005.

None of that will comfort gold bugs. But for the moment, there's enough room for profits across the sentiment spectrum. Performance in stocks and commodities has been robust this year. Can the twin engines of light and dark last into 2006?

Posted by jp at 10:44 AM | Comments (0)

December 6, 2005

ALL EYES ON THE FED

Gold prices moved above $510 an ounce in Asian trading today, touching the highest price since 1980. Embedded in this ongoing bull market for the precious metal is the not-so-subtle message for the Fed at its meeting next week to keep hike rates.

By implication, the gold market would like to see additional tightening in the money supply of the world's reserve currency. Echoing the embedded counsel in the price of gold is the Shadow Open Market Committee, an informal club of monetarist-leaning economists who second-guess the Fed and otherwise issue pronouncements on monetary policy in their spare time. Nothing less than additional rate hikes are still required, the SOMC said in a statement yesterday, according to Bloomberg News. "Conditions require a more aggressive stance to ensure that inflation and inflationary expectations do not take root,'' the committee advised.

Even the bond market seems inclined to agree these days that the Fed should further constrict money supply next week. The yield on the benchmark 10-year Treasury Note continues to rise, closing yesterday's session at roughly 4.57%, the highest close since November 14.

Meanwhile, the latest trading in the December Fed funds futures assumes that the central bank will raise rates to 4.25% from the current 4.0%.

The predictions are in, and the prices have been reset; all that's needed now is for the Fed to confirm what everyone already expects. At some point, the Fed will stop raising interest rates, but not just yet. Chatter recently that the end of the rate hikes is in sight reportedly helped elevate equity prices in recent weeks. But in a sign of the moment, the S&P 500 slipped yesterday, perhaps signaling that the stock market too thinks more rate hikes are coming after all.

So, what economic and financial wallpaper might attend an end to rate hikes once it finally comes? The chairman of Atalanta/Sosnoff Capital and Forbes columnist Martin Sosnoff thinks he has the answer. Writing yesterday, he opines: "If you want to know when the Fed stops bumping the Fed funds rate, just project when the economy will show some deceleration, when oil prices will range closer to $50 per barrel than $60, and when wage inflation holds at its benign rate of 2.5%."

Good luck with that one. But Sosnoff redeems himself by offer a bit more clarity in his prognostications: "My best call is that the Fed relents by next spring after oil stabilizes around $50 a barrel. The market would experience a change of leadership. Big-cap growthies would outperform, even Wal-Mart and Microsoft. Money would come back into GE, Procter & Gamble, Philip Morris, Intel, IBM--anything with 10% top-line and bottom-line momentum."

In fact, S&P's retooled style indices already show just that in the fourth quarter. The S&P 500/Citigroup Pure Growth Index has posted a total return of 3.03% this quarter through December 5, vs. a 0.51% loss for its value counterpart. Is this evidence that value's long dominance is finally fading? If so, who could have predicted that growth would return during an extended period of Fed tightening? Higher interest rates = a boost for growth stocks? Apparently so. Any other questions?

Posted by jp at 7:23 AM | Comments (1)

December 5, 2005

NIMBY AND ENERGY CLASH AGAIN

High oil and gas prices may have shocked, shocked Joe Sixpack and his compatriots, but when it comes to building new refineries and other plants a solution for increasing supplies of natural gas, well, let's not go overboard.

The NIMBY factor, in sum, is alive and well in the new new age of energy crisis. NIMBY, of course, is short for not in my backyard. Its governing philosophy is essentially: solutions are all well and good, just as long as they're nowhere near me. In theory, it seems reasonable. Oil and gas refineries are big, ugly, dirty and carry a threat of trouble if there's an explosion. Of course, such eye sores exist primarily for the convenience and comfort for the same people who oppose them. Regardless, building such facilities far, far away from population centers has immediate and wide appeal. Never mind that building a liquified natural gas facility in remote areas would insure higher costs since the fuel would have to be shipped back to demand centers. In which case, cries of price gouging might arise in no short order.

But there seems to be no risk of that particular form of abuse for the simple reason that efforts to build new refineries, near or far, are stopped before they get off the drawing board. Incentives to maintain that status quo are likely to be enhanced with crude oil and refined gasoline prices in relative retreat (for the moment).

Might there be a different verdict when it comes to natural gas, whose price continues to remain high relative to crude and gasoline? A clue might come soon via the outcome of a suit brought by Delaware in an effort to block plans by a unit of BP for building a liquified natural gas plant on the New Jersey shore of the Delaware River. The case is scheduled for a hearing today at the United States Supreme Court.

John Hughes, Delaware's environmental secretary, reasons that his state's in the right because Delaware's laws bar "heavy industry and certain manufacturing procedures inside our coastal zone," he told AP last week via Newsday.com.

The core of the dispute is that the new facility requires building a peer which extends out into the Delaware River, a project that will entail dredging a portion of the riverbed that Delaware says is under its jurisdiction. On that basis, Delaware has so far put the kibosh on giving BP a permit to proceed, arguing that the work would risk environmental damage.

But there's a legal glitch for Delaware in the form of 100-year old agreement between the state and New Jersey that gives the latter the right to ok development for the BP project. As a reporter for law firm Goldstein & Howe's blog observed last week of the inter-state dispute now awaiting resolution at the Supreme Court: "New Jersey argues that the compact gives it control over riverbank areas of the Delaware on its side, and thus contends that Delaware may not stop it from authorizing development of those areas."

Legal issues aside, New Jersey residents living near the proposed LNG facility are concerned with safety, which is to say, NIMBY rules. "If, God forbid, anything happened, there would be a domino effect up and down the river," Bob Grant, a retired truck, said in a New York Times story yesterday about the potential for trouble with BP's project.

Opposing LNG-facility developments is nothing new, of course. Back in March, CS wrote of the high-level battles in Washington as efforts to thwart plans for developing various LNG projects proceeds apace. Indeed, the NIMBY effect has been no trivial reason for the lack of new oil refineries in the U.S. over the past generation.

With that in mind, the market may be watching the outcome of today's Supreme Court skirmish over LNG as sign of things to come. But while the lawyers chatter and the Justices listen, natural gas prices continue to hover near all-time highs. In fact, the January 2006 natural gas futures contract reverted to form in the last week or so, rising 23% as we write, relative to November 28's close.

So, while the Supreme Court weighs the pros and cons of the Delaware/Jersey dispute, Mr. Market seems to have already filed his verdict. NIMBY, in sum, has an effect on the trading mentality, but in manner that digs ever deeper into Joe Sixpack's disposable income.

Posted by jp at 9:33 AM | Comments (0)

December 2, 2005

TIPPING EVERY WHICH WAY

Is this the long-feared wake-up call for the bond market? Maybe, but the bond ghouls don't give up so easy. But there's at least reason to sit up and take notice, if only to keep things interesting and provide a change of pace for a day or two. Indeed, this week's economic data was unmistakably positive, and in some cases far stronger than the consensus expected. The fixed-income set responded, but only modestly so far, selling the benchmark 10-year Treasury to the tune of lifting its yield to 4.52% as of yesterday's close. That's up about 10 basis points from the end of last week.

The rise of long-term rates may be warranted from current levels, given the robust upward revising in third-quarter GDP to 4.3% growth from 3.8% previously estimated. And as this morning's employment report reminds, November was the 30th consecutive month of rising nonfarm payrolls. Meanwhile, the European Central Bank has joined the interest-rate-hiking bandwagon and elevated the price of money on the Continent for the first time in five years. It may not be a trend, but it certainly smells like one.

But if an epiphany is coming in the bond market, you wouldn't know it by reading the latest missive from Pimco's Bill Gross, who runs the world's largest bond fund. Gross continues to talk of a slowing economy and lower yields. Writing in his latest Investment Outlook, he opined, "Now after 300 basis points and 17 months of tightening – which by the way is typical of prior bear cycles as well – it should only be logical to expect a slower economy in 2006, an end to Fed tightening, and the beginning of an easing cycle late in the year."

It's unclear if the bond market agrees, only because yields have tended to move sideways for some time, and that habit more or less remains intact for the moment. True, the 10-year's yield has nudged up this week. Then again, the 10-year's yield hasn't changed all that much since May 2004.

The bond ghouls may be a determined crew, but the forces of optimism are fighting back. Brian Wesbury, chief investment strategist with Claymore Advisors, skewers the pessimists today in a Wall Street Journal op-ed (subscription required). "During a quarter century of analyzing and forecasting the economy, I have never seen anything like this," he wrote. "No matter what happens, no matter what data are released, no matter which way markets move, a pall of pessimism hangs over the economy."

But the pessimists aren't likely to be moved. There are more than enough worries out there to keep the bond ghouls active and thoughts of crisis bubbling. Indeed, preceding Wesbury's chastising in today's Journal was another op-ed piece in Thursday's Journal from Michael Darda, chief economist at MKM Partners, who warns that any of the new tax hikes being discussed in Washington might take a heavy bite out of the economy at this juncture. One reason is that things might not be as rosy as they appear. Darda notes that using gold as a deflator, instead of the government's consumer price index, reveals an economic horse of a different color: "If we use gold (which is real) as a deflator instead of the Consumer Price Index (which is not), the median home price stood at $216,200 as of October 2005, compared with $334,000 (in 2005 gold-based dollars) in July 1970."

Northern Trust's Paul Kasriel is partial to such thinking, as he explained in a research note yesterday. "If we use the price of gold as the deflator rather than the Commerce Department’s deflator of chained 2000 dollars," Kasriel wrote, "it looks as though the U.S. economy still is in a recession despite the touted supply-side tax cuts we have had since 2001. Thanks for the tip, Mr. Darda!"

Posted by jp at 9:52 AM | Comments (2)

December 1, 2005

NOVEMBER EQUITY SCORECARD

November 2005 Performance
(Ranked in descending order)

Russell Capitalization/Style (total returns)
Russell 2000 Growth 5.66% <--Growth continues to rebound…
Russell Midcap Growth 5.43<--In midcaps too…
Russell 2000 4.85
Russell Midcap 4.44
Russell 1000 Growth 4.31<--And in large cap growth
Russell Microcap 4.31
Russell 2000 Value 4.06<--Small value looks tired…
Russell 1000 3.81
Russell Midcap Value 3.53<--Ditto for midcap value…
Russell 1000 Value 3.29<--And large cap value

Morningstar Equity Sectors (total returns)
Energy 30.81%<--Still rockin'
Utilities 12.02<--Interest-rate sensitive--Not
Business Services 11.14
Financial Services 8.36
Healthcare 8.01
Industrial Materials 7.39
Hardware 3.86
Consumer Goods 3.24
Consumer Services 2.75
Software 1.12
Telecommunication -3.29
Media -8.06<--Ouch!

International (price change, US$)
MSCI EMERGING MARKETS 8.19%<--The global hot spots…
MSCI LATIN AMERICA 7.93<--The spicy south
MSCI CHINA 7.01<--More of the same
MSCI EASTERN EUROPE 5.75
MSCI JAPAN 4.26
MSCI WORLD 3.14
MSCI PACIFIC Ex JAPAN 3.00
MSCI EAFE 2.25
MSCI EUROPE 1.44<--Rate-hike blues?

Sources: Frank Russell Co., Morningstar, and MSCI

Posted by jp at 11:11 AM | Comments (0)