WEEKLY ECONOMIC ANALYSIS: December 4th, 2009

Provided by TEAM Financial Services

"I will do everything I can to stop your nomination and drag out this process as long as I can. We must put an end to your and the Fed's failure and there is no better time than now. Your Fed has become the creature from Jeckyll Island."
- Senator Jim Bunning, December 2009

Items for discussion

For those readers who don't live all things financial markets/economy, you may have missed Senator Bunning's "questioning" at Fed Chairman Bernanke's confirmation hearing this week. It is the first time we've seen a government official address Mr. Bernanke, or Mr. Greenspan, in a way we can relate to. The 13 minute video can be seen on Youtube here. Personally, I probably haven't cheered on someone so gleefully since John Elway during the last touchdown drive of the 1998 Super Bowl versus the Packers.

The rolling waves of internal market correction finally reached our shores in a violent fashion Friday, as many commodities and related stocks suffered a substantial selloff. As we have long warned our clients, positions in the precious metals industry are infamous for incredible volatility, and the past few weeks have certainly not disappointed in this regard. From the beginning of November, the HUI precious metals stock index was up over 36% into its peak reached this week. Friday ushered in a vicious one day decline of over 7% at one point on Friday. December gold futures declined over 6% from the Thursday peak of about $1,226 per ounce at their low on Friday.

The US dollar enjoyed a violent rally versus every major currency, as the US dollar index was up over 1.5% - a huge move for the index. It appears that the one sided anti-dollar trade finally attracted one too many adherents, at least in the near term, and the vicious process of the pendulum reverting in the opposite direction may have commenced.

It is always difficult to experience these types of violent moves regardless of how many times one has experienced them in the past. The better than expected November US employment report released Friday morning appears to be the major catalyst for this latest shift in markets. TEAM is busy trying to ascertain whether a fundamental and intermediate term inflection point may be developing or whether this is simply a nasty shakeout/correction that will serve to scare the you-know-what out of those who own these positions. At present, it is too early for us to offer a definitive “forecast”, but we can offer our initial take.

Markets appeared to have priced in the base case assumption that the Federal Reserve would keep interest rates near zero through 2010 and even into 2011. Friday’s employment report appears to have re-introduced some anxiety over the wisdom of that assumption. We certainly understand the rationale behind this anxiety and respect the fact that markets often move violently once too many people have moved to one side of the boat – just a small number of people shuffling back to the other side can cause a rapid period of the boat tossing back and forth.

While the current reshuffling of the boat deck could certainly take a couple/few weeks to unfold, we do not yet see signs that the cyclical recovery in commodities is over. There has been a Pavlovian reaction from traders to sell commodities with any whiff of US dollar strength, which is something that historically is not a given. There have been many periods historically in which commodities rallied with the US dollar in relation to foreign currencies, and TEAM believes that a similar scenario is possible. In addition, this latest spike in the US dollar could end up being very temporary, though significant in percentage terms, before it resumes its downtrend.

We continue to retain our significant allocation to commodities and related stocks, as painful as doing so was on Friday, as we believe they continue to present a compelling risk/reward opportunity over the intermediate term. We were encouraged to see that precious metals stocks were down about in line with the metal itself. Often times during these types of violent moves the stocks will be down a multiple of the metal. This suggests to TEAM that the stocks may be poised to finally lead the metal once the current decline exhausts itself, whenever that may be.

Market/Economic Climate

The strength in Friday’s employment report corroborates the forecast we made a couple of months ago that job growth could actually resume by the end of 2009. As completely unlikely as it seemed at the time we expressed that forecast, it now appears within reach – such is the “magic” of well constructed leading indicators! TEAM continues to forecast that government reported GDP growth in the 1st and 2nd quarters of 2010 will surprise many with the extent of the strength. Our research suggests that there is widespread aggressive inventory management across many industries. Whether it is retailers petrified of a weak holiday shopping season or an industrial firm worried the demand for their widgets will not resume.

We already know that firms have cut payrolls aggressively over the past two years, so if/when demand does pick up, even if it is modestly and regardless of whether it is being created by government stimulus, a cyclical “perfect storm” could unfold. With inventories extremely low and labor cut to the bone, production and labor pressures could emerge quickly. There is no question that the US has lost a huge amount of its manufacturing base to other countries, so employment trends in the US could continue to lag. However, whether a widget is manufactured in Malaysia or Michigan, the demand for raw materials is the same.

We believe this combination of low inventories, dramatically reduced work forces and incredibly loose monetary policies globally is likely to keep a significant wind in the sails of commodity prices. As we stated several months ago, leading indicators suggest the US service sector is poised to lead the US recovery, so service jobs and end demand may revive faster than most expect.

Humor for the Weekend

Weekly Economic Analysis newsletters are provided by TEAM Financial, and are written by TEAM's Chief Investment Officer, James L. Dailey. Visit TEAM's website if you want to receive weekly economic updates right in your inbox - Click here.