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We seem to be witnessing a battle between two sets of indicators at the moment, each with its own opinion on which way the market is headed.
On the one hand, as we have been expecting, our Long-Term Master Key has dropped below -80%, which is a “sell” signal. On the other hand, we have a lot of technical and economic evidence that argues against a sharp fall in the market.
In your last update, we explained why a so-called “sell” signal in the Long-Term Master Key would not send us into a panic mode. Before you start dumping good stocks, let's review the situation.
In the first place, the market has already retreated significantly from its highs last fall, perhaps in anticipation of this week's “sell” signal. So prices today are quite reasonable.
We should also remind you that there's nothing magical about the -80% figure. It's just a rule of thumb based on historical data. But we can't really say that there's much difference between -80% and -79%.
More importantly, we should point out that the Master Key has a certain built-in bias due to the fact that it relies on the price of oil as measured in U.S. dollars. This bias towards U.S. currency might not be as appropriate anymore when considering global oil prices. For instance, if we measure oil prices in terms of the Euro or other world currencies, they are nowhere near the -80% threshold.
It may seem like we're fudging a little here, but we are not. The U.S. dollar has been exceptionally weak lately (in the last 2 ½ years, it has lost roughly 20% of its value). In fact, the weak dollar has been a factor that has kept our economy strong – allowing exports to grow dramatically. Nonetheless, when considering what prices the world pays for oil, the dollar is not as good a measure as it used to be.
We will be closely watching the other economic indicators, as well as oil prices. However, we have already adjusted our sector weightings to accommodate the gains in oil, as the Master Key has begun approaching the “danger zone”. Keep in mind our low-risk hedges, which are designed to thrive in all market conditions, are now the most heavily weighted group in our portfolio. We may weight them even higher in the months ahead.
At the same time, you want to avoid making dramatic changes. One significant advantage you have when you subscribe to TCI (as opposed to just reading our books) is that you get on-going, up-to-date information that can help you better adjust to the exact conditions as they unfold. It's like the difference between putting your ship's rudder on autopilot for most of your voyage and taking the wheel yourself. In the latter case, you can instantly adjust to changes in the wind in order to give yourself a safer trip.
Regarding that economic data we are monitoring...
RECESSION WATCH NEWS
All the indicators suggest today that the economy is in a low or zero growth phase (at worst, only slightly negative). Our worst fear, a decline that feeds upon itself, has not occurred.
The employment report on Friday showed a surprising downtick in the unemployment rate, alongside a small downfall in total employment. The most disturbing figure released was an uptick in UI claims, but even that left the 4-week moving average at around 460,000 and declining, which is far lower than we'd expect to see during a recession.
Most of the surveys, (such as the ISM survey) which try to judge people's opinions on how manufacturing and various sectors of the economy are doing, suggest the economy that is either growing slightly or slowing slightly – but definitely not collapsing.
We continue to focus on the strong uptrend in industrial commodity prices, which is a sign of a healthy manufacturing sector. These are spot prices, incidentally. There has been much concern recently that speculation is unduly influencing commodity prices. We don't buy this. But even if you do, the commodity prices we refer to are not those traded on futures exchanges. They are not ones which can be hoarded. They are simply spot commodity prices contracted and negotiated between corporations.
Unlike other commodity indices such as the Reuters-CRB Index or the Reuters/Jefferies CRB Index, which have declined noticeably from their highs in recent weeks (perhaps due to speculative selling), the spot prices are still very close to the top of their chart.
(If you want to check this out for yourself, go to the Commodity Research Bureau website and look under “raw material spot index.” A similar index is the Journal of Commerce Index published in Barrons, but we prefer the former.)
Also, we note that the leading indicators of the major worldwide economies have been rising in recent months. While this rise hasn't taken the indicators to new highs yet, it has come on the heels of a very shallow decline – one even shallower than that which preceded the mild recession of 2001.
Finally, the latest round of corporate earnings numbers have been very good. The vast majority of stocks in our portfolio have surprised to the upside. The only disappointments were in the financial sector. So it looks like the weakness in the economy has been successfully restricted to the financial and housing areas, and has not spread. Thank rising exports and the declining dollar for that.
As for where to put your investment dollars today...
GOLD'S DOWN A LITTLE, BUT FAR FROM OUT
Last week we suggested that gold could decline a little further, and so it did by another 3.5%. We suspect that it is near an important bottom. We don't want to claim that the bottom will be $850 or any other magic number. In fact, even if gold declined to the high $700s, our fondness for it would not waver. On the contrary, it would shake out all the weak hands, setting the stage for another run at the $1,000 mark – and possibly beyond.
Everything we look at, from the not-so-weak economy to triple-digit oil prices, tells us that in today's world currencies will no longer function as a safe store of value, no matter whether you hold the dollar or the Euro or even the Swiss franc. Inflation is rising throughout the world, and the only refuge that has proven safe historically against this is gold. If you're feeling rattled by the recent shake-up in the yellow metal, remember that gold is still up 25% year-over-year. If stocks had performed that well, investors would be ecstatic!
When gold finally regains its footing, we expect it will become the strongest of all the commodities. One reason is that we have seen record growth in money supplies lately. The Fed may no longer keep track of M3, the broadest measure of money supply (probably because its rapid expansion lately would trigger alarms). However, some private researchers still do the calculations themselves. Their work shows M3 has been growing at a year-over-year rate of 17% -- a record high.
It's really a no-brainer. More money means money is worth less, which means gold is worth more. It's just a matter of time until the market sniffs out a bargain and pounces on the yellow metal.
NOT ALL OIL STOCKS ARE ALIKE
In addition to gold, we remain bullish on stocks leveraged to higher energy prices. These do not include major oil companies, unless you want to buy them for defensive purposes. The reason is that production for many majors is declining.
Take Exxon, for example. Recent figures showed a relatively moderate 17% increase in the company's profits despite a 70% increase in energy prices and a 30% increase in Exxon's exploration expenditures.
The reason earnings lagged behind oil prices was that production fell 5%. This is alarming, considering how much more Exxon has been spending on exploration. It's looking more and more like Peak Oil is on the doorstep, at least for the non-OPEC world. And the OPEC world doesn't offer much more reassurance.
The upshot is that, when you are choosing oil stocks, buy the oil service companies. They are the ones leveraged to our increasingly urgent need to find more hydrocarbons.
