The Fed Meeting Fallout, US$ Strength / Smaller than Expected Debt Limit Increase, Shadow Home Inventory on the Rise, State Budget Problems

The Fed chose not to change rates or comments during the Wednesday meeting. While we anticipated this outcome in our Monday post, the market reaction has been anything but expected. In months past the type of Fed commentary exhibited this week led to a lower US$ and inverse strength in commodity and equity markets. This week the results have been anything but ordinary. The US$ gained strength, some commodities have rallied with the US$ (e.g. Oil) but precious metals have suffered. Meanwhile the Treasury markets have rallied and equity markets seem to have stalled.

The Fed's commitment to a lenient stance is not a surprise. The following two stories are just a couple of the driving forces applying pressure to the economy and in turn the Fed...

More homes are poised to hit the market - LA Times
LA Times reports a supply of 1.7 million homes headed for sale because of foreclosure or delinquency looms over the nation's housing market, which could dampen progress toward recovery should the Obama administration fail in its efforts to aid struggling homeowners, researchers said. A variety of measures to keep discounted bank-owned properties off the market -- including moratoriums on foreclosures by major lenders and federal initiatives aimed at keeping people in their homes with mortgage payments they can afford -- has helped increase a backlog of so-called shadow inventory 55% in the year ended Sept. 30, according to a report released Thursday by First American CoreLogic, a Santa Ana-based real estate research firm.

States scramble to close new budget gaps - WSJ
WSJ reports the patches used by states on their ailing budgets just months ago are now failing. Ohio lawmakers were expected late Thursday to vote on a compromise reached with Gov. Ted Strickland to avoid cutting education budgets an average of 10% on Jan. 1. In Arizona, lawmakers met in a special session Thursday -- their fourth on the budget this year -- to grapple with a new deficit. And in New York, Democratic Gov. David Paterson said Sunday he would postpone paying $750 million of state bills to avert a cash crunch. Many states eliminated expected deficits earlier this year with budget cuts, tax increases, short-term borrowing, accounting moves and planned gambling expansions. But despite a slight improvement in the U.S. economy, states are now finding those measures didn't go far enough. Tax collections continue to trail projections in some states, and court rulings and political battles have blocked some gap-filling moves. Plus, some legislatures didn't fully deal with the deficits, leaving the toughest decisions to governors... Only a few states now have cash-flow problems. But if revenues continue to fall below expectations, the list could grow, said Scott Pattison, executive director of the National Association of State Budget Officers.

...the US$'s strength as well as the strength in the Treasury bond market does however, provide some consternation. Apparently, other factors have overshadowed the Fed meeting this week and driven the direction of markets. Many attribute the strength of the US$ to troubles developing in Europe. The fears of a debt default in Greece have led some to believe the viability of the EU is in question. We believe this fear is unfounded and would instead direct your attention to the following story...

House narrowly passes $290 billion increase in debt limit - WSJ
WSJ reports the House approved a short-term $290 billion extension in the nation's debt ceiling, delaying a decision until February about a larger increase in the borrowing cap. The vote comes less than a week after House Majority Leader Steny Hoyer (D., Md.) said he intended to seek a $1.8 trillion increase in the ceiling to support federal government borrowing through 2010. A decision was made to seek the more modest increase after it became clear the larger increase may have failed to win support in the Senate. The Senate must still take up the two-month increase, which it is expected to do next week.

...The decision to delay the "larger increase in the borrowing cap" in our opinion added fuel to a short covering rally already underway in the US$. I will note that the vote has only been delayed and will no doubt be passed in the not to distant future.

In short, year-long trends remain in place although severely tested this week. Seasonality would suggest equity market strength during the last two weeks of the year. Volatility as judged by the VIX index has remained subdued during this week's shenanigans and would add credence to the idea of a resumption in seasonal trends.

Stock Market Investing: Expect Trends to Remain Intact, Investment Strategy: The Fed Meeting Holds the Key,Trader Dan & The Continuous Commodity Index

Trader Dan Comments On This Week’s Action In The Continuous Commodity Index: Courtesy of Jim Sinclaire

...This chart...is significant in telling us the direction that gold prices will take moving forward. For the deflationists to be proven correct, this chart will need to break down technically which would require both a move below the 400 level and a downturn in the rising moving average in which price moves below that average as it trends lower. AS you can clearly see, the moving average is trending higher and prices are above it. This signifies that the inflationists have the upper hand and their assessment is currently the correct one.

Until this chart reverses its positive technicals, those calling for a major top in gold are simply mistaken in their assessment and are attempting to impose their view on the markets rather than reading what the market itself is currently saying. That’s the problem with analysts and even traders who cannot let the market speak to them and get stuck in a losing trade because they refuse to acknowledge that they might be incorrect. In effect, they end up fighting the trend or the tape as we used to say. Continuing Education...

Stock Market Investing: The equity markets have consolidated over the last few weeks in a tight trading range. Meanwhile, the US$ has caught a bid sending Oil and Gold lower. Once again the financial media would like you to believe a major crossroads has been reached. We at RCM would beg to differ. Perhaps a review of reality would help:

1) Over the last several months, the US$ experienced strength during the week or so before the Fed meeting. Said strength rapidly dissolves as Fed comments from the meeting reiterate the need and desire for easy credit. If the US$ strengthens after this week's meeting then perhaps a "crossroads" has been reached. Until then, recent US$ strength appears nothing more than the financial equivalent of a hiccup.

2) Please review the chart and comments above from Trader Dan. Clearly, the commodity markets as a whole have not responded to the "US$ strength" of the last two weeks. One would need to see the up trend in commodity prices challenged before a "crossroads" could be reached.

3) During previous US$ rallies in '09 the equity markets have suffered. Often a sell off of 5 - 10% would occur in the equity markets if the US$ rallied 2 - 3%. This time however, equities have used the US$ rally to consolidate gains in a tight sideways movement. Equity players may be signaling disbelief of US$ strength, the exact opposite of a "crossroad".

Investment Strategy: The Fed meeting this week will be key. Should the Fed choose to change language and appear inclined to reduce liquidity then a crossroads of some kind will in fact be reached. However, until the Fed stance changes expect year long trends to remain intact.

As I have explained above, commodity and equity markets are not foreshadowing a change in Fed stance.

On the other hand, the last two weeks have been replete with Government statistics suggesting economic "strength". The retail sales data "surprised" on the upside and University of Michigan Consumer Sentiment Index rose more than expected. Both announcements led to spirited US$ rallies.

What will the Fed decide? We won't know until the stories hit the wire.

However, we do know rates need to remain low for this country to handle an enormous Federal debt burden. We know the economy, whether recovered or not, is precariously perched and needs liquidity. We know consumer confidence does not equate to consumer spending; income is required for consumption. And we know income will continue to be constrained as debt defaults continue to mount...

The Coming Wave Of Debt Defaults -Sam Rovit and David Sweig - Forbes

The worst is not yet past. Be prepared.

The trouble in the commercial real estate markets is getting ugly, as the precarious situation of Dubai World has made all too clear.
Expect many more unpleasant situations like that one. Speculative-grade debt issuers are bracing for the default rate to hit 12% to 14% by the end of 2009, according to our projections at Bain & Company. The last time the U.S. economy experienced default rates of that magnitude was 28 years ago. Continuing Education...

My parting question: Knowing all that we know, should this week's Fed comments really be a mystery? What possible good could result from the Fed changing its stance at year end? A stance change now would simply not be logical and perhaps that is where the risk lies. Logic and government are often at odds.

Stock Market Investing: The Dubai Implications, Investment Strategy: Generational Move Unfolding For Gold and Silver Prices

NEW YORK (CNNMoney.com) -- The news that the sovereign wealth fund of Dubai requested a postponement of billions of dollars of debt this week could pose a big problem for U.S. banks...

...Bove said the underlying problem is that there is a lot of uncertainty floating around. For example, there's little information available about counterparty derivatives, guarantees that transfer default risk from lenders to other financial institutions. And it's unknown how much of Dubai World's debt guarantee is held by U.S. banks. Read More...

Stock Market Investing: The above story along with many others have filled the airwaves and blogosphere over the last 4 days. I will refrain from adding my voice to the din. Moreover, endeavoring to postulate on the repercussions seems to me a fool's errand. The sheer plethora of moving parts and back room deals makes a supposition worthless.

I will, however, offer some insight to a more pressing question: How will this event effect the US$, the equity markets and the price of Gold?

An avid reader of this blog will find the answer both simple and familiar. Bad news on the global economic front equates to good news for the U.S. equity markets and the price of precious metals, Gold and Silver.

Investment Strategy: The legend for deciphering this market environment:

Neg.Eco.News = Con't.Q.E.; (Q.E. = Quantitative Easing; catchall for liquidity creation)

Con't.Q.E. = Con't.US$.Dval.; (US$. Dval = US$ devaluation)

Con't. US$.Dval = Exponential Gold and Silver price increases + higher US equity prices

This legend, in all likelihood, will remain in force until major policy changes occur within the White House, U.S. Treasury and Fed. Never in history has the systematic devaluation of a currency led to sustained economic recovery and long-term growth. However, without fail, said devaluation leads to inflation, often hyperinflation, and a flight out of the currency into hard assets. The move unfolding in the price of Gold and Silver will be for most unimaginable, but for the few, the proud, the aware, it will be a move of a lifetime.

Housing Starts Crater, Economy Woes Tie Fed Hands, GLD Warnings, Paulson & Touradji Make Bold Gold Statements

Mid-week and the economic numbers continue to disappoint. However, equity investors should take heart and view the chart above. This is a monthly chart illustrating the direction of the US$ and the inverse relationship with the S&P500. The chart dates back to 2000, but you can see the correlation has become more intense in the last 12 months.

So, as long as this correlation holds, remember bad economic data equals good equity market performance due to continued Fed accommodation that leads to a weaker US$...

Fed's Bullard says possible Fed won't hike rates until 2012

Housing Starts Crater
The talk that housing starts were stabilizing hit a snag in October as new housing starts plummeted 10.6% to 529,000 units from 592,000. The consensus forecasted an increase in starts to 600,000...Single family starts fell 6.8% to 476,000 and is at its lowest level since May. Multi-family starts fell a whopping 34.5% as only 53,000 new units were started. Multi-family starts have never been this low since the index was created in 1959

I mentioned Monday, "Make sure your precious investment is backed by the actual metal." Below you will find an excerpt from the Gold ETF (GLD) prospectus. This same language can be found in the Silver ETF (SLV) prospectus. Take heed of these warnings. I fear in a world that has become numb to a long list of possible side effects to the drugs taken, you may view this prospectus in the same light. Don't make that mistake! These are very real warnings that could effect your financial health. Why even take the risk, when there are so many quality alternatives? Please, feel free to log onto our website http://www.rosenthalcapital.com/ for a complete discussion of said alternatives...

Gold bars allocated to the Trust in connection with the creation of a Basket may not meet the London Good Delivery Standards and, if a Basket is issued against such gold, the Trust may suffer a loss. Neither the Trustee nor the Custodian independently confirms the fineness of the gold bars allocated to the Trust in connection with the creation of a Basket. The gold bars allocated to the Trust by the Custodian may be different from the reported fineness or weight required by the LBMA’s standards for gold bars delivered in settlement of a gold trade, or the London Good Delivery Standards, the standards required by the Trust. If the Trustee nevertheless issues a Basket against such gold, and if the Custodian fails to satisfy its obligation to credit the Trust the amount of any deficiency, the Trust may suffer a loss. Read More...

...Meanwhile, the best in the business are coming our way. To Touradji and Paulson I will say, from all of us at RCM, welcome to our world!

Paulson & Co. to launch new gold fund January 1; Paulson to personally invest about $250 mln in new gold fund - Reuters

Touradji Capital Management LP, the New York hedge-fund firm that oversees about $2.7 billion, bought 2.23 million shares of Barrick Gold Corp., the world’s biggest gold producer, while selling shares in SPDR Gold Trust, the largest exchange-traded fund backed by bullion. Read More...

Stock Market Investing: Stay the Course & Ride the Wave, GDP not 3.5%?, Economic Numbers Troublesome, Hyperinflation Rapidly Approaching

Stock Market Investing: No change from last week. The technicals didn't get much better but an overwhelming tsunami of weak economic data helped to drive the US$ lower and drove both hard asset prices and equity prices higher.

Investment Strategy: Ride the wave! This market behavior reminds me of the waters off Jupiter Beach, FL, where I live. Right now I'm looking at a beautiful expanse of ocean as far as the eye can see (don't hate the player, hate the game) and I see perfect 5ft. rollers washing up on shore. The break is speckled with surfers all the way down to Juno Beach pier where the best are attacking the biggest swells.

The picture seems perfect but the key word from the description above is ATTACKING. I sat through brunch on Sunday next to a local surfer girl. She was around 16 and had everything going for her with the tiny exception of crutches and a rather large bandage on her foot.

While the surf was perfect for humans, it was also an absolute delight for the sharks. Do you see where I'm going with this? When investing in today's markets you can enjoy the ride but you better remember the sharks are circling.

Time to review the details from last week. Follow the bouncing ball and you will get to the inevitable conclusion that hyperinflation is raging toward us like a Hammerhead that smells blood....

Fed's Fisher says Q3 US GDP growth probably not quite as robust as originally reported, closer to 2.5% - Reuters

November University of Michigan-prelim 66.0 vs 71.0 consensus, October 70.6

Initial Claims Continue to Fall
Initial claims again beat consensus estimates as claims fell from 514,000 new claims to 502,000 for the week ending Nov. 7. While the drop in claims doesn't represent a clear turning point, for the second consecutive week claims have fallen below the 520,000 to 550,000 range that it seems to have been stuck at during the previous month. The market is going to take the drop as a sign that the labor sector is beginning to turn around, but we've seen a similar decline in claims before when initial claims fell below the 550,000 threshold at the end of September...

The drop in continuing claims was not due to workers finding new jobs, but due to people running out of unemployment benefits. Approximately, 7,000 unemployed workers lost their benefits every day. Congress recently passed an extension of the unemployment benefits that gave all unemployed workers an additional 14 weeks of unemployment insurance payment and an additional six weeks to workers that live in states where the unemployment rate is above 8.5%. Obama signed the extension into law on Nov. 6. The extension will stop the downward trend in continuing claims...

More workers are still losing their jobs than finding new ones and we expect the data to show a slight uptick in unemployed workers over the next three months. Due to timing of the releases, the data will not show the results of the unemployment extension until the Nov. 25 release. This means that the continuing claims numbers will show a decline in next week's reported numbers.

...The details above represent "blood in the water" that requires the Fed to remain easy. However, these policies that balloon money supply have fueled the decline in the value of the US$. I have written volumes about this vicious cycle. For the sake of new readers I will repeat the RCM mantra: Hyperinflation is a currency event not an economic event.

I am forever baffled by the ignorance of many financial commentators when asked about inflation. They point to economic troubles and scoff at the very idea of inflation but applaud Fed policy and cheer rapidly inflating asset prices. Do they not see the oxymoron? Or are they simply morons? (OK, true that was trite and a little unfair but it couldn't be helped.)

Hyperinflation is rapidly spreading worldwide because currencies around the globe are being devalued in an effort to keep up with the Bernanke "helicopter" drops of US$. The world is heading toward a Forex crisis as the Economist article below suggests. Our response to this roller coaster: Please hold on to the (GOLD) bar...

The Economist on Gold and Forex:

Developed-country governments have attempted to control bond yields through quantitative easing and to support stockmarkets through ultra-low interest rates. But they cannot support their currencies as well without risking problems in the bond and equity markets. Gold’s surge may indicate that investors fear the next stage of the crisis will occur in the foreign-exchange markets. Read More...

...Meanwhile, even as Brazil implements policy changes to stop its currency from appreciating, the Real advances adding credence to the Economist theory of a Forex crisis approaching ...

Brazil’s real is up 1.1 percent against the dollar this month, even after imposing a tax in October on foreign stock and bond investments and increasing foreign reserves by $9.5 billion in October in an effort to curb the currency’s appreciation. The real has risen 33 percent this year. Read More...

...As you can see, the march toward hyperinflation and perhaps a currency crisis seems inevitable. The best defense: Precious metals, Gold & Silver. A note of caution: Make sure your precious investment is backed by the actual metal. More on that topic next time...

Stock Market Investing: Technical/Fundamental Battle, Investment Strategy: Ride the Gravy Train, FOMC Policy, Consumer Credit, Busi. Bankruptcy

Stock Market Investing: A battle between investment disciplines has developed over the last 3 weeks. As discussed in the Oct. 28th post, numerous warning signs of a technical nature are flashing. However, last week's news headlines were replete with US$ bearish/equity market bullish fundamental data. Which discipline will ultimately prevail, technical or fundamental? The answer is unclear, for now we remain bullish with a healthy dose of skepticism.

Investment Strategy: Never fight the trend. If the equity markets want to advance we will gladly participate and enjoy the ride. Stay focused on the areas of the market that have the strongest fundamentals for moving higher; namely the commodity space as this rally is pure and simple a vote against the US$. Remain over-weighted in the precious metals. The relative out-performance of this group was significant during the last market sell off which was, I will humbly remind you, anticipated by RCM.

Now, I would like to take you on a journey through some of the key events of last week. My intention is to reduce the noise generated from traditional news outlets and focus your attention on the important issues driving the markets. You will see how these issues have led to the resumption of the US$ breakdown and the mirror image breakout of the equity markets.

We will begin with some excerpts from the FOMC meeting on Nov. 4th. There was an expectation that the Fed may change wording to appear more US$ supportive. In the prior two weeks, the simple possibility of a discussion about an exit strategy for the current liquidity glut was used as an excuse by traders to bolster the US$. However, as you will read below, the Fed has no intention of changing the policy at this time...

ECONX Summary of FOMC policy statement; maintain the target range for the federal funds rate at 0 to 1/4 percent
...Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales.

Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability. With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time. (Is this a boldfaced lie? Surely the Fed knows inflation is a currency event, so why pretend there is no inflation when the US$ is collapsing in value? Simple: the scenario is called "between a rock and a hard place." If the Fed admits inflation is a problem then easy liquidity policies are more difficult to maintain.)

In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trln of agency mortgage-backed securities and about $175 bln of agency debt...(Logic suggests rates must remain low while the Fed is buying said debt.) In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010....

...And so the US$ began to lose its bid the minute this story broke on Wednesday last week. In response, the price of Gold rallied and the precious metals mining companies ended the week at new highs on major volume. Interestingly, this group has seen a lot of volume accumulation during a time when the rest of the equity markets are seeing volume selling and/or low volume rallies. This is one sure reason for the strong relative price out-performance the group has enjoyed.

Why does the Fed have no intention of changing policy? Because the economy is in trouble, plain and simple...

September Consumer Credit -$14.8 bln vs -$10.0 bln consensus, prior revised to -$9.9 bln from -$12.0 bln

As expected, consumer credit fell for the eighth consecutive month. Credit declined $14.8 billion in September, far worse than the consensus forecast of -$10.0 billion. The consumer credit decline for August was revised up to -$9.9 billion from -$12.0 billion. The reason for the decline in consumer credit has not changed. Consumers continue to believe they too highly leveraged and are working to repay their debts.

At the same time, banks are worried about possible loan defaults, and in return, they have tightened lending conditions and pulled available credit from even the most credit worthy borrowers.

...Without the consumer there will not be a sustained economic recovery. Furthermore, the state of small business in America would suggest consumer credit is not likely to see a recovery any time soon...

Business bankruptcy filings increased 7% in October - WSJ reports business bankruptcy filings jumped in October, reversing two consecutive months of declining commercial filings and indicating that bankruptcies could continue to rise as the economy struggles to stabilize.

Last month, 7,771 businesses filed for bankruptcy protection, compared to 7,271 that sought shelter from creditors in September, according to new data from Automated Access to Court Electronic Records, or AACER. After two months of decline, the 7% rise in commercial filings shows that businesses are still struggling to access financing and are facing weak demand for their products....
...Add to business bankruptcy problems the number of banks going bankrupt themselves and you get a morbid U.S. economic picture demanding Fed leniency...
Nine U.S. banks seized in largest one-day haul - Reuters.com reports U.S. authorities seized nine failed banks, the most in a single day since the financial crisis began and the latest stark sign that substantial parts of the nation's banking industry are being crippled by bad loans.

Five more banks fail - 120 for the year - CNN Money.com CNN Money.com reports five banks failed late Friday, bringing the 2009 tally to 120. The biggest to fall was United Commercial Bank of San Francisco, which had 63 U.S. branches as well as operations in Hong Kong and Shanghai. The bank held deposits totaling $7.5 billion.

A couple of weeks ago, we warned the "equity markets are trading at these lofty levels because of liquidity not reality and if the Fed-controlled gravy train of easy credit stops, then trouble will ensue." Well, when you combine recent Fed comments with terrible economic data the result is a gravy train of liquidity that continues to roll and keep equity markets buoyant.

Meanwhile, in this Greek tragedy we are watching unfold, the reciprocal of stronger equity markets is a weak currency. The US$ declines as economic numbers worsen and to add insult to very serious injury, the carry traders are having a field day. I warned "The U.S. $ carry trade will gain steam if European economic recovery/inflation outpaces the U.S. and leads to rate increases". It seems with every passing week this prophecy gains momentum and the US$ value declines...

Australia raises rates for second straight month - NY Times reports Australia's central bank on Tuesday raised its benchmark interest rate for the second month in a row, as widely expected, and suggested a gradual withdrawal of stimulus measures amid mounting evidence that the Australian economy is rapidly picking up speed. The increase in its key cash rate, by a quarter-percentage point to 3.5%, makes Australia the only country in the world to have ventured two successive rate increases this year.

Inflationary pressure returns as UK PPI rises - DJ reports U.K. input producer prices rose unexpectedly in October, suggesting that inflationary pressures could be building after remaining muted over the past year, official data released Friday showed. Prices paid by factories for raw materials rose to a 16-month high of 2.6% on the month in October compared with a 0.2% fall in September. On the year input prices rose 0.1%, that was the first annual increase since February, and compares with a steep 6.2% year-on-year decline in September, the Office for National Statistics said. The gains came as a surprise. Economists, on average, were expecting a 0.5% fall on the month and a 6.5% year-on-year drop.

Top 5 October Investment Strategy Posts

For your convience, going forward we will be compiling a "most popular blog post" for the previous month as chosen by the readers. The recap post will consist of direct links to the fan favorties for a quick review of the month's commentaries. Enjoy the read...

#1 Gold Hits New High, U.S.$ Approaches New Low, Nouriel Roubini Rants, Geithner and Lamont Looking Similar, Saudi Central Bank Denies Replacement $

#2 Inflation, Hyperinflation, Stagflation and the Investment Strategy to Benefit, Richard Russell, Fed's Lacker, Credit Tightens, Banks Sift Reserves

#3 Investment Strategy Turns More Cautious, Existing Home Sales, Record Auctions This Week, Galleon Grief

#4 Investment Strategy: Batten Down The Hatches, Quantitative Easing to Slow, Consumer Confidence Suffers, CNBC Viewership Plunge

#5 US$ Carry Trade Intensifies, Pound Sterling Advances on BoE Comments, Fed's Yellen's Comments Add to US$ Decline, Mortgage Apps.Decline

Investment Strategy, Equity Market Trouble, "Positive" GDP, Norway Increases Rates

Stock Market Investing: The equity averages are down another 2.5+% today capping off an awful week during which time the uptrends from March and the 50day moving averages have been violated. The price action should not come as a shock but instead as a reminder of the tightrope the Fed must walk in order to keep this economic house of cards from collapsing.

The Fed's quagmire: Use quantitative easing and other liquidity producing programs to save the U.S. economy from a depression while at the same time avoid turning the US$ into the North American equivalent of the Argentine Peso. (This method of saving the economy is a pet project of Ben Bernanke and the culmination of his years in academia, G-d help us. Never in history has the debasement of a currency led to a true and sustainable economic recovery. But I digress.)

So, in order to continue the debasement shell game, the Fed must occasionally make it look as if US$ strength is important. What better time to feign support than at the completion of a $300 billion Q.E. program and in the midst of positive GDP excitement. I have been writing for weeks that when we begin to read about "good" economic numbers we must take action to protect the portfolio. Well, this week was replete with "positive" numbers, so the US$ rallies and asset prices suffer.

Investment Strategy: Remain long a core position of precious metal investments and use inverse ETFs to benefit from market weakness. We expect precious metal investments to outperform on a relative basis and would view any weakness as opportunity. I will note: today the spot price for Gold is down only .15% as I write this; the epitome of relative out performance.

You may wish to know why I place quotes around words like, good and positive, when discussing the recent spat of economic numbers. Well, the answer is simple: when we and our respected colleagues parse the numbers warning signs are uncovered. Please review the following two accounts of the "exciting" GDP data so you can better understand our concerns...

Briefing: Q3 GDP Goes Positive!

As expected, GDP growth in Q3 went positive for the first time in four quarters. GDP performed better than expected as output grew by 3.5% quarter-over-quarter annualized compared with the consensus expectation of 3.2%. Demand was strong across all sectors of the economy as consumption increased 3.4%, gross private domestic investment increased 11.5%, exports increased 14.7%, imports increased 16.4%, and government expenditures rose 2.3%. With all sectors seemingly humming along in Q3, final sales of domestic product jumped 2.5% compared with an increase of only 0.7% in Q2...

Unfortunately, a more detailed look at where economic growth occurred makes it difficult to pronounce a full sustainable recovery is on its way. Government assistance played an extremely large role in producing the positive GDP result. For example, the Cash for Clunkers stimulus package boosted motor vehicle sales and contributed 1.47 percentage points out of the 2.36 percentage points that personal consumption added to GDP. Further, the first-time homebuyers tax break has benefited not only the construction firms, who have ended their decline in manufacturing new homes, but also realtors through increased income/fees. The jump in realtor expenses accounted for a full third of the increase in the residential investment component...

Inventories provided positive growth to GDP for the first time since Q3 2008. However, the data is a little misleading. GDP is measured as a rate of change between quarters. Inventories actually declined by $46.3 billion in Q3. However, the drop in Q2 was so severe that the rate of change was actually positive $29.4 billion. We expect inventories to continue to improve over the next year and provide a strong bonus to GDP.

GDP is...Better Than Expected?: The Market Ticker

You cannot have an economic recovery when on a q/o/q basis real disposable income is contracting at a 7.4% annual rate and worse, the spread between nominal and real income is widening, indicating that mandatory purchases such a food, energy and health care - are increasing. MORE...

Meanwhile, Norway becomes the second country behind Australia to increase interest rates. The heat is being turned up on the carry trade and the Fed. This development out of Europe places further pressure on the Fed to reduce Q.E....

Norway's central bank hiked rates by a quarter-point to 1.5%, the first interest rate increase in Europe since the global financial crisis bit a year ago. It signaled more tightening to come as the economy recovers. Higher crude prices have helped oil-rich Norway. Commodity-rich Australia hiked rates earlier in Oct. The U.S., U.K. and euro zone are unlikely to hike rates soon.

Next week I will discuss the possible duration of this US$ rally as well as the Fed's ability to remain hawkish. Until then chew on this...

A government big enough to give you everything you want, is strong enough to take everything you have. –Gerald Ford

Investment Strategy Turns More Cautious, Existing Home Sales, Record Auctions This Week, Galleon Grief

Stock Market Investing: The Equity markets were down across the board Friday as the week ended. Last week was a week of churning and distribution, two actions I hate to see during a market advance as they often mark the end of a rally. To make matters worse the churning occurred at key areas of resistance on all three major averages: 10,000 on the DOW, 2,200 on NASD and 1,100 on the S&P 500. Investment Strategy: Turning more cautious.

With this negative week still fresh on the mind it seems appropriate to evoke the immortal words of Andy Grove, "Only the paranoid survive." and discuss three possible developments that could derail the bull.

Development One: Economic numbers that suggest recovery begin to outpace negative economic news. This leads to the perception -- or possibly, the reality -- that the Fed will reverse its stance on easy credit.

If you are a new reader I strongly advise the perusal of past posts before you begin your protest. Those of you who are familiar with my work will know the well documented relationship between bad economic numbers, easy credit, weak US$ and strong equity markets. As long as the Fed remains committed to easy credit in all its forms the bull market can continue.

However, I have witnessed a disturbing trend over the last few weeks. Good news on the economy leads to selling. This suggests to me a real fear pervades the markets with regard to the continuation of easy credit. The equity markets are trading at these lofty levels because of liquidity not reality and if the Fed-controlled gravy train of easy credit stops, then trouble will ensue. When the gravy stops dog will eat dog. What the distribution of the last few weeks may be telling us is that the big dogs are smelling trouble and are preparing.

Today's trading offers a perfect illustration of Development One. First, good earnings numbers out of Microsoft & Amazon were not able to move the markets higher. Instead, the excitement was used by the big players to distribute their holdings. Second, the following "good" economic report hit the news wires this morning, but the equity markets sold off almost immediately after the release:

Existing Home Sales Exceed Expectations
Existing home sales jumped 9.2% to 5.57 million units in September. The increase followed an unexpected decline (-2.9%) of sales in August. The consensus was expecting sales to rise by a much more modest 5.1% to 5.35 million units.

Beyond the headline sales numbers, there was another good piece of news from the data release. Distressed properties, which accounted for almost 50% of sales throughout the spring and summer, have declined significantly to only 29%. Sales of non-distressed homes make it more likely that consumers will start looking at more expensive properties as homeowners move up the pricing ladder. The increase in sales helped push the total available supply down to 7.8 months.

Development Two: A funding crisis unfolds.

Will the US$ decline in value to a point where long rates must increase aggressively for our government to continue funding its debt? How long will China and others tolerate the ruse of quantitative easing before demanding higher rates?

We obviously don't have the answer to these questions. However, this very real possibility must be respected. There has always been a high correlation between long rates and the equity markets. I can think of no better example than the crash of 1987. For four months the bond market was collapsing (rates rising) before the equity markets infamously followed.

Of course, in '87 bonds sold off because the Fed was tightening. If, however, bonds sell off even in the face of Fed easy credit policies then I hate to see the ensuing equity market response.

Record Auctions Announced...euro 1.5001...yen 91.5060 (3.411% -07/32)
Treasury will sell a record batch of bonds next week with $44B 2-yrs Tuesday, $41B 5-yrs Wednesday and $31B 7-yrs Thursday. The record levels show an increase of $1B on the 2-and-5s, and $2B on the 7-yrs. There will also be $7B reopened 5-yr TIPS going off Monday along with $29B 3-mos and $30B 6-mos. The market may get some relief as the news is over, but the high end of expectations had been for closer to $115B versus the $116B announced, so any relief may be brief.

Development Three: The high profile SEC take down of Galleon may cause a ripple effect leading to hedge fund unwinds.

Galleon had over $3 billion and now according to DJ: "Galleon is winding down all hedge funds."

Last year we all witnessed what happens when hedge funds are forced to unwind. Many of the big funds are often involved in the same trades and one unwind leads to another. There will be many denials along the way but the equity markets will speak the truth.

I will also respectfully submit to you, the readers, that the derivatives crisis is far from over. The individuals who created the credit crisis are still running the show. If you believe this statement is incorrect or feel President Obama promised you change so his cabinet must be full of new thinkers, I suggest you view the PBS Frontline documentary entitled The Warning.

The Warning brings to mind two obvious questions:

1- What will cause the next derivatives crisis? Could it be the take down of a major hedge fund that ignites the next collapse?

2- Why isn't Brooksley Born a major member of the Obama administration? If Obama was truly an agent for change wouldn't she be a must in the cabinet?

RCM Investment Strategy, Earning GS/JPM/INTC/GOOG, Industrial Production Surges, Michigan Sentiment Misses, 60% Of Borrowers Underwater, Fed's Fisher

Tea Leaves; in the last couple of days there have been a lot of them, so let's start reading:

Earnings from the technology space, Intel & Google to name a couple, have been well above expectation. This could be a positive development, but of course expectations are a joke. Analysts constantly get it wrong so let's dispense with the "better than expectations" farce. A note a caution on the Intel number and others on that end of the food chain; an inventory rebuild is occurring at an aggressive pace. This rebuild is only a good thing if consumers spend. I would be more apt to cheer a good earning number out of, say Best Buy, as that would show end user demand. Inventory build without end user demand spells trouble for the economy in Q1 of 2010.

I am loath to discuss the earning of the banks. JP Morgan and Goldman Sachs showed strong results. However, when we parse the numbers it appears that earning were again created with clever accounting.

The tangible parts of GS's earnings were suspect (Investment Banking -38%, Asset Management -6%, Trading and Principal Investments -7%) while the FICC unit (Fixed Income, Currency, Commodities) showed all the gain. "Net revenues in FICC were $5.99 billion, significantly higher than the third quarter of 2008. These results reflected strong performances in credit products and mortgages, which were significantly higher compared with a difficult third quarter of 2008." In other words, last quarter this division had mark downs and this quarter the assets were marked up. Is that a sign of a strong business or clever accounting?

JP Morgan's results were similar to GS. Should we cheer or should we be concerned with this ugly little fact buried in the announcement: "JPMorgan’s loss provision to cover current and future home loan defaults rose to $3.99 billion, while its provision for credit card losses surged to $4.97 billion"

We will choose to be concerned. However, the share prices of the financial group remain in an uptrend and while it may be stupid to believe the earning "surprises" it may be equally stupid to fight the trend of higher share prices. I would suggest you keep the above discussion in the back of your mind so when prices begin to falter you will not be the proverbial "deer in the head lights."

A review of our investment strategy may be in order before we begin the reading of economic tea leaves. I have established over the last few months that the inflation trade is under way. Assets are inflating, both the commodity and equity markets, because of increasing U.S.$ weakness. Hence, weak economic numbers are actually positive for the aforementioned markets because the Fed can not raise rates and defend the U.S.$ while the economy is still in trouble.

So, how is the economy looking?


ECONX Industrial Production Surges
Industrial production rallied for the third consecutive month as production increased 0.7% in September. The consensus expected a much more moderate increase of only 0.2%. The jump in production was expected to be driven by the auto industry, and the sector didn't disappoint as motor vehicle production rose 8.1% as assemblies of autos and light trucks increased 13.0% to 7.15 million vehicles.

The numbers were even better than the headline suggested as total manufacturing excluding motor vehicle production rose a healthy 0.5%. This includes strong growth in consumer goods excluding motor vehicles, which jumped 0.3%.

There is a drawback to the strong production numbers. We have not seen orders for manufactured goods pick up. If orders stay low we could end up with a big increase in manufacturer inventories. This would cause manufacturers to pull back on their production. If this scenario occurs, manufacturing production will see a "double-dip" as production rises today and quickly falls back in a few months.

Ok, we know from the recent spat of "good" earnings that production is up, but as we discussed this will be negative down the road if consumers don't wake up.

How is the consumer doing...? Briefing: October University of Michigan Sentiment-prelim 69.4 vs 73.3 consensus. This was a bad miss and could spell trouble. Again I will say, this is good for stock market investing.

One reason for this bad Michigan number may be related to the on going problems in real estate as evidenced by this Fitch story...

Fitch Sees 60% of Current RMBS Borrowers Underwater

"The majority — 60% — of remaining performing borrowers within ‘06- and ‘07-vintage residential mortgage-backed securities (RMBS) bear negative home equity, meaning they are underwater on their mortgages and owe more than their houses are worth.The rating agency noted the number of non-agency borrowers 90 plus days delinquent reached 1.66m in September — the highest level on record. The rating agency expects US unemployment to peak at 10.3% in the middle of next year, further pressuring current borrowers. House prices will ultimately decline another 10% over the next year."

What has been the Fed's response to all these tea leaves? Read on...
Fed's Fisher says keep rates low, inflation not a risk - Reuters.com
Reuters.com reports the U.S. economy is recovering but the upturn will be slow and it makes no sense to raise interest rates in this climate since inflation is not a risk, a top Federal Reserve official said.(I humbly suggest someone clue in Fisher to the reality that (all together now) Inflation is a currency event, not an economic event.)

"I am worried about unemployment and I see an enormous amount of slack. I hear it everywhere," Federal Reserve Bank of Dallas President Richard Fisher told Reuters in an interview. "I am super-hawkish on inflation. I don't think that is where the risks are right now," Fisher said.

His comments will reinforce the impression that the U.S. central bank is in no hurry to raise interest rates, despite guarded optimism that the U.S. economy is healing. Fisher, who takes pride in a reputation as an anti- inflation policy hawk, said the U.S. central bank would not lose sight of its long-term obligation to keep price pressures at bay. But he stressed that this was not the current issue. "Right now that is not the risk. The risk is a disinflationary/deflationary risk," he said...

Fisher, who is not a voting member of the Fed's policy-setting committee this year, said it would take "a while" to work off excess capacity in the economy. "I don't see a 'V'-shaped recovery. I see a couple of quarters of growth and then the question is where do we go from there. That is the real key question in 2010 and 2011."

The Inflation Trade, Alcoa EPS, Obama's New Stimulus Plan, Australia's Interest Rate Increase, Commercial Real Estate Woes

Today we are going to follow the footprints of the hyper-inflation/stagflation trade that I have been writing so much about. By simply understanding the impact of the important news stories and avoiding the noise of the traditional media outlets, tracking our quarry will be relatively easy.

Footprint number one: Alcoa has a much better than expected earnings number. However, the key takeaway here is not that a 33.8% decline y0y was better than analysts thought. The gem in this story is that Alcoa beat expectations because of rising prices. Revenues beat expectations because the price of the commodity is rising. We call this little phenomenon INFLATION.

AA Alcoa beats by $0.13, beats on revs (14.20 +0.31)
Reports Q3 (Sep) earnings of $0.04 per share, excluding restructuring and non-recurring items, $0.13 better than the First Call consensus of ($0.09); revenues fell 33.8% year/year to $4.62 bln vs the $4.55 bln consensus. Sequentially, revenues were helped by an increase in realized prices for primary aluminum to $1,972 per metric ton from $1,667 per metric ton in the second quarter, as well as stabilization in the end markets. Co reports cash sustainability are exceeding targets. "In the second half of 2009, there are signs that key markets the Company operates in are stabilizing. Due to low inventories at distributors and rising shipments, regional premiums are improving and global aluminum consumption is expected to increase 11% in the second half of 2009." (Stock is halted.)

Footprint number two: The administration recognizes the economic recovery is in trouble and is preparing another stimulus package. So, we have rising commodity prices and no economic recovery. This combination is called STAGFLATION.

Oct. 6 (Bloomberg) -- President Barack Obama is considering a mix of spending programs and tax cuts to respond to widening job losses that would amount to an additional economic stimulus without carrying that label. Read More

Footprint number three: The commodity based economy of Australia heats up and its central bank raises rates. This morsel of a development will have a significant impact on the value of the U.S.$ going forward. The Australian announcement obviously strengthens our case for higher commodity prices and in turn inflation, but the real important consequence of the move will be its influence on the carry trade. The currency of choice for the carry traders of the world is now the U.S.$.

In years past the Japanese Yen was the whipping boy of the currency carry trade as traders sold Yen and bought U.S. treasuries or other assets to benefit from the spread in interest rates. Now, with interest rates held down by the Fed, carry traders can sell U.S. dollars and invest in, for instance, Australian government debt and profit on the interest rate spread. This trade also benefits as the Aussi $ goes up in value versus the U.S.$. As you can see, this behavior begins to feed on itself. The more U.S.$ sold and Aussi bonds bought with Aussi $s the faster the value of one currency goes down while the other goes up adding to the profits of the trade. The result is a progressively weakening U.S.$ leading to a nasty little thing called HYPER-INFLATION.

SYDNEY (Reuters) - Australia's central bank raised its key cash rate by 25 basis points to 3.25 percent on Tuesday and heralded more to come, saying it was safe to row-back on stimulus now that the worst danger for the economy had passed. The Australian dollar jumped to a 14-month high and interbank futures slid as investors rushed to price in at least one more hike by Christmas, and rates above 4 percent in a year. Read More

Why don't the powers that be do something to prevent the tsunami of U.S.$ selling you ask? Well, their hands are tied as the story below illustrates. With commercial real estate teetering on the brink, an increase in interest rates is out of the question. You can forget all the verbal attempts the Fed and Treasury secretary Pinocchio (Geithner) make to support the greenback.
Fed frets about commercial real estate - WSJ
The Wall Street Journal reports banks in the U.S. "are slow" to take losses on their commercial real-estate loans being battered by slumping property values and rental payments, according to a Federal Reserve presentation to banking regulators last month. The remarks suggest that banking regulators are girding for a rerun of the housing-related losses now slamming thousands of banks that failed to set aside enough capital during the boom to cushion themselves when the bubble burst.

"Banks will be slow to recognize the severity of the loss -- just as they were in residential," according to the Fed presentation, which was reviewed by The Wall Street Journal. A Fed official confirmed the authenticity of the document, prepared by an Atlanta Fed real-estate expert who is part of the central bank's Rapid Response program to spread information about emerging problem areas to federal and state banking examiners throughout the U.S. I

In another sign that many U.S. financial institutions are inadequately protected against potential losses on commercial real-estate loans, banks with heavy exposure to such loans set aside just 38 cents in reserves during the second quarter for every $1 in bad loans, according to an analysis of regulatory filings by The Wall Street Journal. That is a sharp decline from $1.58 in reserves for every $1 in bad loans from the beginning of 2007. The Journal's analysis includes more than 800 banks that reported having more half of their loans tied up in commercial real-estate, ranging from apartments to office buildings to warehouses.
Tune in next time for a discussion on the best way for an investment portfolio to benefit from the scenario discussed above....

Employment Report Weakness, Fed's Pianalto & Rosengren Dovish Statements, Credit Markets Don't Confirm Sell Off

The economic news continues to be terrible. The knee jerk reaction; sell off the equity markets run into U.S. treasuries. This type of action would only make sense to the person who ran directly from his cabin into the galley on the Titanic and felt he had gained safety. Furthermore, this fatuous trade into T-bonds has place a brainless bid into the U.S.$.

Allow me to be extremely clear, the worse the economic numbers are the more stimulus will be needed leading to an even bigger debt burden. This is ultimately not good for T-bond prices. However, when T-bond prices ultimately collapse is not easy to foresee because of Fed intervention. On the other hand, for the U.S.$ the picture is vivid. Negative economic news means further Fed intervention which strengthens the case for an even weaker U.S.$....

ECONX Employment Report Weakens Significantly
The employment report came in worse than expected in September. The consensus expected the labor situation to improve and projected payrolls to decline by only 175,000. Instead of an improvement, payrolls fell 263,000 -- worse than even the ADP employment report projected.

The unemployment rate declined 0.1 percentage points to 9.8%, exactly what the consensus was expecting. However, the unemployment rate is very misleading. The civilian labor force declined 571,000 in September compared to an increase in the labor force of 73,000 in August. If the labor force held steady in September, the unemployment rate would have increased to 10.2%! ...

Total private weekly hours worked declined 0.1 hours to 33.0, below the consensus expectation of 33.1. Further, hourly pay only increased 0.1%, also below consensus expectations. The drop in hours worked and the lack of a strong increase in pay pushed weekly earnings down 0.2% and will lead to lower consumption from people that have maintained their jobs over the last month...

Looking at the payrolls a little more closely, there is no sign of an improvement in employment in the near future. Government payrolls declined 53,000 as state and local government budget cuts forced out workers. Construction and manufacturing employment declined by a combined 115,000. Service-providing firms shed 147,000 jobs as retail trade lost 39,000 jobs, business and professional service lost 8,000 jobs, and leisure and hospitality employment declined 9,000. Only the education and health service sector posted positive employment gains, but the increase was extremely small with only 3,000 new jobs.

...So, after a week of hawkish comments from various Fed governors what do we hear in the wake of these negative economic numbers? Don't forget, the G20 meeting is now a distant memory....

Fed's Pianalto says pace of Fed pullback depends on how econ conditions unfold - DJ

DJ reports the pace at which the Federal Reserve will withdraw its support from the economy when the time is right depends on how economic conditions evolve, said Sandra Pianalto, President of the Federal Reserve Bank of Cleveland.

Responding to audience questions after delivering prepared remarks at the Down Town Association in New York, Pianalto reiterated her view that the Fed's current accommodative policy is appropriate, and said that at this point it is difficult to determine just how fast the Fed will eventually remove its easy policy. "It's going to rely on how economic conditions unfold," she said. "We'll continue to monitor how economic conditions unfold and then act appropriately." Pianalto reiterated comments from her prepared remarks that she anticipates a gradual recovery and bumps along the road. She said she hopes "they're just bumps and not shocks," because "another shock could be very detrimental."

Fed's Rosengren says Fed will stay until clear econ can keep improving without help - DJ
Rosengren says expects to see positive growth in Q3, Q4

...All of the above thoughts lead us to the obvious question: what is next for the equity markets? Is the sell off on the negative news a beginning of an October rout or simply another normal retracement? Well, we will of course need to monitor the uptrend and see if support holds. However, for now I will simply comment that the credit markets are not confirming the weakness in equities as of yet. Mike Johnson form M.S. Howells says it best when he wrote this morning....


....Credit sell-off confirmation is nearly non-existent. TARP-Supported Preferred Equity Index (TSPEI) was only down 0.05% on Thursday with KEY, JPM, HBAN, GS, BK, C, and USB preferred equity members all posting gains. Given the low after tax cost of debt financing and the minuscule returns available to executives hoarding cash, we expect to see an increase in the number of executives announcing new debt-financed equity buybacks this earnings season.

Hawkish Fed Comments From Warsh, Bullard, Plosser Why? Terrible Economic Numbers, Chicago PMI, MBA Mortgage Applications

U.S.$ weakness of late has spurred a cacophony of comments around the world for a new reserve currency. Now the Fed is attempting to fight back. Over the last few days a number of Fed governors have made hawkish statements to bolster the U.S.$ (the fact that these comments were offered before, during and after the G20 summit is not a coincidence).....

Fed's Warsh says Fed may need to roll back policies sooner - DJ

Fed's Warsh says last few months show continued improvement in economic performance - Reuters

Fed's Bullard says Fed should consider rules governing quantitative easing policies with rates near zero - Reuters

Fed's Plosser says policy shift may need to be aggressive - Reuters.com
Reuters.com reports the Federal Reserve will have to act quickly, and "perhaps aggressively" when the time comes to pull back its extraordinary support for markets in order to avoid stoking inflation, the president of the Federal Reserve Bank of Philadelphia said.

"The Fed will need courage," Charles Plosser said in remarks prepared for delivery at Lafayette College in Easton, Pennsylvania. "I believe we will need to act well before unemployment rates and other measures of resource utilization have returned to acceptable levels."

The Federal Reserve cut interest rates to near zero percent last December and put in place an unprecedented array of emergency support programs as it battled the deepest recession since the Great Depression. That has worried some market participants that inflation will result. "Just as the Fed has taken aggressive steps in flooding the financial markets with liquidity during this crisis to reduce the possibility of a second Great Depression, it will also have to take the necessary steps to prevent a second Great Inflation," Plosser said. "We recognize the costs that significantly higher inflation and the ensuing loss of credibility will impose on the economy if we fail to act promptly, and perhaps aggressively, when the time comes to do so," he said.

...However, economic reality still suggests the need for aggressive stimulus.....

September Chicago PMI 46.1 vs 52.0 consensus, August 50.0

ECONX Chicago PMI Halts Expansion - Briefing.com
The expansion in the manufacturing sector hit a major speed bump as the Chicago PMI declined 3.9 points to 46.1 in September, well below the consensus expectation of 52.0. The drop below 50 signals a contraction in manufacturing. A negative feedback loop seems to have reentered the manufacturing sector...

The drop in PMI was mostly due to a severe cutback in both new orders and order backlogs as new orders declined 6.2 points to 46.3 and order backlogs declined 9.1 points to 36.7. It seems that manufacturers had bought into the economic recovery scenario and decided to ramp up production in August. At the same time as production revved up, the contraction in new orders had ended and most firms expected growth to continue into the future. The increased production was used to work off the backlog along with the new orders that arrived. Unfortunately, at the same time as production ramped up, consumer demand in September seems to have stalled and along with it the recovery effort. Wholesalers and retailers did not need any new goods and orders dropped precipitously. Production in September tumbled.

As long as consumer demand continues to stumble, the recovery effort cannot be sustained. Instead of multiple months of expansion, we may see these PMI indices becoming highly volatile as production meets a fluctuating order schedule.

There was one positive sign from the data. While inventories are still contracting, the rate of contraction slowed. Eventually inventory levels will shrink enough to force manufacturers into production just to restock the shelves. Unfortunately, the consumer will dictate when this will happen. Other components of the index showed problems in manufacturing including: The prices firms paid expanded for the second consecutive month as the index rose to 51.3 from 50.0. The contraction in employment held steady as the index increased only 0.1 to 38.8. Supplier deliveries reentered a contraction phase as the index declined to 49.3 from 54.6.

MBA Mortgage Applications -2.8% vs +12.8% Prior

...And the struggle between reality & the desire to support the U.S.$ has the Fed speaking out of both sides of it's mouth....

Fed's Lockhart says worst is likely ahead for commercial real estate - DJ
Says return to robust bank lending unlikely in near term

...The take away? We must not let the short-term strength in the U.S.$ alter our investment strategy. This strength was purely cosmetic and created for the G20 summit. The stagflation trade is alive and well (Please see the Sept. 7th post for details). This trade will gain strength as poor economic numbers continue to evolve during a time when prices manufacturers pay for goods continues to increase (see the red text above).

The asset of choice for this environment is Gold. We don't know all the answers but we are eminently comfortable owning gold. Gold is the only international monetary asset with globally declining supply and rising demand. How smart do you have to be to join us?

Companies of Interest

(Please click on the link above to review previous EPS/Company posts)

Periodically I will post the EPS news or other relevant coverage of companies we find interesting. This is not a recommendation to purchase or sell the shares. The purpose of these posts is to give you, the reader, an idea of what companies our research department deems worthy of review.

Of course, if you are an investor in any of the Fortune's Favor Family of Funds or a client of RCM our door is always open. Feel free to call or email questions at any time for further information.

C Citigroup: China wants Citigroup to expand - WSJ (4.70 )
WSJ reports a top banking regulator in China said Citigroup's local operations "absolutely" should expand in the country, suggesting the U.S. government's big stake in the bank isn't troubling Chinese regulators. Citigroup's China unit was "very prudent and careful" amid the global financial crisis and now should be "expanding, absolutely,"

Yan Qingmin, director of the Shanghai branch of the China Banking Regulatory Commission and one of the top regulators for foreign banks in the country, told The Wall Street Journal in an interview. Showing an unusual willingness by a regulator to comment on an individual company, Mr. Yan offered a glimpse into how China views the recent overhaul of the U.S. financial system and said Citigroup should take advantage of growth in the Chinese economy and expand in the world's most populous nation. He signaled a view that despite the shock of seeing an "aircraft carrier" of the U.S. financial industry fall into the government's arms, Washington's support for Citigroup was the correct decision and that the result has done little to alter how Chinese policy makers regard the financial-services giant.