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May 27, 2008

Economic Realities Continue to Favor Inflation
by Chris Ciovacco

Prior to the holiday weekend the markets learned the median price for existing home sales declined 8% from the year-earlier period. More concerning was the inventory of unsold homes climbed 11% resulting in a backlog which would take more than 11 months to clear based on the current rate of sales. While a record average gasoline price of $3.875 a gallon may have distracted many economic observers, we should not forget the prior positive economic impact related to the housing boom. Approximately 74% of all new jobs created between 2000 and 2005 were related to housing in some way (agents, brokers, construction workers, architects, etc). As of this writing, there appears to be no sector of the American economy ready to step forward and fill the void being rapidly vacated by housing. As a result, calls for an end to stimulative Fed and government policies may have been premature.

Investors Are Taking A Step Back From The U.S.

After a sharp correction in any asset market, it is not unusual for investors to play the bounce all the way back to the market's 200-day moving average. This is known as basic support and resistance trading. For the market to clear the 200-day moving average (resistance) you need fundamental buyers to step in and help make the final push higher. As a market approaches the 200-day moving average many investors ask, "Do I really want to own this based on the long-term fundamentals?" In the case of the S&P 500, the initial answer appears to be "no".

The S&P 500 Fails To Clear Its 200-Day Moving Average (red line)

After a significant and protracted downturn, long-term investors should wait for any market or asset class, including the S&P 500, to clear its 200-day moving average before committing significant amounts of capital. If the March bottom turns out to be "the bottom" and the start of a new bull market, there will be plenty of time to profit from the new trend.

The dollar has been unable to sustain any type of trend-breaking rally with the negative economic clouds hanging over the U.S. As shown in the chart below, a serious move toward the dollar's 200-day moving average has not been within reach, which means it remains firmly in a downtrend.

Dollar's Recent Rally Is Faltering

The U.S. bond market has an important tug-of-war going on between safety and inflation/debt. Similar to the U.S. dollar, U.S. government bond investors show confidence in the U.S. as a whole and the government's ability to meet its obligations when they buy bonds. In the current downturn, the desire for safety has prevailed to date. With massive trade and budget deficits, along with a falling dollar, it is only a matter of time before investors begin to question the safe haven status of U.S. government bonds. As economic and currency risks rise, investors will command a better return on their U.S. government bonds. A higher return on government bonds means higher interest rates for mortgages, credit cards, business loans, etc. Higher interest rates would not be welcome in an economy saddled with debt. There is nothing yet too alarming about the chart below, but it bears close watching.

10-Year Treasury Yield: Rising Bond Yields Are Bad For The Unbalanced U.S.

The charts below of U.S. financial and housing stocks show little to get excited about as of the market's close on Friday, May 23, 2008.

Financials: A Dead Cat Bounce?

Housing Stocks Continue To Hit A Wall At 200-Day Moving Average (red line)

Commodities Are Strong, But Economic Weakness a Concern

While commodity investors are well versed in the India-China demand story, it is prudent to acknowledge the historical correlation of annual GDP (YOY % CHG) and the CRB Index.

Commodities: What Is Driving Prices?

Hedging, investment, and speculation
Loose monetary and fiscal policy
Weak U.S. dollar
Expensive to drill, mine, refine, and ship
Regulatory hurdles to adding capacity are high
Declining production rates in some markets
"Flat World" demand from India, China, etc.

Commodities: What Should We Be Concerned About?

Speculation
Cyclical nature of demand / economic weakness
Volatility even within context of secular bull market

CRB Index Continues To Make New Highs

Crude Oil Adds To Economic Concerns

Gold: A Close Above $955 Would Be Bullish

Chris Ciovacco
Ciovacco Capital Management

Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC. More on the web at www.ciovaccocapital.com.

All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors and tax advisors before making any investment decisions. Opinions expressed in these reports may change without prior notice. This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. Past performance is not necessarily a guide to future performance. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. All prices and yields contained in this report are subject to change without notice. This information is based on hypothetical assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION CONTAINED IN THIS ARTICLE.

Ciovacco Capital Management, LLC is an independent money management firm based in Atlanta, Georgia. CCM helps individual investors and businesses, large & small; achieve improved investment results via research and globally diversified investment portfolios. Since we are a fee-based firm, our only objective is to help you protect and grow your assets. Our long-term, theme-oriented, buy-and-hold approach allows for portfolio rebalancing from time to time to adjust to new opportunities or changing market conditions.