Trends I'm Watching

Commodities are Key to Fed Actions

Trend: Commodity prices are a key driver of inflation and interest rates in today's marketplace.

Jeremy Siegel at Yahoo!Finance describes the dynamics of the stock market, commodity prices, interest rates, and the Fed. Excerpts below.

Source: Stock Sell-Off: The Pause that Refreshes: The Future for Investors - Yahoo! Finance

After the Dow Jones Industrial Average came within 80 points of its all-time high, stocks simply fell apart.  The decline occurred immediately after the May 10th FOMC (Federal Open Market Committee) meeting when the Fed said that there weren't enough solid signs that inflation was under control for it to stop raising interest rates.

Bubbles to Pop

I have maintained that in order for the Fed to stop raising rates, two bubbles must pop:  Housing and Commodities.  There is now overwhelming evidence that housing has turned down.  All economic indicators - Housing starts, completions, mortgage activity, sales of new and existing homes - you name it - have topped out.  And realtors will tell you that house prices, particularly those in the hot areas on the East and West coasts, have turned downward.  Prices of condominiums in my home town of Philadelphia are down anywhere from 5% to 10% from last year.

So why didn't the Fed pause raising rates? Commodities.  In early May, just before the Fed meeting, gold soared to a 26-year high and oil prices topped $75 a barrel.  Furthermore, industrial metal prices, such as for copper, aluminum, nickel, and zinc were setting all-time highs. If the Fed wanted to maintain its anti inflationary credentials, which are particularly important with a new chairman, it could not promise that inflation is under control.

Higher Rates Beginning to Slow Economy

After the stock decline and upward movement in bond yields, we are seeing tentative signs that the commodity bubble may, like the housing market, be cooling down.  As of this writing, gold is down to $652 an ounce, nearly $80 below its high of $730 reached on May 12.   Other metals are also down and, more importantly, oil is (so far) staying below its $75.35 a barrel high.

I wish I could say with certainly that the commodity bubble has burst.  But I cannot.  Previous price declines have been met by even higher prices later on. If the commodity market surges again, the Fed will be forced to raise rates. If this happens, I think that a 50 basis point (one-half percentage point) increase will do the trick and convince the speculators that the Fed is serious and can squash any bubble it wants to.

Trends for a long-term investing strategy

Jim Jubak at MSN Money describes the trends that will influence investments in the long term.

Source: Turn short-term fear into long-term profit - MSN Money

The developing world is growing richer

Oh, not all of it. But countries such as China, India and Vietnam -- more than 2 billion people just in those three, and many more in other developing nations -- are growing their economies at rates double or triple the 3% growth rate for the developed world projected by the Organisation for Economic Co-operation and Development. That will add hundreds of millions of consumers to the global middle class who will demand middle-class products and services such as life insurance, home mortgages, hotel rooms and cars.

Demand for commodities will continue to exceed supply

A fast-growing developing world has created demand for commodities that global commodity producers in industries from oil to copper to coal to iron (and don't forget water) are having a tough time meeting. That has produced what some Wall Street investment houses are calling a "supercycle" boom in commodities prices.

We've seen the low in the inflation cycle

Although it will be a very odd kind of inflation, higher energy and commodity prices will bleed through into the core inflation rate. "Loose money" policies in China and the United States and the need to recycle petrodollars will keep the globe awash in cash, although not as much as at the peak in 2005-2006. However, thanks to the surplus production capacity added to the global economy from China, India, et. al., the prices of manufactured goods aren't likely to climb very fast.

The dollar will continue to slide

Probably not as fast as the doomsayers now predict because Japan and the European Union have their own problems that will keep pressure on the yen and euro. But thanks to our huge trade deficit and the utterly feckless fiscal policy in Washington, the world isn't exactly clamoring to hold more U.S. dollars.

Baby boomers will be retiring

The U.S., with its combination of great wealth and relatively high rate of population increase (thanks to a relatively high birth rate and relatively open immigration policy), might be best positioned to muddle through. But it will require the baby boomers to cash in real estate by downsizing to cheaper geographies, and require that those boomers admit that the country can't afford to spend every last cent on prolonging their lives.

Best bet on the demographics of U.S. real estate: banks and land companies in low-cost retirement areas such as the Carolinas, Georgia, Arkansas and parts of Texas.  And if you're cynical about any attempts to control health-care costs, as I am, look to companies that profit from the chronic diseases of old age.

Video Ads from Google Search

Trend: Ads on search results pages will be more interesting with Google's latest move.

Jim Hedger describes Google's latest advertising enhancement and its implications. Will this solve the pay-per-click problem?

Link: The Revolution Will Be Televised, Details After These Ads by Google.

Google introduced a new age of advertising earlier this week by announcing plans to distribute video commercials on websites in its pay per click AdWords network. The move opens the once exclusive marketing channel of televised ads to a far wider array of small and medium businesses.

The sudden appearance of Google’s online video ad distribution service is going to have multiple repercussions for the $38 Billion US television advertising market. It is also going to present multiple opportunities for search marketers and their clients.

Starting today, Internet users in the US, Canada and Japan, will see an increasing number of click-to-play video boxes appearing amongst standard text-based AdWords ads on websites displaying Google generated advertising. An example video ad is posted on Google’s Inside AdWords Blog, appearing in a passive-play mode allowing viewers to click on it before it runs. Others have been spotted at, dictionary and translation site, WordReference.com, and on the front page of Blogthings.com.

According to Inside AdWords, “… video ads will compete for placement on sites in the Google content network with other text, Flash and image ads.” Advertisers will bid for placement of their video ads using the same cost-per-click (CPC or PPC) or cost-per-thousand impressions formulas used by competing AdWords advertisers.

The pay per click advertising model is widely credited as the primary factor behind the rapid growth and evolution of the business of search. Google makes over 9/10 of its money from paid search ads showing consistently higher revenues based on the strong growth of its various search advertising services.

A lot more money is about to move into the online medium. Even if the next six to twelve months are more a time of trial and testing, there is no way advertisers are going to resist creating their own video ads. The applications for advertisers are endless and suddenly very inexpensive. Search engine marketers, website owners and online advertisers should be preparing to deal with the video advertising market as it expands.

Google appears to be making it as easy as possible for smaller advertisers to upload video ads by allowing for any video format. Video ads are uploaded to Google servers where they are stored and served based on contextually similar content found on the sites displaying them.

Small to medium sized advertisers also have the ability to geographically target ads and to test different versions of their video ads. One of the greatest benefits of online advertising is the ability to track where every click came from and when, giving advertisers and marketing professionals a great deal of instant information about what does and does not work.

This is potentially the most disruptive move Google has made since the day it opened its doors. Paid search advertising will have a driving force in the migration of advertising money away from the traditional print and broadcast media. That migration, in turn, will cause enormous changes in the search marketing sector.

The sudden appearance of Google’s online video ad distribution service is going to have multiple repercussions for the $38 Billion US television advertising market. It is also going to present multiple opportunities for search marketers and their clients.

Leveraged Long/Short ETFs Approved by SEC

Trend: Leveraged long/short ETFs add another tool for investors without the disadvantages of mutual funds.

Tom Lydon at ETF Trends describes a signficant new variation on ETFs.

Link: ETF Trends - Leveraged Long/Short Funds Arriving Shortly

ProFunds has won long-awaited approval of its proposed leveraged exchange-traded funds.

In doing so, the shop has become the first firm to gain approval to launch ETFs that use leverage to exceed positive and negative returns of indexes. In addition, it is the first shop to gain approval of ETFs that are structured to perform the opposite of specified indexes.

ETF trackers, meanwhile, say the funds should appeal to a variety of different types of investors. In that regard, they should prove to be popular, says Tom Lydon, president of Global Trends Investments.

He points out that firms that offer leveraged mutual funds such as ProFunds, Rydex and Direxion (formerly Potomac) have enjoyed steady fund sales. That’s been driven, in part, by investors’ beliefs that the equity markets will gain only modest returns. Investing in funds that seek to earn one and a half or twice the returns of an index is one way to rev up returns, he adds.

At the same time, the market has been moving upward over the past few years, so some investors may be expecting a market decline, or correction. Those investors may be attracted to ProFund's bearish ETFs.

Is the Commodity Boom Over?

Trend: Commodity stocks are in a significant correction, which indicates the high volatility of this sector and uncertainty about the continuation of the recent up trend.

Jesse at Stock Market Crash! Blog makes a case that the commodities boom is over.

Link: Stock Market Crash! Blog

There are several indications that the commodity market bubble is nearing its end, likely within the next two months:

1)Prices are beyond over-extended, with many markets going nearly vertical since January 2006. This action isn't justified by fundamental demand, but rather caused by excessive speculation.

2)The Dollar's five year bear market, which helped fuel the commodity boom, seems to be ending as I've written in this post. A decline in the Dollar helps boost gold and precious metals prices upward, due to their inverse relationship. In general, a weakening Dollar is bullish for commodities, and vice versa.

3)Global bond yields and interest rates will continue their upward trend for a bit longer, helping to temper some of the strong economic growth that led to such strong commodity demand in the firstplace.

4)The US economy has already begun to show signs of a slowdown, with more to come, according to April's Leading Economic Indicators which fell by a greater amount that expected, foretelling slower growth environment 3 to 6 months in the future.

5)The housing bubble has popped and that homebuilding activity and prices will continue to decline, causing a decrease in demand for building materials such as copper, cement, wood and sheetrock.

6)The emergence of commodity exchange traded funds likely signifies that the commodity trend is over, as these types of developments tend to occur too late, created in response to the commodity speculation fever. There is now an oil ETF, symbol USO, a gold ETF, symbol IAU, a silver ETF, symbol SLV and rumors that a copper ETF is receiving SEC approval soon. Once the little guy has a chance to get into such a trend, its usually over, according to contrarian thought.

There are a plenty of ways to profit from the commodity collapse, and investors should look forward to this event with just as much alacrity as with a bull market in stocks. Not surprisingly, the strategy involves shorting commodity stocks that have benefited from the long commodity bull market.

A Zero Energy Home

Trend: After home owners have been paying high energy bills for a while, energy efficient homes become a lot more attractive.

HousingZone.com describes a $200,000 Zero Energy Home that produces as much energy as it consumes in a year, achieving net zero energy consumption.

Link: HousingZone.com - A Zero Energy Home - 5/1/2006 - CA6332828

Ideal Homes built the first zero energy home in the country priced under $200,000. The modest one-story, three-bedroom, two bathroom home produces as much energy as it consumes in a year, achieving net zero energy consumption.

Ideal Homes of Norman, Okla., winner of the 2006 National Housing Quality Gold Award, prides itself on its commitment to building high-performance homes.

Photovolatics placed on the south-facing roof of Ideal Homes' Zero Energy Home captures energy from the sun to help offset consumption.

Ideal Homes' most recent test home, one of several done in partnership with the U.S. Department of Energy's Building America program, is the first affordable zero energy home (ZEH).

A ZEH is connected to the utility grid, but at off-peak time periods, it generates more power than it uses by combining renewable energy technologies with advanced energy-efficient construction. As a result, a ZEH lowers the power demand on its utility provider. It produces about as much energy as it consumes during a year, so it is considered to achieve "net zero" energy consumption.

Ideal Homes is the first to build a ZEH under $200,000, making this model home affordable for most home buyers. The house was completed in September 2005.

Ideal Homes' ZEH measures about 1,650 sq. ft. and has three bedrooms, two bathrooms and a two-car garage. It's based on one of the builder's stock floor plans.

The ZEH has been a great traffic draw for Ideal Homes' Valencia neighborhood — its first master-planned community located in Edmond, Okla.

Other builders have constructed zero energy homes. AndersonSargent Custom Builder L.P., which won the NAHB Research Center's 2006 Energy Value Housing Award for Builder of the Year, built its first ZEH in Frisco, Texas, just outside of Dallas, in 2004. The home retailed in the $1 million range.

Ideal Homes normally incorporates energy-efficient construction methods like fresh-air indoor HVAC systems; low-e vinyl windows; and insulation systems in walls, ceilings and around foundations. In addition, for the ZEH, it placed photovoltaics on the south-facing roof to capture energy from the sun and help offset consumption; used ground source heat pumps buried underground to harness the earth's constant temperature to heat in winter and cool in summer; installed tankless hot water systems that heat water instantly when the tap is turned on, conserving energy by not maintaining heated water 24 hours a day; and added energy recovery ventilation to maximize operating efficiency.

The use of these renewable energy technologies can be pricey, but costs remain similar regardless of the price of the home.

The ZEH model is a test house and is not an available plan for purchase, but it has created so much interest and traffic at Valencia that sales in the community are brisk — they've averaged 20 homes per month since June of 2005. Ideal Homes has had an increase in requests for tankless water heaters, ground source heat pumps and other elements of the ZEH, but not for a replica of the ZEH.

The ZEH will be rented out for one year so that its energy performance can be monitored, and then the house will be sold. Projected proceeds from the sale have already been donated to the Central Oklahoma Habitat for Humanity.

via Emerging Technology Trends

How Japan sank the U.S. market

Trend: Policy changes at the Bank of Japan are having a global impact on financial markets.

Jim Jubak at MSN Money says the Bank of Japan is responsible for the correction in the equity markets.

Source: How Japan sank the U.S. market - MSN Money

If you want to know what has rattled stock markets around the world and when you can expect it to end, study the Bank of Japan.

Right now the Bank of Japan, not the U.S. Federal Reserve, is the most important central bank in the world. It's the Bank of Japan that's calling the tune for the world's equity markets.

The market decline, which reached a temporary crescendo with May 17's 214-point tumble on the Dow Jones Industrial Average, is a result of worries that U.S. inflation is in danger of spinning out of control and that the Federal Reserve will have to raise interest rates at its June meeting and beyond.

Gold also behaved oddly. The metal is the classic inflation hedge, and yet gold sold off on these inflation worries -- if that's what they were. The metal, which had been selling at $700 an ounce on May 10, closed at $657.50 an ounce on May 19. That's a drop of 6% when gold should have been climbing -- if the financial markets were focused on the U.S. Federal Reserve and heightened fears of inflation.

And finally there was the strange behavior of the U.S. dollar. If worries centered on the U.S. Federal Reserve and concern that the Fed and its new Chairman Ben Bernanke had lost control of U.S. inflation, you'd expect the dollar to sink against other global trading currencies as investors sold dollars to find safer havens in euros and yen. But instead, the U.S. dollar has actually stayed steady against these currencies. The U.S. dollar sold for 110.6 yen on May 10 and for 110.7 yen on May 18.

As good as its word, the Bank of Japan has been taking huge amounts of liquidity out of the global capital markets. In an effort to re-inflate the Japanese economy and end the years of deflation that had kept the country mired in a no-growth swamp, the Bank of Japan had pumped billions into the country's banking system. Now that the economy is finally growing again and now that prices aren't sinking any longer, the Bank of Japan has given two cheers to the return of inflation and has started to remove some of that cash from the financial markets.

This sign of the return of economic and financial health to Japan is, however, bad news to the speculators who have used cheap Japanese cash to make big profits by buying everything from Icelandic bonds to Indian stocks. The momentum in many of the world's riskier markets was a result of ever increasing floods of cash -- borrowed at 1% in Japan and multiplied by leverage as speculators turned $1 of capital into $3 or more of borrowed money.

New inflows of cash are needed to keep the momentum going, hot money investors know, and it looks like the supply of money flowing into these markets might diminish. The moves to date by the Bank of Japan aren't enough to radically diminish global liquidity, but they are enough so that the investors who have fed some of the world's riskier markets understand that the trend has turned.

What we've witnessed since May 13 is a global flight out of more leveraged and more speculative investments. Speculators attracted by the momentum of the gold, copper, and silver markets have sold -- and are still selling -- rushing to get out before other speculators could liquidate their positions.

What the Bank of Japan has done is to set off a global re-setting of investors' risk tolerance. With Japanese interest rates so low and Japanese cash so abundant, speculators, traders, and investors have been more and more willing in the last few years to take on risk at increasingly low premiums.

Risk tolerance doesn't get reset in a day. The Bank of Japan is only halfway through removing liquidity from its domestic and global markets. Interest-rate hikes are likely to follow that with the first increases coming in the second half of 2006. At the same time, the European Central Bank is raising interest rates.

All excess liquidity has by no means been removed from the global financial markets. But the speculators know that money is gradually getting more expensive. Rallies can count on less hot money to fuel their last stages. Getting out earlier in rallies starts to seem wiser. Some risks are just not worth taking.

The correction that began on May 13 is part of the process of resetting risk tolerance and recalibrating risk premiums. It's not likely to last terribly long. Frankly I think the turn in this correction isn't that far off, and it's probably time to look for a buy or two. And it's likely to be followed at some distance by another bout of speculative momentum, which will be followed by another correction. Markets move from one equilibrium point to another by a messy process of over-shooting on each extreme of the swing until they find a new center.

Will Commodities Rebound?

Trend: Supply and demand projections suggest that the commodities boom has paused and will resume.

Jim Jubak at MSN Money discusses the commodity sell off and prospects for a rebound.

Link: MSN Money - 3 stocks for the commodities rebound - Jubak's Journal.

The sell-off in commodities from gold to copper to oil that started last week is, in my opinion, a needed short-term correction for a market that had run up too far, too fast.

But I don't see any signs that the long-term boom in commodities is over. It looks like it has years to run. The fundamental imbalance between supply and demand for many of these commodities will persist into 2008 as best as I can tell right now.

Which puts investors who agree with my assessment of the long-term upward trend in commodities prices in something of a bind: When have prices -- and in which commodities -- corrected enough so that buying is a smart move?

The traders who dominate the commodities markets know they're dealing in volatile markets that have a history of selling off big time after spikes like these markets have seen this year. Copper, for example, even after a three-day sell-off was still up 90% for the year as of May 15.

When I say volatile, I mean volatile to a degree that investors in stocks really don't understand. Platinum, for example, hit a high last week 25% above the peak price during the metal's boom in the 1970s. Platinum traders know, though, that the earlier peak was followed by a crash that dropped the price of the metal 50%. In a month.

Think that the commodities boom is over in the long term? Not a chance, in my opinion, as long as the economies of China and India keep devouring a bigger chunk of the world's raw materials and as long as the established economies of the United States, Japan and Europe keep chugging along at growth rates between 2% and 4% annually.

Platinum, for example, showed a net supply deficit in 2005 of 70,000 troy ounces. Supply rose by 2.2%, but demand climbed faster, by 4.8%.

And platinum is by no means an isolated case. There were supply deficits in aluminum, zinc and copper in 2005. Forecasts by Desjardins Securities show supply deficits in 2006 continuing for copper and zinc, with nickel moving into deficit in 2006 after showing a slight surplus of supply over demand in 2005. The supply deficits in copper, zinc and nickel are projected to continue into 2007, with aluminum moving into deficit that year.

Foreign ETF Performance

Trend: Some foreign markets ETFs have produced some great gains over the last 28 months.

Eddy Elfenbein at CrossingWallStreet provides a look at foreign market ETFs. I wonder if Brazil's switch to ethanol has boosted that economy? Which of these investments have peaked and which are just getting started?

Link: CrossingWallStreet.com: Your Guide to Financial Success

Foreign markets have been the place to be. Here's how several foreign iShares have performed since the beginning of 2003:

Brazil (EWZ)....................433.95%
Austria (EWO).................275.42%
Mexico (EWW).................242.81%
Sweden (EWD)................174.01%
Australia (EWA)...............165.13%
South Korea (EWY)..........162.61%
Canada (EWC)..................161.36%
Belgium (EWK).................151.58%
Spain (EWP).....................143.78%
Germany (EWG)...............139.12%
Italy (EWI).......................116.39%
Japan (EWJ).....................109.14%
France (EWQ)..................107.73%
Switzerland (EWL)............98.81%
Hong Kong (EWH)..............97.52%
U.K. (EWU).........................89.00%
Netherlands (EWN)............82.27%
Malaysia (EWM).................68.05%
Taiwan (EWT).....................67.08%

By comparison, the S&P 500 Spyders ETF (SPY) is up just 52.81%.

Addicted to Oil: Hiding the Real Cost

Trend: Most Americans drive a lot and need cheap gasoline to do it. Most American politicians put off tough problems until later. These tendencies can synchronize and explode.

Roger Ibbotson, Ph.D., professor of finance at the Yale School of Management, argues that Americans should pay the full cost for gasoline. Excerpts below. His logic is sound, but what politician is bold enough to propose a tax increasing the price of gasoline?

Source: MSN Money - Extra: A sure cure for oil addiction

The United States accounts for a little more than 4% of the world population but consumes about a quarter of its oil. Even by developed-nation standards, we consume a disproportionate amount of energy. The U.S. has around the same size population as Western Europe, but it uses twice the oil.

Western European and Japanese leaders have successfully reduced oil consumption in their countries, while the U.S. has continued to guzzle.

The reason the Europeans and Japanese have been successful where we have failed is that they realized you don’t cure an addiction to oil by subsidizing it. You cure an addiction to oil by making people pay full price -- both the direct and indirect costs.

The United States imported approximately $251.6 billion worth of oil last year -- a significant portion of our trade deficit. And more than half of that oil goes to gasoline for cars. The fuel-efficiency standards enacted after the oil crisis didn’t work to curb oil consumption in the U.S., partially due to population growth, but largely due to the changing mix of vehicle sales.

Politicians wanting to support American car manufacturers proposed far less strict fuel-economy standards for trucks. Today, approximately half of all vehicles sold in the United States are categorized as trucks -- the category includes SUVs and minivans -- and do not have to comply with the same standards as cars.

Americans think cheap gas is their right. Every time gas prices rise, there's a national outcry -- as we can see going on right now. Americans are pointing their fingers at big oil companies, OPEC and government taxation. But in fact, gasoline taxes have actually declined over time, while the amount we're paying in indirect costs for gasoline has increased.

The U.S. government uses a large portion of its expenditures to build stable, friendly governments in countries where we have an economic interest -- in particular countries that supply us with a reliable source of oil. But these military costs are not reflected in the price of the oil we consume. Instead, they’re paid for by non-oil taxes. This, in effect, creates a price subsidy for oil.

The U.S. government has been spending approximately $100 billion a year on the Iraq conflict. This expenditure is approaching $1,000 per American citizen since the war began. And not only does much of that money flow out of the U.S. economy, but revenue from our oil imports goes to prop up regimes that suppress their people and sponsor terrorism. Since Americans are already paying high indirect costs for gasoline (funding wars with their non-oil tax dollars), why shouldn't we keep that revenue in our own country by enacting a meaningful gasoline tax?