COMMODITYINSITE.COM

by: Jerry Welch

October 30, 2009 -- The Gross Domestic Product report for the 3rd quarter showed US economic growth rising a brisk 3.5 percent. The data was above expectations and the best showing in two years. It was one more piece of encouraging news suggesting the economy is emerging from the worst recession since the 1930's, 80 years ago.

On the day of the GDP report, the Dow gained 200 points to settle at 9962, the largest one day rally since July. The CRB index followed suit. Or, led the way depending on your bias by posting a whopping gain of 1000 points.

The market psychology was giddy. It was euphoric. It was near manic. But when it comes to a report, the devil is in the details. The specifics of the GDP report show the rise in growth was due to the Fed stimulus programs for autos, Cash for Clunkers, and tax credits for homes.

The devil in the report prompts me to pose this question: What happens when the Fed programs end? When the programs end or the marketplace begins to sense the programs will end, stock and commodity values are likely to retreat considerably.

The Dow has rallied 54 percent off the March lows while the CRB Index has jumped 43 percent. Both markets have inflated considerably since summer thanks to various Fed stimulus programs. Take the stimulus programs away or hint the programs will end and investors will find a vacuum under stock and commodity values.

The Fed has stated repeatedly they intend to keep interest rates, “low for an extended period of time.” That specific wording was the green light go for those bullish stocks and commodities. The wording informed investors and traders first hand the Fed was going to tolerate some level of inflation to help the economy stabilize. The steep percentage rise with paper and hard assets is proof positive the economy is far better off today, than anytime in the past two years. The economy has stabilized!

In the week ahead, the Fed will meet to set monetary policy and as usual will follow up with a statement explaining their intentions and outlook. But the financial landscape is far more robust and inflationary today than when the Fed met last month. As a result, there is a chance they may distance themselves from the promise to keep rates, “low for an extended period of time.”

Any change in the wording will be viewed as a not so veiled attempt to curtail the giddy, manic buying that has pushed stocks and commodities sharply higher.

With the economy finally showing signs of life, the Fed may feel compelled to prevent another bubble or two from forming. The last thing the Fed wants to confront are new financial bubbles poised to pop just as the economy is on the mend.

The market to focus upon is the US dollar. The Greenback recently hit a 14 month low and remains under pressure because US interest rates are low. The dollar simply has no friends. But why should the dollar have a bull following or friends when US rates are near zero while stocks and commodities have posted gains of 43 to 54 percent in just six months?

However, if the Fed hints it will not keep rates, “low for an extended period” they in essence will be throwing the US dollar a lifeline. At this juncture, any news viewed as bullish the dollar such as the possibility of an up tick in rates should allow the greenback to bottom out for the time being. And any significant improvement in the value of the dollar will weigh heavily on stocks and commodities.

A week ago, Australia became the first G-20 nation to raise interest rates to slow growth and to keep inflationary pressures in check. India is rumored to be on the verge of also reversing past interest rate cuts.

Japan announced today they will stop buying corporate debt by the end of the year as their recovery gains traction. Germany has indicated that the European Central Bank will scale back its aid package.

Writing for Bloomberg.com, Justin Carrigan states, “Central banks are signaling they are ready to withdraw stimulus measures even as economic reports show the recovery from the worst global recession since World War II may be tepid.” He goes on to say, “The U.S. exited recession in the third quarter, official figures showed, fanning speculation policy makers will drop emergency measures taken at the height of the financial crisis.”

Late last year, the worlds major central banks flooded the credit markets with cash to rescue the global financial system from collapsing. The strategy worked. But as the various stimulus packages are reduced, and possibly eliminated, it can be expected to be bearish for a wide array of markets that have gone too high too fast. Markets across the board have gotten ahead of themselves!

My bias remains unchanged. Stocks and commodities have more than likely peaked or topped out for the rest of the year. How much is coming on the downside remains to be seen. But for the Dow Jones, my work suggests it is headed to 8000, give or take 500 points.

(The information in this article is the opinion of Commodityinsite. com's Jerry Welch and subject to change without notice.)







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