China, Commodities, & U308
By Frank Barbera CMT. August 28, 2007
It has been a difficult and challenging period of time in the investment markets over these last few weeks, as the Credit Markets have moved to center stage. Against this backdrop, what can we say about the outlook for Commodities going forward? To begin with, there are a couple of key points most investors need to be aware of. First off, a recession is as close to a ‘lock’ as it can probably be at the present, so the question must be posed, how will a broad economic slow down affect commodity markets. For most commodities, the answer is very likely to translate into downside price action as during a recession; aggregate demand slows, and commodity prices weaken.
Ah, but there is that question about the global economy, and the now ever present specter of China growing rapidly and providing the ‘permanent floor’ to the global economic boom. Forgive us for blaspheming in public, but we are not ready to sign on that dotted line at the present time. Yes, we know the Chinese would like their economy to continue to grow at a rapid clip right into the 2008 Olympics. Yes, we know they will be building stadiums, and roads, etc. all the infrastructure to ‘look good’ next year. However, whether or not the Chinese economy can grow much longer at the present rapid pace is in our view, a very big question indeed.
To begin with, the world economy is still largely running on a one-engine airplane which, in the final analysis, is predicated on the US Consumer. Put a big slowdown in the US economy and on US Disposable Income, and you put a big whammy on the demand for imported Chinese Goods. Not only for China, but ditto Europe, Germany, and Japan as well. In his excellent article entitled, ‘The Rest of the World is Going to Rejuvenate the US Economy?‘ written on May 14th of this year, economist Paul Kasriel states,
“For starters, a lot of the economic growth in the rest of the world is being generated by the rest of the world's exports. Charts 1, 2 and 3 show the recent behavior of domestic demand relative to GDP for the economies of the European Union, Japan and China. As can be seen, domestic demand is flagging relative to total GDP, implying that exports are the marginal factor of strength in the rest of the world's economic growth. U.S. consumer spending amounts to 29% of the rest of the world's GDP. With U.S. households and businesses starting to slow their spending, the export sectors of the rest of the world will slow. In other words, U.S. domestic demand in recent years has been the economic locomotive for the rest of the world. Now that the locomotive is stalling, is the caboose going to cause the locomotive to re-accelerate?”
Kasriel then goes on to show some of the trends for Domestic economic strength throughout Europe, Japan and China. None of them represents a positive or inspiring trend hinting that without the robust export growth of recent years, these countries could well be due for a serious slow down and rising unemployment.
Another major factor at work in China is the deteriorating situation with Domestic Price Inflation. As can be seen in the following AP Article, Food Prices in China are on the rise and are driving domestic inflation rates toward 6%. To combat late cycle inflation, the Chinese government is raising interest rates, with the most recent hike representing the 4th hike this year (see below).
From the London Financial Times:
“China has raised their official interest rates for the 4th time this year. The official borrowing rate was hiked 18 basis points or .18% to 7.02, and the official deposit rate was hiked 27 basis points or .27% to 3.6%... The Bank of China is fighting inflation pressures the hard way.”
Food Prices Fuel China Inflation Fears
Sunday August 19, 2:05 pm ET
By Joe Mcdonald, AP Business Writer
China's Sharp Jump in Food Prices, Which Have Risen 15.4 Percent, Fuels Inflation Fears
BEIJING (AP) -- Grocery shopping has become a painful experience for Zhang Xueyi. Meat prices have risen 50 percent in the past year, and eggs and other products are not far behind, forcing the 31-year-old railway technician's family to spend a third of its $400 monthly income on food. "If prices go up more, we have to pay. We'll cut back somewhere else," said Zhang as he hefted bags of eggs, vegetables and rice from the market down a narrow Beijing lane. After a run that has seen sizzling growth top 10 percent for four years, analysts say China's supercharged economy is facing strains that could break out into an upsurge of inflation. So far the worst damage has been confined to food prices, which jumped 15.4 percent in July over the same month a year ago and drove overall inflation to a decade-high 5.6 percent. But wages are rising too, as are the costs of oil and electric power. Record-setting exports and a stock market boom are sending cash flooding through the economy, stoking demand for goods. The Chinese economy "might have entered a region where we should be on guard," said a central bank official, Zhang Tao, quoted last week by the state newspaper China Securities Times. If the trend goes unchecked, the impact could be felt abroad as consumers who depend on China as the world's low-cost factory have to pay more for appliances, shoes and other goods. Pinched Chinese consumers might spend less on foreign goods, widening a yawning trade surplus that has strained relations with Washington and other trading partners. Economists say the latest price spike is due mostly to temporary shortages of pork, the staple meat whose price soared 86 percent in July from a year ago.
Pressure is growing in energy, where Beijing is holding down retail prices by blocking state-owned gasoline and power companies from passing on higher costs, said Nicholas Kwan, an analyst for investment bank CLSA in Hong Kong. Chinese oil refiners are losing $5 per barrel of oil that they process into gasoline or diesel, he said. "I think it's just a matter of time until they have to bite the bullet and raise domestic prices," Kwan said. "Otherwise they risk an artificial shortage because oil companies will refuse to refine oil into gasoline if they are losing money." Wages rose 21 percent in the first quarter of the year over the same period of 2006, according to the government, as companies competed for labor. Even that rise might not reflect the extent of pressure faced by employers, because those data cover only government companies, not the booming private sector. "There's very little spare labor for manufacturing now, so we think we're seeing more wage pressure," said Stephen Green, senior economist at Standard Chartered Bank in Shanghai. Add to rising costs the "wealth effect" produced by a stock market boom. The country's main stock index is up more than 70 percent this year, making speculators rich on paper and fueling spending. Exporters already are struggling with the steady rise of China's currency, the yuan, which has pushed up the U.S. dollar prices of their goods by almost 10 percent over the past two years. The price surge has alarmed Chinese leaders, who remember that 1989's Tiananmen Square pro-democracy protests were driven in part by anger at raging inflation that exceeded 18 percent a year. Premier Wen Jiabao has ordered urgent measures to boost food production, promising farmers free vaccinations and other aid to raise more pigs. Local authorities have been ordered to subsidize the grocery bills of poor families. Beijing has raised interest rates three times this year to cool the boom and avert a rise in inflation. After seeing the July price data, economists said they expect another rate hike shortly.
Until now, intense price competition in a Chinese market filled with low-cost goods has prevented makers of most goods from passing on rising costs to consumers. But economists say struggling companies might finally be forced to stand their ground and rise prices. Last week, the government said an investigation into rising food costs found that makers of instant noodles illegally colluded to push up prices by up to 40 percent. An official of a noodle trade group defended the increase as a response to rising raw material costs that have slashed profit margins to as little as 1 percent. "If we don't lift the prices, there will be no profit," the official, Meng Hesu, was quoted as saying.
OK, so we have a runaway economic juggernaut that is generating accelerating price inflation, serious shortages, which in turn is now forcing the government to tighten the price of credit. Does this sound familiar to anyone -- the US in the 1970's perhaps? Oh yes, I almost forgot, throw in a parabolic stock market with widespread participation from the Middle Class and completely unbridled speculation. Now we are starting to sound more like the US in 1929. In our view, the Chinese stock market, which has been to this point singularly immune to the problem besieging other capital markets, remains a serious accident waiting to happen. While some may argue that China is the next secular bull, and we have the field of view to potentially agree, in the closer time frame of the next 1 to 2 years, we still remain of the view that China will turn into a serious bust, with the stock market rolling over and taking back a large portion of the gains seen during the last two years.
While the Shanghai Composite continues to score new all time highs on a daily basis, and our prior analysis looks early, the daily momentum profile undeniably peaked back in January of this year and produced a decisive failing high in mid-May of this year. On occasion, blow off rallies can extend forming a second failing momentum peak which could be rolling in over the course of the weeks just ahead. The implication would be even higher prices for this runaway train in the near term, but at some point an exhaustion run will be complete and prices will double back with a vengeance. In our view, a great crash is still ahead for the Shanghai Composite and that crash is likely to begin before 2007 is complete. At the present, using Elliott Wave analysis we believe the Shanghai is completing a long five wave advancing sequence dating back to the inception of the bull market in July 2005.
Above: Shanghai Composite with Medium Term RSI Momentum Gauge
Above: Shanghai Composite with Elliott Wave Count with the current advance a fifth wave (terminal) movement.
Among the many commodity prices that have gained on the back of a strong Chinese economy, probably none has performed better then the price of Uranium, U308 also known as ‘yellowcake.’ As can be seen in the chart below, over the last few years as word spread that China plans to build more then 30 nuclear reactors to help fulfill the nations energy thirst, the price of yellowcake exploded from a late 2000 low near $7.00 per pound to a recent mid-June high of nearly $138 per pound. Many thoughtful experts still foresee higher Uranium prices in the years ahead with targets above $200, and in some cases above $500 per pound. They may well be right over the course of the next few years, especially if monetary reflation becomes the bail out recipe for the current credit debacle. Yet, once again, in the near term, it appears that a mini-bust is underway with prices for U308 already down 35% from the mid-June high to a current quote near $90/pound.
Above: the long term chart for U308 - Yellowcake, which is now correcting some of the prior advance.
Not surprisingly, as the price of U308 has declined, the high-flying Uranium Mining companies have sold off sharply. Back on June 21st, in our report for The Gold Stock Technician Newsletter, I noted that,
“In addition to the Gold and Silver universe, our investment tastes have led us to develop a strong fondness for Uranium Miners where a raging bull market has been present these last few years. Another sector that we believe is engaged in a long term, secular bull, the Uranium Miners are also currently potentially in the act of turning bearish. We show the charts of Denison Mines, Strathmore Minerals, and Cameco on the next page --- all of which are sporting potentially bearish divergences and/or topping patterns. While we like all of these companies a great deal, and we admit, we could be wrong, in our view, the fact that a few months have passed during which time Uranium prices have soared, while the stocks have been unable to advance tell us the stocks are acting very heavy and could be ripe for a major decline. For those of you who follow this sector and have profits accumulated, our advice would be too tighten up stops and let the market take you out of your long positions if it moves down from here. We intend to return to some of these names later on, and will be following them closely in the weeks and months ahead, as we do like the larger, long term story.“
In that same report, we showed the bearish divergences (see following charts) for Denison Mines, Strathmore Minerals and Cameco - all of which have subsequently declined drastically, in line with our original thinking. What follows is the BEFORE and AFTER (updated thru today, August 28th) charts side-by-side.
Above: our original call on Denison Mines which Double Topped with failing momentum in mid-June and the result, shown below, with the stock presently below all three important moving averages, the 50 day, 100 day, and 200 day averages. Fundamentally, we like DML, but where will the bottom ultimately form? At the moment, a trend following approach is the best idea.
Above: our chart on Strathmore Minerals showing the Rounding Top June 21st, and the outcome today (below) with the stock now potentially beginning a more important basing process. That ‘basing’ process is highly contingent on the overall stock market, and on credit conditions. If things deteriorate dramatically from where they are now, the bottoming outcome may not develop. A certain amount of ‘normalcy’ would be required for a real bottom to form, and that, at present, is a big wildcard.
Above: Our original call on Cameco (CCJ) which looked ‘tired’ back in mid June. That was with the stock price of $53.17 and today share price is closer to $37.60, a decline of more then 30% from the high. Will it bottom this year? Hard to tell, but we will be watching with great interest.
Above: Palladin Mining (PDN-TSE) another high quality name now down almost 50% from the absolute highs one day, this will be an outstanding repurchase candidate, and one day this stock will soar again to dwarf the highs seen in the first half of 2007 long term investors, no worries, it's just a question of following the stock down and letting it tell us when the bottom has been seen.
So what’s next for Uranium and Uranium Miners? In our view, both Uranium and Uranium stocks are in a primary degree correction, meaning a correction that can last many months. In addition, with the prospect of a global recession, if not an outright depression looming directly ahead, we feel that it is best to use a cautious approach and not try to pick a final low. To help clarify this point, on all of the updated charts shown above, the ‘AFTER’ charts through today's trading we include the three most important moving averages for each stock, the 50 day, the 100 day, and the 200 day. In all cases, the moving averages have rolled over and experienced downside cross-overs, with the slow poke of the group, the 200 day moving average in most cases just turning down. That is a sign that it could still be very early in the downtrend, as normally, declining markets tend to see the 200 day moving average trending down week after week after week after week, until eventually, the darn thing starts to flatten out.
As I write this, I am reminded of Stan Weinstein and his terrific stage analysis, wherein these stocks would all be in stage four declines. For those of you who like to read up on Technical Analysis, Stan is both a gentleman and a scholar, and a number of years ago turned out a first rate tome entitled, ‘Stan Weinstein's - Secrets for Profiting in Bull and Bear Markets’ -- still a Barbera, ‘House Favorite.’
Putting a slightly different spin on the Uranium Sector, I note that my GST Uranium Index (which includes about a dozen names among the likes of Cameco, Denison, Strathmore, Paladin, Pinetree, Crosshair, JNR Resources, Mega Uranium, Laramide, UEX Corp., Fronteer Development and SXR Uranium) is now down 51.02% from its April 10th, 2007 peak. Now there are those that would say that's the entire bear market. Yet, what is common in situations like this is for prices to retrace a proportional amount in relation to the advance which came before. In the case of the Uranium stocks, the percentage increase seen in the last few years is measured in the thousands of percents. When viewed on a semi-logarithmic scale, we note that to date, the very steep percentage decline off the high has only approached a minimum .236 Fibonacci retracement. More common, would be a .382 fibonacci retracement which could carry the index even lower toward the 420 level, with index closing today at a reading of 902.50.
Ok, we can hear the cringe, and readers should understand that while that type of move is possible, it may not in fact develop. What we are trying to point out is even if the entire sector were to be cut in half again from present levels, it would still fall into a clear cut ‘Wave 2’ type of outcome, and would not change the very long term secular bull market view. Admittedly, a move down to the low 400 level on this index would be an unbearable amount of pain, but it is possible within the context of a major crash in the global markets that readings like that could be seen in the months ahead.
For now, the best approach is to be a trend follower and recognize that the trend is now definitively down. Until we see the kind of basing action that would suggest momentum divergences and downside deceleration, readers are advised to remain cautious and ideally on the sidelines and out of harm's way with regard to this group. In many cases, corrective Wave Two patterns traces out an A-B-C structure, within which it is possible that Intermediate Wave A of Primary Wave (2) has just recently bottomed. In this vein, a counter-trend ‘B’ Wave advance could provide those holding these stocks with a loss, the opportunity to reduce the loss into strength and then stand aside as prices move down in Wave C, and into a more important final low.
Above: the GST Uranium Index
It was another rough day in the financial markets as S&P reported that home prices fell at the sharpest rate since its index was started back in 1987. In Q2 2007, the S&P Home Price Index tumbled by 3.2% with most analysts agreeing that there will be no change in the downward direction for some time to come. For the banks and other mortgage lenders, falling home prices threaten impaired collateral and write downs of asset values on the balance sheet. Will the Fed respond to the latest market decline with a reduction in interest rates? Only time will tell, but with the S&P down just barely 10% from the highs and the US Dollar perched above all time record lows, one thing is certain. The Fed had better be very careful not to resort too quickly to the kind of moral hazard that a bail out would perpetuate. Over-reacting this early in a crisis could push the Fed into a crippling and irrelevant posture with lower interest rates ultimately set to backfire on Treasury Debt. In that outcome, the damage to the system would be even more extreme and would amplify the current crisis more then one thousand fold.
At the close, the DJIA ended the day down 269.63 index points at 13,052.50 for a loss of 2.02%, with NASDAQ down 59.56 at a close of 2501.69 or 2.33%, and the S&P 500 down 34.43 at 1432.36 for a loss of 2.35%. The 10 Year Bond ended the day at 4.53% with nearby Gold down 2.50 to close at $673.70 the ounce.
That's all for now,
© 2007 Frank Barbera