Weekly Marketmail

Slow economic growth is helping to lower demand for all kinds of commodities. The commodity “crunch” since early July hit gold, silver, platinum, and other metals last week. Gold fell below $800 per ounce for the first time this year when it closed at $776.90, 24.5% below its March high. According to the World Gold Council, the demand for gold in the second quarter declined 19% to 735.6 tons due to a 24% drop in demand for jewelry. Silver has fallen even more. It’s now $13.06 per ounce, down 36% from its March high. But the biggest decline belongs to platinum, which is now at $1,360 per ounce, a 10-month low, and down over 40% from its all-time high of $2,290 per ounce reached in March. Despite a strike in South Africa, which produces approximately 70% of the world’s platinum, slumping vehicle sales in the U.S. are decreasing worldwide demand for catalytic converters that use platinum.

Meanwhile, falling energy prices are now helping to boost consumer confidence in the U.S. and hopefully around the world. The University of Michigan/Reuters consumer sentiment index rose to 61.7 in early August from 61.2 in late July. Back in June, the index reached a 28-year low of 56.4. As commodity prices continue to moderate, the hope is that consumer confidence will improve further. The key to continued commodity price relief is a strengthening U.S. dollar and a global economic slowdown, which some Nobel-winning economists are now predicting. Read More.

Other economists are forecasting a significant slowdown in the States. Read More.

But it will be difficult for consumer attitudes to improve significantly if job losses accelerate in a slowing economy. Moreover, access to loans is being constrained by tighter lending standards from the banking industry. Continuing losses from major banks, like J.P. Morgan announced last week, and rising loan delinquencies are resulting in tighter lending standards that will likely constrain spending further.

The Fed reported last week that the credit squeeze at banks worsened in the past three months. Specifically, the Fed said in its quarterly senior loan officer survey of 52 major banks that a record percentage of banks were making it more difficult for borrowers. A majority of banks tightened their rules for granting loans to businesses and consumers. The survey shows little appetite at banks to lend for home mortgages, credit cards, home equity loans, commercial real estate loans, or commercial and industrial loans. Also interesting is that no bank in the survey eased credit terms for any type of loan in the past three months, and only one bank said it anticipated easing standards for consumers in the next 12 months. Virtually all economists expect that tighter consumer spending will impede future economic growth.

These tight credit standards are evident in other data from the Fed that show consumers increased their borrowing on credit cards and auto loans through the end of the second quarter, perhaps because other sources of borrowing, such as home-equity loans and auto leases, are increasingly less available. Banks surveyed told the Fed they were restricting credit because of worries about the economy, worries about risk or illiquid markets, and worries about their own fragile capital position. 98% of the banks surveyed cited the uncertain economy, 92% cited illiquid secondary credit markets, and 75% cited reduced appetite for risk. Overall, it is clear that the banking industry’s stricter lending standards will impede future U.S. economic growth and may lead to a recession.

Financial Band-Aids

The Fed recently announced that it is continuing to implement several steps designed to enhance its emergency lending program for banks and primary dealers. For banks, the Fed said it would lengthen some of the credit it extends to 84 days. Previously, the loans the Fed has made to banks have been for only 28 days. For broker dealers that serve as primary dealers of Treasury debt, the Fed said it would introduce auctions of options on $50 billion of loans. These options could be exercised if needed in periods of elevated stress in months to come, such as the end of financial quarters. The Fed also said it’s officially extending its primary-dealer loan program to the end of January from mid-September.

The Financial Accounting Standard Board (FASB) recently gave banks a one-year reprieve from having to realize up to $5 trillion of offshore debt on their balance sheets. Yikes! It was bad enough that firms helped to pioneer SIVs, which were essentially a leverage arbitrage bet base on yield curve differentials that were packaged in offshore commercial paper, but subsequently ended up in institutional money market funds. Obviously, from a disclosure point of view, financial institutions have more to hide. FASB’s chairman, Robert Herz, said that the FASB’s decision was made reluctantly after a staff recommendation for a delay because there might not be enough time for all companies to adjust to the upheaval of having to realized their off balance sheet instruments. Specifically, Herz said that “It does pain me to allow something that has been abused by certain folks, to let that go on for another year.” Clearly, some major financial stocks still have more surprises in store.

That’s why the Fed and the FASB are helping banks to artificially boost their capital and hide their losses. Recently, the SEC extended their order to prevent “naked” short selling of major financial companies, including Fannie Mae and Freddie Mac. But that didn’t help Fannie and Freddie. Both GSEs are floundering and will likely need the U.S. Treasury as a backstop. Read More.

Fannie and Freddie preferred shares cut to lowest rating

Warren Buffett not interested in Freddie Mac stock

Obviously, the Fed, FASB, and the SEC are all working together to resolve the credit crisis that is threatening to sink more major financial stocks, like Fannie, Freddie and Lehman Bros. By the way, Lehman could be headed for a hostile takeover. Read More.

However, in the end, credit markets remain in shambles and the Fed, FASB, and the SEC may be just postponing the inevitable.

Conclusion

Financial stocks are still in a world of hurt, so don’t begin to think the sector is out of the woods because of today’s rally. Most of the rebound was likely from short covering after an analyst said Lehman is now a potential hostile takeover candidate.

You have to stay disciplined, especially in bear markets. When all the dust settles, the stock market always reverts back to underlying earnings.

The bottom line is companies that continue to grow their earnings should outperform the overall market if you keep a long-term perspective, but the ride can get bumpy at times, and high volatility is kryptonite to an undisciplined investor, so stay focused.

The best earnings in the next couple quarters will likely remain in commodity-related stocks, with the possible exception of natural gas. Fertilizer companies should have stunning earnings. Oil service companies have big order backlogs and will also continue to post record sales and earnings, even if the price of oil continues to trend lower near term.

Despite the strong inflation rhetoric from the Fed, it cannot raise interest rates anytime soon. If it did, the housing market would get trashed even more and banks would face more foreclosures, credit card defaults, auto loan defaults, etc.

As such, it makes sense to stay in sectors that are benefitting from inflation. It’s here to stay for a while. Furthermore, many of these companies will begin to pay dividends or increase them in order to limit the downside in their stock prices. Speaking of dividends, you should read our free 11-pg report called The Performance Power of Dividends.

Have a good weekend.