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    - 28 February 2001

Economy and Fed Watch

Economic Update

In the latest WMU we included a chart of the Cyclicals Index and noted that the Index was sitting right at its 50-day moving-average and its up-trend line. In other words, it was right at critical support (all pullbacks since last October had halted at the 50-DMA). The Cyclicals rallied strongly on Monday and then held their ground during the Tuesday/Wednesday sell-off in the market, thus keeping their up-trend in tact and providing further evidence that the economy is not as weak as many people suspect. Until the cyclical stocks turn lower, which would be confirmed by a decisive break below the 50-DMA, we will give the US economy the benefit of the doubt.

Today (Thursday) we get the widely-watched NAPM (National Association of Purchasing Managers) survey results. Although the latest NAPM survey (February) is likely to reveal continued economic weakness, it will probably show an improvement from January and show less weakness than the consensus forecast currently indicates. The dilemma facing the stock market is that most traders/investors on the 'long' side want to see economic data that will encourage the Fed to cut rates (data that reveals substantial weakness) and, at the same time, they want to believe that company earnings have bottomed. There is, therefore, a conflict.

More words of wisdom from Uncle Elmer

During his testimony on Wednesday Alan Greenspan implied that there would be no inter-meeting rate cut, at least not in the immediate-term. Wayne Angell ("the entertainer") had previously assured the market there would be a rate cut this week but, ironically, those same assurances probably eliminated the prospect of a cut. 

It is rare for us to agree with the Fed Chief, but in this case we do. A rate cut at this time would be counter-productive if done for the benefit of the stock market (it was, until yesterday, too widely anticipated to have had any positive impact) and is not required as far as the economy is concerned. Having quelled the inter-meeting rate cut expectations, Greenspan & Co. now have a genuine opportunity to surprise the market if they wish to do so in the near future, thus getting more 'bang' for their rate-cut 'buck'. 

The US Stock Market

Current Market Situation

From the Feb-27 Market Alert e-mail: "A rally into Wednesday (the end of the month) and then a reversal lower during the first 2 days of the new month would suggest that the market's decline will continue throughout March. This would be a very significant divergence from the early-1990s Nikkei pattern and would obviously be short-term bearish. It would, however, have longer-term bullish implications as the ultimate bottom would most likely be brought forward by 12 months (from October 2002 to Sep/Oct 2001)."

Further to the above, a continuation of Monday's upside activity on Tuesday and Wednesday would have been short-term bearish because it would have set the market up for a renewed decline in March. However, the fact that the market reversed lower on Tuesday and dropped into month-end sets up the potential for a rally over the next few weeks. Note that a rally over the near-term keeps the early-1990s Nikkei comparison alive and potentially has longer-term bearish implications by postponing the ultimate bottom.

We expect a reversal higher during the next few days. The QQQ call option trade suggested over the past week is still suitable for aggressive traders experienced in this type of trade (with the option price dropping to around $2 late yesterday it is even more suitable). We will also add one more tech stock - Avanex (NASDAQ: AVNX) - to the Portfolio. AVNX closed at around $19 yesterday, down from a 52-week high of $273. Similar to LightPath Technologies, which we mentioned in the Feb-14 IU, AVNX is not a 'value' investment in the traditional sense (even at its current price). It has, however, developed technology that will play a central role in the expansion of optical networking capacity. In short, AVNX has developed a product that allows thousands of separate signals to be simultaneously transmitted along a single strand of optical fibre. As is the case with LightPath, the major telecom equipment suppliers are demonstrating their acceptance of AVNX's technology in the best possible way - by issuing purchase orders. This is an extremely volatile stock and, in the short-term, it could quite conceivably drop by 50% or rise by 100%.

There's always a bull market somewhere

While a lot of people are focussing on the last boom, the next boom is well underway. Below is a chart showing Australia's All Resources Index (an index of Australian commodity-oriented stocks). We like some technology stocks as long-term investments and occasionally as trades, but we also acknowledge that buying tech stocks at this time is akin to swimming against a very strong current. Investors in resource stocks, however, are presently swimming with the current. We have 3 non-gold resource stocks in the TSI Portfolio (Cameco, Western Mining and Occidental) and would have more except for the fact that we are overweight the gold sector. 

Gold and the Dollar

Current Market Situation

With regard to our gold investments, we are in the early stages of a campaign that should last a minimum of another 12 months. As such, as long as the underlying trends towards higher inflation and a weaker Dollar remain in place there should be no reason for investors to disturb longer-term gold stock positions (except to switch from the lesser-lights, such as PDG and ABX, to the brighter-lights such as HGMCY and GOLD). In addition to maintaining a core investment we will also be attempting to trade the major swings in the gold market. Unlike investments, trading positions will be kept on a tight leash - sell-stops will be used to limit losses and profits will be taken during price surges.

Further to Market Alert #27, we added a second trading position in DROOY at $1.06 on Feb-28. A sell-stop has initially been set at $0.83. We also took advantage of a pullback in the Australian gold stocks over the past 2 days and added Lihir Gold (ASX: LHG) to the Portfolio at A$0.62 (the initial sell-stop is set at A$0.53). LHG's leverage to the spot gold price is far greater than any of the other large or medium-sized Australian gold producers.

The XAU is currently overbought and may have commenced a pullback. This is not the ideal scenario, but is also not unusual. We would be concerned (and may exit trading positions) if the XAU closes below its 200-day moving-average (presently at 50.8) on 2 consecutive trading days.

Gold interest rates dropped sharply on Wednesday, suggesting that the shortage of physical gold is being addressed (the central banks are adding liquidity). There was also a nice upward reversal in silver.

Bond Market Update

We turned short and medium-term bearish on bonds on Jan-08. We then went short-term neutral (and remained medium-term bearish) on Jan-31. It is now time to reinstate our short-term bearish view.

As we write, the June T-Bond Contract is trading at 105-20/32. The Jan-03 peak, which occurred just prior to the Fed's surprise rate cut, was 106-20. A rally to new highs seems highly improbable due to:
a) Strength in the cyclical stocks (bonds and cyclical stocks are inversely correlated)
b) Strength in Australian resource stocks (telling us that a sharp drop in commodity prices is not on the cards)
c) Signs of life in the gold price 
d) A likely upward reversal in the stock market
e) The on-going rapid expansion of the US money supply
f) The A$-Bond relationship (refer to the latest WMU)

Oil Update

We are almost, but not quite, ready to turn short-term bullish on oil. Oil is potentially bottoming at the moment, but we will need to see how it finishes the week and also receive some confirmation from other markets (eg, an upward reversal in the stock market would be bullish for oil).

Changes to the TSI Portfolio

LHG, DROOY (2nd trading position) and AVNX added to the Portfolio.

 
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