Archive for August, 2008

Commodity Correction Nearing An End?

Tuesday, August 19th, 2008

Below is an article from Jim Jubak discussing why we have seen the downside of the commodity correction and why China and the rest of Asia may hold the key to the next leg up in the commodity bull market.

Many thanks to my friend Peter Schmidt, owner of UpClose Printing & Marketing, for this article. UpClose is the printer for my periodic Investment Strategies newsletter, so I can recommend his company if you are looking for someone to designing and printing your forms, brochures, or producing a broader marketing campaign.

Here is Jim’s column:

The key to our wild market: Asia

As developing giants like China and India grapple with high inflation and slowing growth, the world feels their effects. Now is the time to hedge with commodities.

By Jim Jubak

One day I’m ready to pull the trigger and load up on rallying financial stocks such as Citigroup (C, news, msgs), American Express (AXP, news, msgs) and Bank of America (BAC, news, msgs). The next day I’m happy I didn’t, as news from JPMorgan Chase (JPM, news, msgs) and Goldman Sachs (GS, news, msgs) takes the sector back down.

Just when I’m ready to dump my energy and commodity stocks, the sector rallies, and stocks like fertilizer maker Potash of Saskatchewan (POT, news, msgs) climb $7.48 a share, or 4.7%, in a single day.

It’s enough to make your head spin.

To make sense of this market, you’ve got to go back to economic fundamentals and to where so many fundamental stories start these days: Asia. Do that and you’ll understand several things:

  • Why the prices of oil and other commodities have been falling over the past month.
  • Why the drop doesn’t signal the end of the commodity bull market of the past few years.
  • Why growth in Asia, especially in China, is likely to accelerate in the beginning of 2009.
  • Why inflation is a bigger danger today than at the beginning of 2008.
  • Why owning commodities as a hedge against inflation is more important than ever.

At the core of the current wave of volatility are investor worries that growth is slowing in the Asian economies, which have been driving the global economy forward since the U.S. economy dropped into low gear in the fourth quarter of 2007.Investors have been expecting that Asia’s export-driven economies would follow suit. Lower growth in importing economies must lead to a slowdown in exports from Asia, right?

Recent figures suggest the slowdown has finally arrived. Growth in China slowed to an annual rate of 10.1% in the second quarter of 2008 from 11.9% in 2007. Economists are predicting growth will slow even more in the rest of 2008 and in 2009. Goldman Sachs is projecting 10.1% for all of 2008 and 9.5% for 2009. The Economist magazine is somewhat more pessimistic, projecting 9.8% growth in 2008 and a drop to 9% in 2009.

The pattern is similar in other Asian economies, big and small. India, where gross domestic product grew 9.1% in the fiscal year that ended in March, will see growth of 7.1% this fiscal year, according to Morgan Stanley. The government of Vietnam has cut its target growth rate for 2008 to 7.5% from a prior goal of 8.5% to 9%. Indonesia recently cut its target rate to 6.4% to 6.7% from an earlier 6.8%.

But it’s not just growth levels

All the economies of the developed world, including the United States, would kill for growth rates like those, but it’s not the absolute level that matters. A drop from a 9.1% growth rate to a still high 7.1% is enough at the margin to cut demand for the commodities that fuel these economies. And that explains the price drop in commodities from oil to fertilizer to copper.

For example, copper, which was trading near historical highs July 6, dropped in price by almost 18% by Aug. 11. With expectations high that demand and price for these commodities would fall even further, commodity stocks have sold off, too.

Video on MSN Money

Chinese flag © Jeremy Woodhouse/Photodisc/Getty Images
Buy China, not Chinese
Robert Hsu of Absolute Return Capital Advisors thinks that despite China’s big pullback, there are still some good Chinese stocks, but he says investors should buy only in New York and Hong Kong.

The slowdown in economic growth in Asia also pushed down the price of commodities and commodity stocks for another reason: Money flowed out of commodity stocks and into financial stocks, consumer stocks and retail stocks during these weeks on the theory that the slowdown in Asia was just beginning while the slowdown in the United States was far enough advanced that the U.S. economy would come out of its slump as the Asian economies were just starting their slowdown.

Earnings growth would pick up at U.S. companies while earnings were still falling for Asian companies, according to the theory. Shares of Bank of America picked up 56% between July 6 and Aug. 11, for example.

But while the slowdown in growth in Asia is pretty much what Wall Street has been expecting ever since the U.S. economy started to slump, the slowdown doesn’t seem to be happening because growth in the U.S. economy has slumped. Instead, soaring inflation in Asia seems to be at the root of the slowdown, and the damage to Asia’s economies is largely self-inflicted.

China, India wrestle with inflation

China, for example, has b
een waging a battle against inflation since 2007. The People’s Bank of China raised interest rates five times in 2007 to a one-year lending rate of 7.29%, the highest official rate since 1998. The central bank has also raised reserve requirements, the amount of capital that a bank is required to keep in reserve and can’t lend, to 14.5% of deposits. The 1% increase in reserve requirements announced Dec. 8 was the biggest jump in four years.

Those moves didn’t work to slow inflation until mid-2008. Inflation climbed to an 11-year high of 8.7% in February before dropping to 7.7% in May and then to 6.3% in July. Of course, fighting inflation also slowed the economy. Growth slowed to 10.1% in the second quarter of 2008.

Continued: India

India, the other big developing economy in Asia, has been waging an even more aggressive battle. The Reserve Bank of India, the country’s central bank, raised its key interest rate to a seven-year high of 9% at the end of July. It’s no coincidence that at the same time the bank raised rates, it cut its forecast for economic growth to 8% from 8.5%.

Infrastructure versus subsidies

Inflation would be cutting into growth in Asian economies even if central banks weren’t raising interest rates. Faced with soaring costs for construction materials, bottlenecks that delay projects and drive up costs, and climbing pay for engineers and construction workers, governments in Asia have been canceling big infrastructure projects. Thailand, for example, has cut $9 billion in mass-transit projects in Bangkok from recent budgets. South Korea has shelved a $15 billion cross-country canal. In Malaysia, the government canceled a $2.5 billion project to build a bullet train to Singapore.

Much of the money from canceling or delaying these projects has gone into subsidies for everything from electricity (in Thailand) to food (in Malaysia and South Korea). Subsidies are essential to prevent the poorest part of the populations in these developing economies from facing starvation, but they also feed into national and global inflation in food and energy prices. The subsidies necessary to prevent widespread hardship from rising prices also ensure that consumers are sheltered from the rising prices that would cut into demand.These subsidies testify to how hard it is to fight inflation in these developing economies. Every government in the developing world, following the lead of China, is convinced that investment in infrastructure is essential to future economic growth. So cuts in infrastructure spending are truly painful. But politicians in Asia think they have little choice. Higher prices lead to political protests that can bring down a government. Lower economic growth leads to fewer jobs and higher unemployment that can threaten even a regime as entrenched as the one in Beijing.

Stabilizing currency

So it should be no surprise that China’s government has begun to signal an end to the emphasis on fighting inflation and a shift back toward policies that promote higher growth. The central bank of China appeared to have slowed the rise of the country’s currency in July, as the yuan rose just 0.2% against the dollar. Before July, the currency had been appreciating about 1% or more a month. A more expensive yuan makes Chinese exports cost more to U.S. consumers, and that leads to lower exports and slower growth. The country’s politburo also got into the act at the end of July by issuing a statement that emphasized the importance of growth and omitted previous mentions of worries about inflation.

China’s apparent turnaround on inflation is likely to have wide influence across Asia. It will be hard to hold the line on inflation in Jakarta or Manila or Hanoi when the leaders of the most successful economy in Asia are saying to go for the growth.

Video on MSN Money

Chinese flag © Jeremy Woodhouse/Photodisc/Getty Images
Buy China, not Chinese
Robert Hsu of Absolute Return Capital Advisors thinks that despite China’s big pullback, there are still some good Chinese stocks, but he says investors should buy only in New York and Hong Kong.

We’re seeing the beginning of a shift away from the fight against inflation that has contributed to a slowdown in economic growth in Asia back toward more growth-at-any-cost policies in the region. In the short run, that will act to stabilize prices for most commodities near current levels. And even after recent 20% drops, those levels are well above the prices that Wall Street analysts are projecting for 2008 and 2009. That means, in my opinion, that on the fundamentals we’ve seen most of the decline in the prices of commodities.

Commodities and other hedges

In the long run, the shift away from fighting inflation and toward growth at any cost is going to accelerate global inflation. Note that the battle against inflation in an economy such as China’s has hardly been won. Inflation dropped to 6.3% in July at the consumer level but is running at 10% or better at what’s called the factory gate in China (roughly equivalent to producer prices in the United States).

That means the next wave of inflation will begin from a higher base rate. A move back toward growth in Asia at this time almost guarantees that global inflation will accelerate to dangerous levels in the next few years. In that environment, you want to own commodity stocks and other inflation hedges.

There are two exceptions to my generally positive take on events and price movements in the commodity sector. First, the cancellation of so many infrastructure projects in Asia will hit big engineering companies such as Chicago Bridge & Iron (CBI, news, msgs) and Jacobs Engineering (JEC, news, msgs) hard. The sector is likely to see some of its big backlog of work evaporate or get stretched out.

Second, while oil, the commodity, fits my scenario fairly closely, the structure of the global industry makes the stocks of oil companies a special case. I’ll explain why and what to do about it in my next column, on Aug. 26.

On A Lighter Note As We Head Into the Weekend

Friday, August 15th, 2008

From today’s NY Times, no less:

Two Georgians Say They Have Bigfoot’s Body

Bigfoot Global

Two Bigfoot hunters, Matthew Whitton and Rick Dyer, say they have the carcass of the creature, left. From left, Mr. Whitton; Tom Biscardi, a Bigfoot booster; and Mr. Dyer.

Published: August 14, 2008

SAN FRANCISCO — In the hairy and hoax-filled history of Bigfoot, those who believe in the mythical beast have offered up all manner of evidence, from grainy photos to hoarse recordings to tracks of those aforementioned feet.

But on Friday at a hotel in Palo Alto, Calif., a pair of Bigfoot hunters say they will present what they contend is the most definitive proof yet of an animal that science says does not exist: DNA evidence and photographs of a dead specimen they say they found in a remote swath of woods in northern Georgia.

“It was very frightening at first,” said Rick Dyer, 31, a former corrections officer who — coincidentally — runs a business that offers Bigfoot tours. “And it got even more frightening when you saw the others.”

Indeed, Mr. Dyer said he and his partner, Matthew Whitton, saw three more of the beasts nearby as they dragged the body of said creature out of the woods. Moreover, Mr. Dyer says he has video clips and photographs to prove it.

One photograph provided to the news media showed what resembled a gorilla — or maybe an old sheepskin rug — lying twisted in a freezer, with a dollop of intestines protruding from its belly.

“There’s a lot of comment being made that it looks fake, or it looks like a suit,” Mr. Dyer said. “But these people wasn’t there when I was sweating, pulling this thing through the woods.”

Tom Biscardi, a longtime Bigfoot booster from the Bay Area, who traveled to Georgia to see the animal, said he was “150 percent” sure that the carcass was a Bigfoot, an American Indian legend whose modern fame dates to an elaborate “footprint” hoax perpetrated at a Northern California logging camp in 1958.

“This is ‘Eureka!’ man,” said Mr. Biscardi, whose operations include a Bigfoot Web site, a Bigfoot merchandise line and a Bigfoot Internet radio show. “I touched it.”

Both Mr. Biscardi and Mr. Dyer said they expected skeptics to discount the find, which is being kept in a freezer in an undisclosed location outside Atlanta. But they promised even more proof, including video, a DNA test and, of course, a mission to capture one of the big guys.

“I’m not asking anyone to believe us,” Mr. Dyer said. “I’m just asking them to sit and watch, because you’re going to eat your words.”

Dollar Rally

Thursday, August 14th, 2008

One of the many reasons given for the fall in commodity names is the rally in the US Dollar, from over $1.60 to the Euro to under $1.50 to the Euro.

The graph above of the US Dollar Index shows that the dollar is moving within its downward trend and at this point it is still clearly within its bear market.

If the dollar can strengthen and break out above the top channel line, then we may have more than a bear market rally. Until then, the trend remains in charge and the poor fundamentals of the US economy – deficits & a weak financial system – are likely to keep the trend moving lower.


US, UK & French Navies Preparing to Provoke Iran?

Wednesday, August 13th, 2008

Below is a blog post from “Europe” the blog.

The story was initially posted late last week, and I’ve been trying to verify it independently from other sources, but most of the media is focused on Russia/Georgia. The best sources I’ve found didn’t appear until today:

The Middle East Times

and a small article in Debka (an Israeli news website) –

The writer uses decisive anit-Bush Administration wording, but the factual parts of the story are fascinating. If his conclusions come true (its hard to tell, but at least the Kuwaiti government appears to be very concerned about developemnts), then the current sell-off in gold and oil are real buying opportunities within the on-going bull market.

If you look at the charts of gold and oil, they are sitting on price support levels. This sort of activity may be the catalyst to move things forward into the next leg of the bull market.

Alternatively, this may all be part of ongoing naval strategy for the US and its allies, and have no provocative intent to it.

However, it does point out that the risks to prices for gold and oil are that they will move decisively higher, not lower.

We will continue to monitor this and other issues, and continue to execute our strategy as articulated in recent posts.

Here is the story:

Thursday, August 7, 2008

Massive US Naval Armada Heads For Iran

Operation Brimstone ended only one week ago. This was the joint US/UK/French naval war games in the Atlantic Ocean preparing for a naval blockade of Iran and the likely resulting war in the Persian Gulf area. The massive war games included a US Navy supercarrier battle group, an US Navy expeditionary carrier battle group, a Royal Navy carrier battle group, a French nuclear hunter-killer submarine plus a large number of US Navy cruisers, destroyers and frigates playing the “enemy force”.

The lead American ship in these war games, the USS Theodore Roosevelt (CVN71) and its Carrier Strike Group Two (CCSG-2) are now headed towards Iran along with the USS Ronald Reagon (CVN76) and its Carrier Strike Group Seven (CCSG-7) coming from Japan.

They are joining two existing USN battle groups in the Gulf area: the USS Abraham Lincoln (CVN72) with its Carrier Strike Group Nine (CCSG-9); and the USS Peleliu (LHA-5) with its expeditionary strike group.

Likely also under way towards the Persian Gulf is the USS Iwo Jima (LHD-7) and its expeditionary strike group, the UK Royal Navy HMS Ark Royal (R07) carrier battle group, assorted French naval assets including the nuclear hunter-killer submarine Amethyste and French Naval Rafale fighter jets on-board the USS Theodore Roosevelt. These ships took part in the just completed Operation Brimstone.

The build up of naval forces in the Gulf will be one of the largest multi-national naval armadas since the First and Second Gulf Wars. The intent is to create a US/EU naval blockade (which is an Act of War under international law) around Iran (with supporting air and land elements) to prevent the shipment of benzene and certain other refined oil products headed to Iranian ports. Iran has limited domestic oil refining capacity and imports 40% of its benzene. Cutting off benzene and other key products would cripple the Iranian economy. The neo-cons are counting on such a blockade launching a war with Iran.

The US Naval forces being assembled include the following:

Carrier Strike Group Nine
USS Abraham Lincoln (CVN72) nuclear powered supercarrier
with its Carrier Air Wing Two
Destroyer Squadron Nine:
USS Mobile Bay (CG53) guided missile cruiser
USS Russell (DDG59) guided missile destroyer
USS Momsen (DDG92) guided missile destroyer
USS Shoup (DDG86) guided missile destroyer
USS Ford (FFG54) guided missile frigate
USS Ingraham (FFG61) guided missile frigate
USS Rodney M. Davis (FFG60) guided missile frigate
USS Curts (FFG38) guided missile frigate
Plus one or more nuclear hunter-killer submarines

Peleliu Expeditionary Strike Group
USS Peleliu (LHA-5) a Tarawa-class amphibious assault carrier
USS Pearl Harbor (LSD52) assult ship
USS Dubuque (LPD8) assult ship/landing dock
USS Cape St. George (CG71) guided missile cruiser
USS Halsey (DDG97) guided missile destroyer
USS Benfold (DDG65) guided missile destroyer

Carrier Strike Group Two
USS Theodore Roosevelt (DVN71) nuclear powered supercarrier
with its Carrier Air Wing Eight
Destroyer Squadron 22
USS Monterey (CG61) guided missile cruiser
USS Mason (DDG87) guided missile destroyer
USS Nitze (DDG94) guided missile destroyer
USS Sullivans (DDG68) guided missile destroyer

USS Springfield (SSN761) nuclear powered hunter-killer submarine

IWO ESG ~ Iwo Jima Expeditionary Strike Group
USS Iwo Jima (LHD7) amphibious assault carrier
with its Amphibious Squadron Four
and with its 26th Marine Expeditionary Unit
USS San Antonio (LPD17) assault ship
USS Velia Gulf (CG72) guided missile cruiser
USS Ramage (DDG61) guided missile destroyer
USS Carter Hall (LSD50) assault ship
USS Roosevelt (DDG80) guided missile destroyer

USS Hartfore (SSN768) nuclear powered hunter-killer submarine

Carrier Strike Group Seven
USS Ronald Reagan (CVN76) nuclear powered supercarrier
with its Carrier Air Wing 14
Destroyer Squadron 7
USS Chancellorsville (CG62) guided missile cruiser
USS Howard (DDG83) guided missile destroyer
USS Gridley (DDG101) guided missile destroyer
USS Decatur (DDG73) guided missile destroyer
USS Thach (FFG43) guided missile frigate
USNS Rainier (T-AOE-7) fast combat support ship

Also likely to join the battle armada:

UK Royal Navy HMS Ark Royal Carrier Strike Group with assorted guided missile destroyers and frigates, nuclear hunter-killer submarines and support ships

French Navy nuclear powered hunter-killer submarines (likely the Amethyste and perhaps others), plus French Naval Rafale fighter jets operating off of the USS Theodore Roosevelt as the French Carrier Charles de Gaulle is in dry dock, and assorted surface warships

Various other US Navy warships and submarines and support ships. The following USN ships took part (as the “enemy” forces) in Operation Brimstone and several may join in:

USS San Jacinto (CG56) guided missile cruiser
USS Anzio (CG68) guided missile cruiser
USS Normandy (CG60) guided missile cruiser
USS Carney (DDG64) guided missile destroyer
USS Oscar Austin (DDG79) guided missile destroyer
USS Winston S. Churchill (DDG81) guided missile destroyer
USS Carr (FFG52) guided missile frigate

The USS Iwo Jima and USS Peleliu Expeditionary Strike Groups have USMC Harrier jump jets and an assortment of assault and attack helicopters. The Expeditionary Strike Groups have powerful USMC Expeditionary Units with amphibious armor and ground forces trained for operating in shallow waters and in seizures of land assets, such as Qeshm Island (a 50 mile long island off of Bandar Abbas in the Gulf of Hormuz and headquarters of the Iranian Islamic Revolutionary Guards Corps).

The large and very advanced nature of the US Naval warships is not only directed at Iran. There is a great fear that Russia and China may oppose the naval and air/land blockade of Iran. If Russia
n and perhaps Chinese naval warships escort commercial tankers to Iran in violation of the blockade it could be the most dangerous at-sea confrontation since the Cuban Missile Crisis. The US and allied Navies, by front loading a Naval blockade force with very powerful guided missile warships and strike carriers is attempting to have a force so powerful that Russia and China will not be tempted to mess with. This is a most serious game of military brinkmanship with major nuclear armed powers that have profound objections to the neo-con grand strategy and to western control of all of the Middle East’s oil supply.

The Russian Navy this spring sent a major battle fleet into the Mediterranean headed by the modern aircraft carrier the Admiral Kuznetsov and the flagship of its Black Sea Fleet, the Guided Missile Heavy Cruiser Moskva. This powerful fleet has at least 11 surface ships and unknown numbers of subs and can use the Russian naval facility at Syria’s Tartous port for resupply. The Admiral Kuznetsov carries approximately 47 warplanes and 10 helicopters. The warplanes are mostly the powerful Su-33, a naval version (with mid-air refueling capability) of the Su-27 family. While the Su-33 is a very powerful warplane it lacks the power of the stealth USAF F-22. However, the Russians insist that they have developed a plasma based system that allows them to stealth any aircraft and a recent incident where Russian fighters were able to appear unannounced over a US Navy carrier battle group tends to confirm their claims. The Su-33 can be armed with the 3M82 Moskit sea-skimming missile (NATO code name SS-N-22 Sunburn) and the even more powerful P-800 Oniks (also named Yakhonts; NATO code name SS-N-26 Onyx). Both missiles are designed to kill US Navy supercarriers by getting past the cruiser/destroyer screen and the USN point-defense Phalanx system by using high supersonic speeds and violent end maneuvers. Russian subs currently use the underwater rocket VA-111 Shkval (Squall), which is fired from standard 533mm torpedo tubes and reaches a speed of 360kph (230mph) underwater. There is no effective countermeasures to this system and no western counterpart.

A strategic diversion has been created for Russia. The Republic of Georgia, with US backing, is actively preparing for war on South Ossetia. The South Ossetia capital has been shelled and a large Georgian tank force has been heading towards the border. Russia has stated that it will not sit by and allow the Georgians to attack South Ossetia. The Russians are great chess players and this game may not turn out so well for the neo-cons. UPDATE 8 August 2008 ~ War has broken out between Georgia and South Ossetia. At least 10 Russian troops have been killed and 30 wounded and 2 Russian fighter jets downed. American Marines, a thousand of them, have recently been in Georgia training the Georgian military forces. Several European nations stopped Bush and others from allowing Georgia into NATO. Russia is moving a large military force with armor towards the area. This could get bad, and remember it is just a strategic diversion….but one that could have horrific effects. Link to story “Russia sends forces into Georgia rebel conflict”. FURTHER UPDATE ~ Russian military forces in active combat; now total of four Russian fighter jets reported downed. ADDITIONAL UPDATE ~ Georgia calls for US help; Russian Air Force bombs Georgian air bases. DEBKA, the Israeli strategy and military site, states that Israeli military officers are advising the Georgian armed forces in combat operations and that 1,000 Israelis are in-combat on the side of Georgia at this time.

Kuwait has activated its “Emergency War Plan” as it and other Gulf nations prepare for the likelihood of a major regional war in the Middle East involving weapons of mass destruction.

Barron's Weighs In

Tuesday, August 12th, 2008

Barron’s weighs in on the energy stock correction…

Energy Stocks Are Too Cheap to Ignore – Barron’s

by: SA Editor Eli Hoffmann posted on: August 10, 2008 |

One of the sharpest corrections ever in energy stocks, which has dragged shares of most large energy companies to below 10x next year’s earnings, is a seldom-seen opportunity to make 25% or more on your money over the coming year, Barron’s Andy Bary says.

Energy analyst David Kistler notes major independents like Anadarko (APC), Devon Energy (DVN) and XTO Energy (XTO) are trading at little more than half their net asset values, making their risk/reward excellent. Such firms are heavily focused on North American E&P, which shields them from much of the geo-political turmoil multinational peers have suffered in Venezuela, Russia and Nigeria. APC and DVN are also prime takeover targets at current prices.

Investors worry the oil majors (ExxonMobil (XOM), Chevron (CVX), BP (BP), ConocoPhillips (COP)) are being hurt by largely undisclosed production-sharing accords with nations in which they drill. Given high oil prices, the agreements – which limit producers’ returns after recouping initial investments – are quickly putting the host countries in control. Barron’s notes that for Exxon, only 20% of its output is subject to such accords, and thinks its problems and those of its peers have already been more than priced into its shares.

Lehman’s Paul Cheng likes Chevron, which trades for just 6.6x 2008 earnings. He sees CVX boosting output by 4% in 2009 and 2010.

Suncor Energy (SU), the most prominent oil-sands play, trades for just 8.5x 2009 earnings. Bear in mind it consistently trades at a premium due to its enormous reserves that could last 100 years vs. 20-30 for other oil majors. XTO Energy (XTO) is another company whose historic premium has vaporized.

“Given such valuations, it seems tough to go wrong now with XTO or almost any major energy stock, even if energy prices fall a little further.”

Flour, Foster Wheeler, and National Oilwell – Where's The Love?

Tuesday, August 12th, 2008

Jim Cramer shares the pain of believing in solid companies with strong earnings but having to watch them be pummeled by the computerized trading systems…

Market Unfairly Beating Up on These Three

By Jim Cramer

8/12/2008 12:34 PM EDT

Foster Wheeler (FWLT) , Fluor (FLR) and McDermott (MDR) are in free fall, and while I was disappointed in McDermott’s earnings, I am miffed that FWLT and FLR, which had really great backlogs and earnings, can’t get any support at all here.

Fluor, first of all, guided up very big, one of the biggest I have seen, so for this stock to be down 10% seems absurd.

Foster Wheeler now trades at less than one time its backlog, a solid backlog put on mostly when oil was substantially lower, so there is almost no chance of cancellation. Yet nobody cares because of the price of crude.

This is a market that loves and hates with such passion that you have to ask yourself if this is the moment when you have to start buying and putting away stocks that sell at valuations that make no sense unless oil is going to $60 [which it can’t – the marginal costs to drill the deep water wells is $80 per barrel] , which is how I feel with these two.

It is also how I feel about National Oilwell Varco (NOV) , with an order book that, again, is the envy of the industry and, again, just needs natural gas above $7 and oil about $70 to make the numbers for at least the next three years.

Unfortunately, the pain of sticking with stocks like Fluor and Foster and National Oilwell is beyond the ken of most mortals.

These are not dot-coms. There is worth here. But nobody cares. One day they will. The trick is to remain alive and in the game until they do, because we know, from the banks, that when they turn, and they will turn [in a big way] because their businesses are, long term so excellent and steady, you will not be able to get into them. You will, by nature, be too late.

Sometimes you have to lose some big money to make some bigger money. That’s how I feel about these stocks at these levels. But boy do I feel lonely

NOTE: On a separate thought, Lehman Brothers upgrades Flour today. Here is their comment:

Fluor Estimates Increased at Lehman
7:41 AM EDT Lehman continues to believe that FLR is the only E&C that provides enough diversity across the sector’s end markets. Analyst sees potential for several large bookings for FLR in the near term. Lehman raised Price Target to $103 from $98. FLR mgmt raised FY2008 guidance to $3.65-3.80 from $3.30-3.45.

Computerized Trading Takes Over The Market

Tuesday, August 12th, 2008

Doug Kass on The Edge has written an article explaining the impact of the computerized trading on the stock market.

I have to be honest that the volatility is having a negative impact on me – and our portfolio performance. The computers are killing the stocks with earnings (selling companies with a 6 P/E that have earnings growing 27% per year and buying stocks with a 18 P/E that have earnings growing at 7% per year). Its trading that doesn’t make sense. Fortunately, its usually short-term in nature – we went through this exact thing in 2006 and it was just as painful then – and the fundamentals take over again. But slugging through it requires lots of Maalox and Ibuprofen as your stomach flip/flops and your head pounds with every illogical tick down.

Anyway, enjoy Doug’s article.

Kill the Quants
8/12/2008 6:41 AM EDT

Momentum-based funds exaggerate trends and chase winners, and they’re a big factor in this summer’s volatility.

The role of the traditional stock investor is to assess the net present value of a corporation’s earnings and share price.

By contrast, the increasingly popular quantitative funds deride the notion of fundamental value (and ignore net present value calculations) in favor of worshiping at the altar of price momentum. The quant funds, which are generally auto-correlated, extrapolate trends by going long what is in favor and going short what is out of favor.

It wasn’t always this way. For some time, quant funds attempted to be long value and short mis-value. But over time, their computer models changed into momentum-based programs whose purpose was to exploit a trend in motion.

Money (especially of an investment kind) goes to where it is treated the best, and the quant funds have been getting much of the marginal cash flow into hedge funds over the last several years. As such, an increasingly large percentage of the trading on the NYSE is quant program-related.

The net of this is that quant funds control a lot of capital, they increase volatility (in both directions) and they invest based on reasons that have little do with how much a company is worth.

By exaggerating broader market moves as well as individual stock price moves, quant funds might be inflicting more damage than good in the efficient pricing of equities.

The role of quant funds, as Mike O’Rourke (chief investment strategist at BTIG LLC) wrote this morning, might also explain the manner in which this market will embrace a theme and then take it to the nth degree.

And perhaps the quant fund activity is behind some of the conditions that Mike has further observed today:

The June-July story was the (now obvious and often belabored) “long energy/materials & short financials/consumer discretionary” trade. Now, the story of early August is “long financials/consumer discretionary & short energy/materials” and of course, both sides are being pushed to short-term extremes. The obvious problem is that the foundation behind the June-July move was the fundamental background behind each side of the trade. We wholeheartedly believe the financials were overdone to the downside. In the same respect, we are also stunned at the willingness of investors to pay up 50%-100% from the trough lows, knowing that there will still be bumps in the road. The correction in crude has breathed new life into consumer discretionary. The same correction in energy has also taken energy and materials stocks down.

The question we find ourselves asking is whether just because one of the fundamental stories behind the theme of the early summer has reversed, have all the fundamentals reversed? Simply stated, does the correction in crude mean that the woes of the financial sector have disappeared (they have not), or that the strapped consumer has access to new capital (he does not), or that mortgage rates are not at five-year highs and set to break out (they are), or that the Americans who have lost their jobs this year have been hired back en masse (they have not)? What is the likelihood that the spurious relationship that energy/materials and financials/consumer discretionary maintained earlier in the summer due to coincident timing will continue to persist? Money in this market has a tendency to chase performance, and it’s August, so the moves tend to become exaggerated.

If I am correct that the effect of quant funds is to exaggerate stock market and individual equity moves (e.g., consider the wide daily price swings and knee-jerk action over the last month), those with patience and good timing can be rewarded.

But many will be “scared out of” positions.

My advice?

Kill the quants!

Before they kill some of us!

Goldman Sachs Raises Outlook for Commodity Stocks

Monday, August 11th, 2008

Goldman has been completely on target with its commodity stock research and analysis. There is a lot of talk about demand destruction which has crushed the energy, ag and metals stocks. However, Goldman believes (as do I ) that this is just a temporary correction in a continuing bull market. The graph above shows the long-term chart for the Oil Service Holders ETF which represents the index for oil service companies. You can see that in spite of the current correction, those companies remain in a long-term bull market and that there have been corrections all along the way during this bull market. They are never fun to experience or to wait out, but they run their course and the stock prices push higher as the weak hands are shaken out.

Below is the article from Goldman published this morning.

Commodity demand restrained, but not destroyed

We continue to believe that recent demand weakness is likely transient, as rising prices have been required to constrain demand in line with supplies. The negative macro sentiment may constrain near-term commodity upside. But we believe that supportive fundamentals remain intact and that the recent sell-off is increasingly providing buying opportunities.

Demand concerns have driven negative commodity performance

Commodity prices and returns as measured by the S&P GSCI Enhanced Commodity Index plummeted in July and have declined further in recent days. Broadly driving these declines has been a substantially negative shift in sentiment, owing largely to concerns about commodity “demand destruction” in the context of both slowing global economic growth and substantial commodity price increases this year. Concerns about increased supply availability – owing to OPEC production increases and substantial improvement in the US corn and soybean harvest outlooks – have also contributed to recent sharp price declines.

Demand restrained, but not destroyed

We continue to believe that US oil demand weakness has been necessitated by extremely disappointing non-OPEC crude oil supply growth in the context of still strong emerging market demand, which explains the lack of a meaningful inventory build, despite the weak US demand. As rising prices explain the magnitude of the recent demand weakness, it is likely that such demand weakness is temporary rather than permanent demand destruction and could reverse substantially following the recent sharp price declines. We believe a similar dynamic has taken place in the agriculture markets, with the recent price retrenchment given improved harvest outlooks likely stimulating sufficient demand to keep soybean and corn balances tight.

Raising 12-month returns forecasts on recent price declines

Although the negative macro sentiment may limit near-term commodity upside, we believe constructive commodity fundamentals remain intact and that potential upside is strongest for oil, soybeans and corn. We are raising our 12-month energy, agriculture and precious metals return forecasts on recent price declines, leading to an upward revision in our forecast of the S&P GSCI Enhanced Index to 17.9% from 9.3% previously.