Economy Healed? No, Markets Fragile As Miners Recoup

Includes: ABX, BHP, FCX, GG, NEM, RIO, XOM
by: Emmet Kodesh

Before you invest further in the indices, you should reflect on the May reports from regional Federal Reserve regions like Dallas, NY, Philly and Richmond. They show "alarming contraction" in many areas. Defensive sectors and precious metals seem more appealing after one looks under the economy's hood and sees increasing rust on the engine. If talk about tapering down QE becomes action, alarm will spread from core areas of the economy to markets and nest eggs.

The Richmond Fed chart of economic activity shows that the central Atlantic region has been in steady decline for two years. At - 2 the manufacturing level is a bit less bad ("diminished weakness" they delicately termed it) than April but employment fell 6 points to - 3. The Philly index supports this sobering view. It now has been negative for 9 of the past 13 months and in May fell from +1.3 to -5.2, a -6.5 decline. "Labor markets showed continued weakness" it noted, the -8.7 reading on jobs dispelling official narratives on the "unemployment" figure. The average workweek fell from -2.1 to -12.4. Perhaps the most striking measure from Philadelphia are manufacturing shipments which fell from 9.1 to -8.5, a 17.6 decline in a month. The Fed Industrial Production chart (NAICS) shows a 3+ year descending trend since 1Q 2010 (scroll down to see the chart). The economy is at the 1Q 2004 level and sinking while sheep run to the markets. The Fed's data on industrial production underscores everything I've written about the disconnect between the economy and the markets.

In dispelling rhetoric about economic recovery, the NY region Fed report is decisive. Its chart of manufacturing activity shows a trend in steep decline since 4Q 2009, the entire time of the supposed recovery from the Great Recession. New orders and general business were both at -1.4. The reporter terms the Philly and NY regions "noisy" to mask the clearly alarming trend of lower highs and lower, more protracted lows as the effects of successive QE phases wear down. Like the Philly and Dallas region reports, in NY, the average workweek declined.

It seems that much of the rise in home sales and prices is from investment firms buying multiple properties to rent. This reflects an increasingly bifurcated society rather than a sustainable economic strength. If the consumer is going to support this economy more people need to participate in the good times. The rate of American home ownership is declining as transience becomes the new norm. There are 14 million leased individual homes that large firms bought at fire sale prices during the housing crash. This kind of lift to the housing market does not denote economic strength. Blackrock and Carrington investment group "are building a new institutional real estate asset class from the 14 million leased single-family residences that are worth an estimated $2.8 trillion." Carrington only has found tenants for 51% of its 25k homes: if it decides to sell the remainder, and other investors without tenants do the same there will be another plunge in housing.

Part of the recovery of housing prices is that listings are down, as much as 37% in regions like Boston, 32% in Denver and 31% in Seattle. Moreover, a new Reuters report shows that pending home sales rose only .3%, about a fourth of the 1.1% expected gain and a fifth of the increase in March. This is only a three-month photo, but it shows a steep decline like the manufacturing numbers cited above. Allowing interest rates to rise clearly would hurt this seasonal slowdown (the season when home sales and contracts should accelerate). Reuters also notes that a third of sales were by cash suggesting that fewer people are able to secure mortgages.

All this combines in what Michael Pento May 29 termed "an anemic and unsustainable recovery" totally dependent on QE. Debt creation boosts asset values in the short term, but the long-term effects will be devastating. Every time there is a hint that the Fed (or BoJ) will reduce or, heaven forefend, halt QE the markets give us a taste of the fragility of the economy. When bond prices decline and interest rates rise, even a bit, those with debt service and adjustable rate mortgages will be hit hard. Pento's book on "the impending bond market collapse" terms the inflation of bond prices via debt purchase "a miserable mistake" and believes that the radically increased devaluation of the yen may trigger collapse of the QE economy.

This "recovery" is filled with jokers and bull traps. As John Williams of American Business Analytics noted, durable goods sales are weak: if interest rates even begin to rise toward a historical norm, the result could be devastating. Utilities and iron ore show weakness in core areas of the economy. Businesses in the Richmond, NY and Dallas areas, among others will not hire and borrow for expansion if the Fed ceases QE and yields and interest payments rise or soar. Unless markets are supported by fundamentals, the recovery will remain a narrative: the talk will remain just that, talk and spin. At some point, we will look for our steak and find only sizzle.

Wednesday May 29 with the Dow heading to 200 red Eric Rosengren, head of the Boston Fed said it was premature to end QE and that helped the Dow close down 106. "Significant accommodation still is needed" he said. This familiar pattern shows the real fuel of this "recovery," debt and massaging the message, burnished analyses of happy futures rather than substance. Read my piece the "Humpty Dumpty" markets and take it to heart. This is not the time to abandon a defensive position in equities although for those of greater means increasing allocation to select companies or ETFs could garner more gains before an inevitable correction in the racing bull when it hits the wall of economic reality and a no-exit fiscal policy.

Lastly, the distribution of big gainers, May 30, was notably weighted toward commodities as investors made value plays and gambled on growth. Diversified miners did well, BHP Billiton (NYSE:BHP) +1.75, Southern Copper (NYSE:SCCO) +2.23 or very well: Freeport-McMoRan (NYSE:FCX) +2.51% and Rio Tinto (NYSE:RIO) +2.74, while PM miners like Barrick (NYSE:ABX) +7.37, Goldcorp (NYSE:GG) +5.55 and Newmont (NYSE:NEM) +3.75 did best of all on heavy volume. Steel companies like US Steel (NYSE:X) and ArcelorMittal (NYSE:MT) were solid as was chemical giant Du Pont (NYSE:DD). Major oil and gas companies like Exxon (NYSE:XOM), Chevron (NYSE:CVX), Shell (NYSE:RDS.B) and British Petroleum (NYSE:BP) did little or declined on lighter-than-average volume. The same was true for Helix (NYSE:HLX) and Transocean (NYSE:RIG), makers and suppliers of technology that service drillers. The USD fell for a third day: let us see what happens to commodity-related issues when it rises again as Japan continues its last gasp resuscitation effort.

Sector action Thursday showed where the value is while Wednesday we saw evidence of the global economy's fragility, dependence on debt creation and lack of real confidence. Despite news from Chile about ABX needing 1-2 years to address concerns on tailing and dust pollution on local glaciers, the President affirms that Chile still wants Pascua Lama and its royalties. I expect that situation to be resolved. Ambulance chasers in the media should note that the eruption of a nearby Chilean volcano may deposit far more ash, cinders and dust on the surrounding areas than ABX would. I will discuss this further in a forthcoming piece.

A similar message needs to be heard on FCX and its repair and investigation of the training tunnel accident at Grasberg. Photos of the collapse suggest that prevention of such problems in future is very achievable. The productive power of FCX, RIO, ABX and XOM will maintain their relative strength in the world's basic materials regardless the extent of economic growth. Their dividends and the miners' value now are appealing.

Gold at $1415 and silver $22.78 still are well below their pre short-sell levels and continued buying suggests they should continue to recover. The PM thesis is strong but in the near term, things may be tricky as the metals approach former support, now resistance at the $1550 and $26.50 levels. They, in any case, will outlast this bull. For the rest, I hope that QE continues while the masters of the machine devise a way out of the corner into which we have been painted by fiat economics, the "zombie jamboree" of monetary history.

Disclosure: I am long ABX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own shares of precious metals miners in two funds.

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