November 2006 Archives

A problem for all investors is confirmation bias. That is, finding information that supports your position. Dealing with confirmation bias is difficult because we naturally gravitate to that data and those points of view that support our own position. I want to bring this topic to your attention because the content of today's post will largely support my cautious outlook. Is it simply confirmation bias? That is for you to decide.

On Saturday, Wal-Mart Stores Inc. (WMT) announced weak comparables at negative 0.1%. You can read the sales summary yourself. The negative data point is especially troubling when you consider inflation.

Some believe that Wal-Mart's troubles are simply Wal-Mart's troubles and not indicative of the larger economy. Perhaps. But as Doug Kass, general partner of Seabreeze Partners Management, Inc. and commentator for The Edge Column on Street Insight (subscription required—part of TheStreet.com family), pointed out, trucking is showing weakness as well. Doug referred to the following article ATA Truck Tonnage Index Fell 1.8 percent in October. Trucking transportation affects more than just Wal-Mart.

Today's Wall Street Journal article Existing-Home Sales Climb, But Prices Show Record Drop (subscription required) describes the recent housing statistics as well as describes the decline in durable goods orders.

It's the first monthly rise in sales that the trade group has reported in eight months. But the national median home price plummeted 3.5% to $221,000 from a year ago -- the largest year-over-year price drop since the trade group began keeping records in 1968, and "it's probably the largest price drop since World War II,'' said David Lereah, NAR's chief economist. It follows a 2.2% price decline in September and a 1.7% drop in August.

...

Durable-goods orders fell 8.3% last month to a seasonally adjusted $209.97 billion, reflecting a steep drop in commercial airplane orders, the Commerce Department said Tuesday. That was the sharpest drop since July 2000. Moreover, "core" orders of capital goods, a barometer of business spending that excludes defense and aircraft products, fell for the first time in six months, underscoring widespread weakness. New orders for core goods fell 5.1% in October, as orders for computers and related products plunged 25.6% last month. Core orders had risen by a monthly average of 1.1% in the nine months through September.

Economists at consulting firm Global Insight said computer orders likely dropped sharply because Microsoft Corp. is introducing a new computer operating system in 2007, which may have caused companies to delay computer purchases. Meanwhile, orders for communications equipment and fabricated metals also fell last month.

I keep returning to the theme of commodities, because so many pundits thought commodities were simply a flash-in-pan phenomena. So far, many commodities are not supporting that theme. According to Bloomberg.com, gold is priced at $646.10; silver, $13.96; oil (WTI), $60.99; and natural gas, $8.559. The sky certainly has not fallen in on these commodities yet. Gold and silver might be affected by a weakening economy because both metals are heavily used in jewelry. But others might buy gold and silver as a currency hedge. I remain bullish on the four commodities mentioned.

Again, it is usually easy to find information and experts that support your investment outlook. The challenge is to keep an open mind and think independently. As part of this process, I do keep a diversified portfolio.

I am somewhat surprised by the lack of vigor in the markets these past few trading sessions and by the weakening U.S. dollar. While I have long been cautious, I had expected performance anxiety to kick in and the market to shoot higher. Like everyone else, I am curious as to what the last few weeks of 2006 bring and how the markets in early 2007 behave.

There are two good articles on the U.S. dollar, both of which are worth your effort to read in full. The first article is from The New York Times Dollar Falls Sharply Against Euro and Pound (registration required).

The dollar dropped sharply yesterday against a range of major currencies, with the euro breaking through $1.30 for the first time in a year and a half. The fall highlighted concerns about softness in the American economy as economies abroad continue to expand.

The currency sell-off came as investors weighed a number of issues that complicate the prospects of the United States in the coming months, including a huge trade imbalance with China and a slowing domestic housing market. On top of that, economic growth in some European countries is gaining momentum, threatening to siphon investment away from the dollar.

The dollar’s losses came in a thin trading day in which the British pound rose to its strongest value against the dollar in two years. The euro traded at $1.3079 yesterday afternoon, up from $1.2941 on Thursday. The pound was trading at $1.9317, up from $1.9156.

The dollar has now fallen this year by more than 10 per cent against the euro and 12 per cent against sterling. Some economists suggest the greenback has further to slide given a weak economic outlook in the US, and the prospect of interest rate cuts there next year.

Steve Saywell, currencies analyst at Citigroup, said: “While the economic data remain soft, the dollar will continue to fall.”

The gaping US trade deficit, the near certainty of a December rise in eurozone interest rates, rising expectations of a cut in US rates in the spring and wariness about borrowing in yen to finance investments in the US all continued to weigh on the dollar, analysts said.

The challenge is that for many key factors, they do not matter until they do, and then they are the only things that matter. Does the dollar come under more pressure? Will foreigners purchase other currencies or precious metals to replace the dollar? Are the problems that many investors have talked about—such as high energy costs, high inflation, softening home prices, and possible adverse tax changes—finally beginning to affect the consumer?

Just as some investors are concerned with the prior problems, other investors point to low unemployment and a reasonably robust economy. While they acknowledge there are challenges, they believe that the strength of the economy is simply too strong.

The problem in trying to answer the prior questions is that you never know until after the fact. It is extremely hard to gauge when change will occur. Sometimes, oftentimes, a trend is sustained for far longer than most expect. As an investor, I try to identify possible influences and then monitor. I also make sure that my portfolio is diversified.

I will be watching carefully to see how the markets and the U.S. dollar react in the weeks ahead.

Much noise is being made in the press with regard to Dell Inc.'s (DELL) preliminary results. On Dell's investor page, you can read the latest press release and accompanying financial statements. The problem is, only preliminary income statement is shown along with some ancilliary data. There is no balance sheet or cash flow statements. For a company as big as Dell with lots of computers at its disposal, I am surprised that it cannot cobble together a complete set of financial statements, even if preliminary. No matter, the bulls are excited and bid the stock up 10% after hours.

The company earned $677 million or $0.30 per share. Revenue was $14.4 billion. From Yahoo!'s website, analysts expected $0.24 per share and $14.44 billion. Given that the revenue number was more or less in line, how did Dell knock the cover off the ball in terms of earnings?

Perhaps when all is said and done, Dell's results are truly outstanding and the company's stock deserves to be bid up even further. My complaint is that, if it is going to release financial information, it should release sufficient information for investors to make an informed decision. Simply providing an income statement is insufficient. Moreover, there was no conference call to allow analysts to probe the company about its financial health.

As a matter of disclosure, I am neither long nor short Dell. I am merely a puzzled observer.

Freeport-McMoRan Copper & Gold Inc. (FCX) is taking over Phelps Dodge Corporation (PD) according to Wall Street Journal article Freeport-McMoRan To Buy Phelps Dodge For $25.9 Billion (subscription required) for $126.46 per share. I recommend reading the complete WSJ article.

The value of the deal in terms of Phelps Dodge's share price could fall as trading opens Monday since shares of companies making big acquisitions typically fall over earnings-dilution fears and other factors. Freeport said it is offering $88 in cash and 0.67 share for each Phelps Dodge share. Freeport will finance the deal's cash portion, some $18 billion, with debt.

The deal amounts to a large bet on the long-term sustainability of high metals prices. Before this latest mining deal, some industry players had thought the industry's consolidation cycle had possibly abated for now in light of recent weakness in the price of copper. Since peaking in May, copper prices have dropped more than 20%, trading at about $3.07 a pound Friday.

Copper-market players have pointed to such factors as increasing Chinese production and slackening demand, and a slower U.S. economy and housing market. Long-held concerns that copper supplies could fall short of demand have been offset by a growing sense that supplies appear sufficient. Industry costs, meanwhile, have climbed sharply in recent years amid high energy prices and equipment and labor shortages.

Still, the current copper price remains very high by historical standards, and provides strong earnings and cash flows to most mining companies. Most copper mines in operation today were built with much lower prices in mind.

At the close on Friday, Freeport and Phelps Dodge closed at $57.40 and $95.02. If Freeport is offering $88 cash and 0.67 shares (equivalent cash value of $38.46 based on Friday's close), then nearly 70% of the offer is cash. Freeport must be bullish on copper, because if it believed that copper prices were headed lower, then it would have waited for the price of Phelps Dodge to fall and used its cash to purchase the same shares at a cheaper price. The International Copper Study Group has an interesting graph of world refined copper stocks for the past six years.

Unlike many pundits who proclaim that that commodity bubble will burst soon and like Jim Rogers, I continue to believe that many commodities are in a long term bull market. Simply put, finding new resources is becoming more costly and more difficult and more time consuming. The low hanging fruit has largely been picked over. Other supplies are often located in less hospitable parts of the world. And everywhere, environmental concerns are more costly and are taking longer to address. As new supplies are becoming more difficult to access, many countries—notably Brazil, Russia, India, and China—are experiencing rapid growth. Moreover, I expect more consolidation to occur as commodity related companies build up their war chests and hunt for growth.

• I previously opined the OPEC would stick to its production cuts (see OPEC Cuts Production 1.2 MBPD), yet many (most?) do not believe OPEC. I have written before that traders were skeptical (see Traders Do Not Believe OPEC Cuts Will Stick), but today, according to a Bloomberg article Oil Falls to 17-Month Low on OPEC Skepticism, Warm U.S. Weather, tanker traffic appears to confirm traders' bias.

  "Some credit for the fall in prices has to be attributed to the tanker movement report, which raised fresh skepticism about OPEC's cuts," said Eoin O'Callaghan, an analyst with BNP Paribas SA in London. "It's more important to look at the wider context. There is a slower global economy and that's reducing liquidity in the markets."

  According to Bloomberg, WTI is now priced at $58.97, up $0.40. That price still seems reasonably strong. The question still remains, will WTI fall to $50 or lower?

  My thoughts were that oil supplies remained generally tight and that OPEC would toe the line. I remain bullish on oil. Day to day price fluctuations are extremely difficult to predict. And of course, OPEC might decide to let prices fall precipitously with the aim of derailing new projects around the world. After a year of low prices, oil companies would once again use a much lower price forecast for new projects and thus delay or shelve new and expensive production. The hard cold reality is that no one knows with complete certainty what to expect with regard to future oil prices. Looking at the NYMEX Oil Futures, we see that after August of 2007, the futures prices are north of $65. I view those prices as bullish.

• While on the topic of commodities, according to Kitco gold and silver ask prices are $622.80 $12.83 per ounce respectively. Both commodities are showing resilience so far. Again, many pundits had expected gold and silver to plunge. I remain bullish on both gold and silver, though I do expect both commodities to be volatile.

• According to a Wall Street Journal article New-Home Construction Slid 14.6% Last Month (subscription required).

  Construction of new homes slid to a six-year low in October, a sharper-than-expected drop that prompted some forecasters to revise downward their estimates of economic growth. On a more positive note, however, the drop in starts could help to stabilize a housing market suffering from a glut of supply.

  The Commerce Department reported that home builders started construction on new houses at a seasonally adjusted, annualized rate of 1.486 million in October, down 14.6% from September and the slowest pace since July 2000. Also, data for September and August were revised downward.

  New home-building activity may have reached its lowest level in six years, but economists were able to find some glimmers of hope in the housing report.

  Economists noted that the monthly housing-start numbers tend to be volatile and subject to revision. Still, the report led many to cut their estimates for economic growth in the current quarter, on concerns that construction activity could decline more sharply than previously thought -- meaning that areas such as business investment, exports and consumer spending will have to grow faster to keep the economy afloat.

  I have been commenting for some time, as have many others, that the housing situation has yet to play out.

The above picture is hosted at Flickr. If you click on the picture of Paula Anddrade, you will directed to a larger version of her picture at Flickr. She owns the copyright to the image, and she has many more pictures that are terrific at Paula Anddrade.