Commodities Market

The CRB commodities composite has been in an elegant downtrend since the end of Apr. 2011.
As most all know, evidence has been gathering since earlier in the year that the global economic
expansion was losing positive momentum. This has been the case although global production
was likely at or near an all time peak through Aug.

The commodities composites are not always captive to the same indicators for touchstones. Now,
commodities have been subject to the downtrends in place for the leading indicators and new
diffusion indices for the purchasing managers activity composites. It is momentum that has players
interested.

There is growing sentiment that the weakness in commodities has been strong enough -- the CRB
is nearly 18% off its cyclical peak -- that recession periods must be at hand for major economies.
Could be, but remember that financial players are heavy into into these markets now through
various ETF and ETN vehicles and this adds volatility to the already volatile commodities
markets.

The significant fall in the commodities composites is leading to a fairly rapid decline in my
primary inflation pressure gauge, a development needed to reduce stress on real wages in
any number of economies. This development will allow central banks more leeway in
considering policy accomodation steps.

Clearly though, this is a risky way to engage monetary policy as commodities price weakness
does suggest growing economic slack in the global basics delivery system and monetary
policymakers will have to act in a supremely timely fashion if, for example, the CRB does
continue to glide lower. But such "soft landing" feats have have been accomplished before
(viz. 1995 and 1999).

The CRB is trading right above cyclical trend support at 300 and super long term trend support
at about 280, so further sharp downside action would be an ominous sign. At 306, the index
is substantially oversold and failure to have a bounce up of consequence soon would also be
a serious matter.

CRB chart.

US Economy -- Key Longer Term Indicator Turns Shaky

First, before I get to the main subject of this post, let me say that the bulk of my longer lead time
indicators remain strongly positive. These would include critical financial measures such as
monetary liquidity, interest rates and the yield curve. Not only that, but the economy is nowhere
near effective capacity while a key lagging indicator -- my short term credit supply / demand
pressure gauge --  is now just rising to an equilibrium level after several years in the doldrums.

But I am worried about one critical mainstay indicator -- the trends of real hourly earnings and of
real take home pay. Measured yr/yr, the CPI has accelerated over much of 2011while wage growth,
low to begin with, has decelerated. So, even factoring in the payroll tax cut, the real wage has zeroed
out and is trending lower yr/yr. Business has not only not adjusted wages for sharper inflation, it
has been handing out progressively smaller wage increases. I had hoped business would be more
generous as inflation picked up. They may still come to the rescue, but the real wage has reached a
point where without substantial rapid improvement, an economic downturn is likely to develope
either late this year or in 2012.

A downturn is not a lead pipe cinch since a number of factors can intervene. Inflation pressure,
which has been driven by now down trending commodities prices, could fall away rapidly (The
Fed's hope). This could lead to an improvement in confidence and perhaps even faster hiring.
As well, consumers could simply grimly expand borrowing and draw on savings to finance
more of their spending -- things they have done in the past.

But, the burden of proof has now swung from bears on the economy over to the bulls. Moreover,
I think it may well be tough to see a substantially stronger stock market without the deterioration
of the real wage being arrested. Now, note here as well, that there could be subsequent fiscal or
monetary easing tactics which might lead investors to foresee better times for the real wage
down the road. But, here too, I think, the burden of proof is now on the market bull.

The Cannes Festival -- Deux

The stock market did rally over the past couple of days on stories the EU had a very large
bailout plan in the works to encompass Greece and its attendant weak sisters. This evening
Germany's finance chief Herr Schauble pissed all over the general idea and pointedly insulted
the White House for entertaining "stupid" notions about how the EU should proceed. Now
both sides have thrown down the gauntlet and without rapid repair, US - Germany relations
will tank further than they already have. The indirect attacks on Geithner may disturb the markets
in the days ahead as equities players liked the idea of a grand scheme of some sort re: the EU.

Since there are many sites and blogs out there which relish international politics, I am going
to leave this fertile new source of conflict to them to ponder and return to more basic economics
and finance.

The Cannes Festival

No, not the film fete, but plenty of drama and some comedy anyway as G20 sets the 11/4 meeting
in Cannes as a deadline for confronting the EU's sovereign debt crisis, a problem severe enough
to lead to bank funding problems in the Eurozone. Already the Fed has had to commit to a large
pool of dollars on loan to the EU area to provide funding liquidity. Moreover, the US dollar
has recently rallied strongly, an event the US does not wish to see sustained. Economists, fund
managers and leading gov. officials are peppering the press with jeremiads to the need for the
EU to step up and make its intentions and plans known pronto. There are rumors and stories
that US Treas. Sec. Geithner is forcefully urging the EU to act quickly and comprehensively on
this matter and that some sort of large scale bail out plan is in the works. To underscore non-EU
concern, the IMF's chief LaGarde is saying large fund infusions may be needed if the IMF must
address solvency problems beyond Greece. This would mean the US, the UK et al would have to
pony up more $.

First step this week is to determine fact from fancy. The interesting issue here is that Geithner
is leaning hard on the EU with generalities but out in full view....

Gold & Silver

Gold
Back on Aug.21, I again mentioned that I have been enjoying shorting the gold price when it
falters. I did so again over the past month via the DZZ ETN and covered today after DZZ opened
on a nice gap. DZZ chart. This was good, nicely profitable fun, but the gold price is so
ridiculously elevated and the long side players so intensely devoted to it that it is not really at
a point where my skills, as limited as they are, are very useful. I can think of good reasons why
gold would be in a bull market, but its price is absurdly high to me. $800 an oz. I can fathom and
tie to concrete economic realities. But, to me, the metal is beyond the pale at current price levels.
If I do short it again, I will use DZZ but only if gold appears to have entered a genuine bear
market. My cumulative return on my shorts since late 2010 was +52.4%.

Silver
Silver has this colorful history in the US, replete mostly with scoundrels but with a few saints
thrown in. When the silver price hijackers are quiescent, it can be an interesting investment.
When I wrote about it in early Apr. this year, the boyz were levitating it toward $50. But
those who know silver's history also know it is one of America's great crash dummies. Now
it is at $30. oz. Technically it is oversold, but like gold, is trading well above sensible
measures of economic value. Because silver is in a strong corrective phase already, I
might consider shorting it on occasions when the time looks right and stay away from the
gold. $Silver.

Gold Price -- A rescue From The Bugz Is Needed

Gold broke $1750 oz. short term support today. The RSI (chart link below) is trending down
rapidly and is now around 60. The bugz have come to the rescue during this bull leg since late
2008 primarily around 50 RSI. The next sensible strong base of support is down around the
spring 2011 break out level of about $1540. The market remains moderately overbought
at 13.8% above the 40 wk m/a. The bugz will have to wave off the recent double top and the
Fed's pass on more QE along with the continued procrastination on the next tranche of the
Greek bailout package. It is stunning the market is still overbought in the intermediate term.
But let's watch to see if a rescue is on tap over the next several odd trading sessions.

Gold Chart.

Monetary Policy & The Economy

At today's FOMC meet, the Fed maintained the ZIRP on Fed Funds, talked more negatively about
the economy and opted to swap out of $400 bil. short term Treasuries into longs. It will also stop
shrinking its asset backed securities holdings by reinvesting proceeds there instead of Treasuries.
No quantitative easing is involved.

The Fed decided some months back not to continue QE for the forseeable future because They
regarded the final months of QE 2 as involving an unfavorable tradeoff between rising output and
inflation. The primary driver of inflation over the past year was higher commodities prices and
especially rising petroleum sector prices. The global economic expansion has cooled considerably
recently with the result that the commodities composites have softened materially in price. Even so,
the Fed has elected to take a pass on further QE for now.

I believe the economy and confidence has improved substantially as a result of the QE programs.
Stepping away from QE does increase the risk for the economy since the private sector credit
markets are thawing very slowly, and there may not be the rising tide of liquidity to support
continued economic recovery without more QE. However, since a portion of the run up in
petrol sector prices earlier this year was likely attributable to QE 2, and, since that surge was
big enough to crimp the real wage, one can understand Fed reluctance to plow along with
another program quickly.

The foregoing shows how easy it is to gild the economic lilly on this issue. Suffice it to say that
the real economy would be best served by a fast and nervous sell off of commodities that
wrings out the speculators and which gives the economy and the Fed some breathing room.

Over the 1932 - 45 period, the Fed increased the monetary base by between 4-5 fold. there was
war time inflation and black marketeering, but the CPI did not hyperinflate. The recent economic
downturn was not at all as deep as the Great Depression, but the Fed's response has been
very aggressive. For what it is worth, Fed QE has been running awfully strong, and, it is
possible the Fed would like to hold the program in reserve for as long as it deems feasible, so
that it retains QE fire power for the future should the economy falter significantly.

Profits Indicators

As the economic recovery has proceeded, quarterly profits progression hit its first inflection
point in mid 2010, following a spectacular initial rebound. Since then quarterly profits have
progressed at a powerful 15% annual rate as stronger top line growth and continuing tight
cost controls have held sway. My profits indicators through Aug. this year now suggest a
moderation of volume growth is underway but that increased pricing power has been making
up some of the momentum lost from smaller volume growth. In fact, the pricing has been
"sticky" despite the loss of volume growth momentum. Now, there is a significant differential
which has opened between the pricing of primary processors such as the oil companies
and that of intermediary goods and services providers such as food processors and a number of
manufacturers. So, the advance in pricing power means earnings fillips for early stage guys
and higher costs for most other companies. Thus, there may be some erosion to the aggregate
profit margin ahead, as more companies struggle to pass on higher costs. The banking sector
looks set to show another sizable gain in operating earnings as the loan reserve has dropped
a large $46 bil. or 17% from year ago levels.

On balance, the indicators suggest that earnings progression continues fairly strong in the
near term although the % of companies showing strong comparison reports may start to
tail off. Also, when pricing power becomes a stronger factor to earnings as it is now, the
p/e multiple for the entire market can often contract in view of the higher inflation.

Stock Market -- Technical Quickie

Short term, the market is edging further into uptrend mode. It is at a critical juncture now. The
SPX is trading around 2.3% above the 25 day m/a. This is about where the bears have hit it in
recent weeks. As you'll see on the chart in a moment, there is overhead resistance in the 1200 -
1225 area, so the market will need to trade through this to gain credibility. Should the market
be on firmer footing, it can easily trade up to the 1245 area from today's close of 1209, and do
so in relatively short order.

The chart also marks the next logical resistance point up at the 1260 pivot line. But first will
come the test in the current strong resistance zone. Support remains down at 1120 - 1125.

$SPX

Stock Market Valuation

The momentum of earnings recovery has eased substantially from a torrid pace but is still solidly
on track. Inflation pressures are moderating. With this immediate backdrop, the SP500 should
be trading for about 16.5x estimated 12 mos. net per share through Sept. or roughly 1550.

With global economic recovery two years along, further earnings progress is now far more
dependent on top line growth than profit margin expansion. Global leading economic indicators
peaked in positive momentum in Feb. this year. The global measures are still positive, but are
far more subdued going into Sept., which portends a sharp deceleration of economic growth
particularly for manufacturing and production. US indicators are in synch with the global trend.

Since the Spring of 2010, when leading indicators suggested a slowing of growth, the stock
market has been more sensitive to leading measures than to coincident measures. This focus
has lead to a substantial contraction of the SP500 p/e ratio, as strong earnings performance
has been offset by a growing sense of investor pessimism about the future. Specifically,
the p/e of 17.7x seen in early 2010 has eroded to 12.5x today. Moreover, the p/e ratio is
not just hit or miss the fair value level of 16.5x, but is trending down to reflect an increase
of investor guardedness about the future.

Now, earnings progress for the SP500 has outpaced that suggested by the leading indicators.
To add to the issue, earnings progression has been far smoother than the leading indicators,
which have been rather volatile. These developments  plus a trend of increasing investor
pessimism make it difficult to say with confidence where the market should be trading today
and even tougher to say where it should be a year out.

The market is very reasonably priced when viewed in longer term perspective, and it has
sizable upside on improvement in shorter term fundamentals. However, experience in this
economic recovery shows clearly that the shorter term leading economic indicators and,
perhaps, the Fed have to be at your back. With an important Fed meeting ahead and the EU
wrestling to save their union now foundering around a prospective Greek default, be careful
to give the market a few weeks to sort this out in your thinking.

Stock Market -- Fundamentals

Primary Indicators
When I look at the fundamentals that have been the most critical to the current cyclical bull market,
I would have to say the situation is more reminiscent of the post - 1932 Great Depression era than
at any time after WW2. As in the 1930s, the US economy and the stock market were starved for
liquidity, and the Federal Reserve was the primary provider. Thus, the Fed's liquidity activities
as captured by Fed bank credit and the monetary base, were the primary drivers of economic and
stock market recovery as was confidence in the financial system and the economy.

SP 500 profits have rebounded handsomely in a modest economic recovery. Liquidity provided the
raw material for the recovery, and the transmission to higher stock prices has occurred only during
periods when investors knew the Fed was expanding liquidity or was about to. Importantly, a
key measure of confidence -- credit quality spreads -- has exhibited the same behavoir relative
to Fed liquidity as the the stock market has.

Financial system liquidity is showing some improvement excluding the direct effects of Fed
policy, but it has been far too modest to encourage investors. As well, rock bottom short term
interest rates have not been sufficient to cushion the stock markets from steep corrections both
last year and this in the absence of quantitative easing by the Fed. In fact, the full constellation
of core fundamental indicators which underwrote every post WW2 bull market have not
provided a rising market with the stability normally observed.

For now then, quantitative easing or the lack thereof, as well as confidence factors such as
quality spreads, continue to carry the day as far as the stock market is concerned.

Other Important Measures
I watch the trend of the oil price carefully in looking at the stock market. I do not think a rising
oil price bothered stock players very much until it shot up from $85 bl. to $115 earlier this
year when the Libyan insurrection began. It has retraced much of the spike in recent months
and I would rate it as a neutral factor now.

Looking more widely, I keep a weekly cyclical fundamental directional measure. This broad
gauge measure has a forward looking bearing and it has been in a moderate downtrend since
early Apr. of this year. Specifically, it has fallen 11% since then while the market is off about
14.5% from its highs seen earlier in the year. Most of the damage to the weekly fundamental
indicator was done over the early Apr. - mid May interval. Over the past 15 months, the
correlation of the weekly indicator with it weekly SP500 counterpart has been 0.6. It is
also interesting that the strongest positive moves in the fundamental indicator match up well
with the bouts of QE in evidence over the past 2+ years.

Total US business sales and the dollar cost of production have both risen more rapidly than has
the broad measure of financial system liquidity since the economic recovery began. Thus in
effect, the capital markets have been reliant upon the draw down of liquid reserves in the form
of money market funds. Here, the draw down has been $1.1 tril. or 32% from historic high
levels seen in mid 2009, and the current level now stands below readings seen at the prior
market top in 2007. A tidy sum of fire power has already been deployed.

Stock Market Technical -- Daily Chart

The SPX is in short term advance mode, with a third rally attempt to build off the short term base
of a triple low of 1124 set during Aug. If it can rally up to and a bit through the 1225 level without
being clipped sharply by the bears, the rally could have some staying power. $SPX

The rally is currently lacking the kind of confirmation I would like to see. Specifically, I would
prefer that the 25 day m/a also turn up over the next 4-5 trading days, and that any extension of the
rally remain above the 25 day m/a as it progresses.

I issue these cautionary preferences because the market remains unstable as it rises or falls in
dramatic fashion relative to the news of the day. Experience also shows that it is unusual to
have rallies with good staying power so soon after the kind of strong downward move in price
level we saw over late Jul. / Aug. From a purely technical perspective, the major reason to be
suspicious the rally might fail is that it is an against-the-house bet at this point in time. Even so,
as Mrs. Loman said of husband Willy, "attention must be paid".

Stock Market Technical -- Weekly Chart

This post takes an intermediate term view of the market. Market internals turned down in early
Apr. of this year when price momentum relative to the 40 wk (200 day) m/a turned convincingly
downward following a large run up in relative standing that left the market overbought. Chart
Notice the downtrend in the price oscillator has remained intact. I will not be getting a positive
read on this indicator until there is a stronger northward move in the oscillator. I will take short
term long positions in the market during a downtrend of this sort, but reserve much larger $ longs
for those periods when intermediate term momentum is on the rise.

There are other indications of internal weakness that show up on the following SPX chart. $SPX
Note here the downtrends underway in RSI, MACD, and ADX +DI. Risk remains in the market
until these trends bottom and show some positive action.

Now the hard truth is that if the cyclical bull market remains intact, These intermediate term
signals can remain suppressed for up to another 2-3 months. That would hardly be an unusual
development.

Let me also venture beyond traditional technical analysis to discuss the trajectory of the market.
The cyclical bull in place since 3/'09 has been the most powerful one since the 1995 -2000 and
1948 - 52 runs. But, unlike those periods, this market has been more volatile, having experienced
strong price corrections in 2010 as well as this year. So, I would not be very surprised or upset
if the SPX traded down to 1050 over the next month or two given the outsized trajectory it
maintained from 3/'09 through 7/'11. I think if the current correction can be contained at 1050,
we still can talk about a cyclical bull market. I have dredged all of this up because there should by
all rights be another decent upleg to this market, and I am not prepared just yet to abandon that
idea.

As a closing note, be advised that I am not projecting a further decline in the SPX to the 1050
level in the months ahead. I have just marked 1050 as a "fail safe" point below which much
darker doings could await.

Investor Worry Near Flashpoint

I like to watch the relative strength of the cyclicals to glean investor expectations regarding the
future behavoir of the economy. I have linked to the relative strength of cyclical stocks ($CYC)
compared to the SPX here.

The cyclicals were the market leaders until February, 2011. The group has weakened appreciably
since late July and a further drop in relative strength below that .685 level could signify market
players may have thrown in the towel on continued economic recovery in the US.

Economic Indicators / Analysis

Using raw monthly data, I have total US business sales up by 11% yr/yr through July in current $
and +7.4% in constant $. Over this period, inventory accumulation has stayed in good balance
with sales growth. Moreover, data on store and auto sales for August were relatively strong. The big drag on the economy has continued to be construction spending which is very depressed still but in
a moderating downtrend (and is included in the total business sales figures).

However, there are some troubling signs. The breadth of new orders reported by business hit
a strong early cycle peak in January of this year and has eroded rapidly to only a nominally
positive level for August. The weekly leading economic indicators (excluding volatile price series)
has started to retreat sharply since the end of July, and, the weekly coincident indicator is showing
signs of flattening out here in August.

The payroll tax cut surely did aid employee take home pay, but deterioration in the growth of the
basic wage rate plus the acceleration of inflation over the Half 1 2011 has undermined basic
purchasing power with the real wage (tax cut included) up but 0.2% yr / yr as we headed into
September. To top off a lousy consumer picture, total civilian employment growth is up but 0.2%
yr / yr, leaving consumers to borrow more and reduce savings to maintain  aggregate spending.

Potential bright spots ahead appear modest. Inflation pressures will be moderating and this will
give some lift to the real wage. Obama and the gang have crafted a jobs program and are looking
at ways to ease the homeowner's burden. The Fed awaits the Obama programs unveiling and does
have some further easing tools to deploy if pressured. However, barring a major surprise from
Obama, nothing grand seems in store, which with the poor labor market, leaves the economy
vulnerable. And, last but far from least, the GOP appears committed to sabotaging the economy
further if needs be to oust Obama. As much as I would like to see more positive leadership and
statesmanship from the White House, I have to say if a political street fight looms ahead, Obama
should drop the velvet gloves and come out swinging.

Electric Power Returns...

Hurricane Irene did moderate property damage in my area, but gale force winds and wet ground
conspired to send a number of trees down. Fortunately, few homes were struck, but power and
phone lines as well as cel towers were taken down. We went five days without power, and with
the well pump out, without water as well. We made substantial use of the neighbor's pool. I am
taking the rest of the evening off, but will return to regular posting shortly.