Monday, June 18, 2012

Monday Morning Economic Assessment

The US Industrial economy advanced again last week (if pipeline scheduling is correct), while consumption turned and went positive for the first time in weeks.

The Production Index (In terms of its 28-day moving average of gas-flow scheduling into US industrial facilities) put in its second up-week in a row, gaining to 124.7 (from last weeks revised 124.1). In its raw dailies (above) the week started slightly soft, then strengthened steadily as the week progressed.

The Consumption Index broke its five-week loosing spell, rising to 141.7 (from last weeks 141.3). In its dailies the measure was strong most of the week then softened into the weekend. Against seasonals (which argue for slowing) the week did very well overall.

The Inventories measure (the cumulative weekly difference between the Production Index and the Consumption Index), continued its long-term decline.

All-told, (for the first time in months), internals are supportive, with food-group scheduling backing bullishly backing off of its highs before the turn in consumption while the extremely-defensive industrial sector continues to tread well behind the reviving consumer sector.

These "Economic Assessment" posts, started about four years ago in the midst of the "great recession", have run for quite a while since their introduction. But its been quite a while since I have written on the methodology behind them. Feeling that it has been too long since discussing the foundations of these posts (and my own investment strategies and philosophies) I started an explanational series with last weeks post, and this week will get into my own theories on the US economic cycle.

When I started investing (in the late 70's... when president Carter was president and hired Paul Volker, who was to reshape Federal-Reserve policy into what it was today) the economy was a morass of stagflation, with interest rates, unemployment, and inflation all exceeding 10%. At that time I tried to learn the principles behind monetarism, and held to them until well past the turn of the century.

Monetarism seemed to make a lot of sense... treating money as a commodity, and regulating its supply to counter demand (theoretically to control inflation) made sense. When you look at any raw commodity, when under-produced its price spikes and when overproduced its price crashes. It made perfect sense to think of money as any other commodity. Limit its supply and its "price" (inflation) goes the way you want it to. Cap the money supply, and you cap inflation.

However, as time went on, strange things began to happen. Debt of all kinds skyrocketed. Interest rates plummeted. The economy, which once (under Keynesian theory) was stimulated by a drop of the prime rate to 10%, or stimulated by small amounts of deficit-spending, in time became like a disease drug-resistant patient, to the point where today, even <1% interest rates and trillion-dollar-US-deficits can't seem to stimulate it.

Then, as I developed my present modeling and started to study patterns both within my own modeling doubts grew about monetarism. My own views simply did not work. And (like any trader that has to change his or her belief system and strategies to keep from getting crushed by the markets) I had to alter my theories. Today, my economic perceptions, while working quite nicely to time and profit from changes in economic trends, are quite radical, and I am very much the "outlier" today in my thinking.

My first "revelation" (forced change in thought) was to foreign trade imports. Conventional wisdom was that the enormous us trade-deficit is caused by US consumer-demand for foreign goods, benefited by substandard foreign-wage systems, that undercut US industrial competitiveness. However, I could not completely wrap my mind around that thinking. If such imbalances did exist, than why would not free-market systems (such as currency-exchange rates) correct for it. And what about foreign "dumping"? Why would a foreign corporation want to sell below cost (take a loss) to sell to the US. Loosing money is not the way that businesses prosper.

Then in my own studies, there was an issue of timing. Why, when foreign trade statistics or exchange rates changed, did not the gas flows not change likewise in a rational manor? And why did changes to foreign statistics lead changes to industrial gas-flows (if US consumer-demand was to blame for the foreign trade deficit) and not vice-versa?

Then it occurred to me... like in the commodities markets (where escalation in price can be caused by EITHER a rise in demand OR a drop in supply), foreign trade-deficits could likewise be triggered by either the buy-side (demand for foreign goods) or the sell-side (demand for US cash).

Suddenly, foreign dumping made sense. It was not US demand for foreign goods, but foreign demand for US dollars. It was foreign interests that wanted US dollars so much that they were willing to take a loss to get those dollars. The loss on dumping was the "commission" on the trade that they were willing to make.

And then there is monetarism... which (in its theory) wants to hold the actual count of dollars created (or printed) to a fixed amount. If the US money supply stays fixed, and demand for it grows, you have an imbalance that raises the value of the dollar (which makes the price of foreign goods even cheaper), pumps the US-foreign trade deficit, drains money from the US populace, and therefore slows the US economy. Like a string of dominoes, the markets, economies, and governments of the world reacts, and a cycle is set up...

The figure above is what I believe is happening, not only to the US, but to much of the "western world" as well, including Europe. It is a "death-spiryl" where foreign-demand for US dollars (See "1." above) drains dollars from the US, slowing its economy, and creating a need for stimulus (on the part of the Federal Reserve or US Government) to revive the US economy.

In the meantime, those dollars (that went overseas in exchange for foreign goods) accumulate in foreign accounts (and foreign central banks where they are converted). Eventually those foreign banks (to get a return on those dollars) seek to reinvest those funds back into the US (a quarter of a percent in interest is better than nothing), giving the US (and US Government) ample funds from which to borrow.

Then there is the US economy. As the US economy drains of US dollars (and its economy slows), and as the Federal-Reserve refrains on creating new money (to control inflation), pressure mounts on the US government to "do something". The easy-out is for the US Government to connect that pool of growing foreign-held US dollars to US consumers. The US government borrows, deficit spends... all problems solved! Foreign governments now have their funds invested and are making a return, US consumers have new cash to invest, and the cycle repeats.

And around and around it goes !

Timing of economic cycles, therefore, is led by timing of US Government Deficit-Spending (and those rare occurrences of US Federal-reserve acquiescence to quantitative easing).

Next week... dealing with that cycle... as an investor.


Monday, June 11, 2012

Monday Morning Economic Assessment

The US Industrial economy inched ahead last week (if pipeline scheduling is correct), as consumption slowed its descent.

The Production Index (In terms of its 28-day moving average of gas-flow scheduling into US industrial facilities) reversed course from the prior week, rising to 124.2 (from last weeks 124.0). In its raw dailies (above) the week started soft, strengthened midweek, then softened into the weekend..

The Consumption Index declined for its fifth week in a row, easing to 141.3 (from last weeks 143.3). In its dailies the measure was soft early but strengthened into the weekend.

The Inventories measure (the cumulative weekly difference between the Production Index and the Consumption Index), continued its long-term decline.

For the first time in months, however, internals are starting to appear supportive, suggesting the slowdown that started early in January may be over.

It's been a while since I posted on economics on the CWEI board (and the first-time for the BRY board - though others have regularly reposted in the past) so it's probably a good time to explain the basic assumptions of these "Economics Assessment" posts.

For some time I have followed natural gas pipeline flows (for investing in exploration & production companies), and as part of that process, broke down pipeline-posted natgas scheduling into a variety of supply and demand categories, including electrical generation, LNG imports, wellhead production, Canadian imports and Exports, and Industrial Usage to a great many industries across the US.

Those daily pipeline statistics for industrial usage, over the years, proved to track the economy quite nicely (judging by the monthly economic data releases) and seemed to peek and trough at the same time, and after several years I gained enough confidence in that correlation to begin to trust in the daily industrial data for my own investing purposes, and began to track and follow the natural gas scheduling into industrial facilities.

After realizing the value of the industrial natgas flow data, I modified most of my spreadsheets to break down the industrial flows by industry, and in that process noticed a correlation between cardboard (paperboard) manufacturing and consumer sales reports as well. Theorizing that cardboard packaging (being as it was a just-in-time shipping commodity) would be proportional to retail sales (most everything is shipped in cardboard in retail), that was modeled as well, as the consumption model.

The difference between those two models (industrial "Production Model" and retail "Consumption Model") then became the basis for a theoretical "Inventory Model", that is also included in these posts.

When the "Great Recession" started in 2008 (as pipeline scheduling first dived for paperboard (retail) then across the board in the industrial groups) after a time paperboard scheduling bottomed, and (suspecting an economic turn at that dismal time) I began the economics posts, and was able in 2009 to document the actual bottom as it happened near the end of the second quarter.

(Over the years in following these numbers I have formed an opinion of the basic causes of the economic cycles that have followed, and have been forced to change much of my thinking on the present "pop-economics" to bring my opinions in line with those of the gas flows, as well as present-day general economic, trade, and monetary statistics. Not to get too far off track here, I will save those thoughts for next weeks economics post. They really are off the beaten path!)

Back to todays modeling stats and observations...

Internally, food-group scheduling (historically counter-indicative of consumer-optimism) has broken well below prior years levels all the way through 2008 (the start of the recession), an indication of a fairly substantial gains in consumer optimism. Given the recent softness in the consumption index, I believe consumers are looking past the present gloom (perhaps to the November Elections) in expectation of change.

Steel-group scheduling (indicative of durable-goods), though still in the doldrums, is running ahead of May so far this month, the first monthly gain for steel since its January '12 peak. Steel's June turn is echoed across the metals groups.

The June strength is uncharacteristic for the metals, at a time when (going towards the traditional automotive retooling period in July) demand for metals generally trails off, and the automotive group (agreeing with the metals) is above prior years levels all the way back to 2008.

Also at multi-year highs are mining, refining and paper.

Housing continues to look sickly, with building materials, lumber, Masonry & brick, and cement groups all below prior-year levels for June. Masonry & brick and cement groups (new construction) are at multi-year lows (very tough year for homebuilders). Building Materials and Lumber groups are less soft looking (remodeling).