All are Bored!

From a podium at the Tony St. Regis hotel in Manhattan
yesterday afternoon, corporate insiders from North
America’s largest railway companies took turns testifying
to the booming global demand for commodities and industrial
products like paper and lumber. We were persuaded by their

The last time your New York editor had strolled into the
penthouse ballroom of the St. Regis Hotel he entered a
dense swarm of well-heeled hedge fund managers and other
professional investors. They had squeezed into the ballroom
to attend one of the ever-popular investment conferences
sponsored by Grant’s Interest Rate Observer. The one-day
conferences almost always yield a couple of worthwhile
insights, and usually a couple of laughs as well…assuming
you’re the type of investor who enjoys a good hearty
chuckle about "inverting yield curves" or "notional
derivatives exposures."

But the St. Regis ballroom felt very different yesterday.
The place seemed as placid and lifeless as a public
library. The sparse population of attendees scattered
throughout the room wore the tired, bored expressions
common to investment conferences. But these folks seemed
even more tired and bored than usual, as if their presence
had been the result of conscription, rather than choice.

Immediately your editor felt intrigued and energized. Any
investment conference that could attract such a miserably
small and disinterested crowd must have something of value
to offer. As most seasoned investors understand,
opportunity resides among the dispossessed. Standing-room-
only conferences, by contrast, like the giddy, tech-stock
conferences of 1999, often signal important tops in a given
stock market sector.

To judge from yesterday’s Merrill Lynch Global
Transportation conference, therefore, the railway stocks
still offer a reasonable investment opportunity. But we
were only half-interested in learning the specifics of each
rail company. We were much more keen to hear from industry
insiders about the trend of natural-resource-product

Their assessments were even more sanguine than we had
expected. Business is booming across all product lines.
"The month of May set an all-time record for tonnage
shipped," beamed Fred Green, COO of Canadian Pacific
Railway. "Nearly every product category performed well. The
agriculture sector is booming, and that looks like it’s
going to continue. Seedings in Canada are ahead of schedule
and every indication suggests that we’ll see bumper crops
again this year.

"The Forest Products sector has been surprisingly strong,"
he continued. "Even pulp and paper has been stronger than
expected. And of course, coal has been quite strong, and
those volumes should grow thanks to our new route

Union Pacific CFO, Robert Knight, echoed Green’s remarks.
"Car-loadings have been setting new all-time records almost
every week during the last two years," he boasted. "We’re
seeing growth across almost all product categories."
In the first quarter of 2005, coal shipments at Union
Pacific jumped almost 20% over 2003 levels. Shipments of
Agricultural Products and Industrial Products increased a
similar amount. Only the automotive sector registered a
decline, "due mostly to difficulties with the domestic auto

When Canadian Pacific’s Green concluded his remarks, he
solicited questions from the audience. He might have better
luck soliciting questions from a roomful of cadavers. So
your editor, feeling sorry for the guy, requested the
roving microphone and asked, "Since you are projecting
fairly robust increases in coal volumes over the next few
years, what contribution do you expect these rising volumes
to make to your earnings per share within three to five

"Well generally we don’t make projections three to five
years out," Green chuckled.

"Well it looks like you already made them three years out,"
we replied, "I was just asking about the EPS impact of
those projections."

"Right, well I’ll let y’all crunch the numbers, but I can
talk about the growth of coal volumes. And yes, we have
been modeling a steady growth in volumes to as high as 27
million tons. But some people think that number could go as
high as 30 million. I’ll tell you this; the three main
Japanese steel makers who have been buying Canadian
metallurgical coal are very excited about our new capacity
expansions. We make a presentation in Japan every year that
usually draws about 50 to 60 people. This year it drew
about 130. So that tells you something about the level of

"According to the Japanese steel makers, they see no
slowdown in demand for their products anytime soon.
Obviously, the correlation between demand for Japanese
steel and demand for Canadian coal isn’t perfect, but a
strong steel market should be very good for coal."

The attendees did not utter any audible "oohs" or "ahhs"
upon learning of the strong Japanese demand. Nor did the
attendees react whenever the speakers peppered their
remarks with almost-sexy euphemisms like "Project Sunrise."
Instead, they sat and stared blankly toward the front of
the room, like Gentiles at a bar mitzvah.

We suspect, therefore, that the railway stocks have not yet
peaked. Indeed, the sector might continue chugging ahead
for a while, assuming the demand for coal and grain and
timber continues to chug ahead as well.

While it’s true that the railway stocks have been trending
higher for the last couple of years, they have trailed well
behind most resource stocks. Most coal company stocks, for
example, have more than doubled over the last 18 months
while most railway stocks have advanced only a fraction as
much. Perhaps railway stocks will continue to lag behind
"direct plays" on coal and other commodities. On the other
hand, the rail sector might play catch-up for a while. As
the industry insiders noted yesterday, "The rail industry
is enjoying the best pricing environment it has seen in two
decades." As a result, earnings at Union Pacific will
likely grow about 50% this year and next, which isn’t bad
for a "mature" rail company.

One reason earnings are beginning to rise so rapidly is
that rail capacity has not kept pace with economic growth.
In other words, there’s only so much rail capacity to go
around. "Today, the value of the U.S. rail transportation
system to the economy has reached, I believe, an all-time
high level," crowed Burlington Northern CEO, Matthew Rose.
Fortunately, investor interest in rail stocks has not yet
reached an all-time high.

Did You Notice…?
By Carl Swenlin tracks actual cash flowing into and out
of Rydex mutual funds, and, while cash flow normally runs
parallel to price, divergences should cause us to pause and
reflect. Today let’s put Rydex JUNO Fund (RYJUX) in the

Rydex JUNO Fund is a bet for rising interest rates, and as
such it is a bet against bonds. As interest rates have been
hitting multi-decade lows in the last few years, an
increasing number of investors have become absolutely
convinced that interest rates must head higher. We can
deduce this from the massive inflow of cash into Rydex JUNO
Fund, reflected by the cumulative net cash flow index shown
on the bottom panel of our chart.

Unfortunately, the market isn’t cooperating. After the
point that cash flow first hit its current level in May
2004, interest rates (JUNO NAV) have trended lower by about
17%; yet the bond bears are still standing their ground in
spite of pain and losses as far as the eye can see.

Typically cash flow will more or less track the price
index, but here we have a case of remarkable stubbornness
on the part of investors, who are insisting that they are
right and that the market is wrong. This usually doesn’t
work, and a final low in interest rates probably won’t
occur until these investors capitulate, an event that will
be marked by a sharp decline in the cash flow index as
money finally exits the fund.

And the Markets…



This week

















10-year Treasury





30-year Treasury





Russell 2000


























JPY 107.51

JPY 107.29



Dollar (USD/EUR)





Dollar (USD/GBP)