US Leading Indicators Push Higher

Yesterday was a quiet trading day to start off the week. As I turn on the computers this morning the dollar index is trading right at the level it was yesterday morning. The currencies were up a bit through most of Monday’s trading day, but the dollar came back in Asian trading leaving us right about back where we started.

The only data released yesterday was the index of US leading indicators, which rose slightly in June for a third consecutive month. The numbers gave a bit of hope for all of the bulls, with many exclaiming that the US economy has turned a corner and the recession has ended. I am not so sure, as rising unemployment and continued weakness in the housing market will likely hold back any recovery.

Aaron Stevenson sent me a story he read on yesterday that highlighted the labor problems here in the US. The article states that more than 650,000 Americans will have used up all of their unemployment benefits by September, and the Labor Department is expecting the problem to accelerate. “In the next few weeks, the victims of the mass layoffs that happened six months ago – when the pace of layoffs was at its zenith – will start running out of their basic benefits. A total of 4.4 million people are expected to face this fate – or 65% of the entire filing population. And while they may have up to another year of unemployment insurance benefits – thanks to the confusing patchwork of extensions that were enacted last summer – they will soon be unaccounted for in government unemployment reports.”

As Chuck has continually pointed out, the Labor Department doesn’t track anyone who has been unemployed more than 26 weeks, and has no plans to adjust the way the report claims (even though they know they are under-reporting the actual unemployment rate!). As a result, the weekly jobs data will probably start showing declines in continuing filers later this year. But these declines won’t be because of an improved job market, but instead will be because many of these filers will be falling off the Labor Department’s radar.

Even the director of the White House’s National Economic Council, Mr. Lawrence Summers, isn’t feeling so rosy about the prospects for recovery. “I don’t feel there’s a basis for predicting that income growth is going to resume in the near term,” Summers said in an interview yesterday. So while the US economy may not be sinking any more, Summers doesn’t believe the economy will be able to quickly pull itself back up from the deepest recession in a half a century. “The pace of growth next year I think is very much in doubt, and difficult to predict, and will depend crucially on our effectiveness in implementing the programs that have been legislated and the kind of confidence that’s provided by what Congress is able to do in crucial areas like health care and financial regulation and energy,” Summers said.

The focus today will shift to Federal Reserve Chairman Ben S. Bernanke who will be giving his semiannual monetary policy testimony to Congress today. The markets are looking for Bernanke to map out an ‘exit strategy’ for the loose money policies which have been enacted over the past few years. Bernanke gave a sneak preview of his testimony in an opinion piece that he wrote for The Wall Street Journal yesterday. “When the economic outlook requires us to do so,” the central bank will employ a series of tools to tighten policy, Bernanke said in the piece. He outlined five different ways the central bank will be able to prevent the record reserves that banks have accumulated from causing money supply and inflation to surge.

I don’t doubt that Bernanke and the Fed have the means to pull liquidity out of the system. What I question is if they will have the cojones to use these methods when the time is right. In order to stem inflation, the Fed will be required to start tightening policy just as the economy is starting to recover. If they tighten too early, they could squash the recovery, and if they wait too long, inflation could spiral out of control. History has shown that the FOMC is typically late in their move to tighten.

And the likelihood of an anemic recovery heightens the risk that the Fed will be late in reacting. The recovery will be weak compared with historic recoveries from recession. I just can’t imagine Bernanke stepping up and pushing rates higher in the face of a weak economic recovery. But we will see what he has to say to congress today. His testimony could be good for the dollar, if he is able to convince the markets that he and his compatriots will step up to the plate and keep inflation at bay. Again, I just don’t believe he has the fortitude to time his move correctly.

Chuck sent me a note after reading a great piece by the Mogambo yesterday… The Mogambo doesn’t think Bernanke will be able to rein in inflation, and believes investors should protect themselves by purchasing gold:

“And if you don’t think that gold will shoot up when inflation starts roaring like that, then you are obviously new at this investing business and you haven’t had time to look at what happened to the price of gold when it was $35 an ounce in 1970 and over $800 an ounce by 1980 when the inflation (from the vast expansions of the money supply needed to simultaneously finance the War on Poverty and the War in Vietnam) was rising along this same parabolic ride.”

I love how you always know exactly where the Mogambo stands on things! I can’t argue with his logic and agree that gold is a good hedge against rising inflation, which I’m sure we will see on the other side of this recession/depression. Every investor should have a portion of their overall investment portfolio dedicated to precious metals, and our unallocated metal select accounts are one of the most efficient ways I know of to hold gold.

Speaking of the precious metal, gold held above $950 an ounce overnight, and seems to be on a fairly sharp upward path. Gold has gained just over $45 in the past two weeks and looks set to test resistance levels around $960. If it can push through these levels, the next resistance would be around $985. And just think what the price will do once we start seeing signs of inflation creeping back into the global economy.

So the dollar will likely move up today as long as Bernanke can ‘deliver the goods’ in his testimony to congress. But if the dollar does rally, I would take advantage and look at the move as an opportunity to purchase currencies at better levels. Some of the largest, and smartest investors are looking to do the same, and share our belief that Bernanke will be unable to turn the liquidity pump off in a timely fashion. PIMCO, the manager of the world’s biggest bond fund, said it is looking to buy the Brazilian real (BRL) as the dollar slumps and growth in emerging economies outpaces that of developed nations. According to a report published by PIMCO, investors should buy emerging market currencies to protect themselves against the risk that US policy makers will allow the dollar to slide should they lack the skill to “drain the system of emergency liquidity at the appropriate time.” The report goes on to say, “In light of an expected long-run erosion in the value of the US dollar, PIMCO will look to take positions in select emerging market currencies that we believe have the most compelling appreciation potential.”