Friday, June 17, 2011

News Letter 6/17/2011

Note: Highlighted words provide links to sources to support my views below. Click on graphs to enlarge for easier reading.

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The Economy
The economy took a step back in June with the latest numbers indicating a lesser of a recovery than economists had originally anticipated. The economic indicators came in below expectations with the unemployment claims being higher than expected at 430,000 claims during the week of June 4th. However, the June 11th data seem to be in line with expectations at 414,000. The GDP grew less than expected in Q1 at 1.8% versus a historic average of 3%. See Chart below. 

Until last week, Oil prices had been hovering above the $100 per barrel mark and gasoline prices had been above $4 per gallon and had taken its toll on consumers. Also, the Greek government taking austerity measures due to lack of revenues, inability to pay debt, lack of liquidity, and lack of availability of debt financing has worried economists that other European governments like Portugal and Ireland will follow suit and will lead to the collapse of the Euro banking and monetary systems. The stock market has reacted with a correction and the Dow Jones Industrial Average went down from a 10% return high in May to a 3% year to date return. See chart below.

The seasonal slowdown in the summer months is also becoming apparent as it did in 2010 when the stock market corrected by more than 20%. See chart below.

As of today the market has corrected itself by retracting about 7% from its peak of 10% in May per the 2011 chart above. The Fed Chairman Ben Bernanke has insisted that the quantitative easing that will not be continued beyond June has a delayed reaction and will eventually work through the system and help create jobs and stimulate the economy. Inflation seems to be slowing down which is good news for the economy. Core inflation which excludes energy and food is under control at 0.3% in May . The Dollar’s slide against the Euro has reversed and the dollar is strengthening again. See chart below.

Future Outlook
The strategy to move cash to the sidelines that was outlined in the April newsletter was the right strategy and would have avoided this painful correction. I continue to advise clients to let this correction take its course and wait for the summer doldrums to pass as it did in 2010 before moving more cash into equities. By the fall the market will start to turn around again just as it did in 2010. See the 2010 chart above. The recovery is slower than economists had forecasted and it is reflected in the pull back we are currently experiencing.

The investment product for this newsletter is the silver ETF SLV. Silver had taken a wild ride in 2011 going from $25 per ounce to $50 and then correcting back to $35. There is no science to evaluating prices of commodities like there is for stocks. There are no discounted cash flow models or P/E multiples. The only force behind commodity pricing is inflation and momentum. If the dollar goes down commodities go up and vice versa. Also, if inflation goes up silver goes up. When momentum investors move into a particular commodity like silver, the price becomes artificially inflated. In my view silver at $35 is fairly valued when looking at a straight line historical chart for sliver per the chart below. Unless inflation takes off again which I don’t expect, I don’t see a large upside to silver and would not recommend the silver (SLV) ETF at this time. SLV is a hold.

Mike Katto
Registered Investment Advisor
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