Gold Higher, Oil Higher Rates Lower

Wednesday, January 02, 2008

ECONOMIC DATA / NEWS

Happy, happy, happy New Year!

Over the last few weeks of 2007 investors were drooling over weak economic data in the hopes that it would bring about additional rate cuts.  Weaker data had actually caused some big stock market rallies over the last few weeks, which is contrary to how the markets normally react.  However, reality has set in with the new year, and investors were hoping the economy wouldn’t slow down this much.  The Dow is down over 100 points already this morning, and between downgrades, geopolitical uncertainty, and technical factors, it looks like stock prices could fall much further.

The ISM manufacturing index broke away from the trend of following the Chicago region in December.  Declines in the Philly and New York regions proved to be more accurate, as the national average actually showed the manufacturing sector contracted in the last month of 2007.  It was worst reading in just over three and a half years.  Manufacturing was a problem all of last year, and it certainly isn’t a good sign that it slipped so much during the busiest shopping month of the year.

Construction spending was stronger than expected in November, but that didn’t make up for the drop in manufacturing.  However, the .1% gain was only due to commercial projects.  Residential building crashed lower by 2.5%.  Residential building probably won’t improve any sooner than the second half of 2008, and possibly not before 2009.  The sunny side of that notion though is that it continues to alleviate the inventory issue that has caused home values to drop each month.

Gold prices skied to record prices around $850 per ounce.  This came on the back of oil prices jumping up about $2 per barrel, edging closer to the $100 mark.  Traders are worried about inflation, which we already saw heat up just a bit toward the end of the year.  The heavy buying in gold and other precious metals signals a flight to safety, which bodes well for bonds, another safe haven investment.  

TECHNICAL ANALYSIS

MBS prices are now just 3bp off their two year high.  The FNMA 30-year 6.0% is up 15bp at 101.75.  And when you take the gap higher between last Thursday and Friday, and the last three day’s candlesticks, which have formed a marching soldiers formation, there are multiple signals of greater upward momentum ahead.  If prices break 101.78, then the sky is the limit.

The 10-year Treasury yield was already set up for a decline based on technical factors, but it really plunged immediately following the disappointing manufacturing report.  It dove to its current level of 3.93% from a peak of 4.05% earlier this morning.  We now see 3.80% as our next short-term target, which could be reach within the next two weeks, and possibly much sooner.  This also supports our three to six month outlook for the 10-year yield to fall to 3.50% or lower.

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