Changing the Guard, Beige Book Recap, Oil Forecast and Pair Trade, Another NYC Skyscraper Sold, and More!

by Addison Wiggin & Ian Mathias

  • Small news highlights big change… the sector that might dethrone financials
  • Beige Book paints dismal picture for U.S. economic growth
  • Dan Denning on the basic idea that should lower oil prices, and the X factor that could send them to the moon
  • Eric Fry presents another pair trade… sell the commodity, buy the sector
  • James Turk with a near-term dollar outlook
  • Another historic NYC building bought with foreign cash

Could it be… a changing of the guard?

“Mining Replaces Financial Services as Biggest Driver of M&A,” reads a Bloomberg headline this morning. In the first five months of 2008, the value of mining-related takeovers tripled compared to the same period last year. Mergers and acquisitions totaled $199 billion during that time. Financials mustered only $173 billion.

This is the first time miners have staged such a coup since Bloomberg started keeping track in 1998. On the flip side, this is the first time financials weren’t at the top of the pile.

Which harkens us back to one of our favorite charts:

“I love this chart,” explains Chris Mayer, “for all the perspective it gives in one glance. And because it shows how great tides shift in the market. Now unfolding is another great shift.

“Financials have enjoyed a long stretch of prosperity. If the past is any guide, you want to avoid the dominant sector. Likewise, giving skinny sectors a look might be a good idea, too. Basic materials have been squeezed so tightly they barely register on the chart.” Today, it seems, the reversal of that trend may be gaining momentum.

What’s more, “South Africa, China and Chile, major mining nations, all suffer from shortages of power.” In a note to The 5 this morning, Chris reminded us that as the metal-hungry world needs materials more than ever, key producers are struggling to keep up. “Electricity costs are skyrocketing, infrastructure is inadequate, supplies are tight… all bullish for the mining and materials sector.”

If you’d care to know Chris’ favorite resource and mining plays, better check out Mayer’s Special Situations.

The U.S. economy is “generally weak,” says the new edition of the Beige Book. The Fed’s latest collection of regional reports from around the U.S. reads similar to previous renditions. Words like “softer,” “weaker,” “slower” and “sluggish” punctuate the report.

Also typical, housing seemed to be the sorest spot in economies around the country. During the six weeks since the last Beige Book, districts mentioned “exceptionally weak” housing markets with prices and sales “down sharply” — by far the strongest language in the report.

Investors have surmised that yesterday’s Beige Book hints that rates will stay the same when the Fed meets later this month. We’re inclined to agree.

The U.S. stock market suffered another rocky trading session yesterday. Oil’s spike (see below) set the mood in the morning. Then continued stress from financials kept the selling spirit alive. The Beige Book was the final blow… The Dow and S&P 500 fell 1.7%, and the Nasdaq dropped 2.2%.

Lehman Bros. is looking worse every day. Shares of LEH plunged 13% yesterday on a Merrill Lynch downgrade and a rumor from the FT that the troubled brokerage house would need to raise even more capital.

And this morning, we learn that Lehman’s CFO and COO are getting the ax. Just a few days after announcing a $3 billion loss and an emergency $6 billion fundraiser, Erin Callan and Joe Gregory have been suddenly stripped of their titles, with no comment from Lehman officials. LEH fell 6% in premarket trading, but rebounded back to yesterday’s levels not long after the market opened.

So congratulations are in order… to Strategic Short Report subscribers. They just cashed out half of their Lehman short position, for 220% profits in less than two months. Judging by this morning’s news, there will be plenty more gains to come.

But don’t think there’s no more money to be made on the short side. Dan Amoss has averaged 85% gains for his SSR subscribers since we launched the letter in January. You can learn more about Dan, SSR and shorting the market here.

It’s worth noting the market at large has shaken off the Lehman news. The Dow opened this morning up over 130 points.

Oil spiked up again yesterday. Crude jumped around $5, to $138, after the U.S. Energy Department’s weekly report showed a surprise 4.6 million barrel oil inventory decline. But since then, oil’s retreated back to $132, on almost no news at all. Some dollar strength may have helped, but we’re left to wonder… at the moment, can the market support $140 oil?

“High oil prices will lead to lower oil demand,” observes Dan Denning from the other side of the world. “This basic law of economics hasn’t been repealed, last we checked.

“With oil, it has reached the point that what’s good for energy investors is bad for the economy. Something will have to give. That’s the beauty of markets. Left unmolested, they work. The X factor is Iran. There’s no accounting for how much geopolitical premium is in oil.

“What is clear is that high oil is already hammering the transport sector, putting airlines out of business and aggravating truck drivers, who pay for diesel, all over the world. If truckers are taking to the streets in protest, consumers won’t be far behind (although we presume they will be on foot or on bike, and not driving… this revolution may not be motorized). This modern oil economy simply isn’t built to handle energy that’s this expensive.”

“Sell crude oil and buy oil stocks,” advises our colleague Eric Fry, with another pair trade. “We realize that we are not the first market observers to identify this prospective pair trade. Further, we realize that any investor who has attempted this pair trade during the last several months has fared poorly, if not miserably. But so be it. We are happy to be ‘late’ to this trade.

“Admittedly, oil might continue to soar while oil stocks languish. But as the chart above illustrates, the divergence between crude oil and oil stocks has already reached a rare extreme. Could this divergence become even more extreme? You betcha. But on the other hand, some sort of regression toward the mean seems like the high-probability bet… at least for those who enjoy betting.”

For more oil insights, be sure to check out today’s Rude Awakening.

Another day, another record gas price. The national average gallon of gasoline ticked up to $4.06 today. Twenty-five states now feature an average price over $4 a gallon. Kevin Kerr tells us the “cheap stuff” around the block from his Connecticut home is $4.59 today. Yikes…

U.S. commuters took 10.3 billion trips on some form of public transportation last year … that’s the highest proportion of public transit users since 1957. According to the latest from the American Public Transportation Association, commuters are trading their cars for the mass transit at a notable pace. Public transpiration usage was up another 3.3% in the first quarter of 2008.

We’re not surprised… according to a recent IBM survey, 31% of commuters who drive to work say if gas stayed over $4 a gallon, they would change their commuting habits.

Corn’s been going gangbusters this week. Futures in Chicago soared past $7 for the first time yesterday. The already flooded Corn Belt is expected to get more rain this week… this nasty spell of weather has pushed corn to its fifth record high in as many days. Most contracts are up over 75% in the past 12 months.

Other food sources are surging too… at $15 and change, soybeans are now less than a dollar below record highs. Wheat, which is still predicted to yield a good harvest this year, is up 5% today, as well. A bushel of the stuff now costs $8.69.

Gold is still in its slump. The yellow metal fell to as low as $860 this morning on the same dollar strength that’s been plaguing it all week.

“The bearish case for the dollar is overwhelming,” James Turk tells us. “Despite all the talk about the so-called ‘strong dollar’ policy, nothing is being done to make it happen. Instead of taking action to strengthen the dollar (for example, raising interest rates and reducing the rate of money growth), the Federal Reserve is focusing on the deteriorating economy, heavy debt load and bank fragility…

“So I am still looking for a crisis in the dollar by this summer, but we need a new low in the U.S. dollar index to confirm that its short-term downtrend has resumed. For three months, the dollar index has been in a trading range that extends from around 71.40-73.50. The dollar index needs to break out of this trading range to the downside and make a new record low. This new low will reconfirm the bearish outlook for the dollar and validate the downward pointing arrow on the following chart of the U.S. dollar index.”

The dollar, despite James’ prediction, perked up again today. The Commerce Department unveiled a better-than-expected retail sales report this morning. The department says sales rose 1% in May, the fastest increase in six months. While those sales were likely the result of higher gas and food prices, traders interpreted the report as a sign of U.S. economic improvement.

The retail report pushed the dollar index to 73.9. The euro is subsequently weaker, down to $1.54. The pound suffered the same, down to $1.94. The yen is weaker too, at 108.

Yesterday, we told you about the UAE’s purchase of the Chrysler Building… today, we learn Europeans are snatching up their own little piece of Americana:

That’s the Flatiron Buidling — a 106 year old NYC landmark, once one of the city’s tallest skyscrapers. The majority stake of the building was sold to an Italian investment fund, the Sorgente Group, for an undisclosed price. “The Flatiron is expensive, but with the dollar, it made sense,” Valter Mainetti, the group’s head honcho, told Time magazine. Interesting times…

“I find it interesting that people still fear gold confiscation,” writes a reader. “Gold is not in general circulation any longer, so I would assume the government will go to where the money is. A big chunk of money owned by the general public is money is recorded and documented upfront: regulated retirement accounts such as 401(k) programs. I can foresee a tax or percentage ‘confiscation’ of these funds as a more tempting target, because it is readily accessible, unlike gold in private possession today. Of course, with Social Security going broke, this could be a risky move that could result in large-scale public revolt.”

“I’m not sure that the U.S. government would be as likely to confiscate gold this time around,” writes another. “The ’30s version was to pull people (kicking and screaming) off the gold standard. By my measure, it worked wonders. The people who might even remember precious metals being used as money are in the process of dying off. When the masses think of wealth building/preservation, it’s in terms of stocks or real estate, not precious metals. I’m not surprised that private gold ownership in the U.S. returned about the time when the U.S. completely went off the gold standard. By then, the deed of disconnecting money from precious metals was pretty well complete.

“That’s not to say that I don’t think gold is a valuable means of wealth preservation — our personal finances can tell you the opposite tale. It’s just that the government confiscating gold would have about as much psychological impact as confiscating Shaker chairs, art, or fancy car rims. People wouldn’t see the connection between inflation/unemployment, because they don’t measure their wealth in terms of hoarding precious metals.”

Talk to you tomorrow,

Ian MathiasThe 5 Min. Forecast

P.S. Here’s a private invitation, only for valued Agora Financial subscribers : Our most elite inner circle of investors is now accepting applications for membership. “The Reserve,” as well call it, is a group of exclusive members, each seeking the maximum possible return on investment in nearly every tradable market. Because of the nature of the Reserve, we can accept only a handful of new members, just a few times a year. For your invitation, click here.

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