The discounting of a lower price in crude oil is responsible for the recent run-up in U.S. stock prices. Since April, the Federal Reserve has taken measures that have taken some of the pressure off what was expected to be an emerging price inflation explosion. China's Central Bank joined the battle to reverse the direction of natural resources last week. Not only do the U.S and China use a significant portion of the world's oil supply, they also use much of the world's industrial metal supply in order to meet the demands of their huge industrial base manufacturing.
The introduction of China into the Federal Reserve's attempt to control and influence the price of crude and natural resources has caused the price of crude futures to drop $5. This happened before China raised its benchmark futures lending rate to 5.58% (its first rate increase since 1995). This indicates China's fledging Central Bank is gaining respect and influence within China's power structure. Thus, if China's Central Bank can manage to slow rising natural resource prices (something its central planners were unable to accomplish), then it would further increase its growing influence with Beijing.
One important thing about the influence of the Central Bank is that it favors moving toward more market driven policies. Adopting a more flexible currency policy that would balance the yuan toward a fair market value is at the forefront of China's market driven policies. Those who know currency value estimate the yuan's fair market value to be between 20% and 40% greater than its current value. Given the massive trade surplus, the Chinese have managed to run up against the U.S. since the mid-1990's, I would now estimate the yuan to be as much as 50% undervalued. So, what does this mean for the investor?
Pressure is now on the price of crude oil and most other natural resources. This should allow U.S. corporations a greater profit margin after November 2, if these prices decline. I believe our economy will improve in the fourth quarter. U.S. GDP should improve about 4.5%. Those who have made money in oil and gas stocks, as well as gold, silver, and industrial metals should keep a close watch on their share's price over the fourth quarter and sell if any of them lose 25% of their profits. Another strategy would be to sell half of your stocks once they hit a 25% profit loss. This will allow you to escape losses and this will make it easier for you to buy back your stock once the central banks ease up on its respective economies. I expect this to happen either in the first or second quarters of 2005. In the meantime, I expect the markets to discount the fact.
The Dow should move higher in anticipation of lower natural resource prices resulting in an increase in both GDP and corporate earnings. Things should improve as long as the dollar continues to move lower and China raises its interest rates and, eventually, the value of its yuan.
Kenneth Coleman
