THE BOUNCING BALL

If you drop a super ball from 10 feet, it might bounce 9 feet high. The second bounce might only be 7.5 feet. Depending on the resiliency of the ball, it will lie on the floor after a certain number of bounces.

Yesterday, I talked about the big swing, but until certain markets get a boost from an outside source, they will go down in a bouncing ball fashion.


In January of 07 the Chinese Bank Reserve Ratio was at 9%. It has since been raised about a dozen times. In August of 08, the ratio hit 18%, more than double the US bank reserve requirement. The Chinese have been applying more and more pressure to its main economic brake. In local currency, the Dow Jones Commodity Price Index went from 1240 in January of 07 to 1650 in July of 08. The price of commodities was in great demand. The last increase in the bank reserve ratio was the "straw that broke the camels back". The commodity index has fallen in two months from 1650 to 1280. The action makes one appreciate why the Core Consumer Price Index is used. The negative annualized inflation of this index for the past two months has been a minus 134%. Yet, the index has hardly changed from where it was 20 months ago. The good news is that the pressure has been taken off the core inflation rate. In the USA, it appears that the FOMC has a 2% core inflation target. The decline in commodities is going to make the 2% easily achievable.

China has not been fighting alone. The ECB, Russia, Brazil, South Korea and India were among the countries that tightened money just before or just after commodity prices broke. Saudi Arabia lent help from the other side. OPEC oil production was running at 29 million barrels per day in May but it was increased to 30.2 million barrels per day by August.

Pundits have suggested that the sharp slowdown will be over as soon as Chinese workers return to work after the Olympics. This slowdown is more than a factory holiday. Euroland's factory index peaked around 58 in 2006, it fell to 47.4 by July of 08. Japan's output growth was better than 8% in 05, 6% in 06, 4.5% in 07 and is down to zero now. India's industrial production was growing at 16% in 2006 but it hit 4% a few months ago.

What would happen to the price of a product if production went up 1.6% but consumption fell by 3.7%? During the first 7 months of 2008, oil production went up 1.6% in the USA and oil consumption fell 3.7%. Day after day, the USA is having success in the oil patch. The hottest "new" location is the Bakken Formation in Montana and North Dakota. Day after day, consumers drive fewer miles and drive a higher percentage of miles in fuel efficient vehicles. The drop in gasoline prices from $4 to $3.45 is not going to cause consumers to buy monster trucks again.

It is part of the "normal" economic cycle for prices of stocks to go up about the same time that commodities and interest rates come down. It took a long time for commodities to peak but most headed down months ago. US short rates are the exception to the rule. The economic brakes have been applied from Russia to India to Australia to Euroland. High short rates in these countries will cause long term mortgage rates to fall. The first increase in US short rates will be the indication that the US economy has been healed. Investors must always remember that the economy will not be healed until long after stocks have been rising.

TECHNOLOGY TO THE RESCUE

BLOOD FROM STEM CELLS -- Scientist have used stem cell technology to grow red blood cells. Human trials are expected to start within two years. This could be a long awaited break through. My family routinely gives blood at the Red Cross. It is a minor inconvenience to millions of people. Add up the time and all the cost and one can see the potential for huge savings. Lives will be saved!

Another group has discovered that menstrual stem cells have very powerful healing properties. Stem cell technology is unlocking some doors that have never been opened before. It is realistic to believe that paralyzed people will walk again. It is realistic to believe that failed organs will one day be regrown.

ETHANOL FROM PLANT STEMS -- My rants about US ethanol production are against the subsides being paid to farmers and the use of food crops for fuel. Japanese Sake makers have just discovered how to use powerful yeasts to make ethanol out of plant stems. While knowing how to do something and doing it commercially are two stories, it is great to see this progress. Despite the rants by environmental extremist, the history of man is of using resources more efficiently. One day, we will efficiently "recycle" our resources. We simply should not recycle just to say we did it. If it cost more to recycle, then it is better not to do so.

Brazil has made the headlines about ethanol production even though the USA produces much more than Brazil. The difference is that Brazil uses sugar cane to produce a profitable profit and the USA uses government subsidies to give the ethanol makers a profit. The more corn ethanol we make, the more damage we do to the environment and the more harm we do to the American taxpayer.

ELECTION NEWS

McCain and Obama are now in a dead heat. If the votes were made today, Obama would get 264 electoral votes, McCain would get 261 and Virginia's 13 electoral votes would be counted and recounted. The above tallies give New Hampshire's 4 votes to Obama even though he leads by the statistically insignificant 1%. Only a few votes would make the numbers 260 Obama and 265 McCain. Democrats continue to hold substantial leads in house and senate races. It is unlikely that the democrats will win a filibuster proof majority in the senate. Should the current trend continue, it is possible that a switch by Lieberman could give republicans a majority.

CREDIT MARKET NEWS

The settlement made by investment bankers in regard to auction rate securities is another step toward the healing that is taking place in the credit markets. The buybacks of auction paper might produce some more paper write downs, but these dollars are now free at last. The jamming up in the credit markets is on the way to an end. When the FOMC is in the position to raise short term interest rates, the credit markets will rally. For now, the fear of what is next is weighing on the markets more than is reality.

Housing sales leveled off 4 months ago. One at a time, bad loans are getting paid off. Even foreclosed loans are a part of the healing process. The best housing bargains are being picked off daily. The best real estate agents are showing apartment renters that they are eligible for $7,500 interest free loans from Uncle Sam. You can expect to see improving real estate numbers in the months ahead. The declining price ball has hit the floor in most markets. It will soon be bouncing again, with each bounce being higher than the last.