Capitulation Low In Commodity Stocks – Get Long – Use Stops!

Nothing has really changed since yesterday. Lehman announced that it is seeking a buyer for the whole firm. The “street” should have suspected this when they could not get what they wanted for Neuberger Berman. Initial jobless claims fell by 6000 last week, but continuing claims shot up 122,000 to 3.53 million. August import prices fell for the first time this year and they declined by 3.7% in August. All told, the news was not market moving. This morning, the market tested the downside first. The S&P 500 futures were down 18 points right out of the gate. Overseas weakness spooked investors and Asia was down 3% overnight. Europe was down almost 1%. We have another hurricane approaching, we are in a seasonally weak period and memories of 9/11 all cast a dark cloud over the market. Fortunately, prices have recovered and it appears that support was found above the SPY 120 level. That is a positive development. Commodities stocks have been crushed and I believe that liquidation was the cause. We may have seen the final stages of the yen-carry trade. Hedge funds would borrow the yen (short it) and use the proceeds to buy commodities. The strengthening yen has put enormous pressure on this position and hedge funds are bailing out. That has forced a massive sell-off in commodities stocks as the trade is unwound. The fundamentals are still intact and these stocks have gone from over-valued to under-valued in three months. I feel confident that we will hear of hedge fund failures in the next few weeks. These liquidations set up excellent buying opportunities and we are near a capitulation low. I do not believe that commodity stocks will return to their old high, but they could retrace half of that distance. In order for commodity stocks to get back to their old highs, global economies need to show growth. We could be a year away from that (or more). In the short term, value investors are getting back and that could spark a short covering rally. China reported that its inflation rate dropped to 4.9%, a 14-month low. Tomorrow, our PPI will be released and analysts expect a decline of .5%. I believe this number could generate a rally. The market has been searching for good news and lower inflation will give the Fed some breathing room. New Zealand lowered its interest rates by .5% (more than expected) and global interest rates are heading lower. That's good news for the dollar. I still feel that danger looms in this market, but the big drops have come off of rallies. Goldman Sachs has finally broken a major support level and the market has prepared itself for a worst-case scenario when it releases earnings next week. That sets up for a rally. I don't want to get long GS, but this is one company I would not bet against. I also feel that GS has been heading down because traders think they will buy LEH. From the early lows this morning, the market has staged a nice reversal. I believe the rest of the day it could find support. Tomorrow, the PPI should provide a positive bias and I expect a contained rally. If the PPI comes out "hot", it will be discounted by traders because they know commodity prices have fallen. I like getting long coal and fertilizer stocks in here.

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