Consumer Price Index: The effect of a rise in oil prices

With crude oil going back over $106/barrel (which is a 20% increase from $90/barrel), let's see how the CPI would do.

As you know, the consumer price index consists mostly of housing (42%), then second comes transportation (17%) and last comes food (15%).

The crude oil is part of the transportation segment. One third of the transportation segment is motor fuel or 5% of the CPI.

So if oil prices go up 20%, the CPI will only go up 20% x 5% = 1%. 

More importantly, housing determines a major part of the CPI.  Half of the housing segment consists of Owners’ equivalent rent of residences which is basically the amount of rent you would pay for staying in the house. This depends on the housing prices. 10% of the housing segment is fuel and utilities. So if oil goes up 20%, the housing segment will go up 10% x 20% = 2%. And the CPI would go up 2% x 40% = 1%.

CPI

So basically, if oil prices go up 20%, the CPI at least goes up 2% from the fuel in the housing and transportation segments (if all else stays equal). The other segments will of course be influenced too by rising oil prices, but to a lesser extent.

So that's the significance of the oil price on the CPI.

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Building Permits Vs. Housing Market

The authorization of building permits is a leading indicator for the housing market. As you can see on this chart, the new private housing units authorized by building permits move first, while the house price index moves several months later. 

This way, you can predict the direction of the real estate market. 

On June 2013, the direction of the housing market is clearly upwards.

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What do the latest GDP numbers tell us?

The GDP numbers came out this week and there was 2.4% growth yoy:
http://www.reuters.com/article/2013/05/30/us-usa-economy-idUSBRE94T0HI20130530

So what does this mean to your equity positioning?

The following chart is used to give a valuation on the stock market and gives you the tool to position yourself. It is based on the total stock index (DWCF) divided by the GNP.

The latest data says that GNP was 16.236 trillion in the first quarter of 2013.

Table 1: GDP and GNP

If we look at the Total Stock Market Index (DWCF), we have 17015.

Now divide 17015 by 16236 and we get: 1.05.

105% is modestly overvalued according to the Stock Valuation Table.

Stock Valuation Table

So I wouldn't buy equities at this stage.

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Wage Inflation Vs. CPI

This page is created to monitor the Average Hourly Earnings of Production Vs. Consumer Price Index (CPI).

The Average Hourly Earnings (blue chart) are a good indicator for the Consumer Price Index (CPI) (red chart). 

It appears that the CPI is most volatile here, so the important trend to follow is the average hourly earnings.

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Capacity Utilization Rate Vs. Consumer Price Index

This page is created to monitor the Capacity Utilization Rate Vs. Consumer Price Index (CPI).

When capacity utilization goes above 80%, the industry goes above a threshold where it lacks capacity to produce. At that moment the only way to rebalance is to increase prices.

When the capacity utilization goes above 80% (blue chart), the CPI (red chart) will follow suit after 1 year as capacity utilization is a leading indicator for inflation.

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GDP Vs. PMI

This page is created to monitor the Gross Domestic Product (GDP) Vs. ISM Purchasing Manager Index (PMI). 

When the PMI declines (blue chart), the GDP growth rate (red chart) declines.

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Correlation: Wage Inflation Vs. Unemployment Rate Vs. Consumer Price Index

There is an inverse relationship between the unemployment rate and the wage inflation. Whenever people get unemployed, it means the economy isn't doing well. Employers won't be able to raise wages of the people during these difficult times, so you will get a low wage inflation trend (blue line). In these periods, the unemployment rate tends to go up (yellow line).

Chart 1: Wage Inflation Vs. Unemployment Rate

The same can be said the other way round. When the unemployment rate declines, people will demand a higher salary as skilled workers get scarcer. At this stage the wages will inflate.

It is also so that wages correlate highly with the consumer price index (CPI). So if the unemployment rate declines, you can expect a higher CPI as you can see on Chart 2.

So if you don't believe the CPI the government is reporting, you just look at the average hourly earnings. The average hourly earnings were positive in March. So I expect the CPI to increase too.

Chart 2: Average Hourly Earnings Vs. CPI

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Record High Insider Selling Marks The Top In The Stock Market

There are several indicators today, marking a major top in the stock market. One of those indicators is the overvaluation in the stock market according to the "Warren Buffett Valuation" of the total U.S. stock market index as compared to U.S. GNP. We found out that stock markets are overvalued today, because the total U.S. stock market index is at 100% of  U.S. GNP. Normally we see that the total U.S. stock market index is at 80% of GNP. We just recently had news that U.S. GDP was negative and I wrote about it here. When GDP declines, it inherently means that the stock market must decline, taking into account the Warren Buffett Valuation theory.

Investors are much too bullish on stocks at this moment and we can see that in the Dow-Gold ratio, which is hitting a ratio of 9 to 1 as we speak.

I believe though, we shouldn't be so complacent about stocks. After all, the P/E ratio of the Dow Industrials stands at 15.3 right now, while in the 70's, the P/E ratio was on average at 10, which is much lower than 15.3. The question is: "Do we expect higher or lower earnings in the future?". I believe the earnings are going to get worse in the future. One way to measure this is to look at the Citigroup Economic Surprise Index (CESI). This index is defined as weighted historical standard deviations of data “surprises”. In human language it means that if the index turns negative, the chance of an "unexpected" downward revision goes up. You will hear more bad news out of the media. And what do you know, the CESI did turn negative in the previous month. So you can expect more bad news coming. Historically, when the CESI goes down, the stock market goes down a few months later as you can see on chart 1.

Chart 1: Citigroup Surprise Index Vs. S&P

To read more evidence on a top in equities, go here.

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100% Chance of a Major Low in Gold Miners

I don't know if you have noticed this, but sentiment on the gold miners is at a record low on a 3 year period (because the free chart only goes for 3 years...)

Each time when we see a bottom in sentiment, the gold miners are bottoming out.

I believe the best place to go right now is in gold mining stocks and I'll put the money where my mouth is, especially when Goldman Sachs tells you to sell your gold.

Some suggestions: ASM, EXK, NEM.

Chart 1: Gold Miners Sentiment Index

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Correlation: Total Stock Market Index Vs. GDP: How to Value Dow Jones

Today I learned about the Warren Buffet valuation of the stock market by looking at the total stock market index and GNP numbers (which is almost equal to GDP numbers + $200 billion).

The total stock market index can be found here and stands at $15.879 trillion on 15 February 2013 (Chart 1). It measures the market cap of the U.S. companies. Don't confuse this chart with the Dow Jones chart.

Chart 1: Dow Jones U.S. Total Stock Market Index

Now you compare that to the U.S. GDP number, which can be found here (Chart 2).

Chart 2: U.S. GDP

If you then divide Chart 1 by Chart 2, you get Chart 3. If the chart goes above 100%, then the stock market is overvalued.

Chart 3: Market Value to GNP ratio

Here is the table for valuation:

Chart 4: Valuation Table

For example, in December 2007, the GDP was $14.25 trillion, while the total market cap was $15 trillion. 15/14.25 = 105%. Meaning overvalued.

For example, in December 2008, the GDP was $14.08 trillion, while the total market cap was $8.78 trillion.
8.78/14.08 = 62%. Meaning severely undervalued.

So today, you could say that stocks are becoming overvalued, so you should take some of your money out of the stock market while you still can.

There is a final note I want to make. If this correlation is true between the Total Stock Market Index and GDP, then you have to take in mind that GDP is very important to watch. If the GDP drops, then the stock market will most likely drop. If the GDP rises, then the stock market will most likely rise.

I pointed out many times that U.S. GDP will not go up, due to the zero hour debt problem, which I talked about here. So theoretically, the stock market cannot rise.

The only way to get GDP go up again is when debt is significantly reduced and we're not at that point yet.

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Correlation: The Ultimate Tool to Predict Gold and Gold Miners Price Swings

It's amazing, every day I learn something new. Today I present another very reliable tool to predict tops and bottoms in the gold price and the gold miners.

The Bernstein Daily Sentiment Index for gold. Apparently, when the index goes below 30, we have a bull alert on gold. Similarly, when the index goes above 70, we have a bear alert on gold.

The problem is, it isn't free, you have to pay to follow this index here: http://www.trade-futures.com/.

Chart 1: Bernstein Daily Sentiment Index

Luckily, Bloomberg has something similar which is free and can be accessed here. On Chart 2 we can see that sentiment is at rock bottom for the gold price, that means we will see a surge in gold in the next few months.

Chart 2: Bloomberg Commodity Sentiment Gold Bullish Readings

To confirm that the gold price is nearing a bottom, we can look at the daily sentiment index for gold miners on the site Stockcharts.com. The ticker is $BPGDM (Chart 3). As you can see, the gold mining sentiment is approaching a bottom under 30 and this should be a positive indicator for the gold mining industry.

Chart 3: BPGDM (Stockcharts.com)

To prove that the correlation works I will compare Chart 3 with the gold miners ETF (GDX) Chart 4. We notice that each time the index goes below 30 on BPGDM, we have a short term bottom in the GDX. Every time the BPGDM index goes above 70, we have a top in the GDX.

Chart 4: Gold Miners ETF (GDX)

The conclusion is that we have a very powerful tool here to mark tops and bottoms in both the gold price and the gold mining industry valuation. I would use these tools to execute short term trading. For example, every time the index goes below 30, you buy the respective security (gold or gold miners) and every time the index goes above 70, you sell the respective security. It's as simple as that!

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Status on the CRB Index

Just recently, sentiment in the commodity market has been positive. Capacity utilization improved, the CRB index started to move upwards, chances on QE3 are improving, the dollar index moves into a top formation. In this article I will discuss the prospects in each sector of the CRB index.

On Tuesday 17 July 2012 the capacity utilization rate came in at 78.9%, up from 78.7% the previous month. As I noted here, the capacity utilization rate is a leading indicator for inflation. This inflation will start to be visible next year as there is a lag between the capacity utilization rate and commodity prices.

The different sectors in the CRB index composition are: petroleum, agriculture, metals and natural gas. I will analyse them one by one in this article.

Chart 1: CRB Index

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Baltic Dry Index Reacting to Iran Oil Embargo

Since Europe banned crude oil imports from Iran on 1 July 2012, the Baltic Dry Index has shot up 10% already from 1000 to 1103 (Chart 1). The reason for this spike isn't because Europe is banning crude oil imports from Iran, but rather the consequence of it. Due to this ban, Iran has renewed its threat to close the Strait of Hormuz. Approximately 20% of the world's oil, which is about 35% of seaborne traded oil, passes through this strait. As this strait is closed down, commodity transport vessels need to make a detour, which will increase the price of oil and increase the tanker rates. The availability of tankers will go down due to this forced rechartering of routes, which will decrease oil supply. As a consequence oil tankers will store oil in anticipation of rising oil prices and this will be beneficiary to the tanker industry. On 4 July 2012, the situation even got worse, with Iran threatening to strike 35 U.S. military bases within minutes. We will see that these events will be beneficial to the Baltic Dry Index and oil prices in general.

To read the full analysis go to my article here: Frontline: How to Profit from the Iranian Oil Embargo.

Chart 1: Baltic Dry Index

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