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Bells Ringing

Paul van Eeden
Jul 31, 2006

US stocks rallied Friday on news that economic growth was sharply lower during the second quarter. The decline can be attributed to lower consumer spending. Consumer spending makes up more than 70% of the US's GDP, so when consumer spending falls it has a really big impact on the overall economy.

It's no surprise that economic growth is slowing down. It would have been surprising if it didn't. The US real estate market is busy melting down and as I have said many times in the past, the real estate bubble kept the US economy afloat during the past five years.

What is surprising is that stocks are rallying upon the release of weak economic news. The reasoning is that slower economic growth will cause the Federal Reserve to stop raising interest rates and since lower interest rates are generally good for stocks, any news that could mean that interest rates will stop rising must therefore be good for stocks.

They say the stock exchange does not ring a bell at the top of the market. Well, I can hear all sorts of bells ringing: when investors buy stocks because they believe the economy is slowing down it is a sign that we have reached the top of the market.

The news that was widely ignored Friday was that while economic growth slowed in the second quarter, inflation (as measured by price increases) picked up. The government's price index for personal consumption rose to 4.1% after rising 2% in the first quarter. I thought Ben Bernanke wanted to fight inflation -- if inflation is increasing is he really going to stop raising interest rates?

It seems the economy is slowing while prices are rising and that means the Fed is caught between a rock and a hard place.

Regardless, I don't see how a slowdown in the economy can be good for stocks, or for base metals for that matter. But when it comes to base metals I have heard numerous people say that the escalating war will be good for base metals demand. The theory is that the US government will build war machines and that its demand for metals will offset any decline in demand from slower economic growth. I think that is nonsense.

The Third World War is unlike the First or Second World Wars in terms of war machines, and defense spending will not create much demand for metals. During WWII the US had 95,901 tanks, 220,689 fighter planes and 1,446 naval vessels that, in total, weighed about 75 billion pounds. Today the US has 8,290 tanks (8.6% of WWII) and 6,501 planes (2.9%). What they have a lot of, which they did not have during WWII, are missiles -- the US has about 67,534 missiles. But missiles do not weigh that much nor do they require as much metal as tanks or planes. The total weight of current war machines we could identify, including missiles, comes to 9.9 billion pounds. That is only 13% of the metal used in WWII. Today the military spends a lot more money on scientists and engineers and far less money on brute force. The United States will not build a whole lot more tanks, ships and planes since it is more cost effective to build missiles and bombs and since these require insignificantly less metal than the tens of thousands of tanks and hundreds of thousands of airplanes that were built during WWII, I do not think we will see any material increase in metal demand from the current military buildup.

On a different note, I will be speaking at the Resource Investors' Forum in St. John's, Newfoundland in September but unfortunately I will not be able to make to the Las Vegas conference. For more information about upcoming conferences where I will be speaking, please visit http://www.paulvaneeden.com/conferences.php.

Paul van Eeden
email: pve@publishers-mgmt.com

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