Stockscom Report for Sunday May 23 2004

Publisher: Colin Alexander Editor: Ken Wilson

Subscriptions and Administration: Pierre Fichaud (toll-free: 866-487-9711)

• Metal stocks coming back?

Market Synopsis

Inflation has become the key to further recovery and despite what many readers expect, we’re not referring to the price of oil, the price of commodities, the price of housing and all other sundry items whose price has crept higher over the past twelve months. No, the Federal Reserve has successfully reflated all manner of prices, kept short term interest rates low so that American consumers could continue the buying spree and has been instrumental in increasing the percentage of people who own their homes. But they have failed in one key area – there is enough spare capacity in the system, enough job competition that inflation has yet to affect wages. In fact, it is no small irony that the reason for a lack of wage inflation is ultimately, globalization, a concept espoused by all free-market adherents. Even with the tremendous job growth of the past three months, the competition for labor has been modest and without much faster growth in employment, this house of cards is doomed.

The lack of wage inflation becomes a problem when inflation in prices is imposed on people who are ill-prepared for the reduction in purchasing power. With the last of the Bush-administration tax cuts winding its way through the system and a certain finality to the wave of mortgage refinancings that have nourished the wallets of eager homeowners, there is no longer a possibility of increasing one’s funds available for discretionary spending yet prices continue to ratchet higher, thereby reducing the amount that consumers can purchase at the margin. Notwithstanding the potential number of delinquent borrowers who suffer with repayments of debts under a higher interest rate environment, there is a much larger problem with regular consumers who wish to make their regular purchases.

We find ourselves at a critical juncture where the underlying belief is that the interest rate cycle will shift to rising rates once the Fed meets in late June. The treasuries have already priced in an increase of a quarter point and the Fed has done nothing to dissuade bond traders of that potential. By most accounts, the Fed is telegraphing its position in order to properly prepare the market for the inevitable, which is exactly what it’s supposed to do. (Strangely, on Friday Dr. Ben Bernanke, a voting member of the Federal Reserve, spoke and though Fed-speak is difficult to interpret at the best of times, he seemed to be back-tracking to a certain degree on the question of a rate hike in June saying that economic data would dictate the speed of rate hikes.)

Now some companies will choose to absorb the extra costs and thus resolve themselves to a profit squeeze as their margins shrink while others will attempt to pass on the extra costs to the consumer. But a squeeze in profit margins will make y-o-y comparisons deleterious to their share prices. Judging by the most recent inflation data, it is no longer the raw materials and intermediate production that is affected most and while the data is not conclusive, the final products are now being affected. We can draw two conclusions from this development. Profit squeezes will be seen in the income statement and large scale hiring is not likely to occur as companies continue to drive out productivity gains as the final recourse in stabilizing or improving margins.

We have refrained from mentioning oil prices to this point only because with OPEC now openly discussing increasing production quotas, an effort actively endorsed by Saudi Arabia, there is a very good chance that the price of oil will settle lower over the next few months. Just the mere discussion and agreement of substantial increases in production will be sufficient to initiate the drive lower of the price of oil on futures markets and essentially remove that potential inflation from the list. Naturally, this scenario will only function properly if larger supplies begin showing up in the weekly inventory figures.

The scent of higher inflation is already affecting equities as they wrestle with ideas of lower future returns and likewise the long bonds have been priced lower as a result. Where we see potential is with metal stocks, which have been sold off in recent months corresponding roughly to the rise of the US dollar. Now these metal stocks have bottomed while the US dollar has possibly plateaued and a favorable bounce would appear imminent in the metals. For the rest, there are pockets of strength, however the markets are likely to be grinding lower in the near term and quite likely until an autumn low develops.

New Buy Recommendations:

Pan American Silver (PAAS #) – this is one of the metal stocks that we consider to have bottomed in the current cycle. In recent days, it has traded below its 200-day moving average but held above its 40-week moving average, a key area of support. Moreover the retracement from the top has been approximately 60%, a level consistent with support in a bullish rally. PAAS has an overall cash cost of $3.83 and with the price of silver edging back higher, the opportunity for increasing profits is greater.

Inco (N #) – a similar case is made for Inco the largest nickel producer in the world. Despite the slowdown in China, the need for stainless steel continues to grow. The chart is identical to PAAS in many respects, namely the support at the 40-week moving average and the retracement of approximately 60% from its peak.

Jetblue Airways (JBLU) – this one may look unusual on the surface but indeed makes sense. Assuming that the price of oil drops, one sector sure to leverage that drop in cost will be the airline industry. JBLU is arguably the best run airline at this moment (though fans of Southwest Airlines will surely protest) and consistently has a large profit margin, which for airlines is a feat few can attest to. The chart already has shown upward momentum since bottoming in March and the outside week this past week is a powerful statement of its strength.

New Short Sales

None.

Stock Positions to Sell/Exit:

None.

Portfolio Comments:

Consol Energy (CNX) – We are watching this share price carefully for though they mostly mine coal, the share price is acting in ambiguous fashion as if it were unsure whether to be bought or sold.

Transcanada (TRP) – This is another energy firm that we are paying close attention to given the weakness in all energy stocks.

Gold stocks – Much like the metal stocks added in our recommendations, we also believe that adding to positions in WHT would be a recommended course of action. We are hesitant about recommending the same for GSS if only because it is currently at a loss and we normally make it a point not to recommend adding to losing positions.

New stops have been added to the list while others have been modified. Those that have blanks, are being carried unstopped for now. Please see our complete list of stops in the table below.

List of Current Stock Recommendations:

Action Ratings. The following is the legend for designating immediate action
for our stock recommendations. The first is B, meaning the stock is timely
to buy but the case for doing so right here is not overwhelming. Either the
stock may have gotten ahead of itself and may be vulnerable to a retracement or
else the stock has been performing disappointingly but may simply be
regrouping. B+ and B++ indicate stocks for which there is a technical case
to buy now, with plusses adding weight according to how many there are, up
to a maximum of two. Stocks rated H are ones to hold, awaiting confirmation
to buy more or to sell. SELL, of course, means what it says. It seldom pays
to override this designation. In the case of stocks held short, the rating is S where positions should be retained. S+ and S++ indicate stocks for which there is a technical case to add to the positions with plusses adding weight similar to long positions. The maximum number of plus signs is 2.

Stocks marked # are eligible as Canadian content in Canadian RSP funds. Otherwise there is a 30 percent restriction on foreign stocks held in these accounts.

Date of Entry	Name	Symbol	Entry Price	Current Price	Stop	Action Rating
03/01/04	Consol Energy	CNX	27.50	28.24		H
04/08/04	Golden Star Res.	GSS #	6.88	5.09		H
04/26/04	Integrated Silicon	ISSI	17.15	14.12		SOLD 05/17/04
04/26/04	Perrigo	PRGO	22.00	19.15		SOLD 05/17/04
03/08/04	Transcanada Corp	TRP #	21.34	19.98		H
11/03/03	Wheaton River	WHT #	2.36	2.75		B+

Short sales

Date of Entry	Name	Symbol	Entry Price	Current Price	Stop	Action Rating
05/17/04	Citigroup	C	45.02	45.34		H
05/17/04	General Motors	GM	43.55	43.08		H

New stops in BOLD

* Stop on a closing basis

** Buy if above entry price