Red-Hot Resources: The Bear Necessities

Commodities were flattened today, largely because of a strong rally in the US dollar. When this kind of thing happens, some analysts dig in and hunker down. I like to give myself a reality check to see if maybe I should change my views. Fundamentals haven't changed much. Today we got higher-than-expected producer prices (inflationary) and higher-than-expected retail sales data (bullish for the US dollar).

These seem at odds, so let's take a closer look.

The Commerce Department said Retail sales increased by 1.2% over October 2006, and up a huge 6.3% from November 2006. However, look at rising retail sales in the context of rising prices. November gasoline-station sales increased by a whopping 6.8%, reflecting the increasing costs for energy and refined fuels. PPI release showed producer prices for energy swelled a record 14.1% last month versus October. Wholesale gasoline prices increased 34.8%. Prices of raw materials, known as crude goods, rose 8.7%. Non Gasoline sales at all retailers in November was a more modest increase of 0.6%. Bottom line: The most likely source of sales gains was INFLATION.

A dollar bear looks at that number and says that the Fed can keep cutting rates. A dollar bull looks at it and says that due to inflation, the Fed will have to hike interest rates.

Something else to consider: Rising retail sales data today have increased the chances that GDP numbers for the fourth quarter will be better than previously expected. That kind of economic strength boosts the prospects for the US dollar, helping it rally.

Here's the thing. I don't think the Fed gives a fig about inflation. I think the Fed will keep cutting rates to put as much liquidity into a sputtering financial system.

I’m not the only one who thinks this way.UBS, Deutsche Bank and Dresdner Kleinwort -- the only primary dealers of U.S. government securities to correctly forecast a year ago that the central bank would reduce its target rate for overnight loans between banks to 4.25% -- now say that the Federal Reserve will need to lower borrowing cost to 3.5% to prevent credit markets from seizing up.

However -- and this is the tricky part -- while the Fed may cut rates longer term, if the market believes the Fed is going to raise rates in the short-term, you don't want to bet against it. the market can remain irrational longer than you can remain solvent. Especially when Uncle Sam is willing to step in and throw money at problems.

So let's look at some charts. We'll start with a weekly chart of the US dollar ...