Current Leaders Portend Trouble Ahead

Even in a bear market, there are certain groups and stocks that do well. Sometimes they do extraordinarily well. It's is just as true for this market as it was in previous bad markets. Right now there are several groups that are working very well indeed. I think those groups tell us a lot about what we can expect going forward.

It is no great secret that the U.S. economy is on the edge of a recession, if not already in one. Under such an economic backdrop, the blue-chip staples stocks have traditionally been the leaders. Beer, food distributors, cigarette companies and the like -- companies that sell products that people buy no matter what -- would be the leaders. They are not this time.

All That Glitters
What is hot? Gold, for one thing. Gold itself and the gold mining stocks have been on fire this year. In just the last six months, gold prices have risen about 24%. Gold stocks have taken off as well. Barrick Gold has risen 75% in the last 12 months. Goldcorp is up 60% in the same time frame.

Gold prices traditionally have risen in periods of inflation, not recession. The weakness of the dollar has helped fuel the rise, as have investors who would rather hold a hard asset than depreciating paper assets. The recent rate cuts by the Fed will likely help gold continue to rally in the months ahead.

The price of gold had retreated a little in the last few weeks, but that appears to have had more to do with hedge fund deleveraging than market fundamentals. In the past few days, the shiny metal has resumed its upward march. That really does not bode well for the inflation outlook, in the U.S. or globally.

A Jolt of Energy
Oil and other energy-related groups are also moving upward. Oil has gone up 21% in just the last three months. In the last 12 months, the price of oil has just about doubled.

Apache is up 68% in the last year. Oil stocks have also flown upward. Anadarko is up 59% and Hess has risen a whopping 77%. Gas prices are up 60% in the last year.

Even previously unloved natural gas has gotten into the game recently, rising better than 30% since the start of 2008. As a result, natural gas stocks have joined the party. EOG Resources is up a whopping 76% in the past 12 months. Chesapeake Energy has risen 50% over that time.

Growing Profits
Another area that has given spectacular returns is fertilizer and fertilizer stocks. In the past four years, fertilizer prices have more than doubled. Fueled by increased global demand driven by growing needs for food, feed and biofuel, the companies that produce the various types of fertilizer have exploded. Mosaic has tripled in the past year. Potash is up more than 200%. Agrium , a real laggard, is only up 92% over that time frame.

I talked to a friend who has a farm, and he told me that the salespeople now tell him how much is he is ordering at a particular time. Demand is so strong he either takes what he is offered or he gets none. Global population is continuing to expand. The forecasts I have read say that the demand for fertilizer products will stay strong for the foreseeable future.


So What?
This is wonderful if you have been fortunate enough to be invested in these groups and these stocks. It is much less so if you are an ordinary stock investor. Each of these red-hot sectors historically has negative correlation with the greater indices. When they go up, it is an indication that stock prices as a whole are likely to decline.

The bad news is that they are going up much faster than stocks have been going down of late. The last time we had these types of accelerated moves in gold and energy in a weak economy, the market collapsed in a bear market of historic proportions. In years past, decreased demand from the U.S. would cause price declines. With the U.S. share of global GDP dropping from almost 60% 25 years ago to 25% today, that is not necessarily true. Demand form a developing middle class in emerging markets such as China and Brazil could act to keep prices high while we slip into a recession, truly the worst possible scenario for U.S. consumers and stock prices.

Can the market bottom and move higher even as the economy weakens and prices of key commodities rise? I suppose it is possible, but I am not going to bet my money on it.