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China Throwing Factories a Bone??

I almost fell out of my chair this morning when I saw a report from the China Securities Journal that the Chinese government may raise tax rebates for apparel exports from 11% to 15%. Definitely a positive gesture, and one I need to consider as it relates to my 'sourcing margin squeeze' thesis. But the bottom line is that this does not come close to moving the needle.

Aside from the narrowing trade gap, the impetus for this move appears to be that Premier Wen Jiabao and his top economic leaders visited major exporting provinces over the weekend, and saw first hand the impact of regional business challenges (quake, floods) as well as rising wage and raw material costs.

Do you think that maybe they should have thought of this before cutting the VAT tax rebate, and then subsequently mandating earlier this year that factories in key regions pay employees back-pay for vacations?

Remember that there were about 4,750 footwear factories in the Guangdong province earlier this year, and that 2,331 of them have closed due to these cost pressures. Perhaps they're showing some regret for the number of factories they put out of business.

Unfortunately, footwear gets no relief here, as these tax rebates in question apply to apparel only.

But even for apparel, we need to do some math. The cash freed up in the supply chain due to these changes equates to about $0.45 on a $100 garment. We need to see 3-4% pricing power to offset cost pressures. Aside from the fact that China accounts for just short of 40% of our apparel imports (vs. 85% for footwear), this is simply not enough to move the needle.

EYE ON COMMODITIES - CORN and WHEAT

  • Corn"The Organization of the Petroleum Exporting Countries is taxing the industrial world into a global depression and Big Oil is behind this year's vicious assaults on corn-based ethanol. The world's largest ethanol conference began with those blunt messages last week here in Music City, USA, where nearly 4,000 people gathered for the 24th annual International Fuel Ethanol Workshop & Expo (FEW), a BBI International event" -Biotech Week G8 climate change agreement includes language about goals to set international benchmarks on biofuels, a move that could require US corn producers to scale back on production for biofuels. The Guardian
  • WheatThe Australian press is reporting that durum wheat prices are on the rise despite a big worldwide crop. Strong demand internationally, particularly in the US, is pushing prices higher. The primary use of durum wheat is to produce pasta.

Copper Is Breaking Down Again: What Does It Mean?

Dr. Copper's class was back is back in session yesterday as indications of loosening current and future supply inspired selling.

Reports that striking workers are returning to the mines in Peru, combined with the return of law and order to Mongolia's capital (with opposition leaders acknowledging that the recent elections where fair, for the most part...), has provided a fundamental backdrop for committed selling in the futures market over the past 24 hours (see chart).

Copper has remains a fascinating leading indicator for me to analyze. On one hand, copper breaking down assures me that Asian economic growth is slowing, which is ultimately deflationary. On the other hand (supply side), copper's June ascent amplified the reality that this brave new interconnected world cannot absorb supply shocks, which is ultimately inflationary.

At this spot price, copper is breaking down. Class dismissed.
KM

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ECB Rhetoric Raises A Fist!

Italian central banker, Mario Draghi, flashed Bernanke and Co. a victory fist this morning as he pointed to the ECB's recent vigilance on inflation fighting as being responsible for this week's drop in commodity prices.

The ECB raised rates last week and this, of course, is what the governor of the Bank of Italy is alluding to in terms of the efficacy of European timing.

European and Australian central bankers continue to have this right. Their respective currencies are the current "Kings" of the foreign currency market, as a result. King Dollar is nothing but a historical name that used to actually mean something other than lip service.

The US Peso is wallowing again this morning, stoking inflation, on the heels of helicopter Ben Bernanke assuring investment bankers yesterday that he is there to bail them out.

KM

One for the Gipper! Weekly Consumer Data Finds Some Light...

Ronald Reagan played the "Gipper" in his 1940 film, "Knute Rockne: All American". By the time he was President of the United States he was equally as inspirational, empowering a consumer spending revolution.

Not all movies end well, and this week's consumer data doesn't change our view of the negative consumer spending "Trend" that is emerging. That said, we have to call the data like it is, and this week we saw upticks in two important readings:

1. The weekly ABC/Washington Post Consumer Confidence # came in at -41, higher than it's all time lows, and up from -43 last week

2. MBA Mortgage Applications accelerated +7% this past week. Again, that's certainly better than the toxic readings we've been getting.

KM

Rally to Zero

Today's late-day rally did wonders for apparel/footwear retail. The sell-off in the CRB and supportive comments from the Fed came at a good time for the group - which is trying to figure out how to be positioned in advance of same store sales this Thursday. I'm not one for predicting the primal reaction of this heavily-shorted group when numbers come out, but I can analyze the facts. The facts are not encouraging.

One of the most notable is in looking at the RTH versus the S&P in the periods leading up to sales day over the past 12 months. There are three key takeaways.

1) The stability of the RTH this month has been surprising. There has not been a month in over a year where we have not seen anything less than a 2% relative performance gap from one sales day to the next. This time, we are sitting at zero.

2) With everyone freaking out about the consumer, I'd have thought the market would be discounting more bad news. Maybe the market is looking at the earnings revision chart I posted earlier today and is assuming that most revisions have already passed. They probably did not read the second part of my posting that talked about earnings expectations still being 1,000bp+ too high.

3) The May comp reported 5 weeks ago came in at 3.1% based on my math. While little changed sequentially, this represented a 220bp improvement in the 2-year run rate. It just so happens that to maintain this 2-year rate, we need to see a 3% comp out of the industry this Thursday. Let's hope that the consumer is spending more than recent newsflow suggests.

The Exhibit shows the RTH relative to the S&P 500. Recent stability is very surprising.

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