Commodities did spectacularly well from winter 08-09 to winter 09-10. Many tripled in price, such as oil, copper and palladium. The world seemed convinced that another great phase of inflation was underway or would start real soon now.
The reality is that demand is anemic and that there has been little or no economic growth. The only exceptions are property bubbles in China, Australia and Canada that are just running on fumes, where America’s was circa 2006. The commodity bounce was purely a technical reaction from an extremely oversold condition, exacerbated by mistaken faith in Keynesian policies deployed worldwide. The rally began to stall out from mid-autumn to this March, and is now starting to roll over in force.
Here’s a 3-year chart of copper, a very liquid and widely followed market. Many believe it is an economic guage, but this is nonsense IMO, since it was trading well under a dollar as the economy was booming a decade ago, and like a lot of other commodities was very expensive in the stagnant 1970s (and right now of course). Prices are driven first and foremost by fads. Why else would you expect it to trade at $3.50 in the middle of a deflantionary depression when stockpiles are huge?
I don’t like to brag, since I get plenty of timing wrong, but back in April I noted the divergence in RSI and MACD right as copper made its top around $3.60.
Another favorite guage of risk appetite is the silver:gold ratio, which has remained stalled for the better part of a year now, and looks set to decline again:
Also check out the palladium:gold ratio, since palladium experienced a major speculative bubble lately which has started to crash very hard:
Here’s oil, West Texas Intermediate… in all of these commodity charts, note the severity and unrelenting nature of the last drop in 2008. There were few rallies where one could safely get on board for a short sale — you were either short from the top for the ride of your life or just had to watch.
I’m not expecting a lot of chop in these markets. I’d love a nice rally here to increase short positions, but it’s not the nature of commodities to take their time on the way down. Traders had months to see this trade coming and set up shorts, but for those who don’t over-leverage themselves it is by no means too late to get on board.
By the way, the commodity currencies (Australian, New Zealand, Canadian dollars, Brazilian Real and South African Rand) have also started to fall hard but have a long way to go to correct their rallies from last winter.
Want to see one commodity market that we’re definitely not too late to short? Gold and silver mining stocks (GDX ETF below). The gold bugs have been extremely confident and their ranks have swelled lately, so a deep set-back is much needed in this sector. After all, mining stocks often have a greater correlation with the S&P 500 than with the gold price (which I expect to fall, though not as much as stocks).
Ironically, I’m part of a group that’s building a huge database and stock screener in this space, called the Mining Almanac. Launching our beta site right at the top of a commodities bubble couldn’t be worse timing, so I’m trying to make lemonade and using it to search not for value stocks (what I designed it for) but the opposite so that I can short them!
For safety, don’t buy gold stocks, which are a financial asset with value contingent upon stock market conditions, tax laws (seen in Australia lately as their leftist government has slapped an extra tax on the mining industry) and myriad operational concerns. Along with plenty of cash and treasury notes, buy gold itself, either stored in your name in a vault oversees or in your personal posession. Gold is money, and in a deflationary depression with undertones of currency crisis, you want the very best.
Just when you thought your respect for economics PhDs couldn’t get any lower, a professor at the top-ranked University of Chicago, Casey Mulligan, is making the case in the New York Times that there was no bubble in housing:
Adjusted for inflation, residential property values were still higher at the end of 2009 than 10 years ago. This fact raises the possibility that at least part of the housing boom was an efficient response to market fundamentals.
Inflation-adjusted housing prices and housing construction boomed from 2000 to 2006 and crashed thereafter. Commentators ranging fromPresident Obama to Federal Reserve Chairman Ben S. Bernanke have described that cycle as a “bubble,” by which they mean that, at least in hindsight, the housing price boom was divorced from market fundamentals.
But maybe there was a good, rational reason for housing prices to increase over the last decade.
Let’s consider first what it means to believe that the spike in prices since the late 1990s was unwarranted — the so-called “bubble theory.”
According to the bubble theory, for a while the market was overcome with exuberance, meaning that people were paying much more for housing than changes in incomes, demographics, technology and other basic factors would suggest.
Now that the bubble is behind us, people today should be no more willing to pay to own a house than they were in the late 1990s. (It’s true that population has grown since the 1990s, but population growth is nothing new and should not by itself increase real housing prices. Don’t forget that greater population also means more people available to do construction work.)
Yet, the professor points out, house prices are still well above 1990s levels:
Ok, so his basic point is that because housing prices haven’t yet declined to 1990s levels, there was no bubble. He doesn’t consider the obvious alternative: maybe prices don’t move in straight lines and that the sideways action in 2009 was the result of an $8000 tax credit and general upswing in market optimism (as seen in stocks and commodities).
Maybe, just maybe, as in Japan after 1989 and the US after 1929, housing prices will decline in a herky-jerky fashion for many years after the peak.
Mama, don’t let your babies grow up to be economists. They’ll never stay smart and they’re always confused.
In other bizarre housing news via patrick.net, some real California estate foreclosure prevention scammers were tied up and tortured after they ripped off another team of real estate rip-off artists.
Forget the middlemen – the real criminals are those who betray their oaths of office.
Via the Motley Fool, here is an email from someone inside John Paulson’s hedge fund:
It is true that the market is not pricing the subprime RMBS [residential mortgage-backed securities] wipeout scenario. In my opinion this situation is due to the fact that rating agencies, CDO managers and underwriters have all the incentives to keep the game going, while ‘real money’ investors have neither the analytical tools nor the institutional framework to take action before the losses that one could anticipate based [on] the ‘news’ available everywhere are actually realized.
Eric King always does a good interview, and Bill Laggner is a hedge fund manager (Bearing Fund, LP) who has been on top of the credit bubble and bust. He comes at things from an Austrian perspective.
- People of wealth around the world have lost faith in their respective governments.
- There is a limit to government borrowing, but establishment economists and politicians are very complacent right up to the end.
- Goldman’s swap transactions on Greek debt.
- Good luck getting Greece to go from 14% deficit to 3%. Mathematically impossible — Greece must default like Argentina did in 2001. They’ll probably leave Eurozone, and this may be best for each of them.
- Portugal, Ireland and Spain face the same issue. Spreads blowing out. Puts heavy pressure on European banks.
- Politicians and talking heads are saying sovereign debt issue is contained, just like they said sub-prime was contained.
- European banks are at least as levered as US banks were two years ago.
- We’re at a juncture where we can print and delay or default and get it over with.
- Some countries may realize they are better off defaulting than taking IMF money and being slaves.
- GS people have been hired by Greek government to advise on bailout.
- Monetary elites like GS face a risk of the structured finance business, their bread and butter, disappearing.
- GS and others don’t produce capital. They speculate and then siphon money from taxpayers when they lose.
- Goldman’s proprietary trading book is highly lucrative, much more so than most other investment banks’. They make money over 90% of the time – how is that possible if it’s all honest?
- Goldman was a credit facility for New Century, one of the worst loan originators in sub-prime. We’ll find out more about their roll in helping build a market for junk mortgages. Possible exposure of fraudulent practices.
- Goldman sold a lot of this mortgage paper on leverage — they provided loans to funds to let them go levered long CDOs.
- Civil litigation will open up Pandora’s Box. Where there illegal activities within Goldman? Possible reputational risk. If they survive, they’ll be a shell of their former self.
- US has the same problems as Europe. US cities and states are just as bankrupt as Greece.
- Local politicians are corrupt and clueless and bankers took advantage of them, as in Jefferson County Alabama.
- Criminal proceedings in Italy against Deutsche Bank should provide insight into possible bribery and fraud related to derivative transactions.
- Expect litigation related to US city and state derivative transactions, as in Jefferson County Alabama.
- Expect increased outrage towards bankers.
- No transparency in US financial system.
- As states and cities go bankrupt, expect them to default on derivative transactions and enter litigation.
- (My own note: what about government employee unions? If you’re looking for an explanation for municipal and state bankruptcies, look there first.)
- US financial reform bill doesn’t solve anything. Still have the moral hazard of too-big-to-fail.
- Geithner is walking moral hazard.
- Amazing rally in risk assets over the last 14 months. Complete about-face in sentiment. New low in bearishness.
- Bill and partner Kevin Duffy are two of the few remaining bears left on the planet.
- VIX is ticking back up, Fed has ended a key lending program, sentiment is too extreme, leading economic indicators are rolling over. Stimulus will wear off like any drug, and there has been nothing done to sustain economy.
- If central banks hit the accelerators on their printing presses to bail out bankrupt governments we could enter a hyperinflationary mode. If we go the route of default, that could be avoided (deflation).
From the National Times:
WHEN house prices soar, you can hear the silent cheering all around you. Most of us own homes, so rising prices increase our notional wealth. They mean someone else will have to pay us more in future to buy our homes.
Market analysts and the media bombard us with data on what are the ”best-performing suburbs” – meaning the suburbs where prices rose most. They see it as self-evident that rising prices are a good thing – and the higher, the better for us.
Well, sorry, but they’re wrong. Rising prices may be good for those of us who own homes – but far less than we assume. And they are not good for ”us” as a society.
Let’s be blunt. No social change in recent times has done more to make younger Australians worse off than the waves of house price rises since late 1987, when Labor restored the tax break for negative gearing.
Since September 1987, the Bureau of Statistics tells us, average house prices in capital cities have risen by 433 per cent. In other words, a typical house that was an affordable $100,000 in September 1987 cost $533,000 by December 2009.
But haven’t incomes risen too? Yes, they have: but by only 195 per cent. So if a typical household had a disposable income of $30,000 in September 1987, it has risen to $88,500 now. (There are no figures for median household disposable incomes, but these are in the right ball park). The cost of a typical home, in this example, used to be 3.33 years’ disposable income. But now it costs six years’ income…
…Rising prices are inflation. We don’t think higher petrol prices or higher fruit prices are a good idea, although they certainly make someone better off. Why do we think inflation is such a good thing when it applies to owning a home?
This is one area of policy where government intervention has made things worse for the group they say they want to help: aspiring home owners. That is clear from the sharp fall in home ownership among younger age groups (indeed, among all age groups under 55). (cont…)
The author makes some good points, such as calling asset prices inflation (they are indeed a symptom of inflation, an expansion of money and credit), but he doesn’t seem to get that prices can form bubbles and crash without any changes to the tax code or the traditional supply/demand curve. What matters is cheap credit made available by the moral hazard extended to banks by the existence of a central bank and its ability and willingness to print gobs of money and bail them out.
Break up the cartel and allow a free banking system, and bubbles would be localized and contained by bank runs and the mere risk of bank runs. Bankers need the “fear of God” as on old-time chairman New York’s Chemical Bank put it when asked how he managed to redeem his notes in gold and silver through panics that sank so many others.
City and state government workers were huge beneficiaries of the boom years, since not only did their houses appreciate by double digit rates, so did their salaries. Since taxes are based on home values, the bubble meant that government got just as bloated as the real estate market. Now that homes are worth less, it is in bureaucrats’ best interest not to admit it.
This story comes out of Nevada, but it could be anywhere.
Don came to the lectern and leaned into the microphone, a resolute, if rumpled, man with thick white hair, a Col. Sanders mustache and glasses.
“Before we came down here,” he told board members, whose faces were mostly hidden behind computers, “we drove around. There are 10 foreclosures within a mile of my house!”
Don mentioned the home that sold for $132,000. Board member Tio DiFederico, a commercial appraiser, had some questions: Was that a bank sale?
“OK, it probably wasn’t in very good shape.”
“Actually, I was in that house. It was in fairly decent shape.”
DiFederico wasn’t swayed. “We’ve discussed this before — these bank sales sell for about 25% less than owner-occupied homes. They need to get rid of them faster.” He suggested the Knights’ home was worth $140,000.
In the audience, Janet grimaced. Still too high.
“The problem with short sales and foreclosures is they always go submarket,” said board Chairman James Howard, in a somewhat conciliatory way. “And if you try to set your values based on those short sales and foreclosures, you’ll always be a little bit low.”
The Knights lost on a 4-to-1 vote. The house’s value was set at $140,000.
“I’m sorry we weren’t able to help you today, sir,” Howard said.
The story says the home in question could have fetched well over $300,000 at the peak.
According to Bloomberg, the big bears are circling China.
Marc Faber, publisher of the Gloom, Boom & Doom Report, says China is overdoing it. “It does not make sense for China to build more empty buildings and add to capacities in industries where you already have overcapacity,” Faber told Bloomberg Television on Feb. 11. “I think the Chinese economy will decelerate very substantially in 2010 and could even crash.”…
…The costs of wasteful investments in empty offices and shopping malls and in underutilized infrastructure will weigh on China, Chanos, president of New York-based Kynikos Associates Ltd., said in a speech at the London School of Economics. “We may find that that’s what pops the Chinese bubble sooner rather than later.”…
Risk for Commodities
Last month, banks lent a further 1.39 trillion yuan — almost one-fifth of the target amount for the whole of 2010. Also in January, foreign direct investment climbed 7.8 percent to $8.13 billion. Retail sales during last week’s Lunar New Year holiday rose 17.2 percent from the same period in 2009, according to the Ministry of Commerce.
While China’s resilience has helped support the world economy, raising demand for energy and raw materials, the bursting of a bubble would have the opposite effect. Government efforts to wean the economy off its extraordinary support may roil markets.
In January, the central government ordered banks to curb lending, which put China’s stock market into reverse. In a sign, in part, of how dependent the world has become on China, stocks and currencies slumped in places such as Australia and Brazil that supply commodities to the People’s Republic. On Feb. 12, the eve of the one-week Lunar New Year holiday, China for the second time in a month ordered banks to set aside more deposits as reserves. The Shanghai Composite Index has fallen 8 percent year-to-date, after gaining 80 percent in 2009.
Bidding Up Prices
“If the Chinese economy decelerates or crashes, what you have is a disastrous environment for industrial commodities,” said Faber, who oversees $300 million at Hong Kong-based Marc Faber Ltd.
The stimulus tap that Beijing turned on has flowed to projects such as its 2 trillion yuan high-speed-rail network. The 221 billion yuan Beijing-Shanghai line has surpassed the Three Gorges Dam as the single most expensive engineering project in Chinese history.
Some beneficiaries of the government efforts have plowed their loans into real estate and stocks. Property prices across 70 cities jumped 9.5 percent in January from a year earlier, according to government data.
…Chanos, a short-seller who was early to warn about Enron Corp., is one of a growing number of investors sounding the alarm. “Right now, the Chinese market is overheating,” George Soros said in a Jan. 28 interview.
Wait, I thought Soros was a Keynesian. Isn’t printing and spending the way to perpetual prosperity?
Another example Chanos has cited is the city of Ordos, where party officials have built an entire new downtown on the windswept grasslands of Inner Mongolia, 25 kilometers (15 miles) outside the existing municipality of 1.5 million people.
Ordos is really comedic. Check out this video:
5-year view of the ASX 200:
Australia has a huge property bubble that has yet to burst. The average home there, at AU$502,492, is priced at eight times average household income, compared to about three times income at the height of the US bubble (though higher in places like California and Florida). This is a country with a population density of just 7.3 per square mile, compared to 83 for the US!
Aussies are still in the denial stage, which says a lot about the nature of group-think, since they can look at the rest of the world and see the exact same dynamic at play, though a couple of years ahead.
China appears to be in about the same place, with prices even more out of whack with incomes and rents, twice as overvalued as the most overvalued California houses in some cases. Australia and China also have plenty of froth in their equity markets, though those resemble the US and the rest of the world.
What would happen to Australia if housing prices, stock prices and commodity prices all collapsed at once? Come to think of it, Canada is in a very similar position, and their housing bubble, while not as wild, has still yet to deflate.