Just think what the last five years would have been like without the real estate boom. Forty-five percent of US economic activity would never have occurred. We would have never seen the $20 trillion bubble that kept our economy afloat. Without the Fed induced liquidity binge we would at best had a serious recession. As we can see the affects of that monetary madness is coming to an end, and we will resume our decent into recession, which we entered almost a year ago. The stratospheric real estate prices are dwindling – the bubble has burst.
The prop under the US and world economies are being removed. Interest rates have climbed some four points, excess liquidity still flows from the Fed and elsewhere, the psychology of ever-higher prices has been broken and the wealth effect is disappearing. Consumer confidence is slipping as the public realizes the game is over. In spite of a strong service sector layoffs are building as a result of a contracting buildings and real estate industry and free trade and globalization. A double whammy.
As we have seen from recent statistics real estate related jobs such as brokers, mortgage workers, appraisers and construction works are disappearing. One-third of all jobs created over the past five years have come as a result of the real estate boom. As this transpires consumer spending and confidence have fallen as well. This leveling and decent of housing prices will cause growth to fall to 1.5% or less in the coming year in spite of increases of money and credit of more than 14%.
For Sales signs continue to proliferate which is a serious situation because the wealth of consumers lies mainly in the rising values of their homes, as well as their mortgage equity withdrawals. A major decline in housing will affect the entire world economy. Many see the value of their home as their retirement savings. This perception is already dimming as tens of millions of homeowners begin to cut back on spending. If you add to this situation that consumers have no savings and are buried in debt, you have an explosive situation in a downturn. Let us also not forget inflation as prices rise relentlessly higher.
As reported some time ago, homebuilder confidence is the lowest ever and dealer car sales as a barometer of economic well being are at recession levels. This is the same pattern we saw in May 2001, in spite of manufacturers virtually giving cars away to clear mounting inventory.
Wall Street, the Fed and our government continues to pooh-pooh the inverted yield curve, but it has been that way for five months consistently. As we write the inversion spread is 20bps, which is gigantic. An inverted yield curve takes place when the two-year Treasury note yield is higher than the ten-year note yield. That means in January recession will officially begin, when in fact recession began last January. Be as it may, recession is here and it has a long time to go. This year that is approaching and the years after will see a doubling of home payments as borrowers watch their mortgage payments double. That will be accompanied by house price declines and higher unemployment. The employment picture will be serious. Over these past several years housing directly and indirectly created 30% of employment. If just 40-50% of those employees are let go we will have major unemployment. Most of the jobs are higher paying construction jobs, which create two problems. On is a majority were held by illegal aliens who average third grade educations and are not easily employable and the new service jobs available pay 50% less than the jobs being replaced. That means consumption is going to plunge. Americans are and will continue to be in denial regarding the changes in real estate values. This simultaneous decline has not happened in the US since the 1930s. There are only a handful of Americans left who can remember that ordeal. There were 30 hotspots across the country and they are all going to get hit fast and furious, and it has already begun. That is some 70% of the housing stock in the country. The Chicago Merc has a housing futures market index that indicates that housing will fall in value nationally for the first time in 75 years. This of course will trigger a very large number of foreclosures and bankruptcies, which will expedite the fall in housing prices and slow the economy further. Late mortgage payments are already over 12.5%. The worst damage thus far has not been caused by falling house prices, but by free trade and globalization. They are the aftermath of the fallout of vehicle production and supporting industries in Detroit and all of Michigan, Ohio, Indiana, Illinois, Alabama, Tennessee and West Virginia. These are areas that generally speaking house prices didn’t boom.
That means the negative affect of default on mortgages has yet to be felt in the 30 former hot areas of the country. Twenty-five percent of mortgages carry adjustable rates, and more than 50% of those loans are sub-prime. People who put nothing down and should have never had a loan in the first place. Calls to the Homeownership Foundation are up over 25%, a record. More than 50% of the distressed callers have ARM loans. In 18 states more than 15% of homeowners with sub-prime ARMS were late on payments.
Foreclosures are like a funnel cloud; they tend to create their own downward spiral once they get started. The whole psychology of the market changes in a housing market down cycle. Fear now dominates the market. Demand falls because people expect prices to be less tomorrow than today. There is little urgency to buy. Making matters worse, lenders who have a large number of foreclosures on their books will try to recover whatever they can, often by under pricing the market. That further depresses retail prices; causing more and more sellers to have negative equity on a home they want to sell. This, in turn, causes more foreclosures, puts more pressure on the lenders to dump properties, and puts more downward pressure on prices. It is a vicious cycle that feeds on itself.
Who is to blame for this problem? The Fed via the lowest interest rates since the 1930s, endless money and credit and no control over loan qualifications. The banks, S&Ls and other lenders such as Fannie Mae and Freddie Mac that threw lending caution to the winds and gave mortgages to anyone who could make his mark on a contract and lie about his income. Then in a class by themselves are the real estate agents. They created a financial death trap for one-third of all borrowers. Over the next 18 months more than $2 trillion of these loans will be re-priced and new monthly payments will be 25 to 100% higher. Most won’t be able to afford these higher payments and they will be forced into another exotic loan or go into default. If you do not have equity or cash to the equity you cannot refinance. Many will just walk away and that triggers debt relief. When a home is sold for less than is owed, it creates what is known as phantom income that the borrower must pay taxes on. That will create many bankruptcies. We can thank the Fed, banks and other lenders for this predicament. If you do not think this is serious, look at these numbers: 32.6% of new mortgages and home equity loans in 2005 were interest only, 43% of buyers put no money down, 15.2% of buyers owe at least 10% more than their homes are worth, 10% of all mortgage holders have no equity and that is growing in leaps and bounds. If we include 2006, 2007 and 2008, more than $2.7 trillion of mortgages will have to adjust to higher rates.
If these facts were not enough in 2006, option ARMS-use grew 50% and foreclosures for this type of loan is rising just as fast.
Over the next few years what can we expect? We can see a 40-60% adjustment in house prices in the former hot areas and those estimates are very conservative. In 1991 the REO was selling off real estate at a 70% to 90% discount. The bubble today is greater than at any time since the 1930s. Who gets hit worst? Los Angeles, of course, where only 2% of families can afford to buy the median priced home. They will lose 50% of value and in the expensive homes 50-70%. The financial ramifications are very large but the social fallout will be equally difficult.
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GOLD, SILVER, PLATINUM, PALADIUM AND DIAMONDS
Wednesday gold was off early in the a.m. $7.80. The sellers threw everything at it and it came back strongly after having visited $615. It closed off $1.50 at $622.50, as silver came back from minus $0.40 to close at $12.86, up $0.05 on the day. The consolidation continues to run its course. In the December contracts gold was $623.80, - $1.50, silver $12.95, +$0.06 and copper finished at $3.15, $0,01. The access aftermarket was up $1.30 after having been down $1.20 earlier.
Gold open interest was up 1970 contracts to 356,575 and silver OI dropped 685 contracts to 117,486. The Tocom finished with OI up 1,572 contract equivalents on Tuesday. Combined OI on Tuesday of Comex and CBOT rose 3,441 contracts. On Tuesday Tocom’s big shorts reduced their shorts by 683 contracts to 133,906. Goldman increased their shorts by 60 contracts to 31,781. Silver contracts were reduced by 410 contracts to 2,725.
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Trading in gold in Dubai set a record on Tuesday. Contracts traded equaled $157.42 million. That is up from $122.44 million set in May when gold and silver prices were at 25-year highs.
Gold supply continues to fall behind demand as new reserves fail to replenish old reserves. This has been happening for years and the effect has been masked by central bank selling and producer hedging. However, central bank sales are starting to whither, and banks have become net buyers of gold. Thus, diminishing supply, jewelry and investment demand will keep gold moving higher.
The defective dollar will continue to aid in making gold go higher as gold asserts itself as the only real currency. The long-term health of the dollar is extremely suspect. Then there is the US budget debt and the balance of payments deficit. You can add in the pending Social Security and Medicare crisis and excessive household debt and no savings.
Massive creation of money and credit and higher commodity costs are continuing to cause inflationary pressures all of which put upward pressure on gold prices, because of gold’s inflationary hedge characteristics.
Mine supply will continue to decline for several years and significantly over the next ten years. De-hedging will continue to draw on mine supply. Central banks have at best 5,000 tons of gold left, because thy have sold or leased their gold and it is not coming back even though they hold it on the books as a physical asset.
Investment demand is very likely to continue to increase significantly through bullion-backed securities (ETFS), which are now acting as the people’s central banks. Those holdings currently are as big as the 11th central bank at 585 tons and getting bigger everyday.
We have two occupations and our president wants to attack another country. That doesn’t in the least sound like political stability. Then we have terrorism. Need we say more?
All these factors are coming together simultaneously. Equilibrium has been reached and momentum is to the upside.
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Every time gold tried to rally, mostly off physical buying, it was knocked back down. We don’t see gold staying down for much longer though. Housing starts were dismal and that kept the elitists from pushing the Dow much higher. It should be noted that many are finally believing that government statistics are all bogus and cannot be relied upon anymore. The dollar took gas as soon as those housing starts hit. Gold open interest fell 2,138 contracts to 354,317, while silver contracts rose 728 to 119,243.
The COT report showed spec longs increasing by 5,501 and they reduced their shorts by 2,167 contracts. The commercials increased longs by 9,004 and reduced shorts by 18,069. That means we were correct in assuming that the commercials would cover at $615, and they did. This is why you have to have patience in this game. The small specs increased longs by 1,525 contracts and reduced shorts by 128 contracts. There is a rumor that another hedge fund is in trouble. After the COT report we see gold rearing to go.
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