-- Posted Thursday, 26 June 2003 | Digg This Article
| HEADLINE from the future: LENDER REALIGNS PORTFOLIO New York: The management of formerly the world’s second largest housing lender announced the restructuring of its portfolio was nearly complete. Ever since the collapse of the U.S. mortgage market major lenders have been moving to aggressively alter their portfolios, acknowledging that the excesses of the past had not enhanced shareholder value. The company said that Gold now represented approximately 40% of the portfolio while performing mortgages stood at 28%. The remainder of assets are mortgages where payments are in default. The CEO said, "Gold continues to perform better than most assets, and with the recent move to above $1,000 confirms the wisdom of our strategy." |
That bubbles burst would seem to be one of those few ideas about markets with which most would agree. That is, except for housing. U.S. housing prices are the only prices that are widely believed to be immune to economics. That accepted article of faith, like those about how the stock market can not go down two years or so in a row, may be about to be tested.
Bubbles are created by too much money being directed into a market in an unreasonable period of time. The stock market bubble, as well as the currently over extended fool's rally, was created by an excessive amount of money chasing stocks. For prices to rise dramatically, a torrent of money must flow into a market. This statement aptly describes conditions in the U.S. mortgage market. Money is the tool of demand to push prices higher. Remember too that the root source of that money is the central bank, or Federal Reserve in the U.S.
Momentum is the manifestation of those shifting flows of money. Rising momentum indicates that money is flowing into a market in an increasing amount. Falling momentum suggests an inadequate flow of money to maintain the previous trend for prices. For those with a mathematical background, this interpretation of momentum compares to the second derivative of the price series.
Momentum tells much about the price trend. Rising momentum suggests that the price trend is vigorous and is rising at a faster rate. Declining momentum is a signal that the price trend is rising at a lesser rate, or losing strength. Falling momentum indicates that the price trend is down.
In the first graph is shown one measure of price momentum for U.S. housing prices. Plotted is the six-month rate of change of housing prices, annualized, as measured by the Freddie Mac housing price index for conventional mortgages. While no measure of house prices is adequate, this measure is preferable to the other measures that are around. In simplest terms, their data base is so large that they are able to capture price changes for the same properties. This index is released on a quarterly basis with a considerable lag.
As is readily apparent in the graph the momentum of the housing market has peaked, and is declining. While still positive, the level of momentum is at the lowest level in fifteen quarters. If not for one data point the current momentum would be a 22 quarter low. Declining momentum also suggests that a market is vulnerable to that unexpected random event that breaks the trend's back and sends prices lower.
To this discussion we now need to bring in Freddie Mac. Is this the random event, the pin that causes the bubble to burst? This author has no inside information on the internal conditions of the company. We probably can all agree that everything might not be what it should be at the company. The firing of the top thee managers would seem to be a fairly strong signal of a situation something short of optimal.
We can also reasonably conclude that this event is somewhat disruptive to the organization's activities. Employees are likely spending a lot of time talking about "things." People spend more time on the phone talking to friends about might be developing. Many are busy updating their resumes. Workers are going to do their job, but certainly not looking for the chance to take risk or stand out. Keeping one's head down becomes the more accepted behavior. A fair guess is that productivity could be slipping some.
The mortgage market in the U.S. is processing billions of dollars of transactions. At the current level of activity the system must operate like an expensive automobile. We are talking about a Ferrari, for example, running over a hundred miles per hour for days at a time. Only an engine precisely tuned can achieve such performance. The event at Freddie Mac is like slipping a tablespoon of sand into the gas tank. No immediate impact is felt on the operation of the car. Gradually the sand causes changes in the internal characteristics of the engine. The impact of the erosion grows gradually, and the performance of the car slumps. A similar set of conditions is now faced by the U.S. mortgage and housing industries.
As the "sand" grates on the effectiveness of the mortgage machine, the amount of money being thrown at housing will weaken. Events at Freddie Mac are that spoonful of "sand," or the crack in the dike if you prefer. A slight tightening twist of the money spigot for the housing market might be another way of looking at it. And note when considering this that mortgages in foreclosure are already at a record high according to 20 June report from Reuters.
Freddie Mac, itself, may not be the cause of the bursting of the mortgage and housing bubbles. These events are just the first signals that the bursting of a bubble is on the horizon. The Federal Reserve can talk all it wants about its deflation delusion, productivity growth, immigrant demand for housing or whatever else it is muttering about on any given day. These mortgage and housing bubbles are on numbered days regardless of what the Fed does with interest rates at the June meeting.
Now, for all you housing bulls out there let us make sure we understand what has been happening. Gold is doing better than housing, and that can bee seen in the next chart. For the past seven quarters Gold has performed better than housing. Forget what you read in the slick magazines and hear on CNBC. Gold is doing better.
Now let us look at the longer term situation, as plotted in the next graph. The good statisticians at Freddie Mac have extended the data on housing prices back to 1970. In this graph is plotted the ratio of the price of Gold to the home price index. A rising ratio indicates that Gold is doing better. A falling ratio means that housing prices are stronger than Gold's price. Recently the ratio passed through a low not seen since the early 1970's, just before Gold exploded upward.
Across the chart is a line which is the average of the ratio. That long-term average is about 3.3 times.
Based on long-term average either Gold should be above US$700, or 90+% higher, or housing prices should be 50% lower. Some combination between the two is certainly possible. But anyway one looks at the situation, Gold is the preferable investment.
While pondering the merits of your Gold and housing investment, consider the attitude of the Federal Reserve. The Fed wants inflation to go up. That attitude means that Federal Reserve policy has a built in bias to make your Gold worth more. The Fed is "praying" for an environment in which Gold would likely prosper.
Based on long-term average either Gold should be above US$700, or 90+% higher, or housing prices should be 50% lower. Some combination between the two is certainly possible. But anyway one looks at the situation, Gold is the preferable investment.
While pondering the merits of your Gold and housing investment, consider the attitude of the Federal Reserve. The Fed wants inflation to go up. That attitude means that Federal Reserve policy has a built in bias to make your Gold worth more. The Fed is "praying" for an environment in which Gold would likely prosper.
As the bubbles collapse, the U.S. economy will weaken dramatically. The dollar bear will become bolder. Domestic economic conditions will worsen. A reinforcing process will develop, enhancing Gold and punishing those invested in mortgages and U.S. housing. Gold sure looks like a better situation than investing in U.S. housing.
The Gold market apparently understands the situation well. As shown in our last chart, Gold is trading only a few percent below the closing high. Excessive optimism in the equity markets is pushing Gold to an attractive, over sold condition. Any price weakness that develops during a period of extremely high equity market optimism and when Federal Reserve policy is positive toward Gold should be used as an opportunity to add to Gold positions. As can be observed in the chart below, the indicator is moving toward an over sold condition, a buy signal, on the current end of quarter weakness.
Gold is on the way to over $1,200, and you should be participating!
Ned W. Schmidt,CFA,CEBS is publisher of THE VALUE VIEW GOLD REPORT. His monumental report, "$1,265 GOLD", with 255 pages and 98 graphs, has now been released. Previous editions of this work have been read by hundreds, probably saving their portfolios countless millions of losses. Ned welcomes your comments and questions. His mission in life is to rescue investors from the abyss of financial assets and the coming collapse of the U.S. dollar. He can be contacted at nwschmidt@earthlink.net. To obtain a copy of "$1,265 GOLD" while subscribing to THE VALUE VIEW GOLD REPORT by e-mail each month click on the button below.
"1,265 GOLD" is also available at www.amazon.com in the book section.
-- Posted Thursday, 26 June 2003 | Digg This Article
