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-- Posted Friday, 21 July 2006 | Digg This Article
On Wednesday the stock market in the US rallied because Ben Bernanke indicated that he might not push for higher interest rates. Two weeks ago the market rallied because of weak retail sales numbers (see previous Commentary, “When bad news is good news, all news is bad news”). This market is dangerous: investors are desperately searching for good news. When weak retail sales figures and the Fed Chairman’s comments that he sees the economy slowing are interpreted as good news for stocks, then you know it is time to get out of the market. Rising interest rates make bond yields attractive, putting downward pressure on stocks. Stock prices then have to decline so that dividend yields can again become competitive against bond yields. The opposite occurs when interest rates fall: bonds become unattractive relative to stocks and stock prices rally. So when investors think interest rates will not rise any further they infer that stocks may become relatively more attractive and the result is a stock market rally. Those investors who are currently buying stocks believe interest rates have stopped rising and are betting that economic growth will continue. But if interest rates are not going to rise any further because of a risk that the economy will slow down, what will happen to corporate earnings? Even though average price to earnings ratios for US equities have come down over the past five years, there is now considerable risk that earnings declines could occur going forward. Declining earnings will cause stock prices to decline as well. You have to ask yourself whether the Fed stopped raising interest at precisely the right time to stifle inflation without hurting economic prosperity. Then ask yourself whether the decline in the housing sector will affect consumer spending – housing starts in June fell 5.3% from May and building permits, an indication of future housing starts, fell 4.3%. Building permits are down 14.9% over the past twelve months. The US economy is driven by consumer spending financed with debt. When consumers can no longer afford their credit card payments, they apply for a new credit card. When they cannot get any more credit cards they refinance their homes. The latter only works while home prices are rising and home prices are not rising any more. That means the only people that still have equity left in their homes are the ones who did not refinance recently. Those who did refinance may soon find that their mortgages are more than their homes are worth. During the first quarter of this year, when home refinancings were still going strong, mortgage debt grew by $250 billion. The total increase in money supply as measured by M3 (yes, you can still calculate it) was only $194 billion during the first quarter. Now if you consider that an increase in M3 mainly reflects an increase in debt, you can see how significant the real estate market is to the US economy. According to the Bureau of Economic Analysis, 70% of the US gross domestic product comes from consumer spending. Given that more than 100% of the increase in money supply during the first quarter came from an increase in mortgage debt, I don’t think I am sticking my neck out too far when I say that real estate is currently the single most important driver of consumer spending. When mortgage debt stops rising at such a rapid pace, I expect consumer spending to slow down as well. That, in turn, will erode corporate revenues and collapse earnings. What will stock prices do? Paul van Eeden If you enjoy reading these commentaries I suggest you go to my website at http://www.paulvaneeden.com/commentary.php and register to get them by email. Rest assured that I do not sell or rent any of my subscribers’ email addresses. Paul van Eeden works primarily to find investments for his own portfolio and shares his investment ideas with subscribers to his weekly investment publication. For more information please visit his website (www.paulvaneeden.com) or contact his publisher at (800) 528-0559 or (602) 252-4477. Disclaimer This letter/article is not intended to meet your specific individual investment needs and it is not tailored to your personal financial situation. Nothing contained herein constitutes, is intended, or deemed to be -- either implied or otherwise -- investment advice. This letter/article reflects the personal views and opinions of Paul van Eeden and that is all it purports to be. While the information herein is believed to be accurate and reliable it is not guaranteed or implied to be so. The information herein may not be complete or correct; it is provided in good faith but without any legal responsibility or obligation to provide future updates. Neither Paul van Eeden, nor anyone else, accepts any responsibility, or assumes any liability, whatsoever, for any direct, indirect or consequential loss arising from the use of the information in this letter/article. The information contained herein is subject to change without notice, may become outdated and will not be updated. Paul van Eeden, entities that he controls, family, friends, employees, associates, and others may have positions in securities mentioned, or discussed, in this letter/article. While every attempt is made to avoid conflicts of interest, such conflicts do arise from time to time. Whenever a conflict of interest arises, every attempt is made to resolve such conflict in the best possible interest of all parties, but you should not assume that your interest would be placed ahead of anyone else’s interest in the event of a conflict of interest. No part of this letter/article may be reproduced, copied, emailed, faxed, or distributed (in any form) without the express written permission of Paul van Eeden. Everything contained herein is subject to international copyright protection.
-- Posted Friday, 21 July 2006 | Digg This Article
Previous Articles by Paul van Eeden
Paul van Eeden is an independent investor, analyst and newsletter editor.
Born in South Africa, Paul graduated from university with a degree in chemistry and applied chemistry with additional credits in accounting, economics, business economics, philosophy, statistics, mathematics, biochemistry and physics.
Paul's first business was an African art distributorship, of which he acquired a 50% interest during his first year at university in 1985. He has experience, either as an owner, manager or director, in plastics manufacturing, food supplements and cosmetics distribution, advertising & marketing as well as the manufacturing and distribution of gas detection equipment.
Paul van Eeden left South Africa in 1994. He joined Yorkton Securities in Toronto as a stock broker in 1995 and moved to Global Resource Investments in Carlsbad, California in 1996. In November 2002, Paul decided to leave the brokerage industry and joined Doug Casey as co-editor of the International Speculator (www.internationalspeculator.com) newsletter.
His investment approach was shaped by the ideas of Benjamin Graham and David Dodd so Paul is always on the search for tangible value that can be bought at a reasonable price. That can usually be accomplished only during the trough of a market, which is currently not the case for general US equities.
Therefore Paul decided to focus on the natural resources sector, specifically gold. The period from 1996 to 2001 was a trying time - the bottom of the worst bear market in gold in twenty years - but, of course, it was also a time of opportunity.
At the San Francisco Gold Show in November 1998, Paul van Eeden introduced his original thesis that the gold price in US dollars is driven by the US dollar exchange rate, and that traditional commodity style analyses would not yield predictive results when applied to gold. He showed that a dollar-only view of the gold market is inadequate: understanding the gold price requires a global view, incorporating exchange rates across many currencies. This novel line of thinking is now ubiquitously accepted.
In 2003 Paul went further, showing that the price of gold in US dollars is tightly correlated to the expansion of US monetary aggregates (M3) and that an analysis of gold as money not only clarifies the gold price from 1971 to the present, it has other implications that are still unforeseen by most financial and commodity analysts today. One of these is that the gold price will soon exceed $1,000 an ounce. Another is that, aside from operational differences, not all gold mining companies will benefit equally from this increase in the gold price.
Paul van Eeden not only does his own research on the fundamental drivers behind the gold market, he also takes a hands-on approach to investment analysis: interviewing management, studying exploration projects and visiting mining operations. Whilst investing in mining and exploration companies is inherently risky, value is never far from his mind and features forcefully in his selection criteria.
Most of Paul's time, now, is devoted to finding investments for his own portfolio.
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What are they thinking?
