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-- Posted Sunday, 15 October 2006 | Digg This Article
A reader recently sent me an interesting chart that compared the housing industry to the S&P 500 stock index. It clearly showed an incredible correlation between real estate and stocks, and it was so amazing that I got the raw data and plotted the chart myself just to make sure it was real. The National Association of Home Builders (NAHB) in the US uses a Housing Market Index (HMI) to gauge the single-family housing market. The HMI is based on monthly surveys of NAHB members and includes things such as the present sales of new homes, sales of new homes expected in the next six months and traffic of prospective buyers of new homes. It is therefore a forward-looking instrument. The HMI is shown on the chart below along with the S&P 500 stock index, which includes 500 of the most widely held US stocks and is a broader proxy for US listed equities than the Dow Jones Industrial Index, which includes only 30 stocks. Given that the HMI is forward looking and that the stock market lags the housing market, the S&P data was shifted forward by one year to show the correlation more clearly. The S&P data follows the HMI data closely from 1995 onward, when massive amounts of foreign capital began to settle in the US, driving down interest rates and fueling the real estate bubble. If we assume that the correlation between the S&P and the housing market will remain strong in the future, this chart portends a major downturn in US equities sometime during the next 12 months as the housing market continues to cool. While I don’t expect the S&P to follow the HMI curve down to 600, I would not be surprised to see the S&P correct down to 1000, a level that would put it where we would expect to find it if we continued its moderate increase before 1995. 
When I saw this chart I again thought about US consumer spending and GDP. As you know, 70% of US GDP is due to consumer spending and I am of the opinion that the boom in real estate resulted in an increase in consumer spending, which has fueled economic growth. Therefore, if the US real estate market cools off, as it obviously is doing, then we can expect a decline in consumer spending and hence a decline in economic growth. Here is a chart that shows how the personal consumption expenditures (consumer spending) component of the US GDP varied over time. 
This chart shows many interesting things. First of all, notice that from about 1950 to 1982, consumer spending contributed 62.3% to GDP with only minor deviations and, starting around 1982, consumer spending as a percentage of GDP gradually increased. US economic growth was robust since 1982 but still consumer spending as a percentage of GDP was increasing: that means that consumer spending was increasing faster than GDP. It confirms that much of the increase in GDP has been due to the increase in consumer spending. Therefore, if consumer spending were to slow down, economic growth could take a considerable hit. You probably also noticed that consumer spending declined dramatically during the Great Depression, but the chart above does not tell the whole story. So let us look at actual economic growth and personal consumption after the Crash of 1929. 
You can see from this data that consumer spending and economic growth both declined after 1929. What you should note is that GDP declined more rapidly than consumer spending. Also notice that GDP increased more rapidly than consumer spending from 1933 and 1937. This is evidence that economic growth is leveraged to consumer spending and therefore a modest decline in consumer spending can have a more dramatic effect on GDP. The rapid increase in GDP from 1939 to 1944 was due to the Second World War, and was not driven by an increase in consumer spending alone, which is why consumer spending as a percentage of GDP bottomed in 1944 as can be seen in the chart preceding this one. Once everything settled down after the War, consumer spending as a percentage of GDP was relatively constant at 62%, as we mentioned earlier. The reason for going over all of this is to illustrate that consumer spending is a major driving force for economic growth and that we have seen a drastic increase in consumer spending as a percentage of GDP since 1982, coincident first with a bull market in stocks and bonds and then with a bull market in residential real estate. The residential real estate market is taking a bad beating, as seen in the HMI in the first chart. That should lead to a reduction in consumer spending and because economic growth is leveraged to consumer spending we can reasonably expect a material downturn in economic growth. That should then lead to a decline in stock prices and hence agrees with the prediction of the first chart that there is a real risk of a major downturn in US equities during the next twelve months. A decline in US economic growth and coincident declines in US equities should make it difficult for the US dollar to sustain its current trading level. If the dollar falls on foreign exchange markets, as I expect it will, it will translate into higher US dollar gold prices. But, the decline in economic growth will also result in less demand for base metals and hence I believe that we will see the gold price decouple from base metals prices at some point in the near future, with the gold price outperforming base metals prices going forward. I was Michael Hainsworth’s guest on Market Call Tonight on Report on Business Television on Wednesday, and answered viewer questions about the market and specific resource stocks. You can watch the show at http://www.robtv.com/shows/past_archive.tv?day=wed; scroll down to 7:00PM. Paul van Eeden Conferences: My next speaking engagement is in New York on October 19th, at a dinner organized by the Committee for Monetary Research and Education. If you are interested in attending, please contact Elizabeth Currier at cmre@bellsouth.net. Newsletter: 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 Sunday, 15 October 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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Consumer Spending, Real Estate and the Economy
