Trading and Investing

It seems that all of the gains from last week have been erased today. Gold dropped $21.40 in a single day!

So what is going on here? I think gold (and oil too) is in the middle of a fierce battle in the $660-690 range. There is a definite gold-bug camp but there is also an anti-gold-bug (but don’t hate the gold-haters) camp at work here too.

The financial markets were in quite a frenzy today. The Dow had it’s worst one day drop since 2001, falling 3.3%. The S&P lost 3.5% today. The decline could have been much worse - China’s leading stock index fell 9% today.

Today’s most read headlines at Marketwatch.com:

Seems the only stocks that are doing well are strip clubs. Time to change up my investment strategy.

My instinct is that this drop is temporary, the stock markets are on their way up before they take an even bigger plunge. And then watch out below.

The big question in my mind is whether gold will rise or fall in an even larger stock market sell-off…

– defo

The biggest economic news of the week was the inflation release and the corresponding move in the price of gold. The BLS Consumer Price Index release on Wednesday indicates that the inflation battle may not be over just yet.

(http://www.bls.gov/news.release/cpi.nr0.htm)

With the price of medical services leading the charge, inflation surged after three months of mild reports. The Fed’s beloved Core CPI rose 0.3% for the month, which puts the year-over-year inflation rate back up to 2.7%. The headline index, which includes oil and food is a bit lower, at 2.1% year-over-year.

The components with the strongest inflation in the last year were medical services (4.3%), housing (3.0%), and food and beverage (2.4%). The transportation index and energy were the only declining components in the last year.

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That’s the cause. Now here’s the effect.

The price of gold, after dropping from $670 to $660 early in the week, screamed out of the gates on Wednesday when the CPI numbers were released. The price of gold increased $25 over the next three days to close the week at $683. The price of gold has increased 6% so far this year from it’s January 1st open of $640. Here is the February chart pasted below:


The explosive increase in the price of gold after the CPI data might have been too much too quickly to hold up in the short term. Every time inflation rises more than expected, gold bugs that you never knew even existed climb out of the woods and just start buying. Then again, this might also be the beginning of the next big move up.

But the long-term outlook for gold is still very positive in my view. The majority of America haven’t even caught on that gold has been on the move since 2001. The price of gold has outperformed stocks over the last five years, and most people are completely oblivious. Just wait until money managers start to recommend that individuals hold 10% holdings in gold or gold stocks. Another interesting scenario is if hedge funds start warming up the buying engines…

The good news is that I’m now following gold on a daily basis, so I’ll report any big moves.

– defo

The big news this week was the huge drop in housing starts. The chart below, from www.marketwatch.com, shows the decline in housing starts over the last year.

Marketwatch reports that the 37.8% decline in new home projects was the “largest year-over-year decline since early 1991“.

The big news last week, as reported by the Wall Street Journal, was that vacant homes, a measure of how many homes for sale are empty, “has climbed to its highest level since the Census Bureau began tracking it four decades ago.”

So what’s the deal? The fact is that there are too many sellers and not enough buyers. Everybody who had the money and was thinking about buying a house already did so in the last 5 years. There’s nobody left to buy! It’s only a matter of time before the higher supply force sellers to lower their prices.

Sellers could always hold onto their houses - after all, you won’t record a loss if you don’t sell at all - but this works for only so long until people who are in over their heads are forced to sell. It starts to get really bad when homeowners start to default on their mortgages at record rates, like they are in California, where the default rate is at its highest in 8 years!

(see http://www.signonsandiego.com/news/business/20070125-9999-1b25default.html)

In fact, the Case-Shiller home price indexes showed month-over-month price declines in 7 out of the 20 cities in the composite index. Every city but one, Charlotte, showed a decline in annual returns from last year. Look for even more cities to show negative growth next year.

(see http://www.boston.com/business/globe/articles/2007/01/31/housing_gauge_shows_price_growth_slowest_in_10_years/)

The housing decline is only beginning…expect it to get much worse. The real question is whether housing will bring the rest of the economy with it. So far signs point to no, but I’ll be watching.

ps. Did the market even flinch when the US Trade deficit hit it’s all time record last month: $68 billion! Of course not…good thing, according to Cheney in ‘04, that “Reagan proved deficits don’t matter”…

– defo

Hi all,

After a brief transition period that involved too many moving logistics and not enough time to think, I’m hopefully going to be back in full season with ideas again.  I’m going to try to release a weekly post throughout the Spring.

Here’s a brief summary of the US Economy from my point of view:

[] The Fed

After 7 straight sessions of holding interest rates at 5.25%, the Fed doesn’t look like it’s on course to raise or lower rates anytime soon.  They continue to warn about inflation risks, although they maintain that inflation will moderate back into the “soft” inflation target of 1-2%.  Wall Street and the media are starting to get irritated by the inflation targeting Fed rhetoric - Bernanke keeps insisting on a target but has yet to define it explicitly: http://www.nytimes.com/2007/01/30/washington/30fed.html

As long as inflation data remains tame, look for the Fed to lower rates this summer to try to save the housing market.  The Fed will probably only start raising rates if core inflation inches up to the 3% level (it has been hovering around 2.5% for some time now).

[] Inflation

In my mind, inflation is going to be the most important determinant of the housing market and the stock market over the next 3-5 years.  If the Fed is forced to raise rates to fight inflation, you can kiss stocks and real estate goodbye.  On the other hand, if inflation continues to be a non-threat, look for stocks and real estate to remain nominally high.

It’s a funny paradox.  The government needs *inflation* to be high to reduce the likelihood of a nominal drop in the stock market or home prices.  But it needs *inflation data* to be low so that it is not forced to raise rates.

My view is that inflation data will remain above the comfort zone for some time, especially as rents catch up to home prices (remember, rents make up 30% of the CPI), agriculture prices continue to increase, and oil stays in the $50-70 range.  I would be very surprised if the core drops below 2% year-over-year anytime soon.

[] Real Estate

This Spring and Summer will be a huge test for the real estate market, as many sellers put their homes back on the market.  Real estate transactions typically pick up during the nice weather, so we will really find out whether buyers come back to the market.  My prediction: too many sellers, not enough buyers, and a slowly but surely deflating home price bubble.

[] US Dollar

The dollar has shown amazing resiliency in the last two months in the face of a huge budget deficit and a continuing trade imbalance with the rest of the world.  This is still in the context of a 40% decline versus the Euro in the last five years, but the dollar pessimists (myself included) have constantly been guessing for a far worse outcome.  I will be following it closely over the next few months.

[] Gold and Oil

As usual, gold has been extremely volatile.  It hit a 6-month high at $660 this week, only to fall quickly back to close the week at $645.  Gold watchers are optimistic these days, pulling for a breakout to the $675 to $700 range, but sometimes too much optimism can result in flat prices.  Gold probably needs another month or two in the $620-650 range before we see a big move up or down.

Oil has bounced back from a temporary low below $50 a barrel.  I just can’t imagine it will creep down there again.  Look for it to hold in the $50-70 range for some time.  This probably means good profits for energy companies in the next 5 years.

[] Economic Growth

It’s strange that GDP can come out at 3.5% annually for the quarter (that’s great growth) while many of the other indexes are showing signs of weakness:

http://www.marketwatch.com/news/story/economy-slowing-two-biggest-reports/story.aspx?guid=%7BC0214641%2D8C7F%2D4661%2D9AF5%2D7FB80D212157%7D

As you know, I’m looking for a slowdown caused by housing, which leads us to:

[] The US Stock Market

If you’ve got to be in the US stock market right now, then try to find quality stocks that will survive a recession.  Companies like Berkshire Hathaway, Exxon, Walmart, Target are probably good ways to preserve investment value.  I’d stay away from the Googles, Amazons, Ebays - anything where prices have built in massive earnings growth.

I still think the US stock market is overvalued, but the future will depend heavily on earnings and inflation.  If earnings can continue to be high in the face of rising wages, then the stock market may be saved.  I’ll create my new index of Google-Starbuck’s earnings - two companies which I expect will get hit hard in a slowdown.  If earnings at Google or Starbuck’s start to slow, then watch out!

[] Chinese Stock Market

Looking for the bubble to burst?  You’ve found it in China.  It’s now a matter of when, not if.  Marketwatch and other financial coverage keep printing articles about how out of control it is: http://www.marketwatch.com/news/story/china-shares-tumble-warning-market/story.aspx?guid=%7B6C39F1CD%2D6ADA%2D48C7%2D9496%2DD48988BBA4CB%7D

When people are taking out home mortgages to invest in the stock market, it’s time to get out, out, out.

[] Global Warming

Haha, just kidding.  Who knows…

 

Getting back into the swing of things…

– defo