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Nowhere to Hide

The financial market saw red ink flowing everywhere today. Virtually every asset group including stocks, bonds, commodities and precious metals took a significant hit throughout the trading day. It all started with announcements out of China that they needed to get serious about slowing down their overheated economy. China ordered 11 of its top banks to cease all lending until May 1^st, and at that point it’s possible some new lending policies will be forthcoming. According to a Bloomberg article, a vice governor of the People’s Bank of China, Wu Xiaoling said the government was trying to slow China’s economic growth to less than 8% this year from a six-year high of 9.1% last year. It’s looking like China is the economic center for global growth, and the news brought asset prices down across the board. For U.S. investors, there was practically nowhere to hide except good old cash or going short on just about anything.

The U.S. dollar had a huge day to the upside with a final close on the dollar index at 91.45. Of the majors, the two biggest losers in the foreign exchange arena were the commodity driven currencies, the Australian dollar and the Canadian dollar with losses of 1.67% and 1.29% respectively. The yen dropped 0.51% to 0.9103 and the euro fell 0.78% to 1.1825. The dollar strength was attributed to the prospect of rising interest rates and expectations of a strong GDP number for the first quarter which will be released tomorrow.

Treasury Debt and Mortgages

U.S. Treasury bonds and notes also fell because of the expected strong GDP numbers tomorrow. Bond traders ran in fear that the economic report will show accelerated growth in the first quarter. They decided to get out of the way before the announcement. The five-year Treasury yield rose to 3.58%, the ten-year yield increased to 4.47% and the 30-year bond yield ended the day at 5.26%. Also putting pressure on the bond market was the auctioning of $26 billion of new two-year government debt. The demand for the two-year Treasuries was the weakest in the last three months, but the Feds must continue borrowing to pay their bills. I have written many times before that no other asset groups seem to move higher when the debt auctions are taking place. I won’t beat it to death, but it obviously happened again today.

The higher interest rates are certainly showing up in higher mortgage rates. In the last week, 30-year fixed rates have moved from 5.84% to 6.01%. This is the first time in eight months the rate has gone above 6%. Mortgage applications had been declining recently, but last week the index rose by 0.5% according to the Mortgage Bankers Association. It looks like this is the beginning of the last hurrah for the mortgage bankers as borrowers rush to get their loans before rates move significantly higher. The re-financing index fell almost 6% last week and is down over 50% in the last six weeks. The government continues to re-finance their old debt and add new debt on top of it to pay the bills. Americans have also been dependent on cash-out re-financing to buy things and pay their bills.

When the debt well runs dry for people to extract more equity from their homes, how will they keep consumer spending on the increase to sustain the economic recovery? What is even more frightening is the fact that people are now resorting to variable rate mortgages so they can enjoy lower monthly payments. They will see a BIG SHOCK as mortgage rates continue to move higher. A steep yield curve offers borrowers more incentive to go with a variable rate mortgage since there is a big difference in the monthly payments. With a flatter yield curve, the interest rates for short maturities (variable rate mortgages) would be closer to longer maturities like the 10-year bond (fixed rate mortgages). I can not say enough on this topic!

If you want to get a handle on the big picture of debt and very specifically with real estate and mortgages, you simply must read Doug Noland of PrudentBear.com. His article from last Friday, “Fannie and Freddie to the Rescue” is one that you really need to read to see what is going on. In my opinion, this will be the death to the housing bubble. This is also compounded by the fact that sub-prime lending is absolutely booming! More credit is being extended to borrowers with weaker balance sheets.

As I said earlier, most everything was in the red today. The only things I saw move higher were a few utility stocks, the dollar, interest rates, beef, pork, lumber, and cocoa. The broad stock indexes were hammered. The Dow Industrials lost 135 points to close at 10,342 (1.3%) and the NASDAQ Composite was tagged for 42 points to fall below 2,000 at 1,989. Oops, I did forget one item that moved higher in price: unleaded gasoline. Most fascinating about the increase is the disconnect from government statistics. The U.S. Energy Department said gasoline inventories increased by 900,000 barrels, while the American Petroleum Institute said gasoline inventories declined by 2,400,000 barrels. Similarly, the Energy Department claimed crude oil inventories increased by 3,200,000 barrels while the API figured they fell by 800,000 barrels. It’s tough to know who to believe.

In Search of Support

I’m not ducking the issue, just out of time since I spent the day looking for support in my favorite gold and silver mining stocks. I actually did some buying with new client money since the mining stocks are at some appetizing prices. Yes, it was ugly today. With the announcement from China that they need to slow things down, copper was the first victim, and that supposedly translated into massive liquidation for gold and silver. My take is they don’t want anybody to make money in this sector since precious metals compete with fiat currencies of all denominations. The stocks I bought a week ago are down 13%, but I averaged the prices down with more buying. When the inflation worries heat up again and the geopolitical problems toss in another wild card, the metals will be headed north. I truly am out of time, so I’ll try to squeeze in a final chart on silver. Hopefully next week I’ll have something more positive to write! Until then…

Mike Hartman

Chart courtesy of StockCharts.com

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