Financial Sense   Home  l  Market Monitor  l  Market WrapUp  l  Storm Watch  l  About Us  l  Contact Us

HOUSING NUMBERS, INFLATION & INTEREST RATES, OPTIONS EXPIRATION AND GOLD

The stock markets are under pressure this morning with weaker than expected data in the residential real estate market and today being the expiration date for November stock options. The U.S. Dollar Index opened in positive territory, but it didn’t take long to roll-over to negative territory following the weak economic data. Bond prices are moving higher, pushing interest rates lower as the bond market has been whip-sawed between inflation pressures and slowing economic growth. Crude oil is hitting fresh new lows for the year with the December contract touching $55.00 a barrel today. Gold and silver came into New York trading with a lower open, but are moving higher through the early trading hours as the dollar continues to slide lower.

The Commerce Department took the punch bowl away from the stock and dollar bulls before trading began with the release of U.S. October housing starts. The data came in much weaker than expected as builders broke ground on roughly 128,000 new homes in October. On an annualized basis this equates to 1,486,000 new homes, down 14.6% from the September reading and down 27% from a year ago. The decline in housing starts was biggest in the South with a drop of 26%; starts were down 12% in the Midwest and lower by 2% in the West, while construction in the Northeast increased by 31% versus the prior month.

Though the rate of construction has declined, the big problem is a rising inventory of homes for sale as actual sales decline. New home sales are expected to fall to 1.06 million units this year from an all-time high of 1.28 million units in 2005. Notice the discrepancy in the number of homes being built on an annualized basis at 1.5 million units versus the expected sales of 1.1 million units.

Supply and demand dictate that prices should continue to move lower. Eric Green, Chief Market Economist at Countrywide Financial made it clear by saying, “Inventories of unsold homes are off the charts.” Robert Toll, CEO of Toll Brothers said revenue for the current quarter is down 10%, but more alarming is the fact that their orders are down by more than 50% from the same period a year ago. According to a Bloomberg article today, Mr. Toll said in a conference call on November 7th that there are no signs that the U.S. housing market will recover soon. I have spoken with three mortgage bankers in the last week that I know personally. In candid conversations, they are saying it doesn’t look good, and all three expect foreclosures to increase next year. Increasing foreclosures will only add more inventories to unsold homes. In the minutes of the Federal Reserve meeting from October 24-25, the Fed-speak language uses the wording, “Further adjustment in the housing market appear likely.”

Rather than continue beating a dead horse with more quotes and data on the weak housing numbers, if you care to look into more detail from a bigger-picture perspective, please see Chris Puplava’s Wrap-up posted two days ago. Chris went into great detail with economic charts covering the last 20-30 years, with some of the data going back to the Fifties. Looking at the longer-term picture, it does appear we have a long way to go to absorb the massive run-ups in residential real estate over the last few years.

Inflation & Interest Rates

Bond prices have been whip-sawed this week as the market attempts to sort-out the ongoing tug-o-war between inflationary pressures and slowing economic growth. Supposedly, the smartest money in the markets is in the bond and foreign exchange markets. Both the dollar and bond prices (interest rates) are trying, with great difficulty, to find their near-term direction. A quick review of this week’s action is in order.

On Tuesday, the PPI numbers came out depicting inflation is virtually non-existent. The headline PPI was down 1.6% with the core (ex-food and energy) down 0.9%. Stocks and bonds rallied, but the dollar closed lower with the conclusion the Fed will not have to raise rates to fight inflation.

On Wednesday just the opposite happened. The Empire State Manufacturing Index was reported stronger than expected and the Fed minutes came out showing bigger concern for inflationary pressures versus slowing growth. Bonds sold-off pushing interest rates higher, the dollar moved higher along with stocks, and precious metals and commodities moved lower.

Yesterday the CPI report came out again depicting inflation as practically non-existent. Headline consumer price inflation was down by 0.5% with the core slightly higher by 0.1%. This time, the smart money in the bond market didn’t react the same way as happened on Tuesday. It was almost as if the bond market was telling the bogus inflation numbers, “We don’t believe you…we are selling-off to push rates higher!”

To sum it up for the three days, the bond market is telling the rest of the world that bond prices can rally (lower yields/interest rates) because we have very little threat in the way of inflation expectations, but bonds won’t break-out to near-term highs until we see more proof of an economic slowdown. The lower than expected inflation caused stocks to rally because it was perceived the Fed would stay out of the way, and possibly have room to move rates lower next year.

Until today, economic reports were healthy enough to show a growing economy without the threat of inflation. It was good for the broad stock averages all week, but today the scales were tipped slightly in favor of bonds relative to stocks moving forward. Without a doubt, the jury is still out on the impact of the housing market on consumer spending and the overall economy. Analysts are split between the soft-landing scenario and big trouble ahead. In my mind, we will not get the optimistic soft-landing scenario unless bonds break-out to new highs. The lower interest rates are needed to help put a floor under the declining real estate market.

Bigger Motive for Lower Rates

I didn’t plan on going this far in detailing what I think will happen to the bond market, but I might as well press on! I said the real estate market needs lower rates to try to absorb all the excess inventory of unsold homes, but the government has a greater need to re-finance their debt than even the struggling RE market. I believe we are going to get one heck of a recession scare in the next two quarters that will have the markets begging for “rate relief” and at the same time justify the Fed’s actions to cut rates in the second half next year.

In 2001 the U.S. Treasury discontinued the issuance of new 30-year bonds. Since that time, they have increased their borrowing on the short end of the curve dramatically. In years gone by the government issued mainly 2-year, 5-year, 10-year and 30-year debt, with the 30-year bond as the benchmark for interest rates. Since 2001 the government has been issuing primarily 2-year, 3-year, 5-year and 10-year debt, with the 10-year note as the benchmark. To put it very bluntly, the Treasury needs to re-finance our national debt on the short end, and go to longer-term maturities.

I do not know where to go to get the information on the average maturity of all outstanding government debt, but I believe the data would prove me correct. With the massive issuance of short-term debt over the last few years, our quarterly debt refundings are going to get much bigger in the coming quarters. The big threat of an impending recession will allow the government to refinance into longer maturities at favorable rates.

I had a fun conversation with Jim Willie about a week ago when I threw my ideas at him. Jim agreed with my line of thinking, but his reasoning was more fundamental than my own. To paraphrase, Jim said recession is good for the government because they don’t sell stocks…they sell bonds! In fact, they create notes and bonds out of thin air to borrow whatever is necessary. They will create the new supply of long-term bonds, and then create the macroeconomic conditions to make all that new debt look very attractive to investors. It’s just my theory, so we’ll have to see how it plays out in coming quarters.

Some Thoughts on Gold and Silver

This week gold has held the range of $614 to $630 an ounce and silver has been between $13.17 and $12.50. Right now gold is $621.70 and silver is at $12.80, both in the middle of this week's trading range. A five percent range for silver and 3% range for gold is nothing out of the ordinary, but note how the mining shares are closing the week close to their lows. Don’t let the red ink in the mining shares, especially from yesterday, throw you for a loop. If you take a look at the stock prices relative to the stock options that expire today, the downside volatility is easily explained.

I’ll use a couple of the mainstream mining companies as an example for what I believe is happening in the precious metals arena to close the week. Newmont opened the week at $46.70 and has dropped to $44.30 as I write. There are 16,415 call options at the strike price of $47.50 and 14,645 at $45.00. The $47.50 calls were not a problem for the call writers, but earlier in the week the $45 calls represented a liability to the writers. With a close below $45, the calls are worthless. As I write, NEM stands at $44.28.

Coeur d’Alene Mines touched a high of $5.24 yesterday, but looking at the call options there are 59 calls at $2.50, 5,261 calls at $5.00 and 69 calls at $7.50. The only significant strike price is $5.00. Yesterday CDE closed at $4.97 and now stands at $5.04. Another nickel lower, and the $5.00 calls will be worthless at expiration…nice for the writers as they pocket their profits. Take a look at GG, SLW, PAAS, etc. and they are all singing the same song!

Another thing that told me the downside volatility was tied to the options expiration is the fact that the juniors didn’t sell-off like the larger-cap shares did yesterday. The junior mining shares market capitalizations are so small; they can’t write options against the stock prices. There was not as much motive to sell the juniors down like they have with the larger cap shares with options attached.

This is temporary trading volatility. If you want to be long the precious metals mining shares, this is normal business. To that point, be aware that the options for December gold and silver contracts expire on Monday, 11/27. There are really only three trading days next week with the Thanksgiving Holiday upon us, so it won’t be too difficult to keep the metals in check until options expiry on 11/27. I believe we will see the upside in gold and silver following the options expiration of the December contracts.

Back to Check the Markets

The tone was set early in the day with the release of the weak housing numbers and not much has really changed since the morning hours. Stocks are mostly in the red, but the large cap shares in the Dow are holding-up better than the small-caps and high-flyers in the NASDAQ. As the dollar weakens, the multinational large-caps can make much of their profits overseas, and then convert their offshore profits into even more dollars with favorable exchange rates.

Treasury notes and bonds are still catching a nice bid with the ten-year yield down to 4.599%. Traders are saying a break below the mid-450’s could usher-in a round of much lower rates. Just remember we will need to see more really nasty economic news in order to bid bonds higher thereby driving yields/rates lower. With the holiday next week, we won’t get very much new information to see where things are headed with growth versus inflation.

Another thing I noted this morning was that copper dipped the psychological $3.00 mark to $2.98 a pound, but has since rebounded to close at $3.06. Copper and nickel inventories have increased over the last 30 days, but we still see declining inventories of aluminum, lead and zinc. (Include silver, and the white metals are the place to be!)

To make a long story a bit shorter, I believe we will see a continuing economic slowdown here in the U.S., but the overall global picture is quite different, especially in regard to commodity demand. Global growth is running MUCH higher than economic growth here in the US. With time permitting, I hope to add more detail to U.S. growth versus global growth when I write the Wednesday Wrap-Up next week.

Candidly, I can’t comment on the closing numbers for the day, because the markets are not closed yet and I’m cutting-out early for the weekend! It looks like the Dow Industrials are headed for yet another record closing high. Are you feeling the love from the wealth effect? Holiday shopping season officially begins next week!

Have a Great Evening!

Mike Hartman

Home  l  Broadcast  l  Market Monitor  l  Storm Watch  l  Sitemap  l  About Us  l  Contact Us