Barron's on Housing and Commodities

A few stories in Barron's this weekend offer further evidence that theirs is one of the sharper editorial staffs around. With the "housing really bad, commodities good" theme in their current issue, they have parted company with many of their financial media brethren who seem determined to breathe life into the former while discrediting the latter.

Unfortunately all these stories are behind the subscription wall, however, you should be able to get more than just a gist of them from the lengthy excerpts below.

• The Big Glut - Trouble in Paradise($)
• Up and Down Wall Street - Farewell to the Nineties($)
• An interview with James Turk - Yes, $8000 an Ounce($)

Still waiting for my complimentary print subscription to Barron's as compensation for making so many online Wall Street Journal subscribers irate months ago when they rejiggered their subscription options for no apparent reason, there is no easy way of knowing what stories are highlighted at the top of the print magazine cover - here's a screenshot of the online version of this week's magazine, with key elements conveniently underlined.

Click to enlarge

First the housing stories. The subject that they tackle is the fate of all the second home purchases that Americans have made in recent years when money was cheap and the sky was the limit for real estate price appreciation. How different things seem a year or two later.

While pundits debate when the bubble might burst in the primary-housing market, the air already is whooshing out of parts of the second-homes market. Naples, on the sun-drenched edge of the Gulf of Mexico in Southwest Florida, is perhaps the most striking example.

Vacationers long have been attracted to Naples' proximity to water, the Everglades and shopping at the likes of Saks Fifth Avenue. Last year alone, buyers bid up the area's median price by 30%, to $482,400. Charles Ashby, president of Naples' VIP Realtors, recalls that one of his sales associates was able to go down to a local bar and sell 26 units in a nearby Fort Myers high-rise the first night contracts were being accepted.

Today, about the most visible activity in that area is the 400 or so daily additions on the multiple listing service -- and price reductions by the dozens. In the 35 years that Ashby has been in the business, this is the first downturn he's seen, even counting recessions. "The mule died," he says.

The 26 condo sales sounds about right, but 400 or so new listings a day seems a bit high, but then again, what do we know about Naples real estate. As for mules dying, this is all we know:

A city boy, Kenny, moved to the country and bought a mule from an old farmer for $100.00. The farmer agreed to deliver the mule the next day. The next day the farmer drove up and said, "Sorry son, but I have some bad news, the mule died."

Kenny replied, "Well then, just give me my money back." The farmer said, "Can't do that. I went and spent it already." Kenny said, "OK then, just unload the mule." The farmer asked, "What ya gonna do with him?" Kenny said, "I'm going to raffle him off." Farmer, "You can't raffle off a dead mule!" Kenny, "Sure I can. Watch me. I just won't tell anybody he is dead."

A month later the farmer met up with Kenny and asked, "What happened with that dead mule?" Kenny, "I raffled him off. I sold 500 tickets at two dollars apiece and made a profit of $898.00." Farmer, "Didn't anyone complain?" Kenny, "Just the guy who won. So I gave him his two dollars back."

Back to the Barron's story, it seems that speculators are responsible for the recent runup in prices, not serious vacationers, and a full sixty percent of these speculators own two or more investment properties. Real estate has been a no-brainer for much of this decade - it's only recently that it's turned into a 'brainer'.

For starters, many second homes have been sold not to serious vacationers but to speculative investors hoping to cash on the national real-estate craze. How else to explain why six out of 10 second-home owners surveyed by the Realtors group own two or more homes in addition to their main residences?

The danger is that if enough of those investors decide the market has peaked, they could trigger a selling frenzy throughout the second-homes market. That, in turn, could add to the pressures in the main housing market. After all, second homes now account for a full 40% of all homes sold in America.

Statistics compiled for Barron's by The Local Market Monitor, a Wellesley, Mass.-based consulting firm, show just how big a role can be played by investors. In Myrtle Beach, S.C., long a favorite vacation and retirement destination, investors owned a full 58% of properties in 2004, the last year with available data. Though Florida communities accounted for eight of the top 10 investor-owned hot spots, Wilmington, N.C., clocked in at 38%, Las Vegas at 26%, and Honolulu at 23%. The normal level is closer to 14%. (See table nearby.)
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Behind all this is a fervor eerily reminiscent of the late 1990s on Wall Street. Some 65% of second-home owners surveyed by the National Association of Realtors said they considered their second homes better investments than stocks, and 29% said they planned to buy additional properties within two years. An eye-popping 64% of investors with four or more properties planned to buy another property within two years.

What is one to make of that crazed 60-65% of second-home owners? It's not known when the survey was done, but if the survey was done recently, about 29% of the respondents really need to pick up a newspaper or turn on the TV so they can be one of the last ones to learn that the real estate boom is about over. That 64% of investors with four or more properties - they should read that 'dead mule' story closely - it may be helpful in the years ahead.

Now on to commodities - in this week's Up and Down Wall Street, the outlook for hard assets seems decidedly brighter than the outlook for housing, despite all the commodity bubble blather (yes, that phrase has been lifted from blog-favorite, Barbara Corcoran).

WHEN BUBBLE TALK begins to lather up around a particular asset market, it usually means a few things. First, that particular asset class is up a lot. Next, the folks who are quickest to apply the bubble label haven't owned any, or enough, of it. Finally, there's usually at least a shadow of truth to it.

This was the case with housing in 2003 and oil in 2005. The successful value-fund manager David Dreman in Forbes referred to "the technology bubble" in 1997. Now we have a clutch of Wall Street observers identifying a commodity bubble, and the recent spill in several leading commodity markets in tandem with the emerging-markets selloff has lent encouragement to this camp.
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John Roque, technical market analyst at Natexis Bleichroeder, has been correctly enthusiastic about commodity and basic-materials stocks for years. These days, he is being forced to confront the bubble talk more frequently with clients.

Last week he was asking clients a question: Since October 2002, what is up more, the S&P 500 or the Reuters/Jefferies CRB commodity index? The clients must think to themselves, "OK, he's been bullish on commodities, he's a technician and technicians like whatever has been working." So they answer "the CRB," every one of them so far. And they're wrong.

Since Oct. 10, 2002, the bear-market low in stocks, the S&P 500 was up 58% through Wednesday after an 18-month bear market, and the CRB was up 53%, after a 20-year bear market. (This return differential comes even after the keepers of the CRB last year reweighted the index in a way that has helped its performance.)

Can this be a commodity bubble if commodities as a class have trailed an unexceptional stock market for 3½ years?
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If this is a long-lived bull move, one can expect money to remain in, or rotate into, other commodities as the leaders correct. Strategist Henry McVey and technical analyst Mark Newton of Morgan Stanley, for instance, are keying on the laggard agricultural markets, including corn, cocoa, hogs and wheat.

A central charge of the bubble crowd is that commodity markets are rife with hot-money speculators simply chasing momentum. Richard Bernstein, strategist at Merrill Lynch, recently noted the performance gap between those commodities on which futures contracts are listed and those without futures. He estimated earlier this month that those with futures showed a 50% speculative premium.

Possibly so. But if commodities are becoming a mainstream asset class and big money is committing to it for the long term, much of this could simply represent the same kind of liquidity premium that one might see in publicly traded stocks versus privately held companies.

Jim Bianco of Bianco Research has been running with this theme for a while. First, he notes the "large speculator" category is essentially positioned neutrally in commodity futures based on weekly regulatory figures. That's a proxy for the purported "hot money" hedge-fund cabal. Bianco sees clear evidence than traditional asset managers and pension funds are methodically allocating a small portion of their funds to commodities, and intend to keep them there for a long time.

Adding up the value of the open interest in all futures contracts that make up the CRB index, Bianco calculates the market now has a bit more than $200 billion invested in it. There are four individual stocks in the S&P 500 that each have a market capitalization atop $200 billion.

There are other ways to gain commodity exposure aside from listed futures, including custom derivatives and physical commodities. But the relative skimpiness of the investable commodities market is important if it continues to gain adherents among the big, slow-money crowd.

In July 2003, Ed Hyman of ISI Group noted that by certain statistical measures, the U.S. housing market had just entered bubble territory. He also observed that stocks had crossed to bubbledom in 1997. So, even if commodities have qualified for bubble status, it doesn't mean an end is near following what could be a nasty short-term shakeout.

And finally, onto the James Turk interview - the first in almost four years at Barron's, but still, Mr. Turk is provided much more access at Barron's than elsewhere in the mainstream financial media. How many other Wall Street publications would feature an interview with James Turk, founder of GoldMoney.com and publisher of the Freemarket Gold and Money Report?

[The FGMR site looks like it could use an update, if nothing other than to remove the "NEW" from the most recent article that was published in 2004. Oh well, GoldMoney.com is probably keeping him busy these days.]

NOT ONLY DID HE PINPOINT THE BEGINNING of the current bull market in gold in these pages in September 2002, but he has been spot-on in continuing to assess the direction of the metal and the drivers behind its move. Turk, a longtime authority on gold and other precious metals, is the founder of Goldmoney.com, a company that enables online cross-border commercial transactions using gold as a currency. He is also a co-author of The Coming Collapse of the Dollar, published in 2004 by Doubleday. As you might surmise from the title of the book, Turk sees plenty of room for gold to climb higher. Here's a glimpse into his thinking.
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Let's talk about the pressures on the dollar.

They are taking on a bit more urgency. One of the things I picked up on a recent trip outside the States was a much greater level of concern about the prospects for the dollar than had previously been the case.

Concerns among whom?

Among sophisticated investors -- wealthy individuals as well as some money managers. That's been linked to two specific events. First, Chinese National Offshore Oil Co., or Cnooc, was not permitted to purchase Unocal. Most people at the time shrugged it off as just a one-off event. But when the Dubai Ports deal was blocked, that really changed people's perceptions, because it made clear holders of dollars outside the United States are not going to be permitted to exchange those dollars for things of tangible value. There's an increasing desire to convert dollars into, say, commodities, which dollars can still buy. The boom in commodities to a large extent is the result of people exiting dollars. People are looking for alternatives to the U.S. dollar, and the dollar's role as the world's reserve currency is being questioned seriously now. The Russian finance minister raised the issue in the recent G-7 meetings. This questioning is a critical development. Financing the growing federal budget deficit and trade deficit requires that a large amount of dollars be created. These dollars are being created as demand for the dollar is declining.
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Do you have a new gold-price target?

It is going much higher, and the $8,000 [per ounce] I mentioned a couple of years ago is probably as good a target as any.

Some reports say $2,000 is reasonable.

I don't rule that out as a near-term spike. There are two aspects to what's driving the gold price: First, there is strong physical demand around the world. When gold crossed the $500-an-ounce level, people started buying gold in anticipation of monetary problems. Second, the physical demand for gold is causing a huge problem for the gold shorts. There has been a large gold carry trade in place. It is very possible gold could have a massive spike in the next six to 12 months to as high as $2,000, driven by these factors.

Are there any signs of this trouble yet?

Central banks loaned a lot of gold from their reserves. It was borrowed by various banks and others for the carry trade. You borrow gold at very low interest rates and sell it at the spot price. Then you invest the proceeds in higher-yielding dollars and other currencies. As long as the gold price doesn't rise, you are going to make a lot of money on the spread. But in a rising gold-price environment, you are stuck. You have to buy that gold back or suffer the consequences of ultimately having to deliver the gold at a much higher price than what you are earning from your assets. The bullion banks and others who borrowed it are short. What's happening in gold is probably even worse in silver, in the sense that the short position in silver looks even bigger than gold's. Recently, silver has risen more rapidly than gold.
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Isn't the government in a bit of a box?

It is trying to fund the federal budget deficits without destroying the dollar, and trying to raise interest rates to save the dollar without destroying the economy. I don't think they can do it. The dollar will continue to lose purchasing power.

Are you recommending any gold stocks? Gold stocks are still relatively cheap. In the past several months, even as the gold price has gone up, the stocks have been reluctantly following rather than leading, which is contrary to what normally happens. If I'm correct that the price of gold eventually goes to four digits, the earnings of gold companies will be significantly higher. As a consequence, gold stocks are still cheap.

To summarize - housing really bad, commodities good.