Paul Brodsky and QBAMCO on Gold

Paul Brodsky always has great insight into the credit markets and interest rates, along with the market in general, so it was great to receive his insight on gold. Here are the two points I want readers to realize:

• Real interest rates (nominal rates less CPI) are negative across the majority of the largest developed and emerging economies, implying that a stable or rising gold price has positive carry.

• When valued in terms of Enterprise Value per Gold Ounce (EV/Gold), in-ground bullion may be owned for as little as $30/oz through shares in operating companies already in production (we will distribute a more in-depth analysis of this to Fund investors later in the month).

I would encourage you to read the entire piece to get a quick summary of the dynamics in the gold market.Viewing the remainder of this article requires a Subscription

And now for some good news

Some readers have emailed to periodically to ask whether I plan to be perpetually bearish, or if it's just a phase. Let me assure you that I am as bearish as I am only because the fundamental AND macro pictures are lining up against financial assets.Viewing the remainder of this article requires a Subscription

PrimeX – The Time For The Next “Subprime Trade” Has Come

The following article came out on ZeroHedge.com early Friday morning. The article is a bit technical so here's a bit, and then some thoughts:

. . . What happened a day prior is that Fitch came out with an eagerly anticipated report titled, "U.S.

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IYR Outside Day

I’m not a technician, but I also don’t like to turn a blind eye. I’ve said it before, so my apologies for repeating: real estate is the beneficiary of excess profits. Fundamentally, it is still sick. Contrary to reports of rising rents, we are still at elevated pricing, ownership rates, etc.Viewing the remainder of this article requires a Subscription

Real estate woes continue

CalculatedRisk pointed out an article in the Washington Post about housing affordability.Viewing the remainder of this article requires a Subscription

New Home Sales

I'll spare you all the details which you can find at CalculatedRisk organized in always-useful charts, such as this: What you should know is that not only are we making new lows in new home sales, inventory is also up (not at new highs, but still up), meaning that expecting a recovery, or even a stabilization in real estate might be premature.Viewing the remainder of this article requires a Subscription

S&P Case Shiller – this just makes it more official

The S&P Case Shiller index reports came out today and not surprisingly they show new lows in multiple markets, and more importantly a resumption of the decline in real estate prices. I don’t want to spend too long on the numbers, but you can see a quick summary on CalculatedRisk. I have some issues with the index composition and the fact that it ends up being a lagging indicator for the real estate market; yet, it’s the most widely followed index and should at least provide confirmation for what we’ve been discussing.

Real estate is regional – or at least that’s what everyone says. That is true to the extent that lending and credit are regional. However, when GSE’s are providing the funding on 95% of mortgages, tax credits are provided nationally, and credit deflation is felt across the board, correlated moves should be expected to some extent. I think we will continue to see pressure on real estate, which in turn means that the US markets will have a tough time finding solid footing.

Relevant ETFs: IYR, SRS

Back to ag

Last week I highlighted some inflation stories that were beginning to surface and readers sent me more – everything from gold and silver hitting new highs to anecdotal evidence of Malawi land prices. You are preaching to the choir – there are global imbalances on the one hand, and power-shifting demographic changes on the other that are supporting the underlying strength in certain commodities (not all). One of the areas that we’ve mentioned in the past as a source of stability in volatile periods, a hedge against inflation, and a hedge against worst-case scenarios for those prone to hyberbole is direct investment in agricultural land. I’ve been discussing it for a few years, mentioning the potential and also the difficulty (both in implementation and in management).

We are not alone, as money continues to flow to arable land: http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7997910/The-backlash-begins-against-the-world-landgrab.html. This article points out another trend that I’ve been discussing, which is the backlash against globalization as protectionist measures increase globally. In a best case scenario, I expect that countries will move to build up strategic supplies of food-stuffs, and perhaps place loose limits on foreign ownership – troubling, but manageable. In the worst case scenario, I think we could have actual land seizures, elimination of certain property rights – in the name of national security, ideology, or what have you, and nationalizations similar to previous decades in various parts. Egypt, which is enjoying a certain renaissance these days, comes immediately to mind, as do various South American countries.

Given some of the challenges of implementation, I continue to focus on diversified baskets of commodities, commodity-related companies, and second-degree beneficiaries for active investment opportunities. In terms of direct investment in agricultural land, there has been a mad rush to Africa, which I am currently avoiding (at the risk of missing significant returns), and sticking to areas that have ample water supply (north/midwest US and Canada). I don’t expect significant returns there – yields should hover in the 3-6% range unless inflation picks up, but in this environment, that’s not a bad place to wait.

For a succinct article with a few different options mentioned, click here.

Fed day: Who cares?

Fed just released its long-awaited decision – no change. Wow!

The real news came out of China where we see 2 major developments. First, there’s a slowing of growth in imports. Guess what that did to commodity and commodity related stocks – yup, they’re all down. Of course, they were only up because some in the investor community believed that China would rise forever. Silly rabbit. The second piece of data is that real estate prices are rising at a slower rate. Now, with something on the order of millions of apartments supposedly sitting empty, I’m surprised they went up at all. What will happen when they actually start to decline? Well, look for more fake numbers from the government, social unrest from the people, and more pressure on resource related stocks that will have to start pricing in a deceleration in Chinese growth.

Lastly, productivity and labor costs (from BLS):

Productivity decreased 0.9 percent in the nonfarm business sector during the second quarter of 2010 as unit labor costs rose 0.2 percent (seasonally adjusted annual rates). In the manufacturing sector, productivity grew 4.5 percent while unit labor costs fell 6.1 percent.

Some late night missives…

IBM disappointed, and its trading down about 4% as I write this. Meanwhile, Tokyo is seeing some tech weakness. The yen has stayed stable so far, but as long time readers know, I’m not a big fan and think it’s only a matter of time before it completely and forever breaks down. The longer the process takes, the more painful will be the unwinding. In the meantime, the euro has been staying surprisingly strong. At first I had no explanation, then zerohedge pointed out the liquidity crunch as witnessed in the spiking of the euribor might be leading to players needing to hold euro, thereby driving the price up. It could get worse before the euro finally breaks, but I’m sticking with my original short euro position. Me and Hendry, I guess.

Otherwise, not that exciting. BAC and the financials continue to pose problems for investors and I’m staying away. Paulson might have been a bit premature with his BAC and real estate positions, but when you’re managing $30 billion you’ve got to get in early or you won’t get in at all – although, had he read our analyses, he would have stayed away from both positions for the time being. I’m just saying…

Morning notes

A lot of huffing and puffing around town, but you should have already been positioned:

• Euro is taking out 1.22, on it’s way to 1.20 and lower. 3M Libor is going up, as we discussed a few weeks ago. European lending/borrowing costs will rise, banks will be hurt, and sovereign debt will need to be repriced. Spanish banks are especially vulnerable given the liquidity crunch coming up once European facilities need to be rolled over in July.
• China can’t hide the numbers any longer. Why would they lie? Because THEY”RE COMMUNISTS! Government numbers in general are massaged, but in communist regimes, it’s on a different scale. For those who remember 5 year plans, pictures of stocked Russian supermarkets, talk of the US falling behind on every level, this is just more of the same – in the end, communism and state directed economies fail. Not a value play (yet?) for me.
• USD is getting stronger and weaker: stronger vs. euro (duh) and weaker vs. yen (huh?). Continued unwinding of the carry trade? Domestic yen coming home from international allocations?
• 10 year yields are saying deflation, and they’re saying that the US government has some leeway since investors still think it’s credible. So good so far.
• Are we on the brink of massive quantitative easing on a never-before-attempted scale? Competitive devaluations? Against what – each other? USD? Gold?
• Real estate: how come when I say real estate is vulnerable you don’t listen but when Meredith Whitney says it 6 months too late, everyone is up in arms. And now Barry Ritholtz and John Mauldin are confirming? Nice, but I hope my readers were already out of the space for the time being.

And right on queue: Transports (IYT)

We’ve been discussing the different underlying messages the market is saying, but recently, a lot of the messages have been quite clear:

• We have real estate rolling over as seen through housing numbers. Any uptick in commercial real estate seems like a last gasp as…
• ECRI leading indicators are rolling over. Recession schmecession – it doesn’t matter what you want to call it, but without jobs in the US, there is no growth in consumer spending. We’ll have periodic upticks as built up demand vents in certain weeks or months, but the consumer is retrenching. Now you might have expected all the global stimulus funds to keep the party going for a while longer, but…
• Europe is starting their austerity program. Guess what, they are so structurally flawed that even THAT doesn’t help the euro. However, it will lead to a slowdown in growth in the eurozone, which wouldn’t be that significant, except…
• Europe is China’s biggest export destination. So you’d think the Chinese would just let things be, but instead, they’re tapping on their brakes and NOW decide to make statements about revaluing the yuan? Aside from a political grandstand to show how weak they believe the Obama administration to be, this is probably cutting your nose to spite your face, because they’ll be doubly hurt when…
• US growth slows along with Europe’s and China’s internal markets prove to be fake. Why? As I’ve mentioned before…because THEY”RE COMMUNISTS! Still, the markets looked like they might like the news, except, the rally quickly faded yesterday and today. Throughout, it was pretty surprising that the Dow Transports were holding up…
• And still are, by most measures. But our goal is to move forward and today’s 3.75% might be a harbinger of what’s to come:

  

• So that leaves us with AAPL. What a company?! What a stock?! Can it last? Me thinks not.

New York Real Estate

As a resident of New York City, this topic is near and dear to my heart, and I am obviously a biased observer; however, today we’ll just focus on the numbers.

Bloomberg recently had an article about New York real estate prices and new condo development. Within the article, was this:

The relationship between home prices and rents typically remains steady within a market, Miller said. In Manhattan, the average apartment, adjusted for inflation, cost 8.1 times annual rent from 1991 to 1997, according to Miller Samuel data. That means that in those years, buyers in Manhattan concluded that the long term benefits of owning an apartment — tax savings and property appreciation — were worth an initial investment of eight times the cost of renting.

Then in 1998, Manhattan prices began a decade-long climb, with year-over-year values rising by 10 percent or more in most quarters. By the second quarter of 2008 apartment prices peaked at 22.4 times annual rent, according to Miller Samuel data.

For the full article, click here.

I went to look at some apartment listing around the different neighborhoods. Here are some of my assumptions:

Assume you bought a 2 bedroom for roughly $900,000 (we’re talking about $750 sq ft) – a good deal, not the top building and a discount for the fact that many buildings in New York are co-ops that face a discount for a host of reasons (annoying boards, lack of liquidity, rental limitations, etc.). The rent on the apartment would be roughly $4,500/month at current rates.

At a rent multiplier of 15 (average of 8 and 22), we’re looking at a “fair value” of roughly $810,000 – a 10% drop in real estate prices. But rents have been falling – the article suggests by 6% from last years levels. Let’s assume a conservative 6% drop going forward to $4,230. If that’s the case, we’re facing a 15% decline in real estate prices.

Those are some serious assumptions – so let’s take a closer look.

1. Rents might stay stable, but with financial services continuing to be a big loser in the most recent unemployment figures (over the last 5 months, financial services lost 58,000 jobs) and those being the drivers of high rents in the city, it’s tough to see rents staying stable. A 6% decrease is just based on the rent decrease last year, however, rents could certainly drop by more. With a lot of the new developments mentioned in the article as shadow inventory for either sale or rent, one or the other will be pressured, probably both.
2. Rent multiplier: I used the average of the high to low mentioned in the article. It’s probably a fine long term assumption, but the trend has been for the multiplier to come down and it could certainly overshoot to the downside. At stable rents (not likely) and a multiplier of 10, we’re looking at a 40% decrease in prices.
3. Range of prices: I used a conservative $750 per square ft. assumption. Many listings are at $1,000 per square ft. or higher, and while the rents in those buildings might be higher, there were plenty available at lower ranges. That would translate into very different rates of change for the higher level and new construction apartments.
4. Condo vs. Co-op: New York is a quirky market. Co-ops are more restrictive, and most apartments are owner-occupied. Additionally, co-op boards have much stricter entry requirements for down payments than banks, so their conservatism means that their owners will face less pressure to sell. In turn this may actually result in MORE selling pressure in the condo market as investors and real estate owners who own both will have more liquidity in the condo market than co-op.
5. External buyers have always been attracted to New York. Pied-a-terre’s for retirees or international owners are relatively more common than most other  cities. In 2004 to 2008, it was common to hear about European buyers coming in as strong bidders. Except, at the time, the euro was strong and getting stronger. These days, real estate in the US looks a lot more expensive and many investors don’t want to lock up their money. Not that there won’t be foreign buyers looking to lower their exposure to their home currencies, just that it will be more of a hurdle.

All of that leads me to be quite concerned about New York City real estate prices.

Conflicting data and the hard trade

The past couple of days, we here at The Hard Trade have been trying to figure out what is actually the HARD TRADE, namely, which trade looks painful from a psychological perspective but may yet reveal itself as the most rewarding?

We’ll get to get to that in a moment, but first, here are just some of the cross currents we have read in the past 2 days (in no particular order):

• Insider’s kicked up their selling. Read the article here. You can get the details in the article, but the gist is that the ratio of sellers to buyers is relatively high. Not a great sign.
• While The World Was Focused On The Yuan, Everyone Missed The Real Tectonic Landmark. Read the full article here. Competitive devaluations? Nope. Singapore might be leading the Asian currencies up in a bid to buy up resources around the world. Should the US worry? Yup. Let’s see: higher Asian currencies means less money flowing into Treasuries as their trade surpluses drop and strategically dangerous as US loses access to raw materials globally.
• In the meantime, foreclosures jump 7% (click here for the article) but we also read that strategic defaults increase consumer spending (click here for the article). Much like the theory that broken windows and natural disasters increase GDP (Broken Window Fallacy), this doesn’t seem like a sustainable trend that can be relied on.
• In the meantime, weekly initial unemployment claims rise to 484,000. For a good summary and chart, click here.
• I follow the technicals a little less than valuation and fundamental data, but seeing the extremes on the put/call ratio certainly doesn’t add to my comfort level. Read it here. On top of that, shorts have been squeezed out already, so the support they provide is gone. Read the numbers here.
• Not that I trust these types of headlines, but heck, I was already wondering: George Soros Warns Of Biggest Market Crash To Come, As “We Are Facing A Yet Larger Bubble” Than During Credit Crisis (Click here for story.)
• Earnings wise, Bloomberg ran a story (click here) that showed how bank earnings (you’d have to be dumb to be a bank and not make money in this environment with the yield curve as it is) are driving the earnings recovery of the market. Check out this chart:

• We’ve got Albert Edwards warning of deflation (click here) and Morgan Stanley exploring the breakup of the euro (click here), while Richard Koo from Nomura compares the US real estate to Japan’s in the 1990′s and it ain’t pretty (click here).

All against a backdrop of a market that is grinding higher and grinding up shorts every day, making hedging or negative directional bets incredibly costly and painful.

The hard trade: is it harder to stay long given all the negative news out there or to go short as the market continually moves against you?

And for those who say real estate is stable…

Morgan Stanley has told investors in its $8.8 billion real-estate fund that it may lose nearly two-thirds of its money from bum property investments, according to fund documents reviewed by The Wall Street Journal. That would likely make it the biggest dollar loss—$5.4 billion—in the history of private-equity real-estate investing.

Not much more to say, but there was an additional nugget in the article:

When times were good, the fund generated fat fees for various segments of the bank. In 2007 alone, Morgan Stanley earned $104 million in acquisition fees, $22 million in fund-management fees, $13 million in financing fees, $36 million in real-estate-management fees, and $21 million in financial-advisory fees, according to fund documents reviewed by the Journal.

To read the full article, click here.

Not much more too say (now for real). Illiquid, no transparency, too much risk, conflicts of interest, etc. The story is old.