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COMMODITY FUTURES FORECAST
Prepared by Philip Gotthelf
Housing Versus Mortgages
(February 23, 2017) Today's Wall Street Journal tops the front page with the headline, "FED Eyes Aggressive Rate Increases." The last set of minutes reveals a propensity toward raising interest rates in March and becoming more proactive in returning short term yields to historical "norms." At the same time, housing supplies are allegedly dwindling as new buyers rush to own real estate before carrying costs become too expensive. In usual fashion, financial media concentrates on immediate statistics and draws upon "experts" for reasons; a/k/a causal correlations. The analysis tends to be superficial, dealing only with immediate and proximate facts.
In reality, President Trump has inherited plenty of good with the bad. Although he recently stated that he "inherited a mess," economic numbers suggest he gained the same foothold as Bill Clinton did after Bush '41 cleaned up leftovers from the Regan Administration. Republicans don't like to discuss how President Regan's agenda to bankrupt Russia impacted the U.S. economy because they rely upon the growth spurt of Regan's second term for their historical perspective. But, the picture wasn't so rosy when Bush '41 took over. In fact, Bush '41 cleaned up more crises in his single term than Clinton faced in their two terms. This is not a political stance, it is simply the history.
President Trump has the significant advantage of maturing Millennials born between 1980 and 1990 who are building families. As this group moves along the career path and builds income, home ownership becomes increasingly competitive with renting. Consider that through the financial crisis from 2008 through 2012, rental properties faired far better than private homes. This is because "kids" had nowhere to go when they were "leaving the nest." Considerable analysis concluded that Millennials were living at home "in parents' basements" because they could not afford to leave. This is only part of the story. There was also a gap in the type of housing Millennials needed.
I bring this up because builders evaporated during the financial meltdown as banks restricted credit and the world went into crisis mode. But, financial constraints do not constrain developing demographics. Millennials literally grew up during Obama's 8-year term. So, it is not surprising that the housing vacuum left by the crisis is correlating with young couples looking for housing. Just as they are ready to buy, the FED is normalizing interest rates and the "great deals" are rapidly evaporating.
As Donald Trump figured out, the U.S. is dealing with two major population bulges; Baby Boomers/Gen-X and Millennials. There are about 70 million Boomers and 60 million Gen-X totaling 130 million or half the adult population. Millenials are approximately 80 million, depending upon how you divide the generations. Trump took a long hard look at the economic situation for each population and designed his messaging to capture potential voters from each group as opposed to likely voters from past records. Obviously, his strategy worked. Baby Boomers are empty nested and looking to downsize while Millenials are about to create their nests and need to move up. This has established the current housing dynamic.
It is coincidental that mortgage rates are just beginning to increase as the housing dynamic comes into play. Builders use short term financing to put up projects which are subsequently bought out with mortgages. In the early 1980s, developers held paper because rates were so attractive and they covered the initial spread with property mark-ups (profits). That does not exist today… yet. Depending upon rate acceleration, we could easily see a construction boom that President Trump will undoubtedly take credit for. Ah… timing!
We see that March lumber was stuck in a wide trading range between approximately 31500 and 35500. Housing data inspired the January rally to achieve 38200 before profit-taking retraced the move to current levels. If you assume 33700 is the starting point for the "flag," we have retreated 50% from the high. Given the projections, the current formation suggests firming and another leg higher as spring approaches.
The fundamental argument against lumber and other building materials is the assumption that higher interest rates will curb demand. However, the nation's general mood is upbeat despite anti-Trump protests. Stocks continue rising and labor is finally getting tighter. Further, the possibility of a $1 trillion infrastructure spending bill boosts down-the-road demand for lumber, plywood and everything else needed for such a massive undertaking.
Compared with the 1980s, today's interest rates are ridiculously low. We have just begun the normalization process and I am sure there will be glitches on the way up. Also, we cannot overlook global pressures exerted by Japan and Western Europe where interest rates are far below the U.S. and credit ratings are perceived as less worthy. I suspect that China has stepped back from dumping U.S. debt to see if President Trump is serious about border taxation and enforcing currency manipulation sanctions. Having seen some setback for our President, China is hedging its bets by curbing defensive strategies until the dust settles.
Rates and Gold
Last week I mentioned strength in gold and silver despite rising carrying costs and sacrificed opportunity related to interest rates. I changed my strategy from trading volatility to taking a long position in April gold as we waited for our March options to expire worthless. Gold broke out today, rallying more than $17/oz. This sets up a test of $1,270/oz resistance which also represents a first objective. If gold can break through $1,270, the chart looks very constructive. Consider that Gold traded to almost $1,350 on Election Day before enthusiasm fizzled in favor of stocks. The price literally collapsed more than $200 or 15% in less than two months.
Since the December bottom, gold has recovered $100 or 8.8%. The FED's insistence on pumping up inflation has led to the more cautious language from Chairwoman Yellen about keeping things in check; codeword inflation. The FED does not want to see a sudden price explosion as consumer confidence heats up and Trump follows through with Tax cuts and tax incentives. Suppose Congress agrees to slash the repatriation tax to 10% and money starts pouring back to the U.S. According to some estimates we would see as much as $3 trillion returning to the country.
Flash back to 1979/80 when gold and silver rocketed to all-time highs. Paul Volcker was FED Chairman and he decided to stomp out inflation with an unprecedented interest rate hike. Economists feared the economy would tank, but it managed to survive on fiscal policy like investment tax credits, interest deductions, and write-offs against ordinary income from ancillary or "passive" investments like real estate. The economy did just fine. Gold and silver did collapse, but that was the result of government intervention.
A great monetary experiment was implemented after President Nixon closed the Gold Window on August 15th, 1971. Thereafter, gold was "commoditized" by repealing President Roosevelt's 1933 Executive Order 6102 that confiscated gold from private owners. Imagine if President Trump tried to invoke such an order today! The Order was rescinded in 1975 and gold began trading at around $150. The average "fix" was less than $65 in 1972.
A series of natural occurrences dramatically raised commodity prices during the 1970s, but the OPEC Oil Embargo was the most central catalyst that pushed floating currencies forward. The West needed to stay ahead of the Middle East after OPEC held the U.S. and Western Europe hostage. It was also obvious that the global money supply was too constrained under a Gold Standard. As I have stated, the flotation experiment evolved into European unification and the Euro Currency. By taking the French and Belgium Franc, German Deutschmark, Italian Lira, Greek Drachma, off the market, there was sufficient consolidation to regulate currency ebbs and flows.
Currencies became commodities in the same way gold and silver were commoditized. Aside from reserve assets, currencies were not an investment class. Although "cash" has been included in financial plans, it is usually reallocated toward equities, fixed income, real estate, hard assets, or other "classes." Now we have the question, "Has the currency experiment come to an end, or is it no longer an experiment?"
I have not been reserved in my criticism of our FED and Treasury in combination with Bush '43 and Obama. I believe the financial meltdown could have been alleviated using fiscal policy rather than solely relying upon monetary manipulation. But, legislators on both sides of the political divide were frozen. They literally had no idea how to handle the pending doom. So, the FED stepped in with an academic at the helm. The result is approximately $15 trillion in debt. Thanks to President Bush '43, we added another $6 trillion to fight in the Middle East… an effort totally squandered by President Obama.
Here we are with a pathological gold lover in the White House who believes he can run government like a business. The jury is still out, but it is likely FED Chairwoman Janet Yellen is not a Trump fan and does not share Trump's business model. She has expressed concern about new policies without becoming overtly political. The fact that gold can rally along with stocks and while interest rates are heading north suggests a monetary hedge is in play. Whether it is in defense of Trump or Yellen is hard to determine.
I say this because the U.S. Dollar Index has rallied back above 100 since the beginning of the month without slowing gold's forward momentum. That would imply a Trump hedge as opposed to a Yellen defense. If investors were concerned about the FED, gold would not be positively responsive because the old argument or logic would stand; i.e. higher rates make gold less attractive and increase the Dollar's relative value which is also a negative for gold. But, when gold rises with the Dollar, there is additional real appreciation.
It is worth noting that we have not seen 3-way arbitrage impacting gold or silver. This means depreciating currencies are losing more relative to gold than our Greenback. No one wants to trade this. I decided to move into the futures instead of trading options because the potential for a gold rush is increasing. When you have divergence, it's a good bet to go where they money is.
I am not saying we are about to see an explosive move to the upside. A test above $1,270 to $1,300 would be impressive enough. For bullion traders, today's action proves the efficacy of Dollar Average buying. There were many disillusioned investors who tried gold and saw it languish relative to equities. They simply don't understand how gold works. It is not an investment with a yield. It is a hedge against monetary realignment. If you don't think we are going to experience realignment, good luck… don't buy gold or silver. If you believe Trump can't pull off his agenda without some realignment, join those who are buying physical gold and putting it away… just in case.
For the near term, I was pleased to see gold pop as I write my REPORT. It makes my analysis consistent with current market behavior. If stocks retreat, gold may remain firm despite falling investment liquidity. That is what the divergent signs in the market tell us. By the way, if you look at Trump's history and how he decorated his apartment, you'd best maintain a healthy respect for the yellow metal. This is the first president who has expressed a personal and ongoing interest in gold!
February 23, 2017
Commodity Futures Forecast
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