Momentum Reversal, Guru’s Fears, Gold Demand, Housing Horrors and More!

by Addison Wiggin & Ian Mathias

• “A complete reversal of market momentum” … Dan Amoss on how to play it

• Why one longtime value guru is “more worried” than he’s ever been in his career

• Another housing statistic that must be seen to be believed

• Reflections from China: One perspective on why the property “bubble” is nothing like the bust in the U.S.

• A BRIC country’s looming election… and two plays that’ll perform no matter the outcome… and more

  “Interesting week,” a reader wrote in, exasperated on Friday night. “What will happen next week one can only wonder.

“The air is news sensitive, we wonder what any bad news… at all… will do.” To be sure, we chose an “eventful” week to be out of the country.

  “We’ve seen an almost complete reversal of market momentum,” our resident stock market vigilante Dan Amoss comments, catching us up on events, “with the ‘deflation trade’ of late 2008 once again growing popular:

Thing is, “moves to the downside often unfold five or 10 times faster than rallies – a sign that there’s little desire to buy into weakness.”

“The decline in risky assets has been violent. Treasury securities – of which there will never be a shortage – have been bid up aggressively. Yields on 10-year Treasuries have declined from 3.9% to 3.2% in a little over a month. This adds to the anecdotal evidence that carry trades – shorting Treasuries and buying corporate bonds and stocks – funded much of the rally in the S&P 500.

“This summer should be the best environment for short selling we’ve seen since early 2009,” Dan concludes.

During that cycle, Dan’s Strategic Short Report bagged at least one 334% gain. If you want immediate access to his latest recommendation, you can do so here for $1.

Better hurry, though: It came out Friday and is still below its buy-up-to price, although probably not for long. Especially considering the point of view expressed by gentlemen like Seth Klarman:

  "The government is now in the business of giving bad advice," Mr. Klarman recently told the CFA Institute in Boston. "By holding interest rates at zero, the government is basically tricking the population into going long on just about every kind of security except cash, at the price of almost certainly not getting an adequate return for the risks they are running. People can't stand earning 0% on their money, so the government is forcing everyone in the investing public to speculate.

Klarman is head of the $22 billion Baupost Group and is equally revered among value investors as Buffett, but without the big brass band. For anecdotal proof, his 1991 book Margin of Safety sells for a minimum $1,850 on Amazon.

"For our parents or grandparents,” Klarman contends “it was awful to have had a Great Depression. But it was in some ways helpful to carry a Depression mentality throughout their later lives, because it meant they were thrifty with their money and prudent in their investment decisions.

“All we got out of this crisis was a ‘Really Bad Couple of Weeks’ mentality."

As a result, Klarman says he is “more worried about the world, more broadly, than I ever have been in my career. Will money be worth anything if governments keep intervening anytime there's a crisis to prop things up?"

  Europe remains a festering source of uncertainty this morning. We didn’t get any dramatic Sunday-night announcement at the end of a meeting of EU finance ministers. But Spain’s central bank did take over a regional bank with too many defaulted real estate loans on its books.

The market awaits bad news it seems. In fact, here’s a sure sign – a rising London interbank offered rate. Libor is the rate banks charge each other for three-month loans in dollars. This morning, it sits at 0.51%, territory unseen since last July and a doubling of the rate in February. Some traders see it blowing out to 1.5% in the months ahead. Those aren’t post-Lehman levels, but are one more indicator of fear returning to the market.

Among the immediate effects, corporate bond sales in May are on track for their weakest month since 1999.

  Yet the euro is up this morning to $1.25. The dollar index is up by an even sharper percentage, to 86.3.

  Gold is recovering a smidge of last week’s losses, passing through $1,188 as we write.

“Fact is, there's a worldwide scarcity of precious metal bullion,” our Byron King asserts. “It's due to high demand. The mines and refineries can't keep up. Then there's even more looming future scarcity due to declining mine output.

“The scarcity and availability issue will not improve with age. If you factor in all the future development projects, there aren't enough future projects in development. So something has to give. Something has to clear the market. That something is called ‘higher prices.’”

From our experience at the “Investment Gold” window at a gold market in Beijing last week, the average Chinese are only too aware of what’s happening in the world. It’s why the Chinese government has been actively encouraging its citizens to stock up.

It’s also why the collectible market for Gold Pandas has been exploding. We’ve been alerting you to the opportunity presented with these coins for several weeks, tomorrow is the last day the offer will be available, so if you’re interested, best take a look now.

  Oil has recovered slightly this morning to just above $70. But hedge funds are bailing. Last week, they cut their bullish bets by 32%, according to the CFTC’s Commitments of Traders report – the largest percentage decline since September 2009.

The prevailing wisdom suggests that trouble in Europe will hamper the “global recovery” and decrease demand for the black goo. Hard to believe oil sat above $87 just three weeks ago, isn’t it?

  For the moment, U.S. stocks are flat from Friday’s close. Traders bid up early losses on the following news: The final month of the homebuyer tax credit goosed existing-home sales by 7.6% from March to April. Year over year, the increase is 22.8%.

The median price for an existing home firmed up to $173,100.

"Although inventory levels remain above normal and much of the gain last month was seasonal,” National Association of Realtors (NAR) chief economist Lawrence Yun pronounced “the housing price correction appears to be essentially over."

  Falling Treasury rates must have helped too. They’ve driven a 30-year fixed mortgage down to 4.86%. Even if this doesn’t drive home sales, it’ll drive refinances, and that’ll generate lots of fee income to prop up the banks’ balance sheets. For now.

  In the meantime, the extend-and-pretend games go on. Look at how long people are staying in their homes despite blowing off their mortgage payments:

Here’s another way to look at it: Out of all the delinquent mortgage holders out there, only one in 10 is less than six months behind on payments. Yikes.

  “A quick note,” a reader writes, “on your bits about the U.S. government ‘being’ the mortgage market. I just found out that they've changed the specs for obtaining a condominium loan. If the condominium complex is not at least 50% sold, you cannot obtain a conventional mortgage. Pure and simple.

“That means that I have to find cash buyers or banks that will do ‘portfolio’ loans to meet the 50% threshold. Guess who will be handing back his two small condo conversions to the bank? Thank you, Uncle Sam, for the broomstick you know where.

  “As for the foreclosure numbers,” the reader continues, “I live in Tidewater Virginia between Richmond and Virginia Beach/Norfolk, where we feel ‘recessions’ about 25% of what the rest of the country experiences, due to the government presence. The foreclosure number here for April just reached a new record, surpassing the old new record made in March 2010 by over 35%. This cannot be good news for the rest of the country.

“I wouldn't place too much emphasis on the ‘only 2%’ increase of foreclosures; I don't believe it.”

The 5: And that’s with the tax credit still in place. Hmmn…

  “If the definition of a real estate ‘bubble’ is what happened in the U.S.,” writes another reader, who also happened to our host last week in China, “then there's no bubble in sight here in China.

“For starters, a lot of China real estate is purchased with cash. There are no bank loans involved. Some Chinese buy real estate as a store of wealth. They don't try to rent out the property, but hold the hard asset as protection against inflation. Property taxes in the U.S. are paid each year, but property taxes in China are a one-time event occurring at the time of purchase.

“For Chinese that do need a bank loan, the lending standards are higher than in the West. Chinese banks will appraise the value of a property to be only 80% of the property's market value. This forces the buyer to put in 20% extra down payment on a property. This additional equity in a house gives Chinese banks a margin of safety in case the borrower cannot repay his loan.”

The 5: With a hand-held iFlip, we recorded a third perspective as The Daily Reckoning’s Joel Bowman debriefed our managing editor Chris Mayer atop the Great Wall about Chinese real estate… and what it means for the Chinese growth story. You’ll find our crude firsthand reporting here:

Of course, we’re still picking through our notes, revisiting the ideas of our multivariate contacts and pondering how all these ideas fit into our investment perspective. We’ll then distill them into actionable advice in an upcoming issue of Apogee Advisory (you can still sign up for beta issues here).

  In the headlines on the front page in Beijing on Friday a university professor was jailed for 3 1/2 years for organizing 18 different sex orgies. His defense? His parties, he said, “hurt no one” and were completely voluntary, so where was the crime?

As we were leaving Beijing on Saturday, we thought, China is dynamic enough, we’re likely to return there before the year’s out, if not sooner.

Regards,

Addison Wiggin

The 5 Min. Forecast

P.S.: While China is on our minds, another of the BRIC country occupies the thoughts of our income sleuth Jim Nelson. “With all the news flying around about Europe’s problems,” Jim writes, “a potential China bubble and even collapsing commodity prices, everyone seems to be forgetting about the real story this year: Brazil.

“If the global economy does crash again,” Jim writes, “wouldn’t you want to put your money in the one place that proved it can handle it? Brazil’s ‘recession’ lasted about two quarters.

“But the real story this year is Brazil’s presidential election upcoming in October. Luiz Inacio Lula da Silva is hitting his term limit this year. So for the first time since Brazil came back onto the global economic scene, it will have a new leader.

“The two main contenders, Dilma Rousseff and Jose Serra, are neck and neck as of the latest poll. Whichever way it goes in October, Brazil will get another center-left president.

“The real questions yet to be answered in this election are: how will the new government handle Brazil’s China-sized growth? And more importantly, how will it handle the inflationary period most expect is coming? Neither party has clearly defined its stance on these issues.”