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One of the best strategic thinkers in the business is Eric Sprott of Sprott Asset Management based in Toronto, Canada. His July comments this month provide valuable insight into the US Real Estate market and global crude oil depletion rates. They are of the opinion that at the moment these two items, more than anything else, are the most important. They are scouring all sources of information that may give them a hint that 1) the US housing market is about to breakdown, or 2) oilfield depletion rates are higher than is being assumed. If either of these proves to be true, then the rosy economic outlook currently in vogue may end in tatters, thus taking recently robust financial markets down with it. A thought provoking article, for more
The core Sprott thesis is that of an impending oil crisis. They are of the view that world production currently hangs on a thread – the slightest disruption can create a de facto shortage, sending the price of crude ballistic. Nothing has the potential to cause such a supply disruption as does unexpectedly high depletion rates. Experts confirm an 8% natural global rate of decline in oil production but unless wads of cash are thrown at oilfield development, this is more likely 20%. Reasons such as horizontal v vertical wells and smaller production fields than the large fields of 25 years ago are discussed. For a 1% increase in decline rates, the world needs 800,000 barrels per day of new production just to stay even – Oil that is just not being found. Oh, and we haven’t even talked about demand-pull and refinery issues.
US housing prices remain on fire. Apparently the hottest new mortgage product is something called an “option ARM” where borrowers have the option to not even pay full interest rate (!) thereby allowing them to grow the principle amount over time. Manhattan, Boston, San Francisco, San Diego, Los Angeles and Miami have posted another 20%+ year on year (yoy) gains. This is not a new revelation but the Fed has been raising short rates, lending standards have deteriorated and equity withdrawal has been running at new highs in recent times. Recent home sale number numbers were at record levels this week as the housing bubble added a further leg. Regardless of where long term interest rates go (Steven Roach and Bill Gross expect them to go lower) there is only so much that housing prices can go up from here as price increases at a multiple of income growth can not increase ad infinitum. Greenspan has made comments of a frothy market and must be careful what he wishes for. It’s like throwing stones in glasshouses! San Diego County median house prices have risen only 7.5% yoy in May, compared to 25% yoy a few months ago. The laws of mathematics are such that when yoy prices begin to slow, the month on month numbers may already be in decline. Developers are also pulling out of Florida, which was the lead indictor for Sydney 12-18 months ago.
Joanne has long argued that the real issue of this housing bubble is the effects the massive home equity withdrawal slowdown will have on US consumer spending and the general economy. Americans have extracted US$700bn from their home equity, last year alone, which is 7% of GDP and 20% of retail sales? This year however these numbers are running 30% ahead of last year so it doesn’t appear to be slowing at this point? The housing market doesn’t need to slow down to derail the US economic mirage but merely decrease in the rate of appreciation. This can create economic havoc on its own. Japan proved 15 years ago and Australia and the UK have proved more recently that when the housing market falls from its lofty perch, their economies head south. If the same were to occur in the US the economic impact is likely to be even greater, given unheard of consumer indebtedness, fiscal imbalances, and a zero savings rate. The million dollar question is when, but there is no doubt the game is in the second half?
Article courtesy of Optimal Asset Management |
