Most metal prices got a boost this week as the dollar faltered against other major currencies, presumably because a weaker outlook for the US economy means no more interest rate hikes and possibly even lower interest rates.
While it is no surprise to see metal prices across the board trading higher in US dollars, the risk of lower base metal prices still concerns me. If the dollar exchange rate falls then everything we price in dollars on international markets goes up in price. But the increase in metal prices from a falling dollar has to be offset against a potential decline in metals prices if the economic woes of the United States deepen and impact its trading partners, causing a decline in demand for base metals and subsequently lower base metal prices.
The US housing market: is the worst over?
A key question therefore is whether the worst is over for the US housing market and whether the fallout from the housing market is going to further deteriorate US economic activity.
Construction of new homes fell 14.6% in October (from September) to the lowest level in six years while data previously released for August and September were revised lower. Homebuilders are facing record numbers of cancellations: D.R. Horton, one the largest home builders in the country by number of units, said its cancellation rate had increased to 40%, up from 29% in the previous quarter. Its historical cancellation rate is 16% to 20%. Toll Brothers, which builds luxury homes, said its cancellation rate had increased from 2% a year earlier to 7% — the highest level of cancellations in the company’s history.
To get rid of the glut of unsold homes, builders are slashing prices. The median price of a new home is down 9.7% from a year ago and building permits for new houses fell 6.3% in October. Single-family home starts were down 32% in October as compared to last year, but in January 1991 year-on-year starts fell 45% and in March 1980 they fell 52%.
One would think that the lending industry in the US would start raising credit requirements given the decline in house prices and softening of the economy. But no, banks are more competitive than ever. It is as if they are racing to see who can generate the largest amount of sub-prime loans. The number of delinquent mortgages is rising as sub-prime borrowers find it impossible to cope with higher interest payments after the initial teaser interest rate gives way to market rates, yet banks continue to lower credit requirements in order to generate fees. Sub-prime borrowers who cannot afford the houses they want are increasingly offered interest-only mortgages and optional-interest-only mortgages, where they don’t have to pay down any principal during the early years. Sometimes they don’t even have to pay all the interest and the unpaid interest accrues to the principal leading to rising loan balances and much larger future payments. When those teaser terms end, these borrowers are often the ones who are forced to declare bankruptcy and walk away from their homes.
The fallout from the US housing bubble
But delinquent homeowners and slowing home sales are not what is going to cause the most harm. The real boost to the economy during the housing bubble came from cash-out refinancings, which occur when a homeowner refinances a larger loan amount and withdraws equity in his home in cash.
In the chart below you can see the amount of cash withdrawn through cash-out refinancings in billions of US dollars on the left axis and as a percentage of the increase in US money supply (as measured by M3) on the right axis. It is important to understand that when a homeowner refinances his house with a larger mortgage and withdraws equity, he has in fact created money.
Now look at the percentage of M3 growth represented by cash-out refinancings on the right hand side of the chart. As you can see, cash-out refinancings have been a major source of financial liquidity for US economic activity and that is why the housing bubble was a major driving force of US economic activity since 2001. I cannot see how cash-out refinancings can continue at their current pace in an environment of falling home prices. Take away the liquidity and consumer spending will most likely decline, which means lower corporate profits, less job creation and the wheel spinning in the opposite direction. The result is slower US economic growth, less demand for imports and all around, less demand for base metals.
In last week’s commentary I explained why the wealth gap exists, why it is growing and why the government is responsible. It really doesn’t matter whether the Democrats or Republicans are in power or even which country you live in. Politicians will not be able to stop the wealth gap from growing and, really, neither do they want to, because doing so would deprive them of their primary ability to buy votes. If you did not read last week’s commentary and you are curious about why the wealth-gap exists I recommend you go to my website and take a look. Here is a direct link to the article: https://www.paulvaneeden.com/displayArticle.php?articleId=184
First published on Kitco.com (www.kitco.com)
By Paul van Eeden
Paul van Eeden works primarily to find investments for his own portfolio and shares his investment ideas with subscribers to his weekly investment publication. For more information please visit his website (www.paulvaneeden.com). If you would like to read more from Paul, you can sign up to get his weekly commentary at https://www.paulvaneeden.com/commentary.php.