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4 New Bubbles? Gold, Oil, Stocks, Bonds
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Author:  Arathain Kelvar [ Mon Jan 25, 2010 12:27 pm ]
Post subject:  4 New Bubbles? Gold, Oil, Stocks, Bonds

http://money.cnn.com/2010/01/25/news/ec ... s.fortune/

Quote:
NEW YORK (Fortune) -- Here we go again.

Less than two years after the housing market collapsed, the U.S. economy is threatened by a new bubble in asset prices. This time, four billowing balloons are hovering: two commodities -- gold and oil -- stocks, and government bonds.

Don't be fooled into thinking that last week's 5% drop in the S&P, and the recent sell-off in oil, remotely makes them fairly valued, let alone bargains. Equities and commodities, as well as Treasuries, which actually rallied as stocks dropped, still have a long way to fall. The reason: They've already seen huge run-ups that put their prices far above their historic averages, and far above the levels justified by fundamentals.

Two examples: Most companies can't possibly grow earnings fast enough to support their lofty valuations, and oil and gold are so expensive that we'll see what high prices always bring, a surge in new supply. That makes a price-pounding glut inevitable.

Since the start of 2009, oil has returned to the danger zone by jumping 63% to $75 a barrel, and gold has risen more than 20% to set astounding new records by climbing above $1,100 an ounce. After briefly returning to historically normal valuations in March, stocks are now selling at price-to-earnings multiples 40% above their historic range of 14, and 10-year Treasuries are so pricey that they yield 1.5% less than they did in 2007.

What's causing this resurgence of speculative fervor? One view blames the same policy that caused the real estate rampage -- incredibly low interest rates that are flooding the banks with cheap funds that, in theory, are available for loans. (The current Fed target rate is between 0 and 0.25%.)

"Investors can borrow at extremely low rates to buy assets," says Brian Wesbury, a monetary specialist at mutual fund manager First Trust. "So they're using cheap debt to bid up prices. The Fed's expansionary policies are making assets look a lot less risky than they really are."

Other prominent economists dispute that we're in bubble territory, at least right now. Allan Meltzer, the distinguished monetarist at Carnegie Mellon, argues that even though banks are loaded with cheap money, they aren't lending -- which is why we have a credit crunch. "I would be a lot more concerned if loan demand were higher," says Meltzer.

The one asset that definitely isn't bubbling is housing. There, prices have fallen to a level where new buyers buy a house for the same total monthly cost as rental. That's gravity operating.

So how do you spot a bubble? My view is that we're now seeing the same signs that exposed the frenzy in real estate: prices flying far above their historic averages, measured either in inflation-adjusted dollars (commodities) or as a ratio of the income they produce (stocks and Treasuries). Watch for gravity to take over, just as it did in housing.

Treasuries

The rate on the 10-year Treasury is now a mere 3.6%, well below the 5.5% rate that it averaged between 1993 and 2007, a period where inflation ran at an annual 3% clip, meaning that the "real rate" after inflation, stood at about 2.5%.

So let's assume that future inflation also averages 3%, about where it stood in the second half of 2009. At today's prices, Treasuries are offering a real yield of just 0.6% -- 1.9 points below our 14-year average.

But as the economy recovers and the threat of inflation causes the Fed to tighten monetary policy by raising rates, the yield could rise to 5.5%, handing investors a big loss. Reminder: When yields rise, bond prices fall.

Yet even that scenario is optimistic. Given the huge deficits from the bailouts, it's likely that investors will want a far bigger cushion for expected inflation -- which suggests, says Wesbury, that the yield on 10-year bills could go over 6% in 2011.

Oil

At around $75 a barrel, oil may look like a bargain compared to the record $148 in mid-2007. But we've simply moved from an immense bubble to a moderate one.

For oil, as in all commodity markets, the highest-cost unit that customers are willing to buy to "clear the market" sets the price. Indeed, prices can go far above cost for short periods, since it takes time for producers to drill new wells or because they hoard inventories.

So how much are oil companies paying to produce the world's most expensive barrels of oil? A good estimate is $55 to $60 a barrel. That's what it costs Anadarko Petroleum (APC, Fortune 500) to extract oil from deep wells in the Gulf of Mexico, according to Anadarko CEO Jim Hackett.

Hence, the world's highest-cost producers are now earning 30% to 40% margins. It won't last; to take advantage of the prices, oil companies will ramp up production, and that extra supply will cause prices to fall back into the $55 range, or even lower.

Gold

Investors are rushing to gold, because they rightly fear far higher inflation in the next couple of years and want to hedge against both rising prices and a declining dollar with a commodity that, they claim, has a fixed supply.

Since early 2009, the price has jumped to $1,100 an ounce from $875, triple its average price between 1990 and 2004. Yet the supply of gold is far more fluid than the gold bugs admit, partly because mining companies are investing heavily to increase production.

The real threat: Prices are so high all over the world that people who once treasured their gold jewelry are now rushing to sell it. Swiss refiners are offering irresistible prices for bracelets and brooches, "cash-for-gold" stores are in Chicago malls, and suburbanites are hosting Tupperware-style parties where neighbors show up to hock their gold teeth.

When this happened in the early 1980s with silver, prices plummeted from $50 to $15 in less than a year. Look for gold to end up below $500 an ounce within two years.

Stocks

Let's assume that investors want a 10% return from stocks (a 7% real return plus 3% gains from inflation). But at current prices, there is no way that the S&P can deliver those kind of gains in future years.

Here's why: Think of the S&P as one company that provides a total return in two components, a dividend yield and a capital gain. Together, the two should equal 10%. But the two are inversely correlated. The lower the dividend yield, the higher the earnings growth rate must be to get you to that 10%. When yields are extremely low, those growth rates become mathematically impossible.

Right now, the P/E multiple for the S&P is an extremely high 20, based on a formula developed by economist Robert Shiller that removes the constant gyrations that can under or overstate the ratio, and the dividend yield is just over 2%. So to hit that 10%, earnings must rise 8% -- assuming 3% inflation, 5% annually in real terms.

But earnings tend to track GDP, which rises about 3% a year over long periods, though far more slowly in a recession. So 3% real GDP growth isn't nearly enough to lift profits 5%. That implies that stock prices must drop sharply: A fallback to their historic P/E of around 14 would require a 29% correction, taking the S&P from its current level of 1,092 to around 770.

"Stocks will disappoint us if we buy them when they're expensive and delight us if we buy them when they're cheap," says Rob Arnott, chief of asset manager Research Affiliates. Now, they're extremely expensive, and destined to disappoint.

Author:  Xequecal [ Mon Jan 25, 2010 12:39 pm ]
Post subject: 

It's really depressing to know that two years ago the DJIA was over 14,000. Now, it's barely above 10,000 and everything is saying stocks are "expensive" and poised to crash 30% or more.

Author:  Beryllin [ Mon Jan 25, 2010 12:42 pm ]
Post subject:  Re: 4 New Bubbles? Gold, Oil, Stocks, Bonds

Housing sales fell another 16.7%, too, or so I read. This is the recovery we're supposed to be happy to have?

Author:  Elmarnieh [ Mon Jan 25, 2010 12:54 pm ]
Post subject: 

I know a person who makes an argument (which is not that weak) that we will experience deflation. The M2 has been slowing its increase for a while but is still positive. This is to be expected when funds in toxic assets simply shutdown and the expansion is fueled only by the hollow spending of TARP and multiple different bailout programs.

I am still in the inflation camp though.

Author:  Hopwin [ Mon Jan 25, 2010 1:16 pm ]
Post subject: 

I beg to differ with the idea that Treasury Bonds are forming a bubble. What you see is people fleeing to what is considered a "safe-harbor" for their monies. If equities or commodities become more attractive you will see people slowly pulling out of the bond market. For some of us in bonds, we are simply matching a targetted amount and are more concerned with longer-term goals than the short-term price.

As for bubbles, how come no one talks about the Commercial Real Estate bubble anymore? People will eventually wise up and realize that as the author points out above, there are houses you can purchase for the cost of a rental. Not to mention the shrinking consumer-goods market has led to the closing of a lot of retailers and many strip malls and other commercial complexes stand at 40-60% occupancy.

Author:  Diamondeye [ Mon Jan 25, 2010 1:17 pm ]
Post subject:  Re: 4 New Bubbles? Gold, Oil, Stocks, Bonds

I haven't made up my mind. In theory we should experience inflation, but on average last year (supposedly) we didn't have overall average inflation. Hence, the outcry among seniors who complained they didn't get their annual SS benefit increase which is... tied to inflation. Of course, they all got a $250 extra payment which amounts to an increase in spending this year anyhow rather than just being told to STFU and quit feeling entitled, but on the other hand, I'm not totally trusting the assertion that we had average deflation either, since I don't know how that conclusion was arrived at.

Author:  Ladas [ Mon Jan 25, 2010 1:34 pm ]
Post subject:  Re:

Hopwin wrote:
As for bubbles, how come no one talks about the Commercial Real Estate bubble anymore? People will eventually wise up and realize that as the author points out above, there are houses you can purchase for the cost of a rental. Not to mention the shrinking consumer-goods market has led to the closing of a lot of retailers and many strip malls and other commercial complexes stand at 40-60% occupancy.

I'm not sure I follow this comment... no one talks about a commercial real estate bubble anymore because it collapsed, and has little prospect of coming back anytime soon, because as you noted, the demand for space in those ventures is negative as more and more companies shed jobs, go under, decrease production.

Author:  Xequecal [ Mon Jan 25, 2010 1:39 pm ]
Post subject: 

One thing the lack of inflation proves though is that the "fear-mongers" were right. They get a lot of **** because they predicted economic collapse if there had been no stimulus. Well, the government has printed about two trillion dollars and prices are still falling. What do you think would have happened to prices without that two trillion dollars?

Author:  Hopwin [ Mon Jan 25, 2010 1:47 pm ]
Post subject:  Re: Re:

Ladas wrote:
Hopwin wrote:
As for bubbles, how come no one talks about the Commercial Real Estate bubble anymore? People will eventually wise up and realize that as the author points out above, there are houses you can purchase for the cost of a rental. Not to mention the shrinking consumer-goods market has led to the closing of a lot of retailers and many strip malls and other commercial complexes stand at 40-60% occupancy.

I'm not sure I follow this comment... no one talks about a commercial real estate bubble anymore because it collapsed, and has little prospect of coming back anytime soon, because as you noted, the demand for space in those ventures is negative as more and more companies shed jobs, go under, decrease production.


When did the Commercial Real Estate bubble burst? I recall the housing bubble but this must have blipped past me.

Author:  Elmarnieh [ Mon Jan 25, 2010 1:49 pm ]
Post subject: 

Not much different at all really. Not much of those bailouts has been spent and they passed them so they could have immediate effects - they were just spending bills nothing more. Government spending cannot have a net positive effect on the economy greater than what the market could do without the associated conditions of the government either taxing or inflation to get the currency to hand out.

Author:  Elmarnieh [ Mon Jan 25, 2010 1:50 pm ]
Post subject: 

It is in the process of popping, it had time to reduce itself a bit so its collapse is not as sharp but we are still in the early phases of commercial property sitting idle and closing.

Author:  Hopwin [ Mon Jan 25, 2010 2:01 pm ]
Post subject:  Re:

Elmarnieh wrote:
It is in the process of popping, it had time to reduce itself a bit so its collapse is not as sharp but we are still in the early phases of commercial property sitting idle and closing.


If that is the case then it hasn't burst yet or begun to. The burst would be when those landlords can no longer weather the properties sitting idle and they dump them on the market driving the CPRE prices plunging. Right now the bubble is just no longer swelling.

Author:  Ladas [ Mon Jan 25, 2010 2:38 pm ]
Post subject: 

I see, you were talking about the pending commercial real estate mortgage defaults. That has started to occur, as you can see in the WSJ article today about the huge development in NYC that just got surrendered to creditors.

However, the market itself collapsed with the housing market.

Or perhaps I am dividing the segments differently than you, given my occupation.

Author:  Hopwin [ Mon Jan 25, 2010 2:48 pm ]
Post subject:  Re:

Ladas wrote:
Or perhaps I am dividing the segments differently than you, given my occupation.


What's your occupation?

Author:  Rafael [ Mon Jan 25, 2010 3:51 pm ]
Post subject: 

Price bubbles tend to spread as they deflate. As I've always maintained, it is impossible to separate market forces on prices from currency forces.

Author:  Khross [ Mon Jan 25, 2010 4:28 pm ]
Post subject:  Re: 4 New Bubbles? Gold, Oil, Stocks, Bonds

It's a little more complex than that at the moment, Rafael; however, I would suggest that it's practicably impossible separate government currency manipulations from supply/demand operations in the market at the moment (as least as a more accurate way of phrasing your observation).

Author:  Rafael [ Mon Jan 25, 2010 5:53 pm ]
Post subject: 

Well, I mean in general. I don't understand how it would be possible to quantify price movements to the point where you could determine how much credit should be given to different forces.

Ideally, private currencies would reduce the quality of this distinction.

Author:  Khross [ Mon Jan 25, 2010 6:29 pm ]
Post subject:  Re: 4 New Bubbles? Gold, Oil, Stocks, Bonds

Rafael:

What is money? The distinction between "money" and "currency" is merely complicated by current policy and macro-economic practice. I would suggest, at least in a Classical Economics sense, that being able to valuate the "real money economy" vs. the "currency economy" (and I don't mean currency markets or speculation here) might help make the separation you seek.

Author:  Elmarnieh [ Mon Jan 25, 2010 7:19 pm ]
Post subject: 

The most simple definition is that money is a currency that would have non-negligible value in barter.

Author:  Rafael [ Mon Jan 25, 2010 9:44 pm ]
Post subject: 

My statement is a bit erroneous. I believe private currencies would tend to be real money.

The only problem is, it's nigh impossible to valuate the "real money economy" because all economies are denominated in currency economies, i.e. the dollar. But since the dollar is fiat and highly tied to the centralized banking system of The Federal Reserve, the bond market, which ironically because of The Fed's and US Governments unwavering no-default position in US Debt Instruments, becomes the de-facto primary currency economy for the Dollar and thus the main currency economy we must concern ourselves with.

Author:  Micheal [ Mon Jan 25, 2010 11:28 pm ]
Post subject: 

There has been no recovery, so far we're at about the level of the guy with a very long snorkel, which will only keep working as long as he keeps breathing very hard to get the bad air out and fresh air in.

This is going to get much worse before it gets better.

Next year, 2011, when China fails, will make what we have seen so far look like a walk in the park. Stock up on non-perishables. Buy new clothes with an eye toward how far they can be taken in.

Okay, I had a dream - this isn't a scientific analysis. Tell me I'm a loon November 2011.

Author:  Monte [ Wed Jan 27, 2010 1:55 am ]
Post subject:  Re:

Micheal wrote:
There has been no recovery,


This is simply untrue. There has been recovery. It has not been a very good recovery, but I blame that more on deficit hawkishness on the party of the Obama administration, and misplaced stimulus. We needed to spend more, not less, and we needed to focus on job creation. We needed a federal jobs program. We needed to put people to work across the country, employed by the federal government if needs be. We could have turned this around much quicker and much more successfully had we actually listened to guys like Krugman and done what he said. Instead, we got something trying to be moderate, and it just wasn't enough to get the job truly done.

However, it's inaccurate to say there has been no recovery.

Author:  Micheal [ Wed Jan 27, 2010 1:57 am ]
Post subject: 

I disagree Monte, when the good news is we lost fewer jobs last month than we expected, and fewer people have been evicted from their homes than we expected, that is not good news. That is not recovery. That is just a slowing down of the fall.

Author:  Rafael [ Wed Jan 27, 2010 8:45 am ]
Post subject:  Re: Re:

Monte wrote:
Micheal wrote:
There has been no recovery,


This is simply untrue. There has been recovery. It has not been a very good recovery, but I blame that more on deficit hawkishness on the party of the Obama administration, and misplaced stimulus. We needed to spend more, not less, and we needed to focus on job creation. We needed a federal jobs program. We needed to put people to work across the country, employed by the federal government if needs be. We could have turned this around much quicker and much more successfully had we actually listened to guys like Krugman and done what he said. Instead, we got something trying to be moderate, and it just wasn't enough to get the job truly done.

However, it's inaccurate to say there has been no recovery.


Spending does not create jobs.

Author:  Khross [ Wed Jan 27, 2010 9:39 am ]
Post subject:  Re: Re:

Monte wrote:
Micheal wrote:
There has been no recovery,
This is simply untrue. There has been recovery. It has not been a very good recovery, but I blame that more on deficit hawkishness on the party of the Obama administration, and misplaced stimulus. We needed to spend more, not less, and we needed to focus on job creation. We needed a federal jobs program. We needed to put people to work across the country, employed by the federal government if needs be. We could have turned this around much quicker and much more successfully had we actually listened to guys like Krugman and done what he said. Instead, we got something trying to be moderate, and it just wasn't enough to get the job truly done.

However, it's inaccurate to say there has been no recovery.
This is all balderdash.

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