Hugh Hendry and Eclectica fund August 2009 commentary

I ran across Hugh Hendry a several weeks ago and enjoy his irreverant style.








The Great Debate right now is inflation versus deflation and Mr. Hendry falls in the deflation camp.

Here's the August 2009 Eclectica commentary which he manages.

Hugh Hendry is also very bearish on China.





Mr. Hendry's positions are quite contrary. How many of his predictions come true will be interesting to observe.

Looking for that inventory bounce

I drive though the Port of Tacoma, which is a major import hub for several Asian car manufacturers, on my way to work every day.

From the freeway spur you can see acres and acres of cars, waiting for distribution to local and regional suppliers. During the panic you could see the inventory stacking up in all sorts of locations not usually used for storing cars. Parking lots for businesses, spare lots, etc. were full of row after row of brand new cars right off the boat.

Some of that excess inventory appears to have been worked off as the fields of cars are only located in their 'normal' staging areas.

Except this spot. This is a brand new warehouse just completed . Google maps' satellite photos don't even show the building yet. It does not contain a business but is completely full, and surrounded by new car inventory.

Driving around the building you can peer inside some of the garage doors and see the entire inside of the warehouse is full of cars as well. This is a 500,000 sq foot warehouse which is absolutely HUGE. Take the time to examine some of the photos below and look at the how many garage doors are along the long side of the building.

At least one real estate management firm is getting inventive on how to lease space.
(Photos were taken August 19th, 2009)












If you are looking for a brand new 500,00 sq foot warehouse right next to a rail hub in Tacoma, you might want to give them a ring.

Home foreclosures and delinquencies accelerating

In my previous postings I may have appeared a bit negative on future home prices and suspicious of the optimistic feelings exuded in the popular media regarding the housing market. Here's some reasons why.

Both graphs show functionally the same data but from different sources and slightly different methodologies. The coming flood of home foreclosures will further erode consumer wealth, bank balance sheets, home prices and consumer confidence. That's just some of the primary effects.

Graph #1 is from Paper Economy blog and shows loans on Fannie Mae's books that are seriously delinquent.

Graph #2 from Calculated Risk blog provides a slightly more granular look at similiar data from a different source, showing both mortgages delinquent and in foreclosure. I recommend you check both blog entries.

Look at the graphs and you will see the foreclosure crisis is getting worse, not better.

First time home buyers skewing sales data

Just like the Cash for Clunkers program, the first time home buyer tax credit is stimulating home purchases.

Calculated Risk blog is all over this.

Remember this in December if home sales fall more than expected.

Home price seasonality

I have brought up the seasonality effect with respect to the quantity of homes sold but Rich Toscano has a great blog entry with some great perspective on the current seasonal national home price rise. In sum, the markets tend to rise in the summer as more people want to move during the summer school recess. As such activity and prices tend to rise during the summer and fall in winter.

ONLY when we see year over year sales and prices stop falling will I consider the housing market train wreck nearly over.

Inflation - Numbers to live by

Not since the 1950's have we had deflation in America. Right now 'headline' inflation is running greater than negative 1% (thats deflation folks) and looks to accelerate downward.


Will we have consistent deflation for a long period of time? I don't know but lets examine some of the factors that go into inflation.



I am focusing on 3 charts; all show data on a year over year basis to remove seasonal fluctuations.


While headline inflation is decidedly negative right now, the 'core' inflation rate is still positive. 'Core inflation' excludes energy and food prices from the calculations. Some may argue one still needs to eat and drive your car to work so why look at a number that excludes these important parts of daily life? Since energy and food prices are highly volatile the theory is they will balance out over time and policy decisions (like raising short term interest rates) should not be based upon such volatile factors.

As you can see we still have inflation within the 'core' but the rate is sloping downwards. If / when this drops below zero and we have 'core' deflation it will hopefully make the news! Core inflation has not dropped below zero in the entire time it has been sampled. (since 1957)


Housing costs are also part of the inflation figure and as you can guess it is also trending downwards and may also start going negative in the near future. Housing inflation has not been negative in the entire data set as well. (since 1967)


Most Americans alive today have not had to deal with chronic deflation and I believe we are culturally programmed to only think in inflationairy terms. Life may get very interesting if the US consumer changes their mindset to one of chronic deflation instead of inflation.


Additional Reading:
WSJ: Worldwide deflation
Bloomberg: High real interest rates attracting interest

Source: Federal Reserve

Weather and Oil

It is fascinating how the financial markets and real world are so intertwined. Take for example, the weather. Recently reading about the hurricane season I realized I had not added that as a factor for oil prices. Duh!


The chart you see here shows the frequency of hurricanes throughout the year. A nice FAQ from NOAA explains the various colors. The majority of severe hurricanes occur in August and September.


By mid August we should be well into the hurricane season and yet we have not had any major storms in the Atlantic. The National Hurricane Center shows in real time any storms and their predicted tracks. As of today there are no major storms threatening the Gulf of Mexico. Storms travelling up the East Coast will not have the same influence on the energy markets as one that enters the Gulf of Mexico. The Gulf is home to a large number of oil and natural gas pumping operations as well as a large portion of the refining capacity of the United States. Not only did Hurricane Katrina (which made landfall on August 29, 2005) devastate New Orleans, it severely hampered the energy capabilities of the U.S. for several months.

Keep an eye on the National Hurricane Center web site. If you see a storm forming with a high probability of entering the Gulf, you'll see oil prices perk up.

Oil Inventory Followup -- Offshore storage

I do not know of any centralized database tabulating all the floating oil and oil products inventory so one only has anecdotal evidence to go on. A Hellenic Shipping News article provides an estimate on the oil and refined products sitting offshore. The estimated 140 million barrels offshore is over 10% of the entire US inventory, not an insignificant number. . .

New Home Sales Followup

Following up my previous post on housing . . .

The WSJ came out with an article the next day with a fuller explanation of the good and bad news regarding Monday's new home sales 'rise'.

Compared to the blogosphere the WSJ was 24 hours too late. I bring this up because 24 hours to the markets is a looong time. Calculated Risk immediately presented the complete picture, good and bad news alike and continues to be an excellent source for the housing market.

While some blogs are complete drivel others are faster and superior to the popular media. Those superior blogs are one reason for the slow decline in the print and television media.

New Home Sales - Statistics Never Lie!

I don't forsee myself commenting too much on events well covered by other bloggers but the recent new home sales reporting deserved some piling on.

New home sales were up 11% or down 21.3% Excuse me? Is that really good news or really bad news?

Yahoo News had this to say:

New home sales in June posted the fastest increase in more than eight years as buyers took advantage of bargain prices, low interest rates and a federal tax credit for first-time homeowners

What was omitted by Yahoo: The home sales increase was on a month to month basis, and NOT on a year over year basis as it should be presented. Month to month (May 2009 versus June 2009) sales were up 11%. Year over year (June 2008 versus June 2009) sales were down 21.3% Like many other economic events, home sales show a strong seasonal tendency and to only tout monthly changes without showing year over year data does not provide a complete picture to the reader.

Calculated Risk provides an excellent blog entry and graph showing the sales during each month as well as year to year.

Fundmymutualfund has a slightly snarkier commentary:

I'm feeling faint.... the news is so overwhelmingly good. Even though sales surge EVERY year in the spring let me shoot this bunny out of a cannon in celebration because....
Sales have risen for three straight months. Now keep in mind this is with taxpayer handouts of $8000 to first time homebuyers, along with unnatural mortgage rates created at the expense of savers in this country via Uncle Ben's actions. More on this later. So the important question in a SEASONAL number is the year over year % change. Sales of new homes were down 21% versus June 2008.

At least the Wall Street Journal had the sense to put in the year over year numbers, but in the body of the article and not in the title?

The Big Picture is also all over this:
More Nar Nonsense

Commercial vs Residential Real Estate

New Home Sales Fall 21.3%

What is going to happen to all the good news reporting in the fall when it is very likely new home sales will fall on a month to month as well as yearly basis?

Disclosure: Short some housing stocks in personal and aggressive client accounts

Oil in storage -- Someone else is noticing

The WSJ must be reading my blog already :) WSJ:OPEC Braces for Decline in Crude Prices

The Organization of Petroleum Exporting Countries is bracing for a sharp drop in
crude prices in coming weeks, as huge reserves of oil-based fuels continue to
pile up and the space to store them runs out.

Considering the current high correlation between oil and stock prices it will be curious to see if/when oil prices drop how much of an affect it will have on stock prices.

Fill er up! Where's all the oil going?

The oil markets are always fun to watch and while the popular media concentrates on how much higher oil can go, I'd like to point out some bearish data.

Oil and oil products in America are on the rise and nearing levels not seen in at least 20 years.

While the I do not have access to the raw data for the OECD, graphs from the International Energy Agency show the same trend.

(If you have access to additional data on inventory levels in America, OECD or emerging markets I'd love to see it.)

I present this information not to buttress a prediction for lower oil prices but to highlight some info that contradicts the current outlook.

Some additional factors for oil:

+ Peak oil - We'll eventually run out of the oil we pump out of the ground. When production will fall off and how much is finally extracted is up to debate. LONG term I am of the opinion prices will be much higher than they are now, the path to those higher prices is unknown in my mind.

+ Geopolitical - The Israeli / Iranian situation could heat up at any time and if the missiles start flying oil prices will rise.

+/- Oil is priced in dollars - Concerns regarding a weakening US Dollar have played a major factor in daily oil price movements.

- Excess supply - OPEC has cut supply and has the capability of pumping more. The timing and extent of their supplies are entirely up to them but for now that excess supply is available.

- Cheating by OPEC members - Cheating does happen by the member countries.

- Floating storage - Oil tankers are being used to store oil and refined products throughout the world. While some of this storage is due to the contango trade earlier in the year, the profitablility of storing then reselling has dropped dramatically.

Additional reading: http://ftalphaville.ft.com/blog/2009/07/22/63186/nothing-bullish-in-crude/


Sources:
http://tonto.eia.doe.gov/dnav/pet/hist/wtestus1w.htm
http://omrpublic.iea.org/stocks/stkxs_oc.pdf

Disclosure: Personal account: long RDC, client accounts: short USO call spreads, long RDC

[edit 07/23/09 12:40pm: cleaned up the prose a bit, added position disclosure]