Hmm. U.S. GDP contracts by 6.3% in the fourth quarter but oil continues its stealth rally. What could that mean? BHP is tapping the bond market for billions. But what does it want to buy? The Reserve Bank likes the look of the housing market. But some are predicting a tidal wave of repossessions. Who’s right? Those questions and more answered in today’s Daily Reckoning.
U.S. stocks ignored the backward-looking GDP and concentrated on the present-looking bond market data. Yesterday we mentioned that ten-year yields in the U.S. were up as the U.S. government sold a boatload of debt. Well, ten-year yields fell today by about five basis points to 2.74%.
Maybe investors were relieved that the auction of US$24 billion in seven-year notes went off without a hitch. It’s always good to know your creditors haven’t cut you off yet-especially when you need to borrow another $2 trillion. It’s no wonder the Dow rallied 174 points and the NASDAQ climbed into positive territory for the year.
Here in Australia there is a bevy of interesting news to digest. At the top of the list is the fact that BHP raised $4.36 billion in the European bond market this week after raising $4.64 billion in the U.S. bond market last week. Credit crunch? What credit crunch?
Now that it doesn’t have to borrow heavily to finance the cancelled takeover bid for Rio Tinto, BHP can turn its eyes on other prey. It appears to be doing just that. Why else would it build its cash position by tapping the bond market? And who is it after?
Hmm. Maybe the Foreign Investment Review Board knows something we don’t. That is, maybe the China Minmetals bid for OZ Minerals is not as urgent as it appears if there are other, more local bidders for OZ.
But who knows about specifics? All we know is that BHP had relatively little difficulty growing its balance sheet in the last two weeks. We also know that the big fish buy the little fish in the consolidation phase of the resource cycle. BHP is a big fish.
So this action is telling us that at some level (even though commodity demand hasn’t recovered and prices for bulk commodities are falling) we may have reached a turning point in the resource market. Even if the recovery is slow, you’d expect BHP, China Inc., and other cashed up players to be on the hunt for good projects they can buy at rock bottom prices.
And then there’s oil. It was up nearly three percent yesterday in New York to close at $54.34. As recently as February 18th, you could get a barrel of West Texas Intermediate crude for $34.67. It’s gone up 56% since then (79% if go back to Christmas Eve-eve, when oil bottomed at $30.28).
Oil Futures Curve Shows Traders Are Betting on Higher Prices
For the last month we’ve been watching the futures market and the contango there. Contango is where the futures price exceeds the spot price. It looks to us like traders are betting oil prices are going to go much higher later this year.
Maybe OPEC production cuts will kick in at just the moment demand begins to recover. Or maybe, as we’ve speculated, the oil price crash virtually guarantees a supply deficit in 2010, and traders are going long now as the price bottoms. That’s a lot of maybes.
What we know for a fact is that at one point, the December 2011 futures contract was trading much, much higher than the spot price. It was a “super contango.” The contango has since narrowed since with the rally in the spot price. But if the oil trade is back on, oil stocks are certainly worth a look. In fact, the bigger energy stocks in Australia have already rallied more than 20% from their lows.
The Australian Office of Financial Management is getting into the spirit of things. Its director Neil Hyden says Australia’s federal debt outstanding could quadruple in the coming years to over $200 billion. Before you complain, just remember you can’t bribe voters with handouts unless you have some money. And if you don’t have a surplus to waste, then you’d better start hitting up foreign lenders.
Borrow and spend! Borrow and spend! It’s the wave of the future!
But who to borrow from? Here’s an idea. Why not China!
The Courier-Mail reports that the biggest investor in all the debt Australia is floating to pay for the stimulus is none other than the People’s Republic of China. “Market insiders believe China is buying 15 to 20 per cent of the $2 billion in Treasury securities being issued every week. This would make China the single biggest lender to Australia, although details of who owns the bonds are cloaked in secrecy. The program, authorised by Treasurer Wayne Swan, will leave Australia with a debt bill approaching $200 billion.”
“Trust me. I’m a banker. Housing is fine.”
It’s not all bad news. The Reserve Bank released its latest Financial Stability Review yesterday. The organisation is content that Australia’s housing market isn’t in for big trouble, especially if interest rates remain low. As it controls short-term rates, the Reserve Bank has some say in this matter.
It was painful, but we reviewed what the bank said…and found it wanting. There were a few charts that showed a rising trend for non-performing loans and higher mortgage stress. We’ll get to those in a minute. But have a look at what the bank said about the Aussie housing market. We’ll quote and comment in between quotes.
“Overall, the Australian housing market has held up better than those in many other countries over the past year. Nationwide indices show a decline in house prices in Australia of around 4 per cent since their peak in March 2008, compared with declines from their peaks of around 10 to 25 per cent in the United States (depending on the measure used) and almost 20 per cent in the United Kingdom. In Australia, the recent weakness has been most evident at the top end of the market, with prices in less expensive suburbs broadly unchanged over the latter part of 2008, after having declined over the previous year.”
No comment. So far so good.
“While further softness in the Australian housing market is possible, the market does not appear to have the same vulnerabilities that have been evident in some other countries. Importantly, the adjustment in the housing market – after a number of years of very large price gains – started at the end of 2003 and thus was well advanced before the onset of the current financial crisis.”
Prices have fallen gently so far. But prices are set at the margin. An increase in the number of sellers (boomers cashing out to finance retirement) can accelerate the decline.
“Reflecting this, the ratio of house prices to household income has declined noticeably from its peak in late 2003. While this ratio remains higher than was the case in previous decades, this is at least partly explained by a number of structural factors, including the transition to an environment of lower inflation and thus lower nominal interest rates. In addition, Australia did not see the very marked decline in mortgage lending standards that occurred in other countries, particularly the United States, and the related negative impact on house prices resulting from a surge in loan foreclosures and a large amount of housing stock coming onto the market.”
Warning! Now entering Absurdistan! As the chart below shows the noticeable decline in the ratio of house prices to household income is still noticeably high (and higher than most other markets in the world). Claiming that this is explained by a structural factor like “an environment of lower nominal interest rates” seems to suggest that interest rates stay low forever. They’ll rise again. It is true, probably, that you never saw a descent to U.S. lending standards. But that hasn’t prevented an increase in the number of people falling behind on their mortgage, as you’ll see in a moment.
House Prices Still Five Times Income
“Also differentiating the housing market in Australia from that of the United States is that the demand for new housing in Australia has outstripped net new additions to the housing stock over much of the past decade, suggesting there is substantial underlying excess demand for housing. Finally, housing affordability has increased considerably over recent months as interest rates have fallen, with the cost of borrowing now similar to rental payments in some situations, after many years when renting was much cheaper than buying.”
See reader comment below on the secret stash of investor housing that may come on the market to meet “excess demand.” And really…housing affordability has increased because access to credit and grants has increased? Isn’t that what happens in credit bubbles? Prices as credit floods the market. Is this really housing become more affordable or is it just credit giving the illusion of home ownership?
There’s been a rise in non-performing loans. It is still, however, small percentage of bank loan books. Arrears are up, especially for loans made by non-traditional lenders. And there’s this as well from the RBA, “Across all housing loans in Australia, it is estimated that around 20,000 borrowers were 90 or more days behind on their mortgage repayments in December 2008, compared with an estimate of 13 000 the previous December.”
Hmm. A 53% increase in the number of borrowers who are 90 days or more behind on their mortgage payment? Maybe this is why some are predicting that 30,000 homes will be repossessed by December. That seems a bit exaggerated, even by our standards. But if unemployment rises even more…
Shall we call it a week then? Let’s! We’ll leave you with a few more reader e-mails.
It seems that the price of housing is a very sensitive subject I guess that’s because over the last few years a lot of people have been acquiring investment properties with a belief that houses will always go up. I can’t understand what the frenzy is, houses fell in price from the peak in the 80s through to the low in the 90s I know first-hand. I had to sell for a loss 7 years later in Brisbane. So I can’t understand why people refuse to accept the business cycle. Over the last few years I know many people who have purchased investment properties. But I don’t know any first home buyers, to me it seems because property became a bubble it was easier for investors to raise the capital than it was for first home buyers.
So investors could snap up properties faster than first home buyers could save for a deposit, which means the pool of available houses is getting smaller that first home buyers have to choose from so prices are forced up. If investors decided to sell their multiple houses that they have purchased in the last five years there would be plenty of houses available for first home buyers.
The housing bubble is only the result of investors being able to get access to credit easier than 1st home buyers. Houses will fall again like they did in the 90s especially as unemployment increases. I can’t understand why people find this cycle hard to accept or maybe it’s a case of people being too heavily mortgaged so they come up with any reason to justify that they made the right decision. I tell you hope will not stop prices from falling.
Read your page with interest this morning and I have a suggestion………. Australia has a history going back nearly two centuries of selling primary products overseas and then buying back the finished goods at high prices……… Could we not suggest a deal where we have the Chinese pay a part of the amount in developing Manufacturing facilities in Oz in joint ventures; with these reverting to Oz ownership after a certain time…….. For thirty years now we’ve seen the decline of Australian manufacturing and I just thought that this, or a variation on this theme could be a way to stimulate growth in Australia instead of using OZ as a big quarry until it’s exhausted and we become a third world country. The Chinese need our minerals etc. There couldn’t be a better time to help turn our economy around and start making dependable products instead of throwaway stuff that just makes the local tip a huge industry.
And finally this.
The present Chinese government is a vicious military dictatorship. It is utterly corrupt and without morals or scruples. It treats its own people as medieval serfs. China has a prison population of around 60 million people, which is used as slave labour. No country in the world can compete with their manufactures, and hence workers in Australia and all developed countries lose their jobs. Do we really want to get into bed with such a monster? Our own little Mandarin monster, The Krudd [ed. note, Australian Prime Minister Kevin Rudd], a notorious Sinophile, thinks so. I wonder what’s in it for him. Has Therese been given permission to set up employment agencies in China?
for The Daily Reckoning Australia