Oil and Bonds
"What we do upon some great occasion will probably depend on what we already are. What we are will be the result of previous years of self-discipline." ~ Henry Parry Liddon 1829-1890, British Theologian
Petrol prices are up 62% from their average low price of 1.61, while crude oil prices are 54% below their old highs. Thus it appears that when crude oil trades back to the 147 mark, petrol prices will most likely be trading at levels in excess of 5 dollars per gallon. If we couple this with the fact that worldwide supplies are dwindling at a rapid rate and that oil companies have drastically slashed their exploration budgets, the long term projection is for the cost of petrol to reach extremely painful levels.
While we can draw many conclusions from the above charts the main one to focus on is inflation. These charts are clearly indicating that inflation is the next major threat and not deflation as most government economists are projecting. Once again, we would like to warn our subscribers that they should cut down on all levels of debt, use excess money to purchase bullion and commodities related stocks on all strong pull backs. The next 3-6 years are going to bring about unprecedented changes.
Look at the dramatic turnaround in 30 year rates, from a low of roughly 2.5% in Jan, they spiked to 4.75% and this is occurring when the Fed is keeping short term rates at close to zero percent. What do you think will happen when the Feds are forced to raise long term rates as a result of foreign investors demanding a higher rate of return in order to compensate for the falling dollar? This chart clearly also illustrates that the real estate market is not going to mount a long term recovery any time soon.
Consider the following facts:
Toll brothers one of the leading home builders reported that its revenues are down approximately 50% for the year. The MBA mortgage applications' index has fallen over 16% for the week ending May 29; the week before this, it experienced another 14% decline. Mortgage applications have dropped by nearly 50% and the latest figures on the refinancing index indicate that it is down over 24%. Not only are fewer individuals applying for mortgages but banks are making the qualifying process much harder now, thus not everyone that applies gets an approval, unlike in the good old days where you only needed to scratch X on the signature line, and you were approved.
The message is clear avoid the real estate sector.
Logic dictates that interest rates will continue to rise and that the bond market will fall to pieces. In the long run, this is true, but in the short term, we actually expect rates to drop again and possibly test their lows one more time and bonds will most likely rally and test or take out their old highs before the bond market falls apart. One other long term negative factor is that America's biggest debt buyers China and Japan are now deploying less and less money into the bond market, they do not believe (and rightly so) that the US is doing all it can to defend the dollar.
In the next 6-12 months, we are looking for bond prices to rise again (interest rates will drop in the process as they trade in the opposite direction to bond prices) and possibly put in new highs but at the very least they will test their recent highs. For this scenario to remain valid bonds should not trade below 112 for more than 3 days in a row, if they do trade below 112 for more than 3 days in a row, the intermediate outcome will most likely change and instead of rallying to new highs bonds will at the most test the lower limit of their old highs. A break past 126 for more than 5 days in a row will be the first sign that bonds are on their way to at least test their old highs.
Assuming that the current picture remains valid and bonds rally to new highs, the next move will be for bonds to put in a very long term top and then start their long decent down. We expect this market to slowly break down and eventually a crash, which will eventually drive interest rates to the 15-18% ranges and possibly as high as 25% before the dust settles down. Those that invested in the bond market should use the upcoming rally to get out of this area for this will be your last chance. If you have a mortgage and you cannot sell the property or do not want to sell the property, then take advantage of the low interest rate environment to refinance your mortgage at a fixed rate. Avoid getting into real estate, unless its farmland and make sure you get a good deal on it. Do not rush into anything; the buyer is now in the driver's seat so negotiate for the best possible deal.
We are expecting the bond market to mount one final rally that should at the very least result in a re test of the old highs if not in a series of 52 week highs.
"Where one person shapes their life by precept and example, there are a thousand who have shaped it by impulse and circumstances." ~ James Russell Lowell 1819-1891, American Poet, Critic, Editor