Why the change?

It’s been almost two years at this blog after five years at the old blogspot blog – the original Mess That Greenspan Made – and I’d probably have just kept doing what I was doing with this blog and the separate investment website except that an opportunity arose for a partnership with InvestingChannel that I just couldn’t turn down.

Basically, InvestingChannel has done all the website development and now hosts the new combined blog/investment website (I probably should have combined the two when I started back in 2005) while also handling all the marketing and sales for the subscription product.

As you may know, marketing and sales isn’t exactly my forte, so, I was more than happy to let them do that and share the revenue. I’ve come to learn over the years that the investment newsletter business is really more about marketing and sales than content and, since I was never very good at the former, I’m happy to just provide the latter.

For those of you who don’t know, a lot of effort goes into the investment newsletter (published weekly) and the performance of the model portfolio going all the way back to early-2005 is quite good (up over 100 percent since that time) , but I’ve just never done much to promote it and have never advertised.

That’s what InvestingChannel will be doing and, now that the development work is done, I’m looking forward to seeing how that all works out.

I’m not quite sure what to do with this blog. My original thought was to make it more of a personal blog and have the new Iacono Research be strictly about economics/investments/finance/money printing. Then, anything else that I felt like sharing could go here. I’m not sure how much more I have to share, so, we’ll just have to see how that works out.

As for the name, I attempted to change The Mess That Greenspan Made to simply timiacono.com, however, the Wordpress Gods did not allow that (I enter the change, but it never shows up at the blog), so, I’m taking that as a sign that I should just leave it alone, at least for the time being.

I’ve been double-posting everything here for a few weeks now and that all ends today. I’m not sure what, exactly, will become of the blog you are now reading, but, like the original one – The Mess That Greenspan Made at Blogger – it won’t be going away anytime soon (I still like that old tag line: “How Eighteen Years of Easy Money Changed the World”).

Gold and silver prices picked up where they left off in January, surging again after a three week pause on optimism that a messy debt default in Greece will be avoided, heightened tension in the Middle East, and a weaker trade-weighted dollar as bullish technical factors triggered hedge fund buying, most analysts now predicting even higher prices ahead.

For the week, the gold price surged nearly $50 an ounce (or 2.9 percent), from $1,723.80 an ounce to $1,773.60, and the silver price jumped 6.4 percent, from $33.28 an ounce to $35.41. Gold is now up 13.2 percent for the year, but down 7.7 percent from its high last year, and the silver price has gained 27.1 percent so far in 2012, now down 28.4 percent from its peak last spring.

Silver reached a five-month high at $35.70 an ounce on Friday after piercing through its 200-day moving average the day before (as indicated in red in the one-year silver chart below) and, while some analysts think it is now vulnerable to profit taking, others think this sets the stage for another assault on the $40 an ounce level, last seen in early-September prior to the vicious sell-off that affected nearly all asset classes.

[To continue reading this story, please visit Seeking Alpha.]

This graphic from the Economist’s Daily Chart depicts how trying it’s been recently, particularly last year when many investors were probably wondering why they were paying big fees to hedge fund managers who underperformed a low cost stock index fund.

Interestingly, according to the Reuters story, after plunging 42 percent last year, the $116 million Henderson European Absolute Return fund claims the top spot in performance this year with a gain of 14 percent through late-January. This compares to a gain of almost 12 percent for the Iacono Research model portfolio so far in 2012 after a decline of 5 percent last year, the same as the average hedge fund performance in 2011.

After marching steadily higher early in the week, gold and silver saw their biggest one-day losses in more than a month on Friday as hopes for more Fed money printing were dashed after the better-than-expected labor report. Still, both metals maintain impressive gains for 2012 after a disappointing end to 2011 as more attention is focused on demand in China and actions by central banks, two of the most important price drivers in recent months.

After rising above $1,760 an ounce for the first time since November, the spot gold price ended the week 0.7 percent lower, down from $1,737.30 an ounce to $1,725.90, as the silver price surged past the $34 mark before reversing course, ending the week down 0.9 percent, from $33.99 an ounce to $33.67. The gold price is now up 10.2 percent for the year, but down 10.3 percent from its 2011 high, and silver has risen 20.8 percent in 2012, down 32.0 percent from its peak last spring.

We’ll find out soon enough if Friday’s sell-off was anything more than a one-day event.

Clearly, there have been many good reasons for the price of precious metals to head higher over the last month – demand from China, loosening monetary policy by central banks, and increased gold purchases by central banks topping that list – and many technical analysts have been shocked by the ease which previous resistance levels have so quickly been surpassed and now function as support. Up until Friday, technical factors were unquestionably positive, but, with the late-week reversal, some now argue that the metals have come too far, too fast and the Friday correction will continue.

[To continue reading this story, please visit Seeking Alpha.]

Aided by a surging trade-weighted dollar on Thursday and Friday when the European sovereign debt crisis took yet another turn for the worse, both gold and silver saw steep declines last week, the former experiencing its sharpest drop since the broad sell off during the first week in May, but both metals still cling to impressive gains in 2011 as other asset classes falter.

For the week, gold on the spot market dropped 2.4 percent, from $1,540.00 an ounce to $1,502.30, and silver fell 4.4 percent, from $35.90 an ounce to $34.32. For the year, gold is now up 5.7 percent and silver has gained 11.0 percent.

With last week’s decline, both metals are now at the lower end of the trading range that they’ve settled into since plunging from the late-April highs and technical analysts are increasingly talking about a developing “triangle” pattern that usually resolves itself with a big move up or down, the direction uncertain.

At times like this, when the next $100 move for gold and the next $5 move for silver could go either way, given the already lofty price and growing uncertainties in the world, it makes good sense to me to remain comfortably sitting on the sidelines with core long-term positions that are not intended to be sold until prices go much, much higher and with ample cash to take advantage of any buying opportunities that might arise.

As shown below, silver has become very interesting yet again and my guess is that there is another $5+ move coming sometime in the next month or two, again, the direction uncertain.

I am far from an expert on this sort of thing, but one idea that I contemplated (but never acted upon) back in late-April when the silver price was oscillating between about $45 and $50 was to buy both calls and puts on the iShares Silver Trust ETF (SLV) in the belief that a big move was coming.

This is referred to as a long straddle (see this Options Industry description for complete details) and it might just work for either July or August expiration dates because any big move – up or down – will be handsomely rewarded, far offsetting the losses on the options that expire worthless.

On the other hand, if the silver price stays near its current $34-$36 range, both options become worthless and the entire capital would be lost.

As noted here a week ago (see Volume VI, Issue 25), I’ll be thinking seriously about adding some long-term positions in SLV (and perhaps start selling covered calls for SLV and/or the SPDR Gold Shares ETF (GLD)) should the silver price move a bit closer to $30 as the metal has exhibited some remarkable resilience lately and I have my doubts about seeing the price go below $30 again given all the demand from Asia. 

Then again, if the downward trend for stocks and commodities accelerates from here, silver and gold will likely be dragged down along with everything else, the only question being a matter of degree.

Relative to other asset classes, I think both metals will hold up better than they did a few years ago, but they are still likely to see big declines initially, last week’s action being a reminder of how quickly and how far prices can swing.

Analysts at Bank of America/Merrill Lynch had an interesting comment last week when they said a gold price between $1,500 and $2,000 could be sustained in the years ahead, but that prices above $2,000 or below $1,000 could not. They said sharply higher prices would likely be the result of safe haven demand that would eventually ebb and that sub-$1,000 prices would quickly see jewelry and industrial demand ratchet up to support prices.

I’ve long preferred the slow, steady 15 to 20 percent per year gains for gold rather than a rapid ascent, a sort of stealth bull market that doesn’t attract much attention but that provides steady returns available in few other asset classes these days.

In China, the central bank announced that it will issue more gold and silver commemorative coins featuring giant pandas to meet soaring demand for precious metals in the country. The bank said that the circulation of one ounce gold coins with a face value of 500 yuan (about $77) will almost double from 300,000 to 500,000. Similarly, one ounce silver coins with a face value of 10 yuan (about $1.50) will see its circulation rise from 3 million to 6 million. Inflation, now at over 5 percent in China, continues to drive demand as China now rivals India as the world’s leading source of gold demand.

Lastly, Rep. Ron Paul (R-TX) chaired a hearing of the House Domestic Monetary Policy and Technology Subcommittee on Thursday to talk about his Gold Reserve Transparency Act of 2011 that seeks a complete audit of the U.S. gold reserves at Fort Knox and elsewhere.

To no one’s surprise, Treasury officials said that all the gold is there and it is regularly checked, however, none of the audit data has been made available to Congress or the public. There is a pretty good summary of what went on at the hearing in this Mineweb report, the detailed nature of ongoing audit programs coming as something of a surprise to me since, for many years, I’ve heard (and written) that the U.S. gold reserves haven’t been audited in decades.

As the gold price continues to regularly make new all-time highs and with the price of silver posting spectacular gains in recent months, now seems like a good time to try to answer the question of whether we are anywhere near the end of this long-term cycle and what signs one should look for when considering whether to sell your gold and silver.

Like all other secular trends, this one too will surely come to an end someday and, given the events of the last year or so, it now seems quite possible that the end may come sooner than the 2013 time frame I’ve often cited, so, giving these questions due consideration sooner rather than later makes good sense.

First and foremost, in my view, at current prices we are nowhere near the top. I’ve long said that we’d have to see prices closing in on the inflation-adjusted 1980 high for gold – roughly $2,300 an ounce today – in order to even contemplate exiting positions in precious metals for good and we remain well back of that at about $1,400 an ounce.

The other major chart criteria to look for is a “blow-off top” similar to what was seen 30 years ago and, as shown below, what we’ve seen in recent years haven’t been bubbles at all – at least not compared to what happened in 1979-1980 when the gold price moved from about $250 an ounce to its January 1980 peak of $850 an ounce in a matter of months.

Now, there are a couple of very salient points about that peak on January 20th thirty years ago, the most important one being that it happened fast and didn’t last long. The gold price doubled in just over a month and closed above $800 an ounce on just two days.

It closed over $700 an ounce on just six days and, for the month of January, the average price was a much more modest $675 an ounce, so, one thing that should be understood early on is that “catching the absolute top” is virtually impossible.

If, back in 1980, you’d have sold all your gold at over $600 an ounce you’d have done well.

After peaking in January and then correcting to under $500 an ounce in the spring, gold prices over $600 were available for much of the rest of that year, in fact, the average price in September of 1980 was just two dollars lower than in January at $673. But, after 1980, a $600 gold price wouldn’t be seen for another 26 years.

Importantly, after the parabolic rise that ends trends like these, there are lots of “true believers” who will stick around and help produce a big bounce up as was the case for the Nasdaq bubble (see chart two sections below), but, for all intents and purposes, the party is over after this “blow-off top” occurs and you’d probably be better off looking at where to put your money next rather than hanging around in precious metals.

As for silver, a closer look at the details behind the 1979-1980 surge to almost $50 an ounce (see this chart) reveals that this is not a very good yardstick by which to extrapolate future events. The silver price tripled from $5 an ounce to $15 an ounce during the first 11 months of 1979 and, then, from December to January, it tripled again to its peak of $48 on January 21st. This price surge was very much a market anomaly due to the Hunt brothers briefly “cornering the market” and is only likely to be repeated if another market anomaly arises and, though an ongoing short-squeeze might fit that bill, I wouldn’t count on it.

As opposed to an average price of $612 for gold in 1980, down about 28 percent from the January peak, the average price for silver that year was about $20 an ounce, almost 60 percent below the peak. I’ve long thought that inflation-adjusted highs for silver of about $128 an ounce today are quite misleading. Using the average 1980 price to produce an inflation-adjusted equivalent of $53 an ounce today is likely a better gauge of where prices might go in the years ahead.

Once again, the key points here are that gold and silver prices remain well back of the inflation-adjusted highs from 1980 and secular trends such as these are normally punctuated by a parabolic rise in prices and we’ve yet to see anything like that which occurred when precious metals last reached a long-term peak.

Other Indications that a Price Peak is Still Far Off

A clear sign that we are nowhere near a peak for gold and silver prices is that, in the Western world, there is no mania. Now, one could argue that in Asia they are quickly approaching that point and this is discussed in the next section, but, in the West, gold as an investment is still largely considered to be a curiosity at best and “gold bugs” are still considered to be a bit loonie, despite having been right about rising precious metal prices for the last decade.

Institutional investors and investment advisors are certainly aware of precious metals as an investment class – after ten years of gains that have trounced equity market returns, they should be – but most have still not looked beyond what has been drilled into their heads over the last 30 years in that prudent investing consists of stocks and bonds only.

Sure, now that the gold price has moved from under $300 an ounce to over $1,400, today you can read that Money Magazine thinks you should have a five or ten percent allocation to precious metals and related stocks as an inflation hedge, but this is really just lip service. Five or ten percent will do virtually nothing for your overall investment performance.

In my view, to have a major impact on your overall returns, a weighting of 40, 50 percent or more in precious metals and related shares (as has been the case for the model portfolio since its inception) is required. I don’t expect this view to become conventional wisdom in the years ahead, but a move up from 5 percent to 20 or 25 percent will make a world of difference for metal prices as these markets are not very big.

While I don’t know the source for the data in the chart below from this 2006 article at USA Gold, it is consistent with what I’ve come to understand about the gold market relative to other asset classes and how this relationship has changed over the last three decades.

Today, you are likely to see a number between five and ten percent – consistent with the Money Magazine advice – but, a move sharply higher has yet to develop, despite the popular SPDR Gold Shares ETF (NYSE:GLD) now being the second largest ETF in the world with assets of $57 billion.

We are getting closer, but we are still far from reaching the mania phase for precious metals in the West and anyone who thinks that the Cash4Gold craze a year or two ago signaled a price peak (at around $1,000 an ounce?) should, by now, understand that this was simply a huge wave of individuals selling their valuables during a nasty recession where people needed cash to pay the bills.

Moreover, anyone thinking that Glenn Beck and any other Fox News shows that advertise and promote gold are signs that prices have reached a peak would do well to understand that cable news viewers buying a few hundred or a few thousand dollars in gold are just a tiny, tiny portion of the market, the notoriety being inversely proportional to the impact on metal prices. It will be wealthy individuals, institutional investors, and investment advisors that will have a much greater impact on the supply/demand dynamic and these groups have yet to make the leap that some Glenn Beck viewers have.

While gold related products are now widely available to anyone with a brokerage account, they are not yet “mainstream” and all one has to do is ask their friends and neighbors if they own any gold or silver. It’s been my experience that almost everybody knows about the rising price of gold, but hardly anybody owns any.

This will soon change, but, before it does, investors must get past the notion that gold is a “barbarous relic” and undo decades of indoctrination from the likes of Warren Buffett who, even after more than a 400 percent increase in the gold price over the last ten years (during which time Berkshire stock has only doubled), has no use for the metal.

Investing in gold has yet to be broadly accepted by the public, but it will in the years ahead, and one way that you’ll be able to tell is that you’ll see investment companies touting their gold products rather than simply providing the occasional gold-related article or two when communicating with their customers. I’ve been with Fidelity Investments for more than ten years now and I’m just starting to see email from them pointing me to their latest article about investing in gold stocks even though they’ve had a gold mutual fund since the mid-1990s.

The Craziness Will Begin in Asia as Inflation Rises

Half way around the world, things are quite different when it comes to investing in precious metals and part of this has to do with the fact that governments recommend and promote it. In both China and India, there are now early signs of “gold fever” with new investment products being launched weekly and soaring demand from individuals from all socioeconomic levels.

Rising inflation in this part of the world is a key factor in this development and this is why, in my view, we are likely to see the real “gold mania” begin to develop first outside of the U.S. as both China and India are already seeing rising inflation and have begun to tighten monetary policy and raise interest rates.

This contrasts with conditions here in the U.S. where, despite record prices for some commodities and oil prices that are now back at about $90 a barrel, policymakers are still more concerned about de-flation than in-flation.

Recall that the 1980 price peaks for gold and silver came at a time when consumer prices had been rising for years, the inflation rate reaching 11 percent after the first oil-shock in the mid-1970s before falling and then surging again later in the decade under the disastrous Fed chairmanship of Arthur Burns, only to climb to more than 14 percent just as precious metals reached their highs in 1980.

Now, inflation is calculated much differently today than it was thirty years ago, so, I’m not sure that it would be possible to have a government reported inflation rate of 14 percent anytime in our future.

For example, as shown to the right, the shelter component that included home prices rather than today’s nefarious “owners’ equivalent rent” accounted for nearly half of the 14 percent inflation rate in 1980. Combine this major change with others such as hedonic adjustments, product substitution, et. al. and government economists may have succeeded in guaranteeing that we’ll never see double-digit inflation again.

Nonetheless, inflation rates of five or eight percent in the U.S. will likely feel about the same way that 14 percent inflation felt thirty years ago. Perhaps more importantly, inflation rates that are already at five or eight percent in China and India will drive policymakers to further tighten monetary policy there and likely lead to higher metal prices.

Today, one has to ask the question of whether rising inflation and rising interest rates in China and India are already pushing metal prices toward their bubbly manic ending.

History shows that inflating asset bubbles don’t really kick into high gear until policymakers begin to take steps to slow the trend, only to find that their timid steps reinforce the very trend they are trying to slow as investors and speculators become emboldened, pushing prices even higher.

The Fed funds rate rose steadily with the gold price in the late-1970s until Paul Volcker became Fed Chairman in late-1979 and crushed inflation (and metal prices) by jacking up short-term lending rates to nearly 20 percent in early-1980.

More recently, neither the Nasdaq bubble or the housing bubble really got going until monetary policy tightened as shown below.

This process may already be underway in Asia where investment demand for gold and silver has reached new highs and, as is the case for other aspects of the global economy, these two nations may be in the driver’s seat when it comes to pushing gold and silver prices to their secular peak.

This is why I’m no longer quite as certain that we’ll have to wait until 2012 or 2013 to see prices peak as a major prerequisite for higher gold and silver prices – rising inflation and rising interest rates – is already in place … in Asia.

Whenever it is that gold and silver begin their final ascent, there should be clear signs that the end is near – maybe not so much in the U.S., but certainly in China and India, so, it’s worth paying close attention to development there. Until that time, just hang on tight.

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To learn more about investing in natural resources using commonly traded ETFs,
stocks, and mutual funds, see this description at Iacono Research.
To begin a subscription, click here.

It was another week of record highs for precious metals, but developments late in the week set the tone for a very uncertain period ahead, metal prices seeing some of their sharpest daily declines in months after new margin trading requirements were imposed for silver and rising inflation in China spurred new fears of tighter monetary policy.

More talk about the relationship between gold and paper money came from World Bank chief Robert Zoellick and more coverage of precious metals came from the mainstream media in the form of a front page New York Times story just after the gold price surged to over $1,400 an ounce, all of this followed later in the week by a plunge of almost $50.

For the week, the gold price fell 1.7 percent, from $1.392.90 an ounce to $1,368.80, while the silver price dropped 2.6 percent, from $26.75 an ounce to $26.04. For the year, both metals continue to carry impressive gains, the gold price now up 24.8 percent while silver has risen 54.3 percent, trailing only the gains made by cotton and palladium.

The most recent run-up in the gold price is again shown in the updated graphic below alongside both the 2005-2006 and 2007-2008 moves. It is important to note that this now-lengthy 2009-2010 jaunt just last week surpassed the one seen just two years ago with a rise of 38 percent versus 36 percent.

As noted three weeks ago when this graphic last appeared here (see Volume V, Issue 43), “the short-term future for both gold and silver prices is now almost entirely dependent upon what the Federal Reserve does” and Ben Bernanke did not disappoint markets earlier this month.

I don’t know if prices are headed higher or lower from here, but I do know that at least a minor correction is long overdue and that, at some point, we’ll have another major correction that is likely to see the gold price dip by 20 percent or more and the silver price plunge by 30 percent, perhaps more.

The World Bank’s Zoellick sparked a controversy last Sunday when he penned an op-ed($) in the Financial Times (try here if no FT sub) in which he suggested any new or revised global monetary system “should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values”.

More than anything else, this is what led to gold’s new highs and there is a pretty good set of links from this item at the blog last Tuesday. Just the fact that the World Bank chief mentions something like this is a big step in wider adoption of the metal as an investment (and a big step to higher prices). For anyone interested in the idea of gold again playing a major role in the global monetary system, I’d recommend having a look at this Martin Wolf commentary from just a few weeks ago, also in the Financial Times. A return to a traditional gold standard would be nearly impossible today, however, there should be some role that the metal can play, it now being the “elephant in the room”, as Zoellick characterized it, increasingly being used as an alternative monetary asset because of unease about the global financial system and the fear of inflation in the future.

There was a good deal of news for silver last week too. As noted in this item at the blog, the inventory at the now even more wildly popular iShares Silver Trust ETF (NYSE:SLV) reached new record highs (along with daily trading volume of 150 million shares on Tuesday) that included an astonishing 352 tonne increase in a single day on Thursday. More importantly, COMEX officials introduced higher margin requirements for silver futures traders that played a big role in the price tumbling by two dollars an ounce on Tuesday, sending traders scrambling. There was a very good write-up on this subject at Kitco last week and, for anyone who is interested, it is well worth a look.

I continue to hear stories about people who just get completely wiped out by things like this and it’s completely unnecessary. Investing with margin is just a recipe for disaster. I’ve never advocated it and believe it to be one of the most important reasons why most “active investors” do not achieve the long-term results that they seek. I believe it’s much more important to have had the foresight to buy silver at $5 an ounce six or eight years ago and have a 400 percent gain on that investment rather than trying to trade the metal on margin here in 2010 to achieve similar results.

[Note: There is a write-up in the current issue of the Weekend Update (available to subscribers only) about how to go about starting an investment portfolio based on natural resources, even at today's lofty prices. All new subscriptions come with a 60-day, no-questions-asked money back guarantee, so, consider this a "risk free" look at how you too can get started investing in the secular bull market in commodities that still has at least a few more years to go, the best being yet to come.]

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To learn more about investing in natural resources using commonly traded ETFs,
stocks, and mutual funds, see this description at Iacono Research.
To begin a subscription, click here.

Over the last few weeks, prices for stocks and bonds have been rising together in what is a most unusual sequence of events where, clearly, one of the two is wrong about the future direction of the economy. Typically, higher bond prices (that result in yields being pushed lower) indicate economic weakness ahead and the lack of pricing pressure, whereas, rising equity markets are typically a harbinger of stronger economic growth and higher consumer prices.

As best I can tell given the recent spate of disappointing economic reports and the beginning of the process where Wall Street economists begrudgingly revise their growth estimates lower rather than higher, the bond market is the one that has it right at this juncture. But, the stock market is now taking its cues (to some degree at least) from the recent talk about quantitative easing (i.e., money printing) and, along with the natural resource sector, prices are being bid higher in anticipation of this effort being successful, that is, at least insofar as it inflates asset prices.

One thing is certain, the economic recovery in both the U.S. and elsewhere in the world at just past the mid-point in 2010 is not what it was expected to be just a few months back when stock prices were soaring and American workers were being hired by the hundreds of thousands. Last week’s labor report was dismal given that we are supposedly more than a year into an economic recovery and the prior week’s Q2 GDP now looks even worse a week later after the latest data came in.

As shown below, absent any other changes, the 2.4 percent growth rate in the April-to-June period is set to be revised downward to about 1.7 percent after the latest inventory data fell well short of where it was estimated for Q2 GDP.

Note: The animated image above should be alternating from 2.4% and 1.7% growth for Q2.

Recall that after skittish managers were, understandably, unsure about future demand back during The Great Recession, they cut back on production and let inventories plunge, all of which added to the severity of the downturn. Then, as the worst of the slowdown passed, they ramped up production again and let inventories grow, the positive change in inventories being responsible for almost two-thirds of all economic growth since the recession supposedly ended about a year ago.

As indicated in the latest data on new orders from the ISM manufacturing index (as detailed in The Economy section above), inventories are highly unlikely to provide this same level of support going forward, in fact, last week’s data showed that some inventory components contracted in June for the first time in a year, rather than expanding as previously believed when the advance estimate (the first of three estimates) for second quarter GDP was prepared.

It’s Still About Housing

This week’s retail sales report follows two months of declining sales and will provide new clues about the state of mind of the American consumer who has been a relative non-participant in the economic recovery so far. While accounting for 70 percent of all economic activity, personal consumption has accounted for only one-third of economic growth over the last year and this has much to do with a new outlook by many Americans, one of modest spending, job insecurity, and a shaken belief system regarding the fickle value of assets, most importantly, the value of real estate, what was once a bedrock of their finances.

More important than the impact of inventory changes on slowing growth in the GDP data is the “stimulus-free condition” of the nation’s housing market and the impact this has on consumer attitudes, a truer state of the housing market soon to be revealed in the level of existing home sales in July set to be released later this month.

Mark your calendar for Tuesday, August 24th, because it is possible that we’ll all be reading headlines about 20-year lows or all-time record lows for existing home sales along with rapidly rising inventory and falling home prices. As shown below, if existing home sales maintain their historical relationship with pending home sales, we could see a seasonally adjusted annual rate (SAAR) of below 4 million units, down by almost half from the boom-time sales rate of more than seven million units, all of which will surely produce even more downward price pressure, the important question being how much.

If not for tax credits and historically low mortgage lending rates that, last week, sunk below 4 percent for 15-year loans and below 4.5 percent for 30-year mortgages, the nation’s housing market would not appear to have stabilized over the last year. In fact, “propping up” home prices was a key part of the recovery effort that began in earnest during the summer of 2009.

While some may think that we’ll see a relatively modest post-tax credit correction over the summer and then stability later in the year, in my view, that is simply wishful thinking. With the “foreclosure pipeline” now holding anywhere from a few million to up to 10 million homes, it seems quite unrealistic to think that the housing market will not falter. Surely we’ll see a double-dip in home prices and, once again, it is simply a matter of the degree.

If home prices decline a few percent later this year after having posted modest gains since last fall, no one will really notice. But, if home prices are on their way to another 10 or 20 percent decline, then we’re in for another credit crisis of some sort and confidence in the economic recovery will fade quickly. I’m of the opinion that we’ll see about another 8 or 10 percent down for home prices nationally – not a disaster, but enough of a decline to rattle markets and shake confidence.

Waiting for the Fed to Act

As I’ve commented to a number of subscribers in recent weeks, at this point, it all comes down to what Ben Bernanke and the Federal Reserve do in the months ahead. Absent the recent talk about QE II, I doubt that we’d have stock prices and oil prices as high as they are now and a gold price of over $1,200 an ounce at this point in the summer would be unlikely.

In the absence of a Congress willing to act in the run up to the fall elections, there is a growing expectation that the central bank will step in to provide support to a faltering economic recovery, likely announcing plans to ratchet up its money printing as soon as this week in an effort to raise expectations for in-flation so as to combat growing fears of de-flation.

The question is whether they’ll act sooner or later.

If the policy making committee fails to provide some signal of further easing to come at the conclusion of this week’s meeting, a big sell off in risk assets is likely. If, on the other hand, the Fed takes bold action, we could see sharply higher prices for nearly all asset classes. More likely, we’ll see something in between (see the Federal Reserve section above for more on this) and, then, it becomes a question of what comes next.

If, in the months ahead, the course chosen is outright monetization of the national debt as recommended by James Bullard and as detailed here last week (see Volume V, Issue 31), things could quickly get out of hand with all manner of rising asset prices, but, Fed economists would surely embrace this problem rather than having to deal with the alternative in de-flation.

As for the typical American, things certainly aren’t getting better as jobs are still scarce and small businesses have participated in the recovery even less than consumers so far if this poll from Gallup last week is any indication.

The fall elections are now less than three months away and we’ll likely have a new political landscape of some sort by the end of the year. It seems that more and more people are realizing how poorly the government is serving their needs at a cost that continues to soar, one that, up until just a few months ago, politicians did not hesitate to pass on to future generations.

Now a full year into the “recovery” with the labor market showing little improvement and small business owners about as pessimistic as the long-term unemployed, the widespread perception that elected officials in Washington and the central bank are more concerned about the health of Wall Street than Main Street is well founded, a condition that is not likely to change until major reforms are enacted, what seems impossible until there are major changes in how Washington works.

It’s possible that we’ll see a major shakeup in November that will lead to the sort of reforms that are needed, but, I wouldn’t bet on it. What I would bet on, however, is that between now and then, risk assets will seem a whole lot riskier and, absent bold moves by the Federal Reserve, there will be more sellers than buyers.

You can see why the Pimco Total Return fund (PTTRX) has become so popular in recent years – slow and steady seems to have won them a lot of new clients despite the four percent front-end loads. Of course, the real lesson in the performance data above might be that simpler is better – if you had only sold your stocks and bought dumb ‘ol gold coins back in 2000, you’d be far, far ahead of just about any other investment on the planet.

For Iacono Research subscription details (where fees are far lower than Pimco’s), click here.

Full Disclosure: Long the model portfolio at time of writing.