A Melman Minute — May 24, 2007

It always amazes me how readily many observers and market investors are willing to believe that serious societal and economic problems have been resolved, based perhaps on one or two favourable reports, or a speech from the President or the Federal Reserve Board chief. Unfortunately, in the real world, simple and quick solutions rarely occur so quickly and easily. Two examples come to mind.

A - Iran is moving ahead with a program to develop their nuclear program. In the immortal words of William S. Gilbert (of Gilbert and Sullivan fame), “of that there is no possible doubt, no possible, probable shadow of doubt, no possible doubt whatever.” Iran has invested huge amounts in centrifuges necessary to create nuclear fuel. They have imported expertise. They have constructed ultra-expensive and complex plants designed for that purpose alone. Their nuclear progress has been documented with utmost thoroughness by the International Atomic Energy Agency.

About three months ago, the United Nations demanded that Iran cease such activities and threatened sanctions if it did not. Iran did not and gold rallied along with the petroleum complex because it was feared that a confrontation between Iran and the international community could lead to a closure of the Straits of Hormuz and a disruption of the world’s petroleum supplies along with the rising potential for armed conflicts with Israel in particular. However, the international community hemmed, hawed, and finally came up with an appeasement plan whereby it would grant favoured trade status if Iran would quit those activities. The public was convinced the crisis was over. However, it is not.

According to a just-released Reuters story, Iran has continued to expand their uranium enrichment activities and the United States has responded by moving NINE U.S. warships carrying 17,000 personnel and 140 aircraft into the Persian Gulf. This came just after U.S. Vice-President Cheney declared that the United States would, “…stand with others to prevent Iran gaining nuclear weapons and dominating the region.”

The situation is far from resolved. Iran continues its defiant stance and the rest of the world cannot ignore the potential lethal threat if Iran acquires genuine nuclear weapons and the missiles to launch them. There is no compromise possible. Either one side or the other must give in to defuse the growing tension - but neither side has indicated it can or will give an inch.

B - The United States economy, of which the ever-buying consumer has been the major support, is facing a real estate crisis of the first order. Sharply rising real estate prices have been supporting an enormous wave of consumer activity stimulated by homeowners’ ability to borrow staggering sums from their price-inflating residences. As an example, in California, according to figures just released from the California Realtors’ Association, the median price of a single family home in that state rose from $241,350 in 2000 to an astonishing $556,640 by 2006, an increase of $315,000 per home in just six year!

Given the fact that there are millions of privately owned homes in California, it can be readily observed that the increase in accessible equity ran into the hundreds of billions of dollars - and homeowners were delighted to tap into that rising equity to pay off debts, go on cruise vacations, buy luxury automobiles, make home improvements, etc.

However, by the summer of 2006, the situation began to reverse itself. Home prices slowed their rate of rise and actually began to decline. New construction began to slow down. Instead of equity build-up we began to see equity diminishment. Fear of an economic implosion began to take hold.

Then, following a few positive comments from industry and government ‘experts’, the public began to assume that there would be a “soft landing” in the housing industry and prosperity would quickly return. But it has not worked out that way.

Despite the occasional upward blip in one category or another of home sales, the trend remains hard down. Companies which have been built on rising home construction are now laying off tens of thousands of workers. Home prices continue to weaken and now, this morning, it was reported that they have fallen an unheard-of ten percent from year- earlier figures. The supply of homes on the market continues to exceed demand, pointing to even-lower prices ahead and this does not take into account the flood foreclosure-based selling which is beginning to loom large along the horizon.

The only conclusion we can suggest is that when a powerful trend is in effect, particularly one with such potentially devastating consequences as these two, it would be worthwhile to seriously consider all available information before deciding that the trend has been reversed and the feared consequences will never take place.

DISCLAIMER

The information presented above is based on data which we believe to be from reliable sources, but the accuracy of which cannot be guaranteed. Any opinions or predictions contained herein are those of the editor and are likewise offered also for information purposes only.

← All A Melman Minute