The Rude Awakening
Melbourne, Australia
Tuesday, May 29, 2007 ------------------------- - The world's greatest short seller's next target,
- The U.S. housing market continues to underwhelm,
- The new light sweet is heavy and sour, and plenty more…
------------------------- From Edinburgh, Scotland, Joel Bowman reports… Yesterday the markets rested. So did we. In the good ol' U.S. of A, your senior editor, Eric Fry, observed the Memorial Day holiday. Over in bonnie Scotland, the nation took off for a bank holiday. We don't quite understand the history behind the bank holiday but, not wanting to offend the locals, we dutifully observed it anyway. Yesterday in Australia, there were no such excuses for indolence. At his desk at the Old Hat Factory in Melbourne, Dan Denning toiled away, pouring through the world's news and furiously scribbling his unique brand of observation. Still, even when you give him the day off Dan is the kind of guy who will still show up for work five minutes early. So it is Dan's labor of love that is to be thanked for today's edition of the Rude Awakening. His musings on the U.S. housing market, a curious shift in crude pricing trends and the bewildering world of financial engineering are yours to enjoy below… ----------------------------------- Don't Forget to Sell
By Dan Denning Jim Chanos has Macqurie Bank (MQBKY: Nasdaq) in his sights. Uh oh. You may not know Chanos. But he's sort of infamous on Wall Street. And when he talks about the stocks he hates, people listen. In late 2000, Chanos went from reputable short-seller to stock market legend with his call to go short on the Houston-based energy trader. Enron. His call turned out to be the call of the decade. Enron blew up in spectacular fashion. The stock plummeted. Investors howled. Congressmen bellowed. Cameras flashed. With Enron, Chanos spotted the special purpose entities (SPEs) that were at the heart of the company's balance sheet chicanery. The SPEs were used to borrow money that didn't show up on the parent company's balance sheet. Privately, the company's insiders said SPE stood for "s*** piled everywhere." What it meant is that investors never had a clear picture of just what the internal finances of the company actually were…until it was way too late. We aren't suggesting that Mac Bank is the next Enron. But at an event in New York last week, Chanos is said to have highlighted the fact that the bank, "relies heavily on off-balance sheet financing and related party transactions," says Alistair Barr at Marketwatch.com. Frankly, we are baffled by the financial engineering that takes place today. We wonder if anyone understands it. The buying and selling of assets is a tricky business. Macquarie did well enough at it the first half of the year, with AUD$733 million in net income. But with AUD$30 billion in buyouts, short-sellers are beginning to wonder if the bank has paid too much for acquisitions and whether it will be able to flog off assets for a profit. There's no doubt MacBank is the poster child for modern financial engineering in Australia. It's got a growing portfolio of global assets and a much higher public profile abroad. Such a high profile, in fact, that one of the world's best short-sellers has taken notice. This prompts an open-ended question for you, dear reader: Is it now time to look at short-selling Aussie stocks? If Chanos is down on MacBank, what about resource stocks? Base metals prices are high. But rising energy costs must certainly be set to cut into profit margins for Rio, BHP, and others. Hmm. Could revenues continue to grow for Aussie blue chips, while net income declines? The "Other" Crude Oil Moving from finance to tangible assets, what the hell is going on in with crude oil? Normally, West Texas Intermediate (WTI) is oil's benchmark. At sixty-five bucks, the WTI price isn't alarming. It's doing what oil's been doing for the last year, hovering stubbornly between USD$60 and USD$70. But Brent Crude, the price of oil from Britain's North Sea, is trading at USD$70.50-a full five dollars higher than WTI. This is unusual, historically speaking. WTI trades at a premium to Brent Crude because WTI is a lighter grade of crude. By lighter, we mean that WTI crude, owing to its purer, less sulfuric quality, is less expensive to "crack" into refined fuels for re-sale to the public. A product with a built-in higher profit margin should trade at a spread to an inferior grade of crude. So what does persistence of the high spread between Brent and WTI tell us? It may very well be telling us we have entered a new phase in the oil age, where the price of oil is based on heavier grades rather than lighter grades. That would be significant because it indicates that the supply of light, sweet crude oil from the Middle East and East Texas is declining relative to heavier, sour crudes from places like Venezuela and Russia (the world's second largest producer behind Saudi Arabia). It's a change in the composition of world oil production that favours producers and refiners of the sour stuff. In simpler terms, the future of oil is sour and heavy. Brent could be the new global benchmark, reflecting new global production realities. Not that the light sweet stuff will go out of style. Just the opposite, in fact. With a bottleneck forming in the refineries, we'd expect the price of the light sweet stuff to actually go up. The oil market may well segment into something like the market for red wine. At one end is sour crude, the table wine of the global economy. At the other end, light sweet crude, the finest vintages affordable to the world's high-rolling economies with deep pockets. Either way, the oil price is just one tiny hurricane in the Gulf of Mexico or one big Middle East war away from "popping" again. And with refinery capacity for sour crude being somewhat limited, exporters of refined fuels (Europe especially) should do quite well. Importers of refined fuels, on the other hand, will find out that being so far downstream from the world's oil supply has real and unpleasant consequences, including but not limited to, soaring petrol prices and massive queues at the petrol station. We reckon in about two years it'll be just like 1979 again. The Housing Crash…in Slow Motion Just a quick note on the US housing market, mostly as a cautionary tale about the grinding and plodding nature of house price declines. Two things happened in the US market last week worth noting. First, existing home sales fell by 2.6%. Second, median home prices fell for the ninth straight month. Housing bear markets are different than bear markets in stocks. They last longer. A man can swallow his pride and sell a stock for a loss. But accepting the idea that property markets are cyclical too, and that you have bought at the top, this is something a man is reluctant to acknowledge until financial necessity forces his hand. The existing home data was slightly at odds with the new home sales data released earlier in the week. New home sales actually increased by 14.6%, accompanied by an 11% decline in the median new home price. No mystery here. US homebuilders are slashing prices to clear inventory. Everything must go! You now have a clash between existing home owners and homebuilders over prices. Investors and individual homeowners will be reluctant to lower selling prices because it means lower profits, or even a loss. But builders are anxious to find the market clearing price for inventory and to clean up the balance sheet. The homebuilders are looking for the bottom. Existing homeowners are stargazing at profits that will never materialize. That means median home prices in the US will grind lower for the next year, and maybe much longer. It is a psychological war of attrition for sellers. And the current paper losses don't account for inflation either, which is working against them. Sooner or later, home owners in over-extended property markets will have to cave. This will mean more price declines. With credit tightening, homes are still not affordable to new and first-time buyers. The housing market always comes down to the affordability of the monthly mortgage payment. And based on that, the end of the housing bear is not near. Property bear markets last a very long time because of this psychological resistance to selling. America's has really just begun. Does the US property market tell us anything about the Australian market? Maybe. Aussies are in love with property, so much so that we find people barely have time for stock market chatter at cocktail parties. The "animal spirits" associated with property are still alive and well, as is the belief that property the quickest, most fool-proof way to wealth. ---- U.S. Housing Market Report ---- WARNING! Brace Yourself and Your Wealth for a Whole New "Second Wave" of Housing Hurt About to CRASH DOWN on Wall Street, the U.S. Economy, and the American Homeowner… Wall Street… Main Street… nobody's money is safe. Learn how to protect your investment with this free report: The Emergency Financial Survival Toolkit ------------------------------------ Joel's Endnote: If you would like to read more of Dan's observations, you'll be glad to know that you can do so for free. He writes for the Daily Reckoning's sister publication in Australia, known as, strangely enough, The Australian Daily Reckoning. If you have comments of your own regarding anything in today's issue, please do not hesitate to pen a thoughtful email addressed to ausiejoel@the-rude-awakening.com and click send. Cheers, Joel | 
