A few nights ago, as I found myself sitting at a dinner table with a group of strangers, by way of making conversation (and doing research) I asked, ""What do you think will happen with the real estate market?"" Their answers: ""It’ll come back"" and ""We’ve been here before.""
Not wanting to be a wet blanket, I didn’t disagree. But I think they’re wrong. I think there’s a lot more downside ahead, and that getting there will take much longer than most people imagine today. My main argument (which I’ve mentioned before) centers on the demographic forces created by the baby-boom generation; they’re finished with buying houses, and next they’ll be pumping up the health care industry.
And now I’ve got a major investment figure in my court. He’s Ken Heebner, one of the most successful investors in recent decades. I like to watch Heebner because he practices in Boston, because he’s shown an ability to think for himself, and because his record is really, really good.
Now 66 years old, Heebner runs four mutual funds, and the most notable of these today, in light of the hole that real estate has fallen into, is his CGM Realty Fund (CGMRX).
Over the past ten years, this fund has gained an average of 19.7% per year, topping the real estate category handily.
More impressive, for 2007, while the average real estate fund is down 7.2%, Heebner’s fund is up 13.0%!
How has he done it?
As usual, by thinking differently (and by having a broader definition of real estate than most other funds in the category).
According to a Wall Street Journal article that appeared on Monday, Heebner has 28% of the fund in REITs that have specific factors helping them ... and the biggest of these factors is mining. Coal companies, for example, own a lot of land, and thus fall under his real estate umbrella.
He noted that the strength of the global economy was driving demand for building materials, among them copper, iron ore, coal and nickel, and that high oil and gas process were driving demand for ethanol, and thus pushing up prices of corn and soybeans ... which provided investing opportunities in fertilizer and farming equipment stocks.
But his most interesting comments centered on the U.S. housing market. In short, he reiterated his belief, first voiced in 2006, that housing prices in certain areas would decline as much as 50%. In fact, he said, ""I think the decline in housing prices will be broader and deeper than I originally thought.""
Happily, though, he doesn’t think such a decline in housing will lead to a recession; he thinks that Fed rate cuts, combined with robust global growth, will prevent that.
We all like people who agree with our opinions, and having Heebner on my side makes me a little more confident about my position.
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But many people disagree with me (that’s what makes a market) and I totally accept the fact that I might be wrong. Being wrong is a normal part of investing, and I’ve been wrong plenty over the years.
But when it comes to investing, it’s not whether you’re right or wrong that matters, it’s whether you make money!
So here’s an email from one of my readers, a gentleman who’s spent 20 years in the real estate industry.
""Dear Tim,
I’m afraid I must take issue with your explanation of the cause of the current housing market’s woes. I think it’s a bit simplistic. While about 15 years ago, analysts did theorize that the boomers would not only stop buying houses about this current time frame, but start liquidating the ones they owned, thereby causing a supply imbalance and depressing prices, it did not account for several phenomena that have driven the housing market to the recent up and down extremes.
First, political pressure to enable virtually every American the privilege of home ownership did not drive boomers to buy - it drove the youngest first-time homebuyers EVER to acquire housing. Add in the number of new immigrants that could buy with little or no down-payment, even non-permanent aliens (not illegals) too. Increasing demand and short supply drove prices higher, while declining interest rates and a mortgage industry that kept originating new products to put more people in homes, regardless of whether the buyer could qualify or not, kept the market rolling.
Easy credit terms, boutique and complicated loan programs, scurrilous lending practices all set up the scenario as people continued to use their homes as ATMs or for laddering or leveraging other real estate.
Along comes Emperor Greenspan who first encourages people to use short-term fixed rate or ARM loans as lending vehicles, then the Fed raises interest rates...17 times in a row, along the way proclaiming the Bubble is coming (one if by land, two if by sea).
Then a whole segment (and a very large segment) of the loan market implodes as those people with ""Pay Option"" ARM loans start realizing they can’t afford their homes they obtained with these time-bomb loans, many of which were ""no income qualifier"" too. These were not boomers. They were the newbies to the housing market, including many minorities without a clear understanding of what they were getting into who were taken advantage of by lenders and brokers.
All this was the fuel, and the ignition for the crash was the MEDIA which started hyping that the Bubble was here, prices were going to drop, if you’re a buyer you should wait, if you’re a seller, get out right away...
And that’s exactly what has happened. The media created the panic and the market stalls. (Yeah, the media doesn’t create the news, they just fabricate it). Buyers stopped buying, millions of sellers all jammed the market over a short time frame, sure enough, ya gotcher Bubble. Self-fulfilling prophecy.
Now, we see people walking away from houses into which they put no equity to begin with, foreclosures are mounting, the time-bomb loans are catching up with the borrowers who never really qualified, NEW loans if they are over the conforming limit are overly risk-priced because of the credit crunch, inventory is sky high and the demand is not there because of FEAR. Irrational Fear (did Greenspan think about that?). We will come out of this eventually but we are only in the 2nd inning of this game. I think the only way the housing market will start moving again is when the media decides it is time. Sad but true. While the level of homeownership reached its highest level ever in 2005, the average level of sophistication of homeowners and potential buyers is probably at its lowest ever now, so the media has definite influence. Having been a professional in the RE industry for the last 20 years, I have seen this whole transformation occur from the inside.
RF""
My comment? Most of what he says is true. He’s certainly right that I oversimplify; on the other hand, I think he may be so deep in the industry that he can’t see the forest for the trees. All these details that he notes may well be the natural result of a demographically-generated wave of demand and the struggle to cope with that wave by the parties on both the buying and selling sides.
But what’s most interesting is his conclusion that the media is to blame. Usually, I’m happy to bash the media as shortsighted, reactionary, inflammatory loons. But in this case I don’t see them as a major culprit.
As for Greenspan, Bernanke, etc., the pressure to ""do something,"" exerted by peers, constituents, media, and other political forces, is so great that in the end I think they’re often little more than cogs in the system.
Still, I’m happy to have the input.
So now on to today’s stock idea.
It’s gold.
I have no love for gold as an investment. I’ve long believed that the best investments are ones that benefit from the efforts of men and women to transform low-value items into high-value items.
Traditionally, an automaker turns steel, rubber and glass into a beautiful automobile, a chipmaker turns silicon into a speedy computing device, or a software company creates a program that allows us to achieve in seconds a result that would previously have taken hours.
Gold is different. While much of it is used in industry (semiconductors or jewelry), a lot of it just sits in vaults, its value determined not by utility but by exterior economic circumstances.
Those, of course, include interest rates, currency exchange rates, trade deficits, fear and greed, and the prospects of war, famine and pestilence. Fundamentally, I have no clue about how to predict the future value of gold prices.
Still, there’s always value in examining charts, and if you examine a long-term chart of the price of gold here’s what you see.
The price of gold (and silver, too) peaked in 1980. (Remember when interest rates were sky-high?) And then gold went into a long decline that lasted ... 21 years! The bottom finally came in April, 2001.
Since then, the price of gold has doubled, from approximately $350 an ounce to $700 an ounce. It first hit $700 in March of this year, and then entered into a normal consolidation phase that lasted six months. But in the past two weeks, it’s broken out to new highs, topping $710! Technically, this is a great positive sign; it suggests that more upside is ahead.
So how can you benefit from this trend? Well, you could buy bullion and bury it in a hole in the back yard. Or you could buy your spouse some solid gold jewelry, and enjoy the purchase while its value appreciated.
But I think the best course is to invest in the companies that are mining the gold. Two of them have earned a spot in Cabot Top Ten Report in recent weeks; here’s the most recent.
""Agnico Eagle Mines (AEM) operates Canada’s largest gold mine, the LaRonde. In eighteen years of production, known reserves at the mine have grown or been maintained every year. The other two properties, Lapa and Goldex, are expected to begin producing in 2008. Beyond that there are many other properties in Canada that are being explored and developed. The Meadowbank project in the Nunavut Territory in northern Canada, for example, is advancing towards initial gold production in 2010. In Finland, construction of the Kittila gold mine commenced in the summer of 2006, and initial production is expected in the third quarter of 2008. And in Mexico, there are advanced exploration projects. But why is the stock strong now? Mainly because turmoil in the housing/mortgage/credit markets has weakened the dollar and in turn made gold more attractive. How long this trend will last, no one knows, but we never argue with trends. Also attractive is the stock’s small dividend (0.2%) and the growing number of mutual funds (145) on board. In the latest quarter, earnings were down because of an acquisition, but the long-term is bright; in fact, analysts’ estimates have recently been raised for both 2207 and 2208.
AEM first hit 45 in December 2006, and the basing period that followed took nine long months. But after trying three times in the past seven weeks to break through that level, the stock finally succeeded last week. That nine-month base now has the power to send that stock on quite a ride, so we say if you like the story you can buy a little here.""
You see, with the stock, you not only benefit from the increase in value of the gold the company holds, you also benefit from the company’s growth.
The company has grown revenues every year of the past decade, and I see no reason why it can’t continue that trend.
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Editor’s Note:
Agnico Eagle Mines is one of the stocks updated in each issue of Cabot Top Ten Report. Every stock in Cabot Top Ten Report earns its spot there with market-leading performance, and subscribers to the service get an expert analysis of both the technical and fundamental aspects of each stock. Past big winners include Crox, Chaparral Steel and Cooper Tire & Rubber ... and that’s just the C’s! If you’d like to get 10 strong stocks delivered to your email inbox every Monday, I recommend that you take a no-risk trial subscription. To get started, simply click below.
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Yours in pursuit of wisdom and wealth,
Timothy Lutts
Publisher
Cabot Wealth Advisory
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