Our regular viewers know that we have been somewhat obsessed with the ramifications of the real estate bubble bursting (see our special report, "Potential Catalyst-Real Estate," September 2003 on left side of our home page).  Now even Fed Chairman Bernanke has caught on to the dangers of the bursting of the bubble.  He stated in both Tuesday's and Wednesday's testimony before Congress, "the housing market is the central element of the financial crisis.  Anything we and Congress can do to strengthen the housing market, or strengthen the mortgage financing market, will be helpful.  We can do this by restoring confidence in the Government Sponsored Enterprises (GSEs)."  We are happy to have Mr. Bernanke on board, but are not too happy about begging Congress to slow down the process by trying to get bills passed that would postpone the inevitable decline and make the eventual decline even worse. We have to let the free market work its way through the housing crises.

Barron's came out with a cover story this week about home prices entitled "Home Prices are About to Bottom".  The analysis made little sense to us.  It showed the historical fact that whenever the housing sales drop from over 2 million units to under 1 million, the housing market activity rebounded within a quarter and caught experts by surprise.  We believe the drop from over 2 million homes sold to fewer than 1 million is completely irrelevant.  In fact, if the home sales do pick up, it will only add to the excess inventory and make the problem worse. 

Chip Case, the co-author of the Case-Shiller home index, said, "in many areas, particularly outside the overbuilt markets of Arizona, Florida and Nevada and the huge bubble market of California, home prices may well stabilize" and begin to recover before the end of this year. This statement came directly from the Barron's article.  Notice Case was not quoted saying "and begin to recover before the end of this year".  That had to be Barron's opinionated addition to what Case said about the prices stabilizing.  The other point the Barron's article made was to "cherry pick" various areas of the country where the price to income rose during the bubble and have now declined to become more affordable.  If you look at the attached charts of home values relative to median income nationwide, you will see the market has to go down much further in order to reach the norm.  The last point they made was to show that inventories of existing homes declined to 4.49 million in May, which was down from April (4.55).  What Barron's didn't point out was that the inventories of existing homes was never more than 4 million until 2007 and fluctuated around 4.5 million all through 2007 and 2008.  We could say that the inventory is up from 3.9 million in December of 2007 to 4.49 million presently, or up from 4 million in February of 2008.

Obviously, we don't agree with the analysis or the conclusion that Barron's reached calling for home prices to bottom.  If Barron's is correct and we are wrong we suspect that we will also be wrong on calling for a much lower stock market over the next year or so.  By the way, Barron's happens to be one of our favorite financial magazines (we never miss reading it) and just 3 weeks ago the cover story was "Luxury Homes 15% Off" where they stated "Bargain hunters, beware.  A further 10% slide is likely."  We think a 10% decline is optimistic and actually think another 25%-30% is more likely.  Please take a look at the attached charts to back up our case for a much more severe decline.  However, all you really have to do is take a look at every stock that's value is based upon either real estate or mortgages and look at their drastic declines (all banks, GSEs, and investment banks that have a large stake in real estate or mortgages).  Don't believe this latest rally in them (we always get rallies in bear markets).  The S&P homebuilder's index is down about 30% year to date and down 60% from one year ago. Also, every bank and investment bank with a large stake in real estate is down severely from one year ago.   

Another clear indicator that the real estate decline is not over is that the decline in prices is accelerating and, along with stock market declines, is wiping out more individual wealth each week.  So far homeowner's wealth is down about $3 trillion, while the stock market has wiped out another $2 trillion.  Also, the National Association or Realtors (NAR) reported yesterday that home builder sentiment hit a record low of 16 (down from 24 in July of 2007).  David Seider, the economist of NAR stated, "given the systematic deterioration of job markets, rising energy costs, and sinking home values aggravated by the rising tide of foreclosures, many prospective buyers have simply returned to the sidelines".  Remember, this is coming from an organization that always puts the most optimistic slant on all news coming out of the real estate industry.  It is our very strong opinion that the depression in the residential real estate market will spread to the commercial side.

We don't have much room to discuss the sub title on the change from the second stage of the bear market "concern" possibly moving to the third stage "fear and capitulation", but we will touch on it.  As we have indicated in past comments, we usually get a rally in the market between the three stages and explained the rally that moved us from the "denial stage" to the "concern stage" ("Three Stages of Bear Market", June 26).  The rally that took place yesterday, and seems to be following through today, could be the rally that catapults the market into the very scary and nasty third stage "fear and capitulation".  We will keep you posted.

Last week we made a few predictions about the rest of this year and those predictions would have to be considered unconventional, to say the least.  We predicted that the U.S. recession would spread abroad and move through the euro-zone and eventually Asia.  The short explanation of this process was also touched on in the last comment, "the end of the insatiable appetite for foreign goods and services by the U.S. consumer will have a major negative effect on foreign economies". 

Now that the U.S. consumer has "hit a wall" the rest of the world will have to suffer.  Remember, the U.S. has about 3 times more GDP than the next largest economy.  The U.S. with a GDP of $14 trillion dwarfs Japan at about $5 trillion, China at $3.3 trillion, Germany at $3 trillion, France at $2.2 trillion, the UK at $2 trillion and India at $1 trillion.  How can a consumer led recession in this country not have an extremely negative impact on the economies that are exporting most of their goods and services to us?  To make the global recession even worse, many of our trading partners have copied our housing model, and now we have housing depressions spreading throughout the globe.

We also predicted that "the global recession would produce a destruction of demand which will break the back of the commodity bull market including energy." 

Comstock believes that the rising price of anything (and any commodity), but especially necessities, is inflationary as they are going up, but once the commodities have risen in price enough to cause cut-backs in other purchases the process becomes deflationary.  The price that causes the consumers to run out of liquidity and reduce consumption on the commodity in question or in other goods and services is called the "clearing price".  This is where conservation comes into play in the energy complex or a change in eating habits occurs when it comes to food.  On the other hand, precious metals probably will be an exception to the break in commodities we expect.

We understand the complex situation in energy could be an exception to the break in commodities we expect because of the strong demand from emerging economies such as China and India, coupled with the scarcity and expense of increased drilling.  Demand for sophisticated rigs is going through the roof and there is no spare capacity.  However, we believe the clearing price is a worldwide process and when the energy subsidies are removed from many of these emerging countries, demand destruction and the clearing price will still bring the prices down in energy along with the other commodities.

Many investors believe that the stock market has been going down for the past 8 months because the rising price of energy and food.  We believe that the market will continue down with the decline in the U.S. economy along with the decline in the global economies.  And even if the energy complex as well as other commodities weakens, we think the stock market will continue down until it reaches reasonable valuations (see the special report on left side of home page "What is the Real P/E?"

We also understand that the price of most commodities rose due to the inflationary policies of the Fed.  Most investors believe the Fed actually prints money from a printing press to increase the money supply.  Here's how it actually works. When the Federal Open Market Committee (FOMC) buys Treasury Bonds, Notes, and Bills they pay the dealers with whom they bought the Treasuries with a check from the U.S. Treasury.  This is "new money" (called high powered dollars) that is going into the fractional banking system where it can be loaned out in multiples of the total amount of the check.  This excess money goes into the system and results in the phenomenon we all have heard of called "more money chasing the same amount of goods and services".  The inflation is exacerbated by the "new money" lowering the value of the U.S. dollar, and since most commodities are dollar based, the commodities rise even further.

However, this phenomenon only takes the system so far with inflation and eventually becomes deflationary once the system runs out of liquidity.  So essentially, we are saying that when the price of anything rises so high that destruction of demand occurs, it causes the "clearing price" effect.  That is when the price breaks down.  We believe that we have reached that point now and the commodity bubble will break during the second half of this year.