Macleans: “Two charts you need to see about commodities and the housing market”; Shiller on the psychology of housing bubbles

Hat tip to DR for sending this link:

Two charts you need to see about commodities and the housing market– Macleans

Veeeeery interesting article.  Some key quotes and graphs:

“The above chart is from this week’s magazine story. It tracks the running 10 year annual returns in overall commodities. Through wars (both hot and cold), easy credit booms and even the U.S. industrial revolution, any time the commodity market has gone through a period like it just has, a nasty spill invariably followed. With the TSX down nearly 680 points or 4.7 per cent this week on softening commodity prices, there’s an argument to be made we’re cresting the peak once again.”

We’ll see about that.  With the Fed mulling a (brief?) end to QE2, there’s a very strong case to be made for a significant potential commodity price realignment.  Zero Hedge recently highlighted the strong correlation between the Fed balance sheet (which bloats as they purchase government bonds….the goal of Quantitative Easing) and virtually every asset class.

The graph is perhaps confusing, but focus on the purple highlighted area which shows the Fed balance sheet, which swelled immensely as it undertook QE1 and QE2.  Note how commodities (green line) and US stocks (solid purple line) both responded to QE.  A number of market pundits remain convinced that Fed-sponsored liquidity has been the major support for much of the asset gains since the start of the QE experiment. At any rate, back to the article.

Investors aren’t the only ones who should be hoping the commodity bull market keeps on a’runnin’. The real estate sector has benefited in a huge way from strengthening resource prices, thanks to low unemployment and higher incomes, not to mention the  overall sense of invulnerability that’s come to pervade the Canadian mindset. But to truly appreciate the stunning heights Canadian house prices have reached, history is helpful once again.

For our story we spoke with Robert Shiller, the Yale professor famous for developing the Case-Shiller House Price Index in the U.S. which tracks prices going back to 1890. In the absence of solid historical Canadian data, Shiller suggested “an exercise” of fusing his index with the Canadian Teranet-National Bank House Price Index, on the assumption that house prices in the two countries behaved relatively similar prior to 1990.

“This is just to give an impression how unusual things are in Canada now. Canada is going through a major historic boom, at least in comparison with booms in the US before 1990.” -Robert Shiller

Shiller on the psychology of housing bubbles

Hat tip to DR and to VREAA for transcribing some key quotes…

“I wouldn’t blame it on the sub-prime revolution, because sub-prime primarily effects low price homes, and you see the high priced homes in the same boom. Moreover, I think the sub-prime revolution is in some sense a consequence of the housing bubble… people got so excited about housing, the lenders believed it too.. thinking they were doing these low income borrowers a great favour by getting them into a mortgage. .. They all believed that home prices were going to just go up and up…”

“This boom was driven not by a sense that we were in a temporary boom, that you want to get out of, it was driven by a sense of a new reality, that home prices would just always go up at 10% a year… it ain’t so, prices don’t do that… people got this crazy idea…”

No one summarizes the mental gymnastics and self-delusion involved in an asset bubble better than Dr. Shiller.  If you can see the parallels with the Canadian experience, the outcome should be clear.  If you still can’t see it, check this out.

Cheers,

Ben

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2 Responses to Macleans: “Two charts you need to see about commodities and the housing market”; Shiller on the psychology of housing bubbles

  1. jesse says:

    “I think the sub-prime revolution is in some sense a consequence of the housing bubble… people got so excited about housing, the lenders believed it too.”

    We should think a bit about who the “lenders” were. Often those administering the signing the contracts for the loans (the “lenders”) were detached from those giving them the actual capital to lend (the actual lenders). I don’t follow bank/mortgagor finances much, but who’s lending the money for mortgage financing in Canada and under what terms?

  2. Serge says:

    Certain assets do go up indefinitely like Nortel stock, except for that one time…

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