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Carvana (CVNA) Is Insanely Overvalued
The following analysis of Carvana is from the September 29th issue of my Short Sellers Newsletter. You can learn more about this here: LINK
Carvana update (CVNA – $187) – Originally I was going to keep this brief. And I apologize to those who are tired of hearing about what a great short CVNA is only to watch the stock relentlessly levitate higher. But once I started re-digging into CVNA’s Q2 numbers and the footnotes in the most recent 10-Q, I believe CVNA ultimately will prove to be one of the best shorts in the next 12 months.
Recall that ALLY Financial announced earlier this month that auto delinquencies and charge-offs jumped considerably more in July and August than its internal risk-control model led management to believe would occur. “Higher than its risk-control model” projected. That is a key phrase.
Risk control models at sophisticated algorithms designed to predict the percentage of loans that will fall delinquent, thereby enabling management to determine its willingness to take lending risks plus how much to charge (loan rate) for each given tier of risk. When the actual outcome jumps “outside” of the guard rails established by the model, it means that a fundamental shift occurred in the ability or willingness of borrowers to make loan payments. Whatever that shift was, in all probability, it’s worse than ALLY’s management represented.
I bring this up because ALLY is the bank that finances the loans underwritten by Carvana. CVNA has a “Master Purchase and Sale Agreement” with ALLY in the amount of $4 billion which enables CVNA to sell the loans it originates to ALLY, subject to certain underwriting criteria.
Given the disclosure by ALLY, it’s a good bet that a material percentage of the loans sourced from CVNA is part of the problem for ALLY. The current agreement expires on January 10, 2025. It’s also a good bet that ALLY likely will tighten the underwriting standards on the auto loans it is willing to buy from CVNA. In turn, this will adversely affect CVNA’s sales volume.
Further to this point, not all of CVNA’s loans (“finance receivables”) go to ALLY. It has also issued $14 billion worth of Asset Backed Securities (ABS) – in this case bond trusts securitized by the CVNA auto loans. In aggregate, the delinquency rates for the loans in these ABS trusts are beginning to soar.
The graphic on the next page is from CVNA’s Q2 10-Q. It was prepared by and posted on Twitter by @Bluechip, someone with whom I share ideas and analysis. I believe he’s a professional investor and analyst. He’s also a fellow CVNA bear. As it turns out, and not surprisingly, the delinquency rate on CVNA underwritten auto loans is escalating:
12.6% of the total loan balance in these trusts is in some degree delinquency. The total 31-day+ delinquency rate jumped from 7.71% in June 2023 to 8.71% in June 2024. The 61-day+ delinquency rate jumped from 2.39% at the end of 2022 to 3.373% at the end of 2023 to 3.97% as of the end of June. The big jump in all delinquencies means that the 61-day+ delinquency rate will be considerably higher by year-end. CVNA has balance sheet exposure to these trusts in the form of variable interest entities. If enough of the tranches above CVNA’s investment in equity tranche become distressed, CVNA’s interest will be wiped out and it will have to recognize the loss on its income statement.
In its latest ABS pool, the weighted average interest rate is nearly 14% with an average remaining term of 71 months. The average principal balance is $24,504. But I noticed something interesting. The average selling price for a CVNA vehicle YTD in 2024 is $23.7k (per the latest 10-Q):
Because the average loan balance in the loans that went into CVNA’s latest ABS deal are below the average selling price of the vehicles, it means there’s a meaningful percentage of these loans that were made with negative equity.
In other words, the car buyer was underwater on the trade-in and CVNA loaned enough to buy the new used car and pay off the loan on the old used car. Those are also likely loans extended to the bottom half of the FICO range in this loan pool (576 to 894), which means the loans carry an interest rate substantially higher than the average rate for the pool (13.69%). It also means that a material percentage of the loans will eventually default.
As with ALLY, as the rate of distress and defaults rise, the market will be less willing to invest in CVNA ABS bonds, which means CVNA will either be forced to retain a higher percentage of the loans that it dishes off to ALLY and the ABS market or curtail the number of loans it underwrites. The latter issue will adversely affect sales.
Here’s also why that matters. In Q2 2024, buried in its income statement (but disclosed in its footnotes), CVNA recognized non-cash $173 million in gains on from the sale of finance receivables. It’s hard to tell where CVNA stashes this number but it is supposed to be an entry below the operating income line item. It’s probably in the “other expense (income), net” line. Regardless CVNA’s net income before taxes was $49mm in Q2.
See the problem? Excluding the non-cash gain on loan sales of $173mm in Q2, CVNA’s NIBT would have been a $124mm loss. Moreover, given that the “other expense/income net” line item was $124mm lower than the gain from loan sales, it likely was because CVNA had to write-off bad loans of that amount or close to that amount.
But there’s more. Recall that CVNA “restructured” its debt and replaced a large amount of cash pay bonds with PIK bonds (payment-in-kind, meaning the interest is paid with more bonds). The bonds PIK for two years then revert to cash-pay. The restructuring temporarily reduced CVNA’s total debt outstanding but if CVNA PIKs the bonds for the fulld two years, it will be saddled with the same amount of debt as before the “restructuring” and the interest rate on the bonds will be even higher (12-14%). The bonds revert to cash pay in 12 months.
CVNA would have trouble making cash interest payments right now on that debt. As the economy gets worse and used car sales decline, CVNA will have no ability to make cash interest payments on that debt.
The bottom line is that CVNA remains insanely overvalued. It trades at 54x trailing earnings and 123x the consensus 2025 earnings. Those metrics are based on just the market cap. Including the debt, CVNA is trading at an enterprise value of 34.2x the last six months’ operating income annualized. But CVNA’s operating income likely will decline over the next six months. For point of comparison, Carmax – which is also overvalued – trades at a trailing P/E of 29x and a forward P/E of 21x.
An argument can be made that CVNA is not even worth the amount of debt on its balance sheet, which is $5.4 billion right now and will be over $5.6 billion when the PIK bonds go cash-pay. Using the Street estimate for 2025 net income, which invariably will turn out to be too high, that “p/e” for the debt is 34x. Using the last six months’ net income annualized that debt is 52x net income. But CVNA’s net income declined from Q1 to Q2. Using the Q2 net income annualized, the debt is 75x net income. Compare those valuation ratios to the ones for KMX above. When CVNA eventually has to restructure its debt, the shares theoretically are thus worthless because that debt will be worth far below par value in bankruptcy.
The short interest as of mid-September has declined by a considerable amount. For most of the last few years, CVNA’s short interest has been over 30% of the share float but it has declined to 12.6% of the float. That’s still fairly high but it makes it more difficult for Street trading desks to engineer short-squeezes, particularly since the founder, Ernest Garcia II has been a habitual seller of shares, including dumping over one million shares this month.
CVNA’s move higher is truly puzzling. It’s reminiscent of the trading action of the dot.com stocks in late 1999/early 2000. If the pattern remains consistent, it would appear that CVNA is getting ready to sell-off down to the $130-$140 area. The next earnings report is at the end of October. I think CVNA will move lower ahead of earnings, particularly if there’s any type of material move lower in the stock market. This is likely why Ernest Garcia II has been one of the most prolific insider sellers in the entire stock market.
Half Of A Percent Rate Cut? It’s Worse Than We Thought
The following commentary is from the September 15th issue of my Short Sellers Journal. For more information on this bear newsletter follow this link: Short Sellers Journal Information
“The US economy is in a good place and our decision today is designed to keep it there.” – Jay Powell at his post-FOMC press conference
Here’s the opening sentence to the latest FOMC policy statement: “Recent indicators suggest that economic activity has continued to expand at a solid pace.” Think about it for a moment: why does the Fed need to cut rates at all given that the alleged unemployment rate is low relative to history, the stock market is at a record high and housing prices are at all-time highs? As the global head of Deutsche Bank’s economic research (Jim Reid) wrote: “the interest rate cut of a half-percentage-point to kick off its easing cycle looks harder to justify than those in 2001 and 2007.” I qualify that by saying “at least on the surface.”
The Fed only cuts 50 basis points at the start of a rate cut cycle as it did in 2001 and 2007 after there’s been a severe deterioration in the markets or the economy. We know the economy is not expanding at a “solid pace,” unless the Fed’s definition of “solid” is the opposite of the dictionary definition. Manufacturing has been in a recession for well over a year, the Dallas Fed Manufacturing index has been negative for 22 consecutive months. Housing hit a wall in May/June and homebuilders have slowed down the rate of housing starts by quite a bit. If it weren’t for a record level of Government deficit spending, the economy would be in a severe recession.
I’ve always maintained that you need to watch what the Fed does, not what it says. If the economy were “in a good place” the Fed would not have needed to start a rate-cut cycle with a 50 basis point cut. In fact, given that the Fed has access to better data than the public, it’s likely that the economy is in worse shape than is discernible from the private sector reports.
We know the Government economic data is manipulated to belie reality by reflecting stronger economic activity and lower inflation than is otherwise factual. During the post-FOMC meeting presser, Powell used the word “recalibration” in reference to the Fed’s level of policy rate being out of sync with the lower inflation rates and rising unemployment. As Rabobank ranted: “Powell had trouble clearly explaining the reason for the large cut because he did not want to admit that the ‘recalibration’ was needed because the FOMC had fallen behind the curve.”
Furthermore, it’s likely that the big bank balance sheets, along with the regional banks, are in worse shape than can be determined with publicly available data. The Fed has been slowly pumping reserves into the banking system since October 2023, which why M2 has risen by $364 billion since October 2023. That number is likely larger now as there’s a two-month lag in the data (the latest number is through the end of July).
The bottom line is that the economy is in trouble both with respect to the declining level of economic activity and the overall level of debt at every level of the economy – public, corporate and house-hold. Furthermore, an increasing percentage of that debt is becoming distressed.
With respect to that latter point, the Government Accountability Office (GAO) estimates that about 10 million borrowers – or 25% – of student loans are behind on payments as of the end of January. About two-thirds of them were more than three months behind. These borrowers are currently protected by a one-year moratorium ordered by the Biden administration that expires next month. There’s currently $1.6 trillion in outstanding student loan debt. The Biden Government has already forced taxpayers to eat $168.5 billion by forgiving it. Of course, that puts more stress on the record spending deficit.
Gold Is Now The 2nd Largest Central Bank Reserve Asset
The following commentary about the dollar and gold is the opening salvo of the September 5th Mining Stock Journal. To learn more about this mining stock news letter, follow this link: Mining Stock Journal info.
Gold’s status as a Central Bank and bank reserve asset is escalating. According to Bank of America, gold has surpassed the euro to become the second largest reserve asset after the U.S. dollar. To be more precise, B of A should have specified that it is the eastern hemisphere Central Banks that are diversifying out of the U.S. dollar and the euro and buying gold and yuan. Nevertheless, gold now represents 16% of global bank reserves. The dollar represents roughly 58% of Central Bank reserves, down from over 70% since 2002.
Interestingly, Poland was the biggest buyer of gold in the second quarter this year (though we do not have access to the actual amount of gold that the PBoC is buying). Furthermore, Poland is insisting that the gold it buys is delivered to the country’s Central Bank rather than letting London banks “safekeep” the gold. In addition, Turkey has been a big buyer of gold. Also several African countries have announced Central Bank gold buying programs.
Though it might not happen this year or next, I think there’s a possibility that gold could overtake the dollar as a reserve asset, particularly if the reports that the BRIC/eastern hemisphere alliance of countries are considering a gold-backed trade currency come to fruition. Russia is hosting a BRICs Summit in Kazan, Russia October 22nd – 24th. There are reports that the discussion of a new trading currency is on the agenda, though I have not been able to confirm that first-hand.
Russia announced today (September 5th) that it will increase its daily gold purchases from $13.5 million to $93 million (1.2 billion rubles to 8.2 billion rubles) for the next month starting September 6th using windfall oil and gas revenue. The report was released by the Russian news agency Interfax. In my opinion, this is related to the eventuality of a BRICS gold-backed trade settlement currency, if not a full-blown gold-backed currency.
I bring this topic up because the Fed has painted itself into a corner. It’s under enormous pressure from the market and Wall Street to cut interest rates. But if it does that, it risks a rapid sell off in the dollar:
The chart above is a 5-year daily of the US dollar index. The dollar is currently testing the 100 level on the index, which has served as technical support since early 2023. If the Fed starts to cut, in all likelihood the dollar will drop to 90, where it was in mid-2021. That will send gold rapidly toward $3,000 and silver toward $50.
A decline in the dollar foments several problems. First, this likely would accelerate the decline in the use of dollars by global Central Banks as a reserve asset. Just as significant, if not more problematic for the U.S., a falling dollar and lower interest rates will make it even more difficult to attract foreign interest in funding additional Treasury debt – something which has already become problematic.
Finally, the Fed knows that inflation is running hotter than is represented by the CPI. Rate cuts will push real interest rates further into negative territory. Using the CPI, “real” rates are positive now. However, using a valid inflation index like the Shadow Stats Alternative CPI, real rates currently -3% using the 1990 CPI calculus and -6% using the 1980 CPI calculus. Negative interest rates fuel price inflation, which is part of the reason inflation has been “sticky.” Cutting interest rates will cause the real rate of inflation to accelerate.
This is why gold has been hitting new all-time highs almost on a daily basis the Fed cut the Fed funds rate earlier this month and why silver is poised to breakout into the high $30s. The precious metals “see through” Jay Powell’s rhetoric and a strong economy and a lowered rate of inflation. The precious metals also are sniffing out an eventual resumption of money printing.
Consumer Credit Is A Ticking Time Bomb For The Banks
The following commentary is from the September 15th issue of my Short Sellers Journal. For more information on this bear newsletter follow this link: Short Sellers Journal Information
“Over the course of the quarter, our credit challenges have intensified…our borrower is struggling with high inflation and cost of living and now, more recently, a weakening employment picture.” – CEO of Ally Financial
Earlier this year I recommended Ally Financial (ALLY – $34.79) as a longer term short. On Tuesday this past week at an investor conference, the CEO of ALLY admitted that the auto delinquencies and charge-offs jumped considerably more than its internal risk-control model led management to expect in July and August. He added further that the Company expects charge-offs to rise going forward and acknowledged that ALLY’s “borrower is struggling with high inflation and cost of living.” The stock plunged, closing down 17.6%.
The ALLY CEO’s admission spilled over into stocks like Credit Acceptance (CACC), which I’ve presented as a short in the past, Carmax (KMX) and Autonation (AN), which I’ve also presented as shorts, Capital One (COF) – same – and the big Wall Street banks.
In general, the delinquency rate for the subprime segment of auto loans is slightly higher than it was at its worst during the great financial crisis (I think the rate peaked in 2009 or 2010). But more recent subprime auto loans are imploding quickly. Of the subprime auto loans originated in 2023, 13.4% are 30+ days to 90+ days overdue. The other problem facing auto lenders is the recovery rate on foreclosed loans (amount of the loan less the amount received from selling the repo’d vehicle) is the lowest on record.
In short, companies like ALLY and CACC are going to experience a rapid increase in delin-quencies, defaults and an increasing degree of loss severity on their auto loan portfolios.
But this problem is not confined to just auto lenders. The same dynamic is affecting credit card lenders like Capital One (which is merging with Discover Financial). Even the delinquency and default rates for residential mortgages are starting to rise. I suspect it’s higher than the banks are willing to disclose but at some point the truth will rear its ugly head.
The above issues address only the rising consumer debt distress. On top of that is com-mercial real estate distress, from which the big Wall Street banks are not immune, and the debt sitting on big bank balance sheets from the private equity bubble in which the PE firms were doing leveraged acquisitions of private companies. With respect to LBO and CRE debt, it’s not a predominant part of the Too Big To Fail bank balance sheets. But in aggregate both categories are in the $100’s of billions and the ability of borrowers to service the debt is in a
state of collapse.
Add to that the $1.832 trillion in loans extended to hedge funds by Goldman Sachs, JP Morgan and Morgan Stanley (link). Those numbers are as of the end of March and the amount is likely even higher now. All three of those banks would have perished in 2008 if the Fed and the Treasury had not bailed out the banks with printed money and taxpayer money.
Then, on top of that is the OTC derivatives. Every loan category discussed above has a massive amount of OTC derivatives connected to the loans. The supposed changes made in the 2010 Dodd-Frank Act, which was supposed to implement more transparency and accountability in the banking and financial system as well as put “guard rails” around big bank derivative issuance and risk-exposure, also made it easier for banks to hide their derivatives exposure off-balance-sheet.
According to a report from Wall Street On Parade, based on numbers from the Federal Financial Institutions Examinations Council, the biggest Wall Street banks held over $192 trillion in derivatives as of the end of 2023. Goldman, JP Morgan, Citigroup and Banks of America in that order were the four largest. Granted, the argument is made by the banks that their derivatives exposure is offset or hedged via laying off the risk to counterparties. But that was the argument in 2008. The models in 2008 underestimated counterparty default risk in 2008 and, without doubt, have done so again.
The point here is that all of the financial bombs that detonated in 2008 are set to detonate again. Except this time the amounts outstanding are significantly larger and, thanks to changes in credit rating and accounting standards, in general the credit quality on the overall pool of loans and derivatives counterparty risk is lower.
Gold And Silver (And Mining Stocks) Are Just Warming Up
The Fed is in a difficult, if not impossible, situation of its own doing. It knows that the CPI is b.s. and that the real rate of inflation is 3-4x higher than the CPI fraud. And hence real rates are negative. Cutting rates will restimulate the escalation of price inflation. It also knows that if it further loosens monetary policy (hint: it’s not tight to begin with as real real rates are still negative and M2 has been rising last October) that the dollar will head south quickly.
Furthermore bank balance sheets are deteriorating in quality with rising asset distress: consumer debt, leveraged buyout debt (private equity related) and the melt-down of CRE loans. The big unkown is true amount of counterparty risk exposure the big banks have from what is now a record level of OTC derivatives. Finally, the yen carry trade will futher unwind if the spread narrows between the cost of borrowing the yen and using the proceeds to buy higher yielding assets. Finally, Treasury debt oustanding is increasing at a rate that will eventually be catastrophically existential to the U.S. dollar and financial system.
Andrew Maguire (Kinesis Money) and I discuss all of these issues plus, of course, the precious metals market and mininig stocks in that latest episode of Live From the Vault:
If you want access to the mining stocks I cover and recomment other than Cabral Gold, use this link Mining Stock Journal for more information about my newsletter.
Truth
Super Micro Computer Is A Bag Of Fraud
This analysis is from the August 11th issue of my Short Seller’s Journal. I also did a deep-dive on it in early June and first presented it as a short idea in early February: Short Seller’s Journal information
Super Micro Computer (SMCI – $508) – SMCI’s share price was blasted for $125 (20%) on Wednesday when it reported its FY Q4/full year numbers Tuesday after the close despite beating revenue consensus and announcing a 10:1 stock split. The Company’s gross margin was well below estimates and forward guidance was much lower than estimates. The Company’s gross margin plunged to 11.2% from 15.5% in Q3 and 17% in Q4 2023. The operating margin fell to just 6.4% from 9.8% in Q3 and 10.3% in Q4 2023.
I first presented SMCI as a short in the February 11, 2024 issue of SSJ when the stock was at $740. This is the second time I exposed teh red flags at SMCI: Super Micro Computer Red Flags. In Februrary I remarked that its 10.1% operating margin was quite low, particularly for a company that is supposedly an innovative tech company trading with a 57.6 P/E and 4.5x revenues (at the time). In comparison, AMZN’s AWS operating margin was 26% in 2023 while MSFT’s operating margin was 43.5%. Now SMCI’s operating margin is just 6%.
SMCI’s EPS declined 18.6% in Q4 from Q3 despite the fact that revenues rose 37.8% QoQ. That shows the degree to which SMCI has no ability to control the prices it pays to suppliers or dictate the prices of the products it sells. Let’s face it, the bulk of its business is building racks to hold servers at data networking centers – not exactly a business with room for innovation or creating products with competitive advantages. The consumer equivalent of SMCI’s products is television and stereo racks.
SMCI also has revenue concentration and accounts receivable payment risk. Its top three customers accounted for 61.4% of its revenues and two of these customers accounted for 19.3% of its accounts receivable. Admittedly these are probably big tech companies like Meta and Microsoft. But at some point there’s going to be an oversupply of data center, cloud computing capacity – just like there became a big oversupply of fiber-optic capacity during the dot.com/tech bubble – and there will be a dramatic drop-off in server rack orders from its largest customers.
Another issue is the rate at which the Company is burning cash. For the full-year FY 2024 SMCI’s operations burned $2.47 billion in cash, including $630mm in Q4. Its operations thus are consuming over $600mm in cash per quarter right now. It funded that cash burn by issuing $1.6 billion worth of shares and a $2.3 billion convertible bond deal in its FY Q3. Both of which are highly dilutive to existing shareholders.
SMCI’s P/E has corrected down to 25.5. In my opinion that is still too high, particularly if earnings per share continue to decline. The Street consensus for its FY 2025 is $44.29. Over a four quarter average, that’s $11.07/share, or 84% above the Q4 EPS. It’s hard to believe that the Street still has that kind of earnings growth built into its models.
SMCI’s best case is that EPS stay flat for the next four quarters. But I don’t see that happening. I expect that several big companies who are spending heavily on AI chips and server capex will start to cut back. This will adversely affect SMCI.
I expect earnings to continue to decline. That means a 25 P/E for a business with 6% operating margins and declining earnings is too high. Hell the homebuilders have much better margins right now and they trade at an average of an 8 P/E. If SMCI can replicate its Q4 EPS over the next four quarters, and we apply an 8 forward P/E because it’s a low margin business with no earnings growth, that implies a forward stock valuation of $192/share.
The easiest money shorting SMCI has already been made. But I think this stock will get cut in half over the next year, which would put it at $250 where it was trading before AI mania engulfed the markets.
Fed Stealth QE Is Driving Gold’s All-Time High Price Run
The following commentary is an excerpt from my Mining Stock Journal newsletter. To learn more about it follow this link: Mining Stock Journal subscription information. Note: I will be hiking the price from $20/month to $40/month soon. Existing subscribers will be grandfathered at the current rate.
Given the large increase in the amount of gold that is flowing to the east, I think it’s easy to make the case that this massive demand for physical gold is a major factor in pushing the price of gold higher. A similar argument can be made for silver, particularly with India and China, which require a lot of silver for their implementation of national solar energy grids. The breadth of countries with Central Banks now accumulating gold was not much of a factor until the last couple of years and I believe the proliferation of eastern Central Banks has offset the seasonal weakness that historically has affected the March through June period.
Secondarily, despite the rhetoric about the Fed’s hawkish monetary policy, take a look at the Fed’s actions vs its words. Despite the maintenance of the Fed funds range at 5.25-5.50% and the monthly QT operations, financial system liquidity has been rising. The M2 money supply measure has been rising since October 2023. More significant, the Fed’s reverse repo facility has been drained over the last twelve months. This is money that returns to the financial system, primarily in the form of banking and financial system liquidity. The Fed could keep that money in the facility with just a small increase in the rate it pays. But for some reason it wants that liquidity to flow into the financial system. In addition, the Chicago Fed’s National Financial Conditions Index shows that the Fed has set the easiest systemic financial conditions since the end of January 2022, one month before the Fed began hiking rates.
The Fed is thus masquerading as a monetary hawk when, in fact, key liquidity indicators reflect the reality of an easy monetary policy. I would argue that the Fed has created this systemic liquidity to offset the deteriorating quality of large and small bank balance sheets – primarily CRE and consumer loans but also leveraged corporate loans. Regardless, the rise in financial system liquidity, in addition to the massive demand in the physical market, is the reason gold and silver prices have been rising steadily since November 2022.
M2 has been rising since October 2023. Most market participants are unaware of this fact because the M2 posts on social media show the YoY percentage change in M2, which is deceptive. This chart is through the end of June, the latest date for which the Fed posts M2 data (intentionally):
Similarly, and again through the end of June, the Monetary Base (formerly MZM) has been rising since March 2023:
The increase in the Monetary Base is more impactful in terms of causing inflation (dollar devaluation) because the Monetary Base is coins/currency in circulation plus banks reserves. Both represent instant spending or lending power.
The final, and foremost aspect of the Fed’s “stealth QE” is the $2 trillion drain of the Fed’s reverse repo facility. The facility was at $2.375 trillion at the end of March 2023. Since then more than $2 trillion has disintermediated into funding Treasury debt and the banking system, ultimately finding its way into the wider financial system. The Fed could have kept that liquidity “captive” with just a small hike in the rate it pays for overnight RRPs. But note that the Fed let the facility start draining around the same time as the regional bank CRE crisis. That crisis, by the way, is now detonating bombs on the Too Big To Fail bank balance sheets (among several other areas of balance sheet distress).
This “stealth QE,” which is undeniable, is the reason that gold has been hitting successive all-time highs. It will be interesting to see if the Fed cuts rates at its September FOMC meeting because it’s obvious the economy is flopping around like a near-dead fish on a dock in Montauk. The problem is that a rate cut could trigger another wave of yen carry-trade unwind, which would cause another sharp sell-off in the stock market.
But for those scratching their head at the impressive rally in gold, look no further than stealth QE that has been implemented by the Fed since March 2023. Precious metals investors have interest rate cuts and the official re-start of money printing in the coming months, which I believe will drive the gold price into the $3,000s in the next 12 months. Silver will outperform gold in that scenario.
Big Breakout Ahead For Silver
Gold recently broke out of 12-year cup/handle technical formation. The price objective from this breakout is at least $3,500. I was looking at a long-term chart of silver. I did not realize it looked like this:
For a refresher, here’s the gold breakout:
The silver cup/handle has lasted for 13 years. The duration of the cup/handle will generate a longer duration, bigger move higher than many believe is possible. Of course, that skepticism preceded the move from $7 to $49 between late 2008 and March 2011. A 7x move when the silver cup/handle breaks out would take silver close to $200…
The Housing Market Is Crashing – Rate Cuts Won’t Help
The following commentary is from the August 4th issue of my Short Sellers Journal weekly newsletter. Click on that link to get more informations. The charts below are through August 2nd. In the August 11th issue I’ll be reviewing Builder Firstsource’s Q2 numbers and explaining why I think it will be a highly profitable short (or use of puts) $BLDR.
Housing market update – Redfin posted data this past week that reflects the degree to which home sales activity is tanking. In June, 15% of home purchase contracts were canceled and 20% of listings nationwide had price cuts. Both metrics are the highest on record for June. In addition, and this is pertinent to CRE and multi-family housing (ABR), new apartments are taking longer to rent out because a near-record of them are hitting the market (new con-struction multi-family units).
The pending home sales index for July rose 4.8% in June from May but declined 2.6% YoY. The not seasonally adjusted numbers showed a 7.8% decline YoY. That comp likely is more reflective of the YoY decline because it doesn’t contain statistical errors in the “adjustments” calculus. The July increase over June is likely just a statistical bounce because the pending home sales index had been trolling record low levels going back to 2001, which is when the data series began. It also correlates with the brief bounce in mortgage purchase applications during mid-June. Pendings are based on contracts signed during June.
Speaking of the weekly mortgage purchase index, it slid to 132.8 which is the lowest level since the week ending May 31st when it hit 132.3. The index continues to press its lowest level since 1995. On a not seasonally adjusted basis, the index is down 14% YoY. It’s down 24.1% since January 19th. Again, the housing market is still in its strongest seasonal period of the year. After that brief bounce in June it’s been in a sharp downtrend and reflects the growing weakness in home sales activity despite the rapidly rising inventory of new and used homes.
It looks like the homebuilders may be headed south. The Dow Jones Home Construction index looks to be rolling over from an irrational move higher since July 9th plus the RSI and MACD are heading south from overbought readings:
The caveat with the builders is that the 10yr yield plunged 40 basis points last week from 4.19% to 3.79% on Friday. I don’t know if the hedge fund algos will start to buy homebuilders if the 10-year yield continues to fall. On the other hand the market may continue dumping homebuilders based on the recent plethora of economic news showing a weaker than previously perceived economy. Certainly the market can not ignore the extreme overvaluation in the homebuilders if the new and used home sales numbers continue to head south.
Beazer Homes (BZH – $28.57) reported its FY Q3 numbers on Thursday after the close. Revenue increased 4% YoY due to a 4.4% YoY increase in closings. However, that’s it for the positive aspect to the numbers. The gross margin declined 310 basis points YoY, which means the Company either had trouble controlling building material and labor costs or offered big incentives to induce buyers – or both. Operating income plunged 38.2%. New orders fell 10.8% YoY and the cancellation rate jumped to 18.6% vs 16.1% in FY Q3 2023 and from 16.2% through the first half of its FY this year. The Company did not offer Q4 guidance.
Looking at the balance sheet, cash fell to $73 million from $132mm in FY Q2 2024 and $345 million at the end of its FY 2023. The inventory jumped 23.6% from FY 2023 year-end and it was up 5.5% vs FY Q2. The 10-Q has not been released yet but BZH’s operations burned $239mm in cash thru 1H FY 2024. With the $117mm increase in inventory it must have burned cash in its Q3. Total debt increased by $46mm from Q2 and $91mm from FY 2023 year-end.
The numbers are going the wrong way for Beazer. Based on the drop in new orders, revenues will soon be heading south, profitability has been hammered, cash is evaporating, inventory is rising, the cancellation rate is rising and the operations are burning cash. It won’t be long before BZH will have to start writing down the value of the inventory with which it will be stuck.
BZH’s chart looks far worse than the chart of the DJUSHB above:
I bought BZH puts ahead of earnings starting on the previous Friday (7/26). I added to my position Wednesday and Thursday. I booked profits on those Friday morning because they were in-the-money and I rolled some of the profits into August 16th $28 puts. I’m actually hoping the stock bounces because I’d like also to have a longer-dated, OTM put position. Like December or February $25 puts (February 2025 is the longest put series right now).