A Bloated Auto Sector Begins to Implode, Risking Contagion

A Bloated Auto Sector Begins to Implode, Risking Contagion by Nathan McDonald for Sprott Money

In what is being taken as another sign of an incoming recession, auto sales across the board are down—and down significantly.

Often used as a strong indicator of a healthy consumer economy, auto sales provide an early warning signal for economists and businesses hoping to forecast our unpredictable economic future.

U.S. auto sales crashed by 6.1% throughout the month of April 2019, to 16.4 million units sold.

This is the biggest drop since May 2011 and the lowest amount of sales throughout a month in over five years.

A similar story is unfolding all across the globe, pointing to a much wider problem within the industry.

However, I believe that there is more to this story than first meets the eye.

Although declining auto sales are indeed a bad sign for the economy in general, what many are missing is the fact that these declining sales directly align with rapidly rising average car prices.

In the United States, the average car price is expected to hit $33,319 by the end of the first quarter, a $1000 increase over the same time last year.

This comes on the back of years of rapidly rising car prices, while the average income of consumers has been relatively stagnant.

So how are manufacturers doing this? How are they demanding higher and higher prices, and why in the world would anyone pay these outrageous amounts for a new vehicle?

The reason for this is similar to the 2008 crisis, as lenders are already forgetting the follies of their recent past.

People are leveraging higher and higher, as lenders extend the average length of their loans while at the same time reducing their standards.

In the not too distant past, car loans were a maximum of five years. Now, that number has increased from six years to a stunning seven!

Depending on where you live, this means your car could be a hunk of junk by the end of your term, while you are still paying the large monthly payments you began your loan cycle with.

Stretching out the length of the loan does not result in lower monthly payments for you, the consumer. No, not at all.

It simply allows the dealerships to charge the same monthly payment you were accustomed to during the five-year term, but for seven years instead.

This is akin to a slow-boil inflation, such as keeping a bag of chips the same dimensions while at the same time reducing its contents. This strategy is now beginning to backfire on those who orchestrated it as people are taking notice and voting with their feet.

Still, even though people are waking up to the con that was pulled on them, this does not mean serious ramifications won’t result because of this.

If we do enter into a serious recession—something that I do see coming over the next few years—then we may witness massive defaults on loans that people are simply unwilling to pay and would rather walk away from.

Car loans are not as sacred as home loans. People are much more willing to simply throw their hands up in disgust and let the Repo man take their car, especially if it means they get to protect their home and other assets.

This could cause a rapidly spreading contagion among the auto lenders who have over-leveraged themselves with these horrible loans. It threatens to bring the entire banking sector to its knees just as we witnessed throughout the 2008 crisis, once again increasing the need for a precious metals “insurance policy”.

Regardless of the outcome, I suspect we will see a swing back towards correction as auto manufacturers are forced to lower their prices… which will be a tough pill for them to swallow indeed.

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Sprott Money

Various authors presenting analysis and commentary on the precious metals, economy and precious metals mining markets.