World markets are discounting that something big will happen

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For my latest musings - please visit www.scottreeve.com
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This is my take on the world economy - Preserve your wealth while you still can!

The current talk is that the US and Europe may go back into recession. The reality is that they never left recession that hit in 2008. Bogus diluted statistics, such as inflation, unemployment rates have falsely portrayed the economic reality being felt by individuals in towns and cities around the world. Arguably many cities have been in depression for the last decade (look at Detroit and parts of Europe). The world economy is now on a detox diet and it will take many years, if not decades, to clean it up.

The markets are currently discounting that something very, very big is soon to happen. The markets always do this long before the average man on the street and the media realise it.

It could be a combination of things:
*country default;
* Euro monetary changes (Greece is insolvent, and other countries are close behind);
* central bank quantitative easing (monetising debt);
* major bank failure (particularly in Europe); and
* a significant slowdown in China.

All of these things are very real and we are already seeing the effects of this on world markets.


European contagion

All the major Euro countries are so intertwined lending billions to each other. A contagion will quickly spread when more of the bad debts rise to the surface.

Most of the current Euro-cris discussion is centred around Greece. By many measures its economy looks quite sick. It's sharemarket is now at its lowest level in 18 years (This is debt implosion!).

On other measures it certainly doesn't look as bad as other countries. Greece doesn't have the largest amount of government or private debts in the world, or the highest debt-to-GDP. One big difference is that it owes a much higher per cent of its debt to foreign creditors (foreign banks and countries).

Many argue that its non-sovereign entities which are clamping down on Greece. ie. the Global banking cartel led by the IMF, the World Bank, the Federal Reserve etc working in tune with the credit rating agencies (Moodys, S&P, Fitch). All I ask is what is the interests of the global banking groups? All actions to date show that they put their interests and survival ahead of everyone else. They do not care about the sovereignty of nation states.

So which countries banks' have the most at stake with Greece?

The following interactive chart I put together uses Bank for International Settlements data demonstrating which countries banks are most exposed to sovereign Greek debt as of the first quarter ending March 31 2011.

The most exposured banks are (by country):
French banks US$56.9 bn;
German banks US$23.8 bn;
UK banks US$14.7 bn;

The most exposed individual banks are:
BNP Paribas with US$7.1 bn (France)
Dexia with US$4.8 (Belgium)
Société Généralewith US$3.8 (France)

This is just the banks. When you add Government's holding Greek debt the amount is another US$145 bn.

Chart : There has been a huge widening of bony yield spreads and risk insurance on credit default swaps. Greece has gone parabolic. Portugal and Ireland are where Greece was a year ago.

or as Alan Kohler puts it, when the financial crisis hit last time in 2008, it was about liquidity (banks wouldn't lend to one another). This time around its about insolvency. There is plenty of cash around, but the banks might be broke.

Chart:
source: Alan Kohler, ABC News, Sept 2011

The dominoes are lined up

The next graph shows why the banking system is trying to fix Greece before it sets a precedent. You may have heard that Spain and Italy are "too big to fail, too big to bail". Europe bank exposure to Spain and Italy's are 6 to 7 times worse than Greece.

Chart :

The harsh reality is that no industry should be bailed out, including the banks from country to country. The ongoing debt crisis has come about because banks have lended and taken billion dollar bets to keep this unsound monetary system going (which is based on nothing but paper money generated out of nothing).

Monetary systems do blow up - why is the Euro any different?

One article I came across discuses that country default is more common than we are led to believe. There were a number of large defaults in the 1980s and 1990s in emerging countries across the Americas and eastern Europe. Economist Carmen Reinhart states that the list of deadbeat countries included

"current investor favorites like Brazil, which defaulted in 1983, went through a bout of hyperinflation in 1990 and effectively defaulted again, for the same reason, in 2000"

Reinhart and Professor Rogoff show that, on average, nations add 86% to their debt loads within three years of a credit crisis. At the same time, government revenue falls an average of 2% in the second year after the onset of the troubles. The way things are heading Greece and other Euro countries are heading down this path. Debts need to be rolled over...just like...a few snow flakes can lead to an avalanche.

The Stumble Cycle

Sovereign defaults--when a country stops paying its bills--go in waves, often following global financial crises, wars or the boom-bust cycles of commodities. Some countries, like Spain and Austria, mend their ways; others, like Argentina, are repeat offenders.

Chart :

The combination can be fatal for investors holding bonds issued by financially shaky countries like Argentina or Greece, which sell a lot of their debt outside their own borders (as does the U.S.--45% of all publicly held debt). As a nation's finances deteriorate, foreign investors sell their bonds, putting upward pressure on interest rates. That usually sets off a spiral including a deteriorating currency, which, if the bonds are denominated in foreign currencies, makes it impossible for the country to pay its debt. Greece doesn't have to worry about this last syndrome, because it uses the euro. But that might make things worse since it can't print its way out of its financial difficulties. "It's like entering a prize fight with one hand tied behind your back," Bass says. Argentina takes a different tack. Still struggling in the wake of its 2002 default on foreign-held debt, its president recently tried, and failed, to seize central-bank dollar deposits (and cashier her central banker) in order to repay overseas debt.

France

Following from earlier discussion, the big questions are which of the big European banks will go under first. The largest French banks, Credit Agricole and Societe Generale have billions in exposure to Greece and other Euro countries.

Chart : The share prices of the 3 largest French banks have fallen 73%, 87% and 87% since start the debt crisis started in 2008.



Italy

Until recently UniCredit was the largest bank in Italy by market capitalisation and a major euro-zone bank. It owns other large banks in Germany, Austria, and Poland with around 40 million customers all up. As the following charts shows, the market is dumping the two largest Italian banks. UniCredit is one of the "too big to fail and bail" euro banks and many of its depositors lie outside Italy, making and bail out practically impossible.

An ironic twist to this is that, UniCredit's predecessor was a bank called
Credit-Anstalt. This bank collapsed in 1931 which lead to a contagion which took Europe off the gold standard and pro-longed the Great Depression. Few people remain from the last depression era. Perhaps the money lessons need to be relearn?

Chart :



Australian dollar

The Australian dollar is a proxy for commodity prices and ultimately China. The Australian dollar has recently fallen sharply to 97 cents and has hit a major support level. If this fails there is another major support level at 94 cents.

Chart: The Australian dollar managed to bounce off the firs support level at US$0.97



Commodities

Overall commodity prices are not showing that China is in immediate trouble. Base metals: copper, zinc, nickel, lead etc are not in a major bear market yet. This may mean that the current correction will be short lived. If base metals start free falling and other negative signs come from China (popping of housing bubble?), than the Australian dollar and commodity prices will fall a lot (a huge amount) further.

Gold

Meanwhile, gold and silver have recently experienced a significant correction. Chart wise (USD/gold), gold's correction is not unhealthy. Gold was sitting at 11 year bull-market resistance line and its trending support line is about US$1550.

Chart:


As I posted recently, I believe the gold demand is getting stronger, and will remain strong, despite the recent price volatility. Since that post it has been reported that Mexico, Russia, South Korea and Thailand have all made large purchases in 2011 and globally, central banks are set to buy more gold this year than at any time since the collapse of the Bretton Woods system 40 years ago. The IMF even reported that European Central banks have started accumulating small quantities of gold after selling on average 400 tonnes of gold a year since 1999.

Silver

Silver plummeted last week by 34 per cent within trading days. It went straight through two key support levels and bounced back above them. After hitting a low of US$26.03, silver rebounded 28 per cent in 28 hours.

Chart: Silver fell 34 percent within 4 trading days, then bounced 28 percent within 28 hours


Is this volatility unusual? Silver is a very small market and historically has been prone to major corrections. My research shows that the major corrections in the last few years has lead to an increase in demand for physical silver (from mints and bullion dealers). I believe this will happen again.

Australia

Take away mining and Australia is in recession, and as I stated early, the key to the Australian economy is whether China can keep its economy upright. If it shows signs of weakness, commodity prices will collapse (along with oil, gold and silver) and the Australian Dollar will fall 10 or 20 cents against the USD.

China kept the world economy somewhat afloat during the global financial crisis, and is the sole reason why Australia didn't go and stay into a technical recession. One of the key barometers on the health of China is commodity prices.

Tourism has been in recession for many years now, in part to the high Australian dollar and a tightening of consumer belts.

Manufacturing has largely been in recession for a number of years except for businesses with astute management and niche business models.

Manufacturing insolvencies growing

Despite insolvencies around the world dropping to their lowest levels in nearly four years, Australia is headed in the opposite direction. This year is shaping up to be a record one for business failures on a par with troubled Eurozone countries. The most recent D&B Global Insolvency Index, ranking business failures in more than 30 key economies, found Australia's insolvency rate was on a par with indebted countries such as Italy, Spain and Hungary. Australia recorded a 12.1 per cent increase in business failures in the June quarter compared with falls elsewhere in the world of 5.7 per cent. D&B said its findings tied in with Australian Securities and Investments Commission data which pegged 2011 as a record year for insolvencies.

Business failures in manufacturing have soared 60 per cent in three years. Almost 300 manufacturing firms went broke in the first six months of this year, the business analyst Dun & Bradstreet says, and just 14 new manufacturers started up. By contrast, in 2008, 974 new manufacturers got off the ground, and only 392 folded.

Retail

Retail is finally entering recession. This has long been coming, even though the likes of Westfield (and other groups) have been creating mega-shopping centres around Australia. The whole retail industry relies on ever increasing amounts of debt (more credit cards and increasing consumption). This model is dead, and there is currently too much competition in Australia alone (before you look at internet shopping of overseas products on eBay and the like). Take electronics, there are so many major stores competing on price, and margins are getting thinner. Many of the private equity firms which bought up a lot of the retailers in recent years have failed, as over-inflated sales targets have missed the mark. In the last 12 months several major groups have entered administration: REDGroup (Borders/Angus and Robertson bookstores); Colorado Group (Jag, and shoe shops), Allied Brands (Baskin Robbins, Cookie Man), Krispy Kreme doughnuts, and Starbucks Australia. Most recently sharper falls in consumer spending has forced Harvey Normany to scrap its Clive Peeters and Rick Hart brands (7 stores to close) and David Jones announcing a 10.3% drop in fourth quarter sales and now expects a small profit for the new financial year.

Sizeable retrenchments are coming.


Housing

Chart:


Lastly, this is a very good presentation by Mike Maloney


Cheers
~ Scott

Superannuation wake up call - markets do not always work for the better good

People around the world are slowly waking up. Politicians and the financial industry have been perpetually lying to us about our retirement future.

In the US this first became abundantly clear in 2008 with the collapse of Fannie Mae and Freddie Mac, Lehmann Brothers and AiG and more recently with the smoke and mirrors game over US national debt. Likewise in Europe, the ongoing myriad of debt is rising to the surface exposing the vulnerability of sovereign nations to a poorly designed monetary system controlled by an international banking cartel which lies outside the nation's political systems. Whether Europe and the US continue to monetise debt and expose more debts, or embrace so called spending cut measures (austerity), the current monetary/economic systems will fall apart regardless. The point of no return was well over a decade ago. This point cannot be understated and it will have severe implications for everyone's every day lives, and expected future retirement years.

In Australia, the spin machine of politicians (on both sides of the fence) has perpetually endorsed the need for compulsory superannuation to fund individuals’ retirement needs. The biggest furphy of all is that “markets on average always go up” and that the Superannuation system will always work. A quick glance at one’s recent Super statement suggests otherwise. For several years I have had an agonistic view of the compulsory Superannuation system. The system is fatally flawed as it is heavily tied to the fortunes of the sharemarket, which itself is heavily influenced by changes in age demographics, major booms and busts brought about from a global debt-based monetary system and speculative malinvestments.

It was no coincidence that major changes were made to superannuation arrangements in the early 1990s, when Paul Keating introduced the "Superannuation Guarantee" in 1992 (or compulsory superannuation for individuals). The political class knew they needed to act quickly to transfer the responsibility of one’s retirement from employers (and ultimately the Commonwealth Government through old age pensions) to individuals, as by 2025 one-in-five Australian’s would be over the age of 65.

What better time for the Government to introduce a compulsory retirement “savings” system, than to do it when the largest demographic, the baby boomer generation, were half way through their working careers – there would be at least another 15 years of compulsory contributions to help prop up the Australian sharemarket.

After more than a decade of compulsory contributions, Australian workers have now amassed over $1.28 trillion in superannuation assets. Australians now have more money invested in managed funds per capita than any other economy. Sadly, markets are prone to huge swings, and people will have to revise their superannuation retirement expectations markedly - and act to preserve what they have.

As Alan Kohler stated in his article of 15 August 2011, Stranded at super’s ground zero

The aim of retirement incomes policy in Australia for two decades has been to shift the burden of risk to individuals before the next big bear market hit. It
worked quite nicely. …

Kohler further explains:

The first fifteen years since the superannuation guarantee legislation was first introduced in 1992 went extremely well. The compound annual rate of return provided by the sharemarket – like manna from heaven – was 15.5 per cent.

And Australia was, and still is, overweight equities. That is, the proportion of our retirement savings invested in shares is about the highest in the world. The OECD average is for about half to be invested in fixed interest; in Australia that’s 10-20 per cent.

If we take a quick snapshot of the sharemarket and annualised returns for the last five years are now sitting at a big - ZERO.

The reality is that the 1990s was a period of excessive credit creation across the Western World. All big booms, end in big busts, and the 90s boom gave us the NASDAQ (dot.com) bubble and bust, and later the massive real estate boom and bust in Europe and the US (and soon to be China and Australia). The superannuation system relies on a worldwide debt-based monetary system with perpetual money creation and debt rollover to function. What we aren’t told is that expansion of the monetary system erodes our purchasing power, creates inflation (cost of living pressures) and misallocates capital and labour to non-productive industries and pet projects.

The other fact is that the “compulsory” element to superannuation in Australia is inflationary by nature. With the Government forcing employers to provide 9 per cent pay, by law, into a super fund, there is a continual inflow of extra money entering the sharemarket system every year, regardless of the current state of the economy or the mood of the sharemarket. In a bull market, super funds, as a substantial proportion of market participants, compete with other buyers in the market, which ultimately leads to higher and higher share prices. In bear markets, the Super funds continue to buy companies in the S&P indexes regardless of poor market or company fundamentals (including companies with suppressed share prices due to large capital raisings to raise liquidity).

The biggest problem of all, is the finance industry itself. Whether the market goes up, down or sideways, the fund managers collect their annual fees and commissions for doing next to no monitoring of your portfolio. They get billions of dollars of inflows into their industry regardless of economic conditions, which ultimately props up the financial industry than what would otherwise be the case. The Government in effect is intervening in the market in a huge way, nurturing bad economic habits by providing the industry with lots of capital it may otherwise not have had. As a result, bad behaviours have grown over time. Parts of the financial community (particularly investment bankers) have used more and more "financial wizardry" to make particular investments more attractive (such as infrastructure assets) and more leveraged. However the catch is that all the bad money gets flushed out of the market system at some point in the future. The future cannot be permanently bought through debt (monetary promises).

Percy Allan’s recent article of 14 September 2011, Bucking the bear market, suggests that things may well get worse and stay bad for many years to come. His studies indicate that the world is stuck in a secular bear market. Secular bear markets is a period of typically 15 to 25 years of major volatility, of large upswings, and several primary bear markets. For instance, between 1965 and 1981 (as seen in Chart 1)there were four primary bear markets in the US, displaying falls from peak to trough of 25 per cent to 45 per cent.

Chart 1: Secular bear markets example

Chart 2: 100 years showing major secular bull and bear trends

Chart 3: The typical phases of a secular bear market. We are in phase 3.

Chart 4: Secular bull vs secular bear markets


The next secular bull market my not begin until 2015 – 2021

A “buy and hold” strategy (or some say a “hope and pray” strategy), which is continually flouted by the financial industry and Government can be disastrous for investor share portfolios (including superannuation) during secular bear markets. Many investors and now many superannuation accounts are spending a great deal of energy trying to recover from previous losses. What if the next four to ten years continues to be a secular bear market? Could you wait until 2021 for the major volatility swings to end?

Allen states that “the Great Depression, like the global financial crisis was the product of excess debt which had to be expunged before a bull market resume”. The 1929 bust for instance resulted in secular bear market that didn’t end until the debt deleveraging was over. Does anyone seriously believe, at this point in time, that the hundreds of trillions of dollars worth of Government debt (from the US, to Europe to China) and banking debt could magically disappear within 10 years?

There are always profitable trading opportunities for those willing to look and manage the risk. Capital preservation should be the primary goal for any trader, particular in this secular bear market. Timing is everything and those traders who have their finger on the pulse of the market, could generate substantial return from the market swings. A mechanical (non-emotive) trading plan is absolutely essential should you dabble in the market, at any stage of a secular bull or bear market.

The Government needs compulsory Superannuation

Yet another reason why compulsory superannuation is a giant rort in Australia, is the excessive taxation place on it. In FY2011 the Australian Government collected $7.1 billion in superannuation taxes, not bad from a “compulsory” system the Government itself setup (expected to rise to $12.8bn in four years time). The Government also uses lots of other calculations and methodologies to manipulate individuals financial decisions when it comes to retirement. The Government’s aim is to keep people in the workforce longer. The perseveration age is being incrementally lifted so that by 2025, no one will be able to access “their” superannuation until the age of 60. Why should the Government decide this for you? Would you wait to 60 years age if these access restrictions weren't there?


So what is the alternative?

What if the advice of your financial planner, accountants, stockbrokers over the decades ended up being totally off mark at the point of retirement or during retirement? There is no backspace button to turn back time.

The alternative is to take responsibility for your own financial decisions, and be sceptical about all the financial advise thrown around. If we invest TIME into financial education about how markets work, investment opportunities and threats become a lot more visible. Further, a basic understanding of monetary history is an absolute must (particularly precious metals). Currency (or money substitutes) isn’t the most preferred form of money in certain times and debt systems which produce big governments do not always work out for the better. We need to understand what happens to markets during transitionary periods. Monetary systems typically only last 40 years and the last change was in 1971 - so its overdue to change again. The US-reserve currency system, and the Euro will not last for many more years in their current form. All fiat currencies are A new monetary system will emerge. Will your savings be tied to the old system or the next system?

For superannuation, diversification to reduce exposure away from the sharemarket is a must - asap. If you are 100% relying on Superannuation to work by the time you retire and throughout your retirement, you are not diversified from the major ups and downs from the market at all. By diversification I mean different assets classes such as exposure to gold and silver and cash. (Not diversification between banking shares and mining shares – all shares are susceptible to the major market swings). Gold and silver have both easily outperformed the world sharemarkets and all currencies for the past decade, and this is highly likely to continue for the next decade. Gold and silver in the hand has no liability (debt promise) to anyone and is a hedge against the Government and banking inflation-machine.

Self-managed superannuation will gain in popularity as more individuals take the responsibility of retirement from the financial industry back to where it belongs, in the home. Recently in August 2011, it was reported that self-managed superannuation grew by $3 billion in three months (7,500 new accounts).

I would also be inclined to think twice before taking any Government-induced incentives before throwing money into your compulsory super account (such as the superannuation co-contribution scheme). Would you make this decision without the Government offer on the table? If not, why should the Government incentive change your actions?

One needs to change their context on investing and have a light bulb moment where your context on the economy changes. The vast majority of people are still thinking about investing with a 1970s, 1980s, 1990s, 2000s mentality. The next decade will be very different. Always remember that the market does not care if you gain or loose money!, so you must take ownership of your money and do it as soon as possible.

Alan Moir Cartoon - this is how your super works

Southpark's take on the finance industry:


Cheers
Scott

The Great Australian (ponzi) Scheme

Back in February 2008, while the so-called GFC was taking hold I posted at length stating several reasons why I believed the Australian Housing (bubble) market was destined to burst. This post will extend on previous thoughts.

Raise your hand if your living the Great Australian Dream?

In past decades the Great Australian Dream became reality for many who rode the debt wave of the 1970s, 80s and 90s. The dream was an expression of financial security as nothing was "as safe as houses". Fast forward to today and Generations X, Y, and Z have little more than a pipe-dream of affordable living and affordable mortgages. We have to try to keep up with the Jones (Baby Boomers), or complain from outside (like i'm doing here). For now, some younger Australians may do well in the short term by embracing government first-home owner handouts, multi-decade low interest rates and other incentives to try to live the dream... and for now Australia is apparently defying gravity. I believe the dream will cause long term indigestion for some, for decades to come if people do not have a backup plan once asset deflation hits Australia on mass. Liquidity on hand will be king (gold/silver not Australian Dollars).


2009 – house prices hesitate and take off again.

Australian house prices ended up rising 1http://scottreeve.blogspot.com/2009/02/beware-australian-housing-debt-bubble.html, the fourth highest growth rate in the world behind Hong Kong, Mainland China, and Israel. However, globally house price deflation continues with house prices falling by 3.8 per cent, led by Ireland, Dubai and Eastern Europe. In my post last month, there is an excellent graph highlighting the next wave of delinquent mortgages on the way (1 in 7 trouble). China will follow, and i'll post more extensively on its problems.

Chart 1:
source: Australian Financial Review, March 2010

Chart 2: Australian house prices by city
source: ABS

Chart 3: The dip and the rebound...
source: ABS

The great Australian ponzi scheme continues upwards again. The combination between unprecedented population growth, low housing starts, government handouts, very low (central-bank manipulated) interest rates, and double-digit M3 inflation growth in the system (during the GFC period) ensured that there would be enough fuel to get more buyers into the Australian housing market. Externally, more and more money is coming from businessmen in China, India and elsewhere whom currently see Australia as a place to invest their savings for a return.

Lets examine each of these issues more closely.

A) unprecedented population growth

Chart 4: 300,000 to 400,000 net new people each year now... lets make the aging population problem (and hospitals) worse.
source: ABC News

Chart 5: Govt: "Even if there wasn't a "real" shortage... lets create one"...
source: ABC News

That's a lot more people that need to consume and a roof over their head. A lot more people that might be bringing valuable skills to Australia right now (a quick fix? ...), but eventually will also add to the hospital cues (and potentially unemployment ques when the economy goes pear shaped). The aging population is still aging!

B) Housing Starts manipulation

As the following graph demonstrates, the three levels of government have successfully been manipulating the supply-side of the housing market, by staging land releases. Arguably, the three levels of government in Australia are the most addicted to keeping Australian housing prices upright, and the most to loose when asset-deflation sets in. Primarily, strong price growth in housing equates to overall consumer confidence in the market, and ultimately confidence in government economic management. Further, local governments remain fixated on housing rates to raise revenue to spend on local roads, while revenue-deprived state governments grow increasingly reliant on land and stamp duty taxes. A blow in confidence in the housing market is a blow to government revenues (direct taxation), but ultimately a total decline in confidence will flow through to less employment (income tax), business profitability etc.

Chart 6: It's in Government interest to not flood the market with too much land...
source: ABC News (RBS data)


C) Government handouts – 1st homer owner loans

In the first stimulus package (A$10.4bn) announced in October 2008, the Rudd Government introduced a First Home Owners Boost to go onto of the First Home Owners Grant. With interest rates cut to four decade lows, this just added further candy to the honey pot to entice young Australians into the housing market. I'm a graph person, and I found the following interesting to decipher. Government's throwing money at problems just disrupts market behaviour. When the Government intervention is removed, the market goes back to levels before their intervened.

Chart 7:
source: Australian Financial Review (analysis added)


D) Very low interest rates

Unfortunately, the four decade low interest rates set by the Reserve Bank of Australia has encouraged more and more Australian to take on ever larger mortgages. Lowering interest rates has had a very significant influence on keeping Australia’s housing prices upright during the GFC and post-GFC period. If the RBA did not intervene in the market to lower interest rates (essentially adding more liquidity, more Dollars to the market), than many Australian’s would not have entered the housing market, or bought addition properties. The RBA is nothing more than a market manipulator, to manipulate investors decisions and to disrupt real market information.


E) Double-digit M3 inflation growth

In one of my first posts in September 2008, I talked about money supply growth and that it was growing at the fastest annual rate since the 1970s. This was in part due to the housing bubble that has continued. But the dip in housing between March 2008 and March 2009, the drop in confidence during the GFC period, the rise in unemployable and underemployment,, and the reduction in bank lending in Australia cooled M3 growth. Right now the annualised rate is back to 5.7 per cent. So the volatility continues. I expect M3 to grow strongly once again (similar to 1970s), and ultimately will go crazy as Government's get desperate to bail out certain industries... Inflation always has a 12-18 month time lag... so even though it may be growing more slowly now, the overall costs of living continue to rise. I don't see milk or rents going down..


Other interesting tid bits:

Steve Keen walks to Kosciuszko from Canberra


Where to from here?

May 2010, the sharemarket is looking shaky with the Dow Jones breaking back below 10,000 point level. Housing market quarterly growth continues in Australia for now... But I ask, what has structurally changed from 2-3 years ago? Structurally nothing has changed in the world since before, during and after the GFC. The United States only continues to live beyond its means because it has the world reserve currency, and can print its way out of trouble for now. Europe, Japan and others have held up until now because confidence in private and government debt has been suffice to keep the current ponzi-fiat-monetary system going. People are waking up to this, and volumes of gold, silver and other so-called "relics" sales are going through the roof (mint-door sales). Real estate markets worldwide continue to fall in local-currency prices - Hong Kong, Mainland China, Israel and Australia are still the exception... for now. Deleverage of over-inflated asset prices will continue (derivatives....), and many more AIG, Lehman's are around the corner - this time Government names will be added to the list (just not officially). Australia looks good for now, but this can quickly change over night. Putting all our eggs in the one basket - superannuation, real estate and relying on exporting commodities to China will inevitably cause major problems for us (Australia). China's centrally planned economy will blow up, they cannot spend, spend, spend, just like the US tried to do with retail consumption and sub-prime. Populating, (retail) consumption and inflating our way through the GFC appears on face-value to work, but it is only postponing our problems: Aging population, consuming the future today (we have no private savings), and increasing our costs of living by diluting our money supply. Now is the time to find value in markets....... I don't think the next 20 yrs will be like the last 20 yrs. Printing money can only cover up so much for so long...

The great Australian dream will turn out to be nothing more than the Great Australian Ponzi Scheme.

Scott

The mother-of-all bounces

Last November I posted on the mother-of-all-crashes Through a couple of graphs I detailed why the Australian and US sharemarkets were falling at a faster rate than the great sharemarket crashes of 1929. After the post, the Aussie market drifted sideways for a few months before falling even lower to below 3100 (March 09), for a total peak to trough fall of 55 per cent.

Now, a year on from that post, we have witnessed, perhaps, the mother-of-all (dead cat?) bounces, in an 8 month period from mid-March 2009 to mid-October 2009, the All Ords has rebounded some 56 per cent from the trough (see chart below).

Chart 1: All Ords - crash and bounce
The rise or fall of the All Ords is largely attributed to the big 4 Australian Banks and BHP. The big four banks account for 21.47% of the All Ords, while BHP accounts for 10.15%. If you compare the chart below (Financials Index) with chart 1, they are a mirror image of each other.

Chart 2: The Big 4 banks led the All Ords crash, and now the recovery. Notice the % fall and % rise similar proportions to Chart 1 (XAO)
No other area in the Australian economy has done as well as the Big 4 Australian Banks. They now have combined market capitalisations which exceed the pre-GFC crash. Through help of the Government, they have increased their monopolistic position in lending. For reasons unknown, the Australian Government and ACCC allowed Westpac to buy St George Bank (no. 5 bank), and Commonwealth Bank to buy BankWest. In early September 2009, the Australian Prudential Regulation Authority figures reported that the big four lenders captured almost 100 percent of the $7 billion in new mortgages written in July 2009, squeezing the small lenders out of the mortgage market. Before last year's funding freeze in global markets, the big four banks' share of new mortgages was running at about 60 per cent. Some day soon, just like in the US, we will be having the “too big to fail” debate in Australia. The Australian banks are sitting on the mother-of-all housing bubbles, which is staying upright for now due to unprecedented net migration and government stimulus intervention (see further below). Give it a couple of years, the Great Australian Housing Ponzi Scheme will eventually run out of buyers.

Like the Aussie market, most world markets have bounced, including the Dow Jones (US). As the following chart demonstrates the length and magnitude of this bear market bounce is unprecedented when compared to the Great Depression bear market rallies.

Chart 3: Depression-era bear market rallies (Dow Jones)
source: Chart of the Day

The three charts above give us a clue about the state of the world economy (and I would argue, the state of the US-centric monetary system). Extreme volatility is in full swing.

USD-AUD Exchange Rate

No better example of extreme volatility in the system is the USD-AUD exchange rate.

Chart 4: In 16 months the AUD has gone from almost parity with the USD, crashing 39%, and now rebounding 56% from the lows at 60 cents
So what has changed?

Nothing, nothing has changed. The fundamentals are still broken. The US is still trading insolvent and an aging population will ensure most Western Countries will pursue a path of monetisation (going into more debt) to pay for the welfare state. What has changed is two things:

Inflation and Timing

During the GFC we were constantly told of deflation (decreasing prices). However, during this time I argued that inflation was and will remain our greatest concern. In the middle of the GFC (June 08), Australia's money supply growth was at 23 percent (annualised), the highest rate since the mid 1970s. I ask.. is it any wonder that it appears Australia is such a buoyant economy right now? We inflated our way through the GFC. Another angle is that we populated our way through the GFC (see chart below). If you add more citizens to the economy, there is greater demand on food, housing and general consumption. Add Government "free" handouts, and the warm fuzzy experience we feel aobut our "resilient" economy was all-but inevitable. To the contrary, I believe this is making a bad situation worse, at least for the long run. The artificial wealth effect continues.

Chart 5: Inflate and populate out of financial crisis! Australia net migration since 1860. You would think there was a gold rush on...source: ABC News, Alan Kohler, 23 Sept 2009

The other difference at play here is timing. During the GFC, the All Ords, Dow Jones and even world trade (click to see charts) were declining at a faster rate than what they did during the 1929 crash. The rate of fall was just unsustainable. It's the law of the markets... or like bouncing a tennis ball. If you bounce it hard on the ground, its going to bounce back to some extend. In market terms, this is called a dead cat bounce (however some stocks fall and just don't bounce...). Timing is everything. For instance BHP was almost $50 per share prior to the GFC crash, than fell to $21 seven months later. Same company, and arguably the fundamentals of BHP were stronger than ever. The difference is market mood. Perceptions of value change over time.

Dow-Gold Ratio still falling

One of the key indicators I keep an eye on is the gold-dow ratio. When we price the world sharemarkets against gold, the downward trend is still well intact. Historically the Dow-Gold Ratio goes to below 1 when gold becomes very expensive relative to the sharemarket (Dow). There is still a long way to go... Gold is very cheap at US$1,100 oz!

Chart 6: What bounce?
source: Chart of the Day

Money can be made in all market conditions. Volatility in the markets in the last two years is telling us something is happening. Short-term it may appear that everything is back to normal. This couldn't be further from the truth. Measuring the share market and housing markets (and other debt-based markets) in terms of a tangible good (ie. gold) tells a very clear non-volatile storey. The long-term fundamentals have not changed, but arguably getting worse year by year, as Government and banks continue to fuel the fire with more fuel (inflation).

Cheers
Scott

(feel free to comment!)

Beware Australian Housing - the debt bubble will burst

(*Note: this post is a rough draft and will be edited/added to in the coming weeks. More new posts will come around mid March)

Australian Housing Bubble?

Almost no other economic topic right now, is as hot and contentious as the direction of Australian housing.

I have come to the conclusion that Australian housing prices must fall, indeed all property prices (commercial, industrial, rural). Demographics, low interest rates, "a housing shortage", historically low interest rates, first home owner grants - cannot stop the direction of the market forces. Both debt and lending are now imploding.

Housing prices, just like the sharemarket go through cycles between boom and bust. However, in Australia I believe we have become very complacent. We think property is a sure fire way to wealth. We believe its normal for prices to increase 5 percent or 10 percent per annum (just like we believe we are recession proof because we haven't had one since 1991). Throughout history house prices have always busted after times of major credit (debt) expansion. A crash will come to Australia soon - its just a matter of timing. Timing is everything.

As Warren Buffett once said,

"You only find out who is swimming naked when the tide goes out."

The tide is well on its way out. Full employment is the key for most individuals on whether they can weather the storm. For others the size of total debts will prove the Achilles heal.


Unaffordable Housing

Australia right now has amongst the most expensive and unaffordable housing in the developed world. The reason it's so unaffordable is that four letter word, D-E-B-T. As we have had economic good times since the early 1990s, individuals and banks have felt more and more comfortable to take on my risk and more debt. With such a long period of job security (for most), we foresee our future to be bigger and better than the past.

As an example I once used, during the mining boom, Perth had a stella rise in housing prices. Miners were flying in and out of Perth and getting paid over $100,000 p.a. to drive a truck. With more and more people on higher incomes, inevitably the housing prices in Perth rose strongly against all the other major cities. To secure their dream home close to the city, buyers out bid each other and took on larger mortgages. Now that the mining boom has come crashing down, where is a mine truck driver going to find a $100K job to meet their mortgage repayments?

Right across Australia, how can the retrenched workers keep their mortgages?
Banks whom are tightening who they lend to... would they now give a mortgage to a low-wage metals factory worker in Western Sydney?
All of a sudden in the last 6 months, Australian individuals and banks have changed their outlook from that of increasing wealth to a complete reversal. Alarm bells are ringing. Some are asking questions about the future. Too many think things won't get bad here. Just like the patriotism we see on US news networks, many Australians think "everything will be different for this time, the Australian economy is strong and resilient!"...

As chart 1 shows below. Real house prices have vastly outrun real wages for the last 25 years. Even more startling is rental yields have just been so low. Negative gearing is one of the big reasons why rents have remained much lower than where they should be (but I will save rent discussion for another time).

Chart 1: Australian Real house prices, wages, construction costs and rents.

Australian housing vs the world

Australia has the most unaffordable housing – study confirms

A group called Demographia released a 'Performance Urban Planning' report ranking property affordability across various countries. The report concluded that Australia has the most unaffordable housing of all the nations surveyed. The report simply used a ratio of Median House Price to Median Household income. A house is "Affordable" if the ratio is 3.0 or less. It's "Moderately unaffordable" if the ratio is 3.1 to 4.0. It's "Seriously Unaffordable" if the ratio is 4.1 to 5.0. And it's "Severely Unaffordable" if the ratio is 5.1 or more.

Results: Australia sports a ratio of 6.3, which is both "Severely Unaffordable" and "Seriously Daloob." New Zealand comes in next t 5.7, followed by Ireland at 5.4 and the U.K. at 5.3. Owing to its large number of metropolitan areas in which there is a wide variety of median prices and incomes, the U.S. nationwide ratio is just 3.2.

On a city basis: The Sunshine Coast in Queensland is the least affordable. The Gold Coast came third, behind Honolulu, and Sydney was fifth, behind Vancouver. Melbourne and Adelaide were equal 12th and were still less affordable than New York (14th), London (16th) and Dublin (32nd).

(More on this survey, including a table of least affordable cities can be seen at Daily Reckoning)


Graphs of concern:

To put more of a perspective on Australia's housing bubble the following graphs compare Australia to some of the other developed countries, which have seen large declines in recent years.

Chart 2: Compared to the United States, Australian households are much more weighed down by household debt.

Chart 3: House Index - Aus, US, UK

Chart 4: Like Japan?


And the big daddy of all graphs (also seen on Chris Martenson's economic crash coarse series)

Chart 5: The history of US housing (in inlfatoin-adjusted terms) since 1890.
The picture speaks for itself. The recent housing boom and crash in the US has been like no other before it. Notice the 1970s and 1980s bubbles came back to pre-bubble levels when it burst. The US is in completely uncharted waters. A graph of Australian housing would look worse than this chart.
Chart 6: This is what WhoCrashedtheEconomy worked out
Australian household debt

If we think subprime was a mess in the US, things could potentially get much worse in Australia when housing prices come down. Indeed, a recession (an ultimately a depression) in Australia is tied to Australian housing (more than anything else). We just have too much debt tied to housing (inflated mortgages)!

Household debt as a percentage of disposable income

Household debt in Australia is alarmingly bad as Alan Kohler pointed out late last year.

In Australia the total debt to GDP ratio is at 160 percent, compared to 100 percent in 2000 and 50 percent in 1980. Household debt to disposable income is over 150 percent, compare to 50 percent in 1990.

Chart 7: Australian vs US household debt
The US reached a height of around 130. Australia has gone over 160. It doesn't matter if we don't have a high level of sub-prime loans in Australia - we are up to our ears in debt.

Once Australia's unemployment rate reverses from around 4% (if you believe that number) and heads towards 6 or 10 percent, housing prices will come down. Australian's are over leveraged to their houses, by taking out huge mortgages to pursue the Australian dream. Few people have taken into consideration that they may loose their job along the way. With no sound income, many Australian's will have no choice but to foreclose on their mortgage. Banks won’t want to hold empty houses, so an avalanche effect can take place when the banks flood the market with discounted homes.

Housing market tends to crash after the sharemarket.........

Sell the holiday house first?

Last year just before Xmas, I was holidaying on the southern coast of New South Wales. The town was, Tuross Heads, a small beach house/fishing town near Bateman's Bay with a population of about 2,000 people. I have never seen so many houses for sale in one spot. In some streets it was nearly every second or third home with a "For Sale" sign on the front lawn. If people expect house prices to come down, is it plausible that people will sell their beach house/investment property first? Is this a sign of the top of the bubble? With one in every 2 or 3 houses for sale in the street, the first couple of sales would impact the selling price for all the other houses in that street. Perhaps this is one reason why property prices (like shares) can fall so quickly if sellers are massing at the front gate. It's better to get out early, then to get out after everyone else.

Since this trip, 'For Sale' signs have become common place around many towns and suburbs. When I went home for Xmas, I noticed nearly 1 in 3 homes/BnB's/holiday houses along a river stretch was for sale. This is a visual sign that things are shifting...

But Australia has record demand for housing!

Some argue that Australian household prices will continue to hold its ground or gain in value in the coming years because we have record immigration levels and demand for housing.

Chart 8: Alan Kohler ABC News 28 November 2008

For a while I felt this argument had some traction. I've come to realise that this will probably not be. If anything, strong housing demand will mean much higher rent prices in Australia. Strong demand does not mean higher prices. For instance, world silver prices are falling right now, but there is now a 10 to 16 week wait to take delivery of silver from a bullion dealer. Silver demand has never been stronger. Prices can disguise real value. There are always market manipulators at play trying to influence under-educated investors, and one of the worst in the housing market is the Australian Government.

2007: The falls have started

Despite record high immigration levels and strong support from first home buyers, Australian housing prices fell in all states except South Australia and the NT.

Chart 9: House Prices 2008
Chart 10: Doesn't matter how you measured it - Australian housing prices will continue to fall.

Australian Government encouraging first home buyers

The Australian Government continues to encourage (through handouts and stimulus packages) Australians to jump into the property market. Buying a property is big investment decision, and unfortunately many buyers do very little due diligence.

I believe the first home buyers grant is extremely irresponsible. (Will add more on this soon)


Housing Deflation - The key ingredient is bank lending (more to come on this section)

There must be liquidity of buyers in the market who can absorb selling pressures. If buyers dry up and widen their spread, price deflation will take hold. Once buyers expect prices to come down $100,000 or so, they will sit back and not participate. In effect you get price deflation (prices fall quickly because you only need a few sellers in the market
without liquidity - home financing + willing buyers (who can absorb selling pressures) - the market falls

In a housing bull market, buyers compromise to the seller. For example is a home is advertised as $500,000, but the nearest buyer is at $490,000 (the spread is $10,000), the buyer is more likely going to raise their offer to $500,000 to get in before someone else.

However in a housing bear market, sellers start to outnumber buyers. Price spreads widen because buyers are no longer willing to take on increased amounts of debt because of uncertainty in the job market and wider economic conditions (ie. what we have today). But the key is expectations. If buyers and sellers start to expect prices to go down (such as selling lots of for sale signs and data which shows this), sellers start compromising and sell to the nearest buyer. eg. if the seller wanted to sell for $500,000, but the nearest buyer is $450,000 ($50,000 spread), they they are likely to do so, particularly if they are forced to because they have no job and the bank repossesses the house. In effect we end up with price deflation (asset destruction) - buyer liquidity dries up and prices fall rapidly (like in the US housing market today).

Price deflation has already hit the Australian sharemarket, with many small stocks registering very few trades now, because buyers feel safer to stay on the sideline. Those holding stock also want to exit the market and will sell at almost any cost to get out and switch to an alternate investment. In the housing market, more pressure will come onto the rental market. Rents will continue to inflate, while the underlying asset value of the house will fall. In effect rental yields will become more attractive over time (as they have been historically low).

Chart 11: Interbank Lending



The value of Australian housing prices in Gold and Silver

A few blog posts back I measured the All Ordinaries in terms of Gold and silver which showed that the Australian sharemarket actually peaked in 1999. It has only been going up in fiat currency terms (until the last year). The same applies to Australian housing. Australian housing has peaked and made plateau (stage 3 consolidation) between 2001 and 2005.

Chart 12: Just like the sharemarket, gold gave early warning signs a few years ago.


The data I have (till 2006) shows that Australian housing has fallen by 38 percent in terms of gold.

In 1986 you needed 208 ounces of gold to buy an average Australian home. At the peak of
the cycle, in 2004 you needed 923 ounces of gold to buy an average Australian home.

(silver chart to come shortly)


Conclusions:

- Debt, debt, debt. Australian's have way to much and its tied to our home prices. The world will continue to witness destruction (deflation) of debt ridden assets. We have seen it in the sharemarket. I will ultimately come to property.
- The ability of banks to lend (debt) is paramount.
- On the buyers side – liquidity (amount) of buyers must be outnumber sellers for prices to hold (and continue to go up). If buyers expect prices to fall, they will widen their spreads and price deflation will set in.
- On the sell side – Unemployment levels are the key, however the type of employment in the economy is critical. If people go from full-time to part-time or casual, or no employment whatsoever, they will be most vulnerable to defaulting on their mortgage. These sellers will sell to the nearest buyer regardless of price offered.
- Holiday houses and the most expensive houses in the cities will be most vulnerable.
- Many regional communities that rely heavily on commodities could face dramatic price declines if the commodity prices and shipping movements do not rebound very soon.
- Perth is the capital city most at risk. Canberra is probably the least at risk. In the long run, all areas in Australia are not immune.
- Above all, do not rely totally on what the Government says, the media, or myself. Everyone must do their own due diligence and come to their on conclusions and act accordingly. The free market is emotionless and does not care if you make money or loose money. Take responsibility into your own hands.

Cheers
Scott


[The 4 Corners program had a look at how the financial crisis has hit Australia so far on Monday night. Worth a look]