Sunday, April 19, 2015

The Politics of Negative Gearing (Australian Property)

Debate over the ability for investors to negatively gear property (claim losses from property against other income) in Australia has been fierce of late.

In a recent article Sinclair Davidson (Professor of Institutional Economics at RMIT University) was reported as describing public debate around negative gearing as “a complete load of rubbish” (sadly his comments were no less bin worthy). Rather than tackle the issue with any seriousness he resorted to ad hominem attacks on those making the case against the tax policy, claiming that "ACOSS and other people who don’t actually pay tax themselves don’t understand much about the tax system". He went on to say that other countries (US, NZ, Japan) allow such deductions (so why shouldn't we) and suggested the campaign against negative gearing is just an attempt to raise more revenue.

Jessica Irvine also suggested negative gearing is a budgetary matter (in an article yesterday), calling negative gearing a "loophole" and suggested it's closure would "raise billions".

The reality is that an end to negative gearing for property wouldn't be a huge budgetary boon (as these commentators have suggested). Most advocating for it's removal suggest a 'grandfathered' approach, which means properties already owned by investors aren't affected (until the asset is sold). Even when investors make a purchase (following negative gearing's removal), any losses which would have previously been deducted in the same financial year against other income could be carried forward to claim against future income or profit from the same asset class (property). While it might delay when deductions are made (and some investors may not make a future profit in property meaning it never is), improving the government budget in the short term, it's long term impact would be negligible.

Furthermore, it's likely that over time investors would adjust their expectations and reasons for investing in property. Currently a large number of investors buy for the tax advantages that negative gearing (and other tax breaks) offers (graphic via Digital Finance Analytics):

It's removal would result in a lower number of investors prepared to speculatively purchase at higher prices knowing that (as it stands now) low yields (& resulting losses) are partially offset by a tax deduction against other income at the end of the financial year (or as they go for those investors using an Income Tax Withholding Variation). Over time this would likely result in a normalisation of rent to price ratios so that fewer investment property purchases would be loss making from the outset.

So why support an end or changes to negative gearing if it's impact on the government budget would be minimal?

Some propose that all investment assets should be treated the same when it comes to taxation (losses from shares or business can also be offset against other income in many cases), but not all assets are equal. Like food and water, shelter is one of life's necessities and although one doesn't need to own the land and home they live in to benefit from it's utility, the increasing cost of housing is having an impact on the ability of Australian families to enjoy a lifestyle we've grown accustomed to.

There will never be a day where every household is able to afford to buy (or have an interest in doing so if the flexibility of renting is preferred), but with a historical home ownership rate of 70%, the figures recently coming out suggest that balance is tipping unreasonably in favour of investors.

Being a Senior Fellow at the Institute of Public Affairs, Davidson would probably be an advocate for a free market approach to the property market and affordability problems that arise, but the Australian property market is far from free with government & public institutions involvement in almost every aspect, including where they will allow new construction and approving or rejecting applications, significant fees and taxes added to the cost of building and selling a new home, setting the cost of money to borrow, regulating lender rules, setting the tax policy which makes it attractive, boosting the ability of buyers to purchase using grants and concessions and guaranteeing the financial institutions who would be destined to fail should the property market ever experience a severe bust. The distorted property market that we have today has come from decades of poor policy decisions, any solution will likely need to come from the same place.

Negative gearing is a tax policy that gives investors an unfair advantage in the bid to secure a property. An investor obtaining rent from a property and the ability to deduct any losses made against other income gives them an ability to carry a higher level of debt than they'd be able to otherwise. One of several government based enablers that are driving the demand side of the market to the point we are seeing a speculative investment frenzy in some cities. It's time to wind back these demand driving policies.

Within the next month we can expect to see the outcomes from the long awaited Senate inquiry into affordable housing. After comments from Nick Xenophon last year in an open letter to Prime Minister Tony Abott, that we should consider tweaking negative gearing to encourage affordable new housing (which I read to suggest quarantining negative gearing to newly constructed homes, a reasonable alternative to dumping it altogether) I was hopeful this inquiry might result in some changes. Recent comments from Abbott suggest that he will not consider such changes.

Despite housing affordability being a hot topic at the last federal election, neither of the major parties had any policy specifically directed at tackling it. Though quarantining negative gearing to new builds or removing it completely would only be one part of a solution to tackle the problem, Abbott has made it quite clear that he's not interested in a sensible debate on the matter. Last month Labor released a discussion paper aimed at informing Labor’s Housing Affordability Strategy (to be taken to the next election). I'd expect that with the right mix of policies directed to tackling housing affordability and the right attitude (knocking back ideas before the results of the Senate inquiry into affordable housing as Abbott has done is one way to show you are not taking the national discussion seriously), Labor might just have an edge that could help them secure a win at the next federal election.

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Sunday, April 12, 2015

Australian Property Market: Secular & Cyclical Trends

Barry Ritholtz recently framed secular markets this way, “The simplest way to think of secular markets is as longer eras driven by overriding dynamics that define the period either positively or negatively”. Wikipedia says a a secular market is a long term trending lasting up to 25 years which consists of a series of primary trends, "A secular bear market consists of smaller bull markets and larger bear markets; a secular bull market consists of larger bull markets and smaller bear markets."

However you want to define it, property in Australia over the last 20-30 years has been in a secular bull trend, not only in nominal prices, but also measured by real increases. Consider the rise in land values compared with GDP (via Prosper, Soos):

A measure of real house prices (via Prosper, Soos):

Or perhaps the most commonly observed, dwelling price to income ratio (via Christopher Joye / UBS):

Some argue that price to income ratios at current levels are not sustainable, but as the chart above shows (at least on a nation-wide basis), the current price to income ratio has levitated within a relatively tight range (4.5-5.5) for well over a decade now.

Price enablers and drivers have included an increase in dual income households, low interest rates, easier lending practices (high LVR loans), tax policies (including the restoration of negative gearing after a brief hiatus, introduction of GST and the Capital Gains Tax discount), strong income growth stemming from a resources boom and mining investment, government incentives (such as the First Home Owners Grant & Boost), supply constraints, strong population growth and more recently investment in residential property by foreign buyers. There is no one cause, but rather the overriding dynamics have resulted in prices in Australia becoming some of the least affordable in the world.

While some of these factors may change (housing affordability is becoming more politicised, especially in Sydney where prices are being driven excessively higher by an influx of investors), some of the changes that have occurred over the decades are unlikely to reverse course and I think those holding out for a significant crash in prices Australia wide (e.g. where we see price to income ratios return to the level seen in the early 1990s) will be disappointed.

It's likely we are nearing the top of the latest growth spurt (at least on a national measure), see this chart from RP Data which visualises the cyclical trend.

But the national rolling annual change doesn't give us a full picture of the performance of all capitals which makeup the series.

I expect that Sydney and Melbourne may be nearing major cyclical peaks (i.e. within the next 12 months). Sydney is showing many signs of rampant speculation that were similarly observable at the 2003 peak (e.g. investor loans reaching record nominal levels and as a % of all lending). Sydney's cyclical peak in 2003 saw prices decline and ultimately 5 years of lower/stagnant prices.

Perth has seen the cyclical climb higher that I predicted from mid 2012 ('Perth Property on Cusp of Price Growth?'), however a sharp drop off in mining investment (the 'capex cliff') and falling commodity prices are likely to take the wind out of the sails going forward (as I speculated might happen).

Adelaide is still playing out as expected with muted price growth given the underwhelming economic conditions ('What's next for Adelaide property prices?'). Despite the recent growth prices in Adelaide (at a capital city level) are only around the same as the last cyclical peak in 2010 and in some suburbs I am watching are similar to those seen in 2008/2009.

I expect growth to rollover to the downside (lower level or negative growth) as reality bites with the closure of the Holden factory, some major infrastructure projects come to an end (such as the new Royal Adelaide Hospital) and with a lack of good economic news in the pipeline. However, I think the next couple of years may provide a buying opportunity in Adelaide, the ability to lock in lower interest rates, with yields at a more reasonable level than the eastern states and prices which will potentially be little higher than they were 6-7 years prior, it's likely to be enough to coax me back into the property market (for the first time since the peak in 2010 when I sold).

That said I will be approaching the market cautiously and looking for opportunities where downside risk is limited if Australia faces recession or continued weak economic conditions.

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Saturday, March 28, 2015

Cash Is A Store of Value If Interest Rates Are Negative

Here is what happens when you take a quote out of context... Rick Santelli (CNBC), Zero Hedge and no doubt many others by now have honed in a line from Federal Reserve Chairwoman Janet Yellen. Zero Hedge has shortened the quote for their headline which reads: Santelli Stunned As Janet Yellen Admits "Cash Is Not A Store Of Value", this would suggest Yellen had been critical of holding cash for that purpose (as a store of value), however watching the clip reveals a very different message.

Yellen does say "cash is not a very convenient store of value", but she says so immediately following a comment that she's surprised there hasn't been a larger pickup in demand for cash (in the Eurozone areas where interest rates are negative).

What Yellen is actually implying in her response is that holding (physical) cash IS a good store of value when interest rates are negative, the reference to it being an inconvenience is presumably about having to deal with it physically. Like precious metals, holding assets physically comes with a different set of risks to owning them digitally in an account.

In fact I recently commented on the blog of JP Koning about holding cash as a store of value, pointing out there may be an opportunity for new services in the secure storage of cash (not unlike an allocated bullion account):

Physical cash acts as a store of value (or potentially even rises in value if the area is experiencing deflation) when interest rates are negative because the nominal amount you own doesn't change, where as if you hold a deposit in a bank account you may be charged a negative rate.

Of course over the long term, assuming a successful return to inflation and positive rates, cash is not a good store of value, but there are periods such as now, in countries where interest rates are negative, that holding cash as a store of value makes sense.

The deceptive way in which Zero Hedge and others have framed this quote by Yellen is why you need to be careful about the narrative and agendas that others drive as I have pointed out several times in the past.

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Tuesday, March 10, 2015

Self-Confessed Gold Bug

Some time ago I added the self-confessed label of ‘gold bug’ to my Twitter profile. Typically the term has been used by the mainstream media or those who own no Gold in a derogatory way as a weapon to feed a narrative that the metal is not worth owning and those who do so are irrational.

I decided to take ownership of the label for two reasons. The first was to reclaim the word so that it’s use against me has no impact. The second was to try and change the perception that a ‘gold bug’ must have a particular view. I am attempting to highlight that we are not all defined by the way someone else means the term.

Many try and characterise gold bugs as holding a very narrow set of views (such as Barry Ritholtz), but ironically in their race to pigeon hole those they berate, often they overlook their own lack of objectivity.

A quick glance at my website or Twitter feed will see many judging the book by its cover, but those who've taken the time to stay and read on will find that many of my views differ to the gold bug caricature that is often assumed. I try and cut through the unfounded conspiracy theories that permeate much of the Gold blogosphere, at times I've owned 'paper gold' and I've even warned investors to be cautious when the sector is overheated, for example in August 2011 (3 weeks before the peak in Gold) I wrote:

"...investors (specifically in the US) may want to consider moving some of their assets back into real estate (even if simply to purchase their own home to live in) as the ratio (HOME:GOLD) is currently the lowest it's been since the 1980 peak in Gold."

The reality is that gold bugs have a wide range of views, reasons for owning Gold and ways of maintaining exposure. Some of them may be ‘gun toting, government hating, hyperinflation expecting, only physical owning, all conspiracy believing’ gold bugs who expect a SHTF scenario in the near future where we return to using it as a means of exchange. Others may have a less extreme view, maintaining a small position in Gold to hedge against the unlikely event of disaster. Of course this is a very westernised depiction of a gold bug, there are billions of people for whom saving in & owning the metal is just a way of life.

So the next time someone uses the term gold bug against you, stand up proudly and own the title. You can explain that it simply means you think it’s worth having exposure to Gold (which is perhaps the only shared view that any gold bug must have) and that your stance is shared by central banks and many of the world’s wealthiest individuals alike.


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Wednesday, February 11, 2015

Storing Gold & Silver: Safe Deposit Box In Australia

Information is Australian specific for those interested in the use of a Safe Deposit Box (SDB) to store precious metals. Not investment advice, draw your own conclusions about the risks and how to best store your physical assets.

Regular readers would know that while I prefer physical ownership of precious metals, I'm no stranger to highlighting the risks associated with doing so. As I wrote recently (If You Don't Hold It, You Don't Own It):
There is no risk free way of owning precious metals (or any asset for that matter) and safe storage is the key factor when dealing with physical.
I've mentioned my preference for Safe Deposit Boxes (SDBs) in an earlier article (7 Ways To Keep Your Gold And Silver Safe):
Get a Safe Deposit Box
This is a personal favourite of mine. If there is anywhere that's likely to be safe for your Gold and Silver it's in a facility that is built for that very purpose. Just remember that not all safe deposit box facilities are created equally. Many large banks will offer safe deposit box services, make sure you shop around for the mix of safety and price that best fits your situation as in my experience both of these factors can vary substantially between providers. While I expect it's far less likely today than in times past, you should consider that keeping precious metals in a safe deposit box does make it an easy target for any government crackdown and confiscation should it occur.
SDBs offer the safety of a secure storage facility, while leaving the physical handling of precious metals or other valuables to the individual. This avails the owner with a level of privacy and independence that allocated or unallocated accounts don't, even if stored in a similarly secure premises (see my article 'How Safe Are Unallocated Bullion Accounts?' for more information about the risks that this type of precious metal ownership entails).

You can't choose to store your bullion in a SDB facility and expect that all service providers will offer the same level of protection. Several years ago I wrote about a Kennards facility which was broken into with SDBs emptied after the criminals (who were eventually caught and jailed) scoped the warehouse by hiring their own SDB with a stolen credit card. While the Kennards facility provided privacy (no 100 point ID check) and accessibility (24/7 access), it was these same features which put a hole in their security.

If we look to the more secure SDB services in Australia (those housed in a vault) then we still have a choice to make between independent private vaults and those provided by banks, though not everyone has the luxury of choice between these two varieties if they want to keep their metal stored locally. When an individual is considering a choice of facilities it's important they compare each specifically on it's own merits (not something I can do in detail here), the below is mostly a general comparison and anecdotal observations.

The eastern states have the widest selection of private vaults with well recognised names such as Reserve Vault (RV, Brisbane), Custodian Vaults (CV, Sydney) and Guardian Vaults (GV, Melbourne and Sydney).

All three of these vaulted SDB providers offer insurance options that are underwritten by Lloyds of London (CV and GV offer $10,000 complimentary cover). All three are privately owned and proudly state their independence (of banks and government) and while the vault operators may not be covered by all banking regulations they they are considered a financial service and governed by some of the same rules as the banks (for example the AML/CTF Act).

The private vault facilities are eager to differentiate themselves from the SDBs offered by banks. CV has a handy little table outlining the differences between their service and those of the banks.

Let's tackle these line by line. Some of my points will reflect personal experience, not all bank SDB facilities are identical.

Insurance: The complimentary ($10,000) insurance is a nice bonus, but if that's enough to cover your stack then a SDB is an expensive option anyway (e.g. $300/pa for the SDB is a 3% annual storage cost on $10k in metals). Having the vault provider streamline insurance options is convenient, but you can always organise your insurance independently through a broker.

Key Ownership: At the bank SDB facility I use each box is dual key, one held by the customer and they retain the second for opening in tandem. They do also keep a copy of my key, in a locked box with my signature over a seal. In my opinion the fact that you receive both copies of the key from CV is a false sense of security. As their terms and conditions state, if the Government has legal authority to access your box CV will provide it (with or without your permission and key) and if you terminate the agreement (not paying storage fees) then they reserve the right to open the box and sell the contents to recoup their loss. The bottom line here is that not having a copy of your key doesn't stop CV from accessing your SDB contents under the terms of your agreement with them.

Accessibility: I can't speak to an unlimited quantity, but at the bank SDB facility I use I was able to add a second operator with no extra charge. I also have unlimited access to the facility, though do know of some banks who limit the number of free visits during the year before additional fees start to be incurred.

Long Term Storage Discounts: This may be a unique attribute, though don't see the discounts listed on the Custodian Vault website, so they may be trivial.

Security: Ok, they've got the banks there. I don't have biometric entry to the vault and would be surprised if any other bank SDP facilities in Australia do either.

Storage Restrictions: This would vary between bank providers, but in my case I was not an existing client of the bank and was still able to open a SDB.

Regulations: It's true the banks are covered by a greater level of regulation ("Banking Law"), I will discuss this in more detail below, but while some may see this as a con, I see the tighter scrutiny and greater accountability for banks as a positive.

While each bank SDB facility will differ and need to be judged on their individual merits compared with CV, I don't think a strong case was made from the table for avoiding bank SDBs.

GV and RV embedded videos on their site outlining risks of the banking system such as excessive leverage, derivatives, monetary system change, bank holidays and bail-in risks. I would posit that 90%+ of the content was not relevant to the safety of your assets stored in a bank SDB. That said let's look at some scenarios where your precious metals might be at risk in a safe deposit box.

Gold Confiscation: In the past when discussing the merits of bank vs private SDBs, some have pointed to Part IV of the Banking Act 1959 (suspended) which can be paraphrased as being unable to "buy, hold or sell gold unless it is a legitimate part of your trade or in the form of jewellery" (via Bron Suchecki at Gold Chat). These restrictions were applicable across the board (until 1976) and while I think it's unlikely they are reinstated in their current form, I'd expect even if they are or new confiscation laws were introduced that any crackdown on SDBs would be across the board with both bank and private facilities affected in the same way. Private SDB facilities will be compliant with any government request to refuse customer access or seize contents as required by law just as their terms and conditions state. Those who think they will avoid confiscation by using a private facility because it's "out of the banking system" are being lulled into a false sense of security. In any event I think Gold confiscation is highly unlikely in Australia and if a trend emerges globally of governments doing so then we should have enough notice to change views on the risk of it occurring and act if necessary.

Internal Theft: While theft by an employee is an unlikely event, it could arguably be made easier if the SDB facility has a copy of both keys to your box. Furthermore I have seen some bank facilities where they retrieve the box for you from the vault (so your only key is to a padlock attached to the metal storage box). It may not be the case that every private facility gives you both keys or that every bank facility keeps a copy, but in my experience the risk of internal theft from an SDB is potentially higher at a bank facility (if ease of doing so is the only consideration).

The Canberra Times, 25th April 1991
External Theft: The risk of this occurring comes down to the security of each facility. I'd expect that some bank facilities exceed the security of some private vaults and vice versa. Reading through Guardian Vaults list of security measures leaves me impressed, but whether this is a significant step up from other facilities I can't be sure. While listing security specifics may help clients feel good about their choice, marketing in this way also puts more information into the hands of those who may want to get around it.

The Canberra Times, 10th October 1984
Insolvency: In the event of insolvency of any facility the contents of your SDB should be owned free and clear. The biggest risk here is if you want access to your SDB contents while the administration processes takes place (the facility may be closed for regular access while that occurs). Here is where a bank facility might be safer than a private facility. We have a greater insight into the solvency of the banks who are open to scrutiny from the public due to their annual reports and other financial transparency. Even if you don't personally understand how to read the financial position of the bank you have your SDB with, it's likely their share price will be an indicator of health and financial news outlets will be quick to report on any trouble. Furthermore it's a fair assumption that a bank insolvency would result in government support. Contrast that to private SDB facilities, we don't know their financial position and you're not likely to have any warning of their insolvency until the day they shut their doors.

Bank Holiday: In the case we see events unfold where there are wide spread bank failures then there's a chance we see bank holidays. Like insolvencies described above this should only result in a temporary lack of access to the contents of your SDB. Some have suggested that bail-ins may extend to SDBs, but I see that as a highly unlikely. I haven't seen any evidence to suggest that SDBs in Cyprus were seized as part of their recent bail-in measures.

Bank SDB facilities get characterised as unsafe due to their connection to the banking system, but in my opinion there are some pros and some cons that result from this association and on the whole I don't see bank SDBs as less safe than their private counterparts. 

The banks are written off by precious metal holders as shady, but if the last 12 months has taught us anything it's that the bullion industry has it's flaws too (ATO and AFP Investigate Australian Gold Industry Fraud). In fact one of the aforementioned private SDB providers (CV) has management ties to the refiner implicated in the GST fraud story from Vedelago.

As it stands there is no private vault SDB facility in Adelaide so my only option for local storage is with a bank, but I feel comfortable doing so and would only consider moving to a newly available private vault if there were measurable benefits in doing so.

Whichever you choose I think both private and bank (vaulted) safe deposit box services are a smart option and in most cases much safer than keeping your precious metals at home.

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