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Sunday, July 5, 2015

Barry Ritholtz: 2% Decline in US Stocks is Armageddon

Look out, old mate Barry Ritholtz has launched another tirade against Gold and Gold Bugs. His Bloomberg article discusses why Gold did not perform well "during Armageddon" as he described a 2% swing in the (US) stock market...
"This was the week Greece inched closest to chaos, as a bank holiday and a technical default caused markets around the world to erupt in turmoil. They recovered somewhat Tuesday, and futures looked stronger Wednesday morning, but on Monday, the NASDAQ Composite Index lost 2.4 percent, the Standard & Poor's 500 Index lost 2.09 percent and the Dow Jones Industrial Average fell 1.95 percent. Volatility exploded, as the Chicago Board Options Exchange Volatility Index surged 35 percent, its biggest increase in two years, to 18.85.

One would imagine that such a scenario might be constructive for gold. It has been called the best measure of fear, the only real currency, a refuge for those who plan for panic. So how is it doing these days? Spot prices were soft on Monday, despite the wild volatility in equities, drifting down a few bucks from about $1,180 an ounce to about $1,176. They fell a few dollars more yesterday, and are soft Wednesday.

I thought gold was an investor’s best friend during Armageddon."
Here is the move in the S&P 500.

Barry Ritholtz says equities have experienced wild volatility and Armageddon this week.

Even the 35% surge in the VIX is tame compared with recent spikes.

Chicago Board Options Exchange Volatility Index (VIX)

But what relevance is the US stock market to the citizens of Greece, ground zero of the current standoff between the Greek government and the rest of the Eurogroup (the chaos Ritholtz refers to)? The real measure of Gold's usefulness and performance should be in comparison to the market local to the crisis, surely?

So how is physical Gold performing when compared with the Greek stock market (using the Athens Stock Exchange General Index as a measure)? The ASE is down 54% from the early 2011 peak (in early 2012 was down as much as 72%) and is 35% lower Year on Year.

Athens Stock Exchange General Index

Gold priced in Euros (yes Barry, Gold is purchased in currencies other than the US Dollar around the globe) does not compete with the euphoric mania seen in US stocks over the past 5 years, but it has held up much better than the Greek stock market. It's currently down 24% from the 2011 peak and 9% higher Year on Year.

Gold price in Euros

Though how important is price when the problem for citizens of Greece this week has been their inability to sell (or buy) in the stock market while it was closed? We don't even know what Greek stocks will open at next week (assuming the market reopens by then) after this weekends referendum on the Eurogroup proposals.

Greek banks have also been closed with ATM withdrawal limits imposed.

Framing a 2% fall in the US stock market as Armageddon is a disturbingly offensive narrative for Ritholtz to be carving out from half way around the globe in his comfortable Wall Street office while Greek citizens struggle with drawing life savings out of their bank accounts to spend on food, medical supplies and other goods they may need to get by in an uncertain future. 

In a situation like this physical Gold (and cash) has performed exactly as you might expect, acting as a store of wealth which could be used immediately as a medium of exchange, something frozen or inaccessible stocks and deposits are unable to do. How do you put a price or value on that?

At the moment Greece's currency (Euro) remains a safe asset to hold when kept in cash (bank deposits may get a haircut at some point), the Euro is not at risk in the immediate future as it's not unique to the country facing the escalating financial, banking and debt crisis.

If you want to analyse the performance of Gold in a real Armageddon scenario then you could look to the north east of Greece. Ukraine, whose financial and geopolitical woes are not cushioned by the use of a shared currency, has seen it's currency (Ukrainian Hryvnia) decimated. Here is the performance of Gold:

Gold price in Ukrainian Hryvnia

If I was a citizen of Ukraine I would feel much more comfortable owning physical Gold rather than shares in the local stock market, local currency (stored physically or in a bank) or real estate.

Perhaps Ritholtz fails to understand physical Gold ownership, after all his description of the metal in an article last year only mentioned contractual representation:
"Like all commodities, gold is purchased via futures contracts."
If the US faced a real Armageddon, it's unlikely that Ritholtz's version of Gold would act as a safe haven, it could very well be suspended (just like the Greek stock market last week), while physical Gold remained accessible and tradable (at which point the [over]hyped paper/physical price disconnect would likely occur).

One sentiment I do share with Ritholtz is a surprise at the lack of interest in Gold from US investors (even if the Greek crisis isn't having any impact on them presently). Ritholtz shrugs this off as either a failed narrative for Gold or an improving US economy and performance of other assets. It could also be that:

A) After 4+ years of talk, Grexit has become the boy who cried wolf and the market now doesn't pay the situation the attention it deserves.

B) The market (rightly or wrongly) thinks the Greece crisis no longer matters and will resolve itself without impacting global markets regardless of referendum or agreement outcomes.

C) The Elite with the help of their bullion banker friends at the Crimex are suppressing the price of Gold during these turbulent times in order to maintain the US Dollar hegemony.*

Like Ritholtz I think the Gold blogosphere produces a lot of dishonest narratives (which I regularly write about), but that doesn't justify his attempt to carve out his own, trying to use short term price movements in one country to show that Gold no longer has relevance, when it's clear that it still does for people who are potentially facing or genuinely experiencing financial catastrophe.


* Hopefully an obvious joke.

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International Monetary Fund vs Geece (Rogue Nation)

I saw the new Mission Impossible movie trailer and thought it would mash-up nicely with a recent interview of IMF's Managing Director (Christine Lagarde) for a new cut that puts a different spin on the situation.

I'm no pro video editor, but this is what I came up with (only intended as humour, not to reflect any real views that I have on current events or organisations).


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Monday, June 29, 2015

Rising Prices Aren't Always Good For Home Owners

Contrary to popular belief that all home owners benefit from rising prices, that is not always the case.

Younger generations who are yet to buy a long term home, who may have purchased a smaller property that suits them for the short term or just to get themselves onto the “property ladder”, may be disadvantaged if they intend to upgrade in the future.

Take the case of a Sydney family who bought a $400k 2 bedroom apartment to tide them over for a few years. They had a 75% LVR to begin with, putting in a 25% deposit, but lower interest rates have assisted them in paying down the principal aggressively and as it stands have an LVR of 60% on purchase price ($240k mortgage). They’ve outgrown the apartment with a new addition to the family and want to now purchase a 3 bedroom house. Let’s look at three scenarios in which they sell their apartment and buy back into the same market.

Original value of 2 bedroom apartment: $400k
Original value of 3 bedroom house: $550k
Sale fee (real estate agency to sell apartment): 1.5%
Stamp duty (to buy house): Calculated on NSW rates

Scenario 1: No Price Change. ($400k apartment, $550k house)
Stamp duty: $20,500
Sale fee: $6000
Cash left for new purchase: $133,500
That’s a 24% deposit leaving a $416,500 mortgage on the new home.

Scenario 2: Prices Rise by 10%. ($440k apartment, $605k house)
Stamp duty: $23,000
Sale fee: $6600
Cash left for new purchase: $170,400
That’s a 28% deposit leaving a $434,600 mortgage on the new home.

Scenario 3: Prices Fall by 10%. ($360k apartment, $495k house)
Stamp duty: $18,000
Sale fee: $5400
Cash left for new purchase: $96,600
That’s a 19.5% deposit leaving a $398,400 mortgage on the new home.

So in the three scenarios above, while the steady or rising prices result in a larger deposit for the new home, allowing a lower LVR, it also sticks the owner with a larger mortgage.

Which of the above 3 mortgages would you prefer to have for the same 3 bedroom house (all else being equal)?

Of course not every situation is the same, a larger fall than 10% may result in Lenders Mortgage Insurance being payable or result in the apartment owner being underwater (mortgage exceeds value of home or is high enough that selling won't leave a large enough deposit) and locked into their unsuitable abode.

The point of this short post was just to highlight the furphy that many spread to suggest that all homeowners benefit from rising prices, when the reality is that it often just means a larger mortgage when they upgrade to their next home.


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Tuesday, June 9, 2015

Adam Carr Wrong on Australia's Housing Affordability

Adam Carr had this to say on housing affordability in Australia (via Business Spectator)...
"...housing is still actually very affordable."
Carr was prepared to dive head first into showing how an $800,000 property is affordable on a $100,000 salary.
"A household on $150,000 could afford a $1 million-plus house -- no dramas. Someone on $100,000 could afford anything in the vicinity of $650,000 to $800,000. A lot depends on the loan-to-value ratio they’re taking -- I’ve used 70 per cent -- but it can be done."
Ok, let's break this down. $100,000 would be roughly $73,000 net, $1403/week. Carr is working from a position that they've saved a 30% (+ costs) deposit. Using $32,000 for stamp duty and fees (I went with NSW figures) and ignoring any other transaction costs (such as legals)... that's $272,000 required in savings (the deposit) before we can even start checking the affordability of the remaining mortgage. Based on a savings rate of 30% of net income ($21,900 per year, very generous if you ask me), it has potentially taken this buyer more than 12 years to save the deposit that Carr says they have on hand. That should already be raising alarm bells on this so called "very affordable" property market we have.

Now we could make any number of assumptions about this buyer, maybe he/she had property that appreciated in value before buying this one, maybe they have bank of mum and dad chipping in, maybe they're a gun investor who has turned a little savings into a lot of capital to fund the deposit... but these would be unfair presumptions to make. We could scale back the price and incomes at a comparable ratio and it would still look awful... e.g. someone on $50,000 buying a $400,000 property (for their first home) and using a $135,000 deposit will have to save for 10+ years using the same measure.

The mortgage repayments (on the remaining $560,000 loan) work out to $655 weekly (at 4.5% interest over 30 years). That's over 46% of net pay (34% of gross) and doesn't take into consideration the extra costs of ownership such as council rates, maintenance, insurance and more. It also doesn't take into consideration the possibility of interest rates rising, if they normalised to 7% the repayments would rise to $860 per week (61% of net income, 44% of gross).

Call me mad, but I don't consider Carr's examples to show affordable property any way you cut it (at least not in the way I think the word should be used)...

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Thursday, May 28, 2015

Rent vs Buy: An Adelaide "Cost Comparison" Revisted

One of the very early articles I wrote on this site compared the cost of buying a home with renting one in Adelaide (Rent vs Buy: An Australian "Cost Comparison"). Earlier that year I'd sold a property I owned in Adelaide (returned to renting), I put my money where my mouth is and at the time it made more sense from a financial (and personal) perspective to forgo the security of owning (or more accurately "paying off") my own home.

Almost 5 years later I am still renting the same property, the lower cost of which (less than the mortgage I had) has been an enabler to put away some extra savings and investment. In the meantime property prices have basically gone nowhere (fell around 8-10% over 2010 to 2012 and have since rebounded back to 2010 levels) and interest rates have dropped.

The comparison I did previously using figures in Adelaide, at the time most other Australian capitals were quite comparable (i.e. yields around 4-4.5% for houses), but today Sydney and Melbourne are in a league of their own. The figures I lay out below make owning look quite attractive, but that same argument probably doesn't hold true in Sydney and Melbourne where prices have gone gangbusters and yields are woeful.

I have revisited the figures from the original article and compared them with today.

Rent vs Buy - The Figures

Property: $500k House

Rent (2010): $25,000pa / 52 = $480pw
Rent (2015): $26,520pa / 52 = $510pw

(Residex shows yields have slightly improved for Adelaide over the past 5 years)

Buy (2010):
$500k + $24,000 (stamp duty and transfer fee#) x 7.25% = $37,990
1% of property value for maintenance and insurance = $5000
Council and water rates = $2000
Total = $44,990 / 52 = $865pw (interest only)

Buy (2012):
$500k + $25,000 (stamp duty and transfer fee#) x 4.15% (3 years fixed) = $21,787
1% of property value for maintenance and insurance = $5000
Council and water rates = $2200
Total = $28,987 / 52 = $557pw (interest only)

# Adelaide based figures, this would differ between states

As I pointed out last time, this still doesn't account for all costs of ownership (or for that matter renting), but you can see that there has been a squeeze in the gap between the two. In 2010 the cost difference was $385 per week, in 2015 that has narrowed to $47 per week, mainly as a result of falling interest rates and a small increase in rents. The above example shows a 6.25% jump in rents, in my personal situation I have seen a 13% rise in 5 years (which reflects the local market, different areas in Adelaide may have seen higher or lower). Over the last 5 years I have also seen my income rise which would make servicing the gap easier.

In Adelaide a $500,000 house would actually buy you something quite nice, a modern 3 bedroom house around 10km from the city, maybe even closer or a small house in the city if that is a preference. If you are prepared to look at modest homes you can buy something more dated, 15-20km out from the city, for around $300,000. Assuming a 10% (+ costs) deposit (leaving a $270,000 loan) and 3 year fixed interest rate of 4.15%, the principal and interest repayments would be around $300 per week. Rent for the same house might set you back $320-340 per week. Suddenly a home in Adelaide is looking quite obtainable, maybe even for a household on a single income.

Now I'm not saying Adelaide is cheap, it's still expensive on a global or historical comparison (if we look back at the property to income ratios of the mid 1990s), but it is definitely obtainable for those who've had the capacity to save a reasonable deposit (circa 10-20%).

There are still some risks to the Adelaide property market, as I outlined a couple of years ago (What's next for Adelaide property prices?) the economic conditions are not positive in the state, we already have one of the highest unemployment rates in the country and things may be set to get worse before they get better as the car manufacturing industry shutters. Further to this Adelaide property is at risk of being affected by recent changes to investor lending (that is likely to tighten further), falling wage growth and a crackdown on foreign investment (some of which was well described in a recent article by Callam Pickering). These factors are likely to continue weighing on Adelaide prices, but in my view with prices being the same level as they were 5 years ago, the risk of a substantial correction (i.e. 15%+ nominal) is unlikely barring a complete meltdown of our banking system or huge spike in interest rates (neither of which I consider to be likely).

FT describes an asset bubble like this:
When the prices of securities or other assets rise so sharply and at such a sustained rate that they exceed valuations justified by fundamentals, making a sudden collapse likely - at which point the bubble "bursts".
Those referring to all Australian cities as being in a bubble (I do agree Sydney and Melbourne potentially are) are either wrong or have come up with their own definition of the term. Perhaps they think it's likely we see a return to the historical price to income values we had in the mid 1990s (or earlier) and that we've been in a long lasting bubble since that time. I think that is an unlikely scenario (returning to ratios from 20+ years ago) given the political and financial system we have today.

On a personal note I recently started looking at property in Adelaide (to buy) for the first time in 5 years (looking at PPOR and/or investment) and I expect to purchase (perhaps more than once) in the next 12 to 24 months. Price growth may be slow to begin with and won't rule out some negative growth (what a term! e.g. falling prices) in the short term, but there are some reasonable yields out there now and the time to buy will be while sentiment remains poor.

And if GFC 2.0 comes knocking on Australia's door and smashes the price of all Australian property in half... well at least I'll still have my Gold ;)

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