Wednesday, December 24, 2014

BitGold: The Digitalisation of Metal

Earlier this year I wrote about several attempts to back cryptocurrencies with Gold (The Truth About "Gold Backed" CryptoCurrencies). Most of those I covered weren't backed by Gold in the conventional sense (i.e. a fixed amount of Gold that could be redeemed per currency unit), instead offering only partial backing. There were exceptions such as Ripple Singapore which offers fully backed units on the Ripple network, but totals held are still very modest (not quite 53 ounces of Gold).

Since that article I've noticed new entrants being marketed in this space and interestingly two competing products appear to be jostling for the same name, BitGold.

The first of those to market comes from Bitreserve, a company offering a digital wallet service where you can transfer between Bitcoin, various currencies (USD, EUR, CNY, YEN, GBP) and now Gold (stored and audited by GBI) all through their 'card' system. Think of it like having accounts in various currencies, you can only deposit funds into their system using Bitcoin, but once deposited you can diversify that value across any of the aforementioned currencies if you don't want exposure to Bitcoin's fluctuating value. Bitreserve maintains real reserves to cover their obligations to customers which are published live on a status page.
With our Gold Card, we are reviving gold for the purchase of goods and services. Bitreserve members can convert their bitcoin to bitgold, whose value is substantiated by bullion in our reserve, but still spend it as bitcoin. By creating a bridge between the revolutionary Bitcoin protocol and good old gold bullion, we enable our members to instantly send or spend bitcoin from the ounces of gold held in their Bitreserve wallet. Our Gold Card makes this ancient store of value instantly transferable, infinitely divisible and accessible to anyone with a networked device. Now anybody with some bitcoin and a Bitreserve wallet can have the Midas touch. Old King Croesus would be chuffed. Bitreserve
They're also introducing a similarly structured card that offers their customers exposure to the oil price.
For the first time in history, oil will become a form of payment and compete against all major global fiat currencies. Using Bitreserve’s Oil Card, anyone can hold their value as oil — the fuel for the modern world economy — and transfer that value instantly and for free.

Bitoil™ will work just as bitgold does today. Oil value can instantly be converted into five currencies, gold, or bitcoin at very low cost and can be spent immediately. Oil has a massive and direct impact on the global economy, and a currency that tracks oil prices could become one of the world’s most widely used digital currencies. Whether you are a consumer looking to hold money that’s tied to gas prices, or a business with a large portion of your expenses in oil related activities, Bitreserve’s Oil Card gives you yet another welcome currency option for holding and spending digital value. Bitreserve
To be honest their system sounds quite innovative, but I am still skeptical about attempts to digitise physical assets as I will explain shortly.

The second "BitGold", is being launched early next year. The site is taking email addresses for pre-launch access at and they've raised C$3.5 million from investors. The founders are Roy Sebag (CEO of Natural Resource Holdings Ltd) and Josh Crumb (Former Senior Metals Analyst at Goldman Sachs).
"The Toronto-based company will allow account holders to purchase bitcoins and exchange them for gold redeemable in various vaults around the world, as well as convert the metal back into the digital currency. Customers will also get a debit card, said Sebag, 29.

The company is trying to muscle in on traditional bullion dealers and gold-backed exchange-traded funds, two of the most popular ways for retail investors to get hold of physical gold." Bloomberg
Interestingly the name that both of these new products are launching with, Bit Gold, has already been used by Nick Szabo to describe what could be considered the inspiration for Bitcoin. 
The Bit Gold proposal, by Nick Szabo, describes a system for the decentralized creation of unforgeable chains of proofs of work, with each one being attributed to its discoverer's public key, using timestamps and digital signatures. It is said that these proofs of work would have value because they would be scarce, difficult to produce, and securely stored and transferred.
His early proposal was so closely worded to the way Bitcoin works that many speculated Nick may in fact be Satoshi Nakamoto (or form part of a team that wrote the Bitcoin whitepaper).

Even ignoring the naming issue, I'm still not convinced that trying to link physical Gold with a digital representation is a good idea and here are some reasons why...

Counterparty Risk: As I said in a recent post (How Safe Are Unallocated Bullion Accounts?), I own precious metals because they have a lower level of counterparty risk, putting other parties between myself and a claim on the physical metal is counterproductive to one of the reasons I hold them. Some of these products are structured so that your claim is with the company providing the digital wallet service, while the actual custodian of the Gold may be another layer or two down. Even if regular audits occur, I would not be comfortable that my Gold would be easily retrievable if something were to go wrong (and not all are offering the ability for redemption of the Gold).

Trusted Third Party: One of the key attributes of Bitcoin and many other cryptocurrencies is the lack of need for a trusted third party to confirm the transfer of units. Transactions occur on a shared public ledger (called the block chain). With no physical asset to account for this can all occur through the use of private keys to sign transactions. The benefit of this is lower transaction costs. Introducing a physical asset to the mix means that you do need a trusted third party (sometimes multiple) to verify the assets, even if a public ledger is still used for transparency of transactions.

Spending Gold: Around 12 months ago I stumbled across a comment from Pierre Rochard talking about the consumer behaviour of those spending Bitcoin, he claimed "Consumers making payments generally replenish their bitcoin balance simultaneously, so it's a net zero." My response, why not just hold their Bitcoin balance steady and use fiat currency to make the purchase? Those introducing these digital Gold products assume there's lots of people out there who want an easier solution for 'spending' their Gold. My Gold holdings are not held for the purpose of short term spending on groceries or electrical goods, I'm not interested in giving up the security of possession for the ability to spend it more easily.

Capital Gains Tax: As I have covered on this site before, Gold (Let Australians Save in Gold Instead of Debt) and cryptocurrencies (Glenn Stevens Talks Bitcoin & Competing Currencies) are not really setup from a tax perspective to facilitate their use as a regular currency (despite the ATO recently giving a break to those using Bitcoins). It's likely that in most situations those using these digital wallet services are expected to keep records of any capital gains or losses (relative to their Australian Dollar value) to tally at the end of year for the purpose of declaring a loss or gain. The Australian tax system is not setup to cater for the use of assets (other than the Australian Dollar) as money and I suspect it would be similar in many other countries. We don't have competing currencies despite Glenn Stevens (Governor of the Reserve Bank of Australia) insistence that we do.

Government Regulation: The idea behind most cryptocurrencies is to have a distributed electronic method of creating and transferring value with no need to be in a specific physical location. Adding Gold to the mix literally destroys the advantages of a cryptocurrency because the asset it's linked to is stored centrally, leaving it vulnerable to the negative effects of government regulation.

One advocate for the mixing of these two assets has been Jan Skoyles, CEO at The Real Asset Company, whose opinion was recently covered by a Forbes contributor:
Jan’s argument therefore that there is demand for both a gold-backed currency, and a fully-transparent and accessible gold-trading system, is a persuasive one. By recording gold purchases on a block chain style ledger, the currency can be used not only as a medium of exchange, but also to facilitate gold ownership, and challenge the status quo for clearing and settlement in the gold market. In other words, you can buy your gold, and you can spend it too.
The article goes on to say that The Real Asset Company has their own product in the works. I tried to reach Jan (by email and Twitter) to confirm that's still the case and get some clarification on how it would work, but I'm yet to hear back (will update this post if I do). I'd think most Gold investors would prefer a level of privacy for their 'digital stack', something a public ledger wouldn't easily accommodate.

Everyone has different wants and needs from their assets, especially those used as a monetary resource, so perhaps there are some individuals who are prepared to look past the described shortcomings of a digitalised Gold product for the flexibility and convenience that it offers. If you are one of those people I'd love to hear your reasoning in the comments below.

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Thursday, December 18, 2014

Reserve Bank of Australia Audits Our Gold Reserves

Gold Bars Stored at the Bank of England
Two years ago the news was publicly broken on this site that 99.9% of Australia's Gold reserves are stored by the Bank of England in the United Kingdom. Attempts by another blogger, interested in the whereabouts of Australia's Gold, had been rejected by the RBA only several months earlier, "The Bank does not publish the location of its gold reserves."

Decisions like this don't happen in a black hole. Something changed the RBA's mind, between August 2012 and December 2012, on making the location of Australia's Gold reserves public.

From my observation, the RBA tends to follow the lead of other Central Banks, so the decision to release information on the location of Australia's Gold may have been a result of Germany's Central Bank (Deutsche Bundesbank) deciding to do so in October 2012 (interview containing the information originally released is no longer published on the site, but available via Web Archive). Only a month later, in November 2012, the Austrian Central Bank released the location of their Gold reserves, revealing that 80% resided in the UK, 3% in Switzerland and 17% in Austria. Cue the RBA feeling comfortable to release the location details of Australia's Gold around 1 month later.

A recent experience of mine with the RBA further highlighted their desire to follow in the footsteps of other Central Banks rather than to think for themselves. An FOI request I made for the Gold bar list was initially rejected, but after lodging an appeal with the OAIC, highlighting that the United States published a list of their Gold bars details (sans the serial number), the RBA decided to follow suit (Reserve Bank of Australia Releases Gold Bar Details).

Earlier this year I spotted a line in the RBA's annual report indicating an audit had been performed (not something I have seen mentioned in previous years):

A question posed by email to the RBA earlier in the year suggested that RBA officials had performed the audit themselves.

I decided to lodge another FOI request.
"I request that a copy of the following documents be provided to me: All documents pertaining to the audit of the RBA's gold holdings performed during the 2013/14 financial year, as was specified in the 'Operations in Financial Markets' section of the Reserve Bank of Australia Annual Report 2014 ("During the year in review, the Bank audited its gold holdings")."
Two months later (decision on the documents was delayed due to consultation with the Bank of England) I received the following list of documents that would be provided (on payment of fees, which were reduced from an original quote due to the small number of documents that could be released):

And today the documents arrived. Here's what we know...

In February 2013, the Assistant Governor (Financial Markets) requested Audit Department include in its audit program a review of the Bank’s gold holdings at the Bank of England (BoE). The Chief Representative in EU approached the BoE to facilitate this review and in late May 2013 initial planning discussions were held with BoE staff with tentative agreement that the review would take place in September 2013.

The audit included:
  • An on-site physical verification commencing 23 September 2013, which will take 4-5 days to complete, assuming two RBA auditors are involved given the proposed scope.
  • Inspecting a sample of RBA Gold bars (list to be provided in advance), including checking the details of these bars against the Bank’s inventory list and weighing of the bars by BoE staff using their equipment.
  • Randomly selecting additional Gold bars from the inventory list and observing these bars being located and retrieved from their vault (plus verifying the details and weighing them).
  • Obtain a high level understanding of the BoE gold safe custody service.
  • Continuing discussions for a comprehensive safe custody agreement between the RBA and BoE.
As the above document list shows, those relating to final audit results were not provided. I would assume the audit was successful, but no doubt that would be a highly contested opinion in the Gold blogosphere. The following reason was provided for denying access to the report:
Documents 10, 11 and 12 are drafts of the report prepared by the RBA’s Audit Department detailing the findings of the audit and document 13 is the final of that report.

Denial of access to these four documents in terms of s33(a)(iii) is appropriate because release of the information (which relates to procedures for the conduct of the audit with the BoE and the subsequent results) ‘would, or could reasonably be expected to, cause damage to’ the relationship between the RBA and the BoE.  This belief is soundly held by us on the basis that we are aware that the BoE provides safe custody services not only to the RBA, but also to other central banks around the world.  Disclosure of the information in these documents could damage the relationship between the BoE and its other central bank clients, and by extension (as the source of the information), the relationship between the BoE and RBA.  As foreshadowed to you in earlier correspondence, we consulted with the BoE in relation to these documents and they affirmed the views we held regarding the damage that would be done to the relationship between the BoE and RBA if the redacted information were disclosed.

Denial of access to these four documents is also appropriate in terms of s47E(a) (‘disclosure would, or could be reasonably expected to, prejudice the effectiveness of procedures or methods for the conduct of tests, examinations or audits’ by the Bank) and (b) (‘disclosure would, or could be reasonably expected to, prejudice the attainment of the objects of particular tests, examinations or audits conducted, or to be conducted’, by the Bank).  The documents in question concern the ‘procedures and methods’ within both the RBA and the BoE regarding the conduct of the physical check of a sample of gold bars (for the purpose of conducting the audit).  Disclosure of this information would, of course, reveal those procedures and methods, and by logical extension render them less effective. Also, the ability of the Bank to attain the objects of the audit (which is to reveal whether the Bank’s arrangements are robust and secure) would be prejudiced. These considerations apply to both the audit currently the subject of your FOI request and also any other audits undertaken by the RBA. A key requirement for undertaking a successful audit (of any aspect of the RBA’s work) is that there is as little opportunity as possible for individuals to take steps to predict what an auditor may choose to focus on, and/or how they will conduct the audit. It is self-evident that if such procedures and methods are revealed, then the opportunity to circumvent them is greatly increased.  As s47E is a public interest conditional exemption, I must take into account whether the giving of access is in the general public interest (in terms of s11A(5)).  When deciding whether access is in the public interest, I must take into account the following from s11B(3) and have noted my views in each case:

Section 11B(3) factors favouring access to the document in the public interest include whether access to the document would do any of the following:

(a) promote the objects of this Act (including all the matters set out in sections 3 and 3A); release would be contrary to some sections, particularly sections 2(a) and 3(3)

(b) inform debate on a matter of public importance; the Bank’s gold holdings, while important and of interest to some, are not a matter of public importance generating any level of debate

(c) promote effective oversight of public expenditure; release of the information would not do this

(d) allow a person to access his or her own personal information; the request is not seeking personal information.

Taking into account these factors, and the implications release of the information would have on the Bank’s audit processes, I have decided that it is clearly not in the public interest to disclose the information in these four documents (10, 11, 12 and 13).  Disclosure of these documents would manifestly harm the public interest by way of reducing the ability of the RBA to successfully conduct audits and tests of its operations going forward.
The released documents (mostly a chain of various emails) also suggested the RBA have been invited back for another review in 12 months.

One interesting point from the documents, the Bank of England was emailing clients in June 2013 (those for whom they're providing custodial services) inviting them to audit samples of their Gold:

Click Above Text To Enlarge
However discussions on the RBA audit were already well advanced at that time.

Given that the RBA has followed the lead of other countries to release reserve location details, perform audits and release (some) bar list details, it will be interesting to see whether they go further and follow the lead of the many countries now deciding to repatriate some or all of their Gold reserves...

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Monday, December 8, 2014

Attention Traders: The Value Of Cash Is Not Absolute

Over the last few years, as the price of Gold declined, several professional traders and financial commentators have taken it upon themselves to unleash their wisdom about the metal being "just a trade". They've decided that everyone should see the financial world through their narrow lens and have used it's declining price as "proof" you should always have a stop and be prepared to exit your position.

The way I've framed the above might suggest I have a problem with their view. In fact I don't, it's one way of looking at the assets in your investment portfolio. However, to take their view you also have to give thought to ALL positions and that includes cash, which should also be considered a trade as it's value can change.

Earlier this year I wrote about Ritholtz's position on gold bugs ('Barry Ritholtz Mischaracterizes Gold Bugs'), one of the rules in his article was:
The Danger of One-Way Trades: What would make you reverse your biggest present holding? What facts or situations would force you to change your views and sell? If your answer to that question is, “Nothing,” you have a huge, devastating flaw in your approach to investing.
I hear traders talking day in and out about 'going back to cash' or 'sitting in cash' after exiting all positions, but if a trader was to think about what they are doing logically, as they would any other position, they are simply moving from one asset which fluctuates in value to another.

What facts or situations would force a trader to consider a position in cash being unsafe? Answer that and you might be on the path to understanding the reasons that some investors choose to hold physical Gold.

A reader of my Ritholtz article commented: "Ritholtz essentially supports his analysis by treating fiat currencies as a bedrock, i.e. asset changes are all relative to this unchanging fiat value." I agreed: "Ritholtz claims to be ‘asset class agnostic’, but then measures the performance of other assets back to fiat which doesn’t have static value."

Newsflash: Cash / fiat currency is not a neutral position.

There is no asset which remains absolute in it's price or value relative to everything else (and yes that includes cash or Gold).

I tried to explain this briefly to one trader (Mark Dow) who regularly has a crack at gold bugs on Twitter, to my amusement he suggested that you don't have to hedge against fiat currency because it's "legal tender".

Click Image to Enlarge
How could anyone think that a currency being legal tender protects the holder from changes in it's value?

Sure it's a unit of account and may remain a constant relative to some assets, for example a $10,000 loan will always require $10,000 in cash (+ interest) in order to repay it, but the value of currencies can be affected in various ways, sometimes to devastating effect.

So how does one hedge or insure themselves against fiat currency and the financial system?

This question reminds me of a discussion that took place in the comments on Cullen Roche's site (comments since disabled, but they were here) a couple of months back when he suggested that those wishing to hedge against the financial system should take a short position on the finance sector. 

Imagine taking out insurance against your house burning down and then leaving the only paper work you could use to make a claim inside the very same house.

That is basically what Cullen proposed. Some of the sensible responses below his suggestion included:
“Gold like cash is a unique hedge because unlike options, or bonds or financial hedges it has infinite duration.”

“I have an allocation to gold and silver because its the only way that I can be 100% sure that my “insurance” isn’t someone else’s liability.”
Precious metals are unique in the sense that they are one of few assets which can be held physically outside of the financial system & can't be diluted in the same way as fiat currencies.

Some traders might argue that significant changes in the value of cash occur so infrequently that it's not worth worrying about (tell that to someone living in Russia, Japan, Cyprus, North Korea, Venezuela), but that's exactly the mindset that some of these traders criticise others for, that is, having a baked on view that holding an asset poses no risk. 

Holding a 100% position in any asset is risky, whether that's cash, Gold, Silver, property or anything else. Diversify or be prepared to wear the consequences if the value of that position moves against you.

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Monday, December 1, 2014

Gold & Silver On Sale - Cyber Monday Deals

Looks like the result (strong rejection) from the Swiss Gold Initiative proposal is showing up in the Gold price this morning. I don't think the result is unexpected. As Bron Suchecki wrote last week, there were some conditions attached to the proposal which were not palatable. Down she goes (continued weakness expected while Gold remains below US$1180)...

For those wanting to try and catch a falling knife and take advantage of some low dealer premiums, there are some great deals out for Australian precious metals buyers with dealers listing some 'Cyber Monday' bargains... you will need to be quick to make a decision on these as most deals will be limited (in quantity) and will likely be pulled end of day if not sold out sooner.

Site sponsor Bullion Money has some great deals posted already, including:

1oz 2015 Kookaburra Silver Coins for less than $5 over spot (premium this low usually reserved for large orders, but can buy as few as you like for this price).

There are some 1/4oz Gold coins on special too, keep an eye on the clearance specials page for all items on special and any others that may be posted throughout the day.

Other dealers who are offering Cyber Monday deals include Gold Stackers (deals live now) & Perth Bullion (deals yet to be posted).

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Saturday, November 15, 2014

Soros Short S&P 500 & Emerging Markets (Puts)

As previously noted on this site (Soros $2.2 Billion Bet On SPY Puts), Soros Fund Management LLC holds a large position in SPY (SPDR S&P 500 ETF Trust) puts. The position was reduced over Q3 (ending 30/09/2014), however the notional value of the position remained substantial, both in dollar terms and as a percentage of the fund.

Click Chart To Enlarge

Following the large decline and then bounce to all time nominal highs in the S&P 500 since the reporting period ended, I would be surprised if the position hasn't been further reduced in Q4, but we won't know for another 3 months.

Another interesting change includes a large short position on emerging markets (EEM put), with a notional value of $935M. It was the second largest position in the fund (by notional value, view all reported positions on Whale Wisdom) and over 2.5x larger than in Q4 2011 when Business Insider noted EEM puts were the largest position held. The iShares MSCI Emerging Markets ETF saw a large price decline during Q3.

During Q2 the Soros Fund increased positions in Gold miner ETFs (such as GDX & GDXJ), which some commentators saw as a bullish omen for this sector, however Q3 shows a reversal with the positions reduced and in the case of GDX calls the position was exited completely.

Of course as I've said before these positions don't tell us what strategy any single position might be a part of and a lot can change in six weeks (positions will have changed again since the reporting period ended).

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Sunday, November 2, 2014

Failed Triple Bottom in Gold

On Friday Gold broke below US$1180, an important price level from a chart perspective, which indicates a failed triple bottom.

Lower prices seem likely in the short term. The breakdown looks eerily similar to the one we saw in 2013 before a waterfall decline when the price broke below $1500 (as I covered on the blog here).

Not to say that I think another $300 decline in price is likely, but those holding long should prepare themselves for the potential of further downside. Australian readers might find the blow cushioned by a lower Australian Dollar.

A set of charts that is worth a look is this recent publication from Peter Brandt where he writes, "Gold is the ultimate charting market. Gold rarely begins a major trend without first ringing a bell and waiving a flag announcing its intentions."

Even if you aren't a trader you'll likely find the repeating patters quite interesting. I've rarely seen daily charts from some of the eras shown and the 1970s cyclical bear market in Gold shows some similar patterns to those we are seeing today.

It's my contention that we are only experiencing a cyclical bear market in Gold today, just as we saw in the mid 1970s pictured above.

Many have suggested that government deficits and QE has already and will continue to materialise into directly higher Gold prices (via high levels of inflation), but I think that narrative has been debunked. The price of Gold has fallen sharply as some of the most aggressive QE programs took place.

As I see it Gold rose over late 2008 to late 2011 as a result of instability in the financial system, stock markets and the perception that the central banks had lost control. However, over several years of QE and as stock markets returned to rising steadily with only small corrections, complacency has set in. I wrote on this theme last year:

Gold Driven By Financial Instability, Not Inflation

Ben Hunt calls it a narrative of central banks omnipotence and believes it has reached a top (via The Ministry of Markets):

"I’m calling a top in the Narrative of Central Bank Omnipotence because it has, in fact, reached its asymptotic limit of influence and belief."

But while the public may believe in the omnipotence of central banks, central banks rely on the omnipotence of Gold (as net buyers for the last half a decade).

In my opinion it will take a shift in perceptions to end this narrative that the central banks have control over the markets, to stop the Gold price decline and see the secular bull market resume.

The conditions that resulted in the Global Financial Crisis are far from over with western nations still saddled with large amounts of debt relative to their size of their economies, a situation that I don't see ending without incident.

The event or series of events that take place to drive that change in the market is anyone's guess. It may be realisation that the United States will be unable to normalise interest rates without sending the economy back into recession, it might be a shock from China or something less obvious at the current time (a black swan).

Short term traders with long positions have probably been stopped out in the Friday decline, but those with a long term view who are holding Gold as insurance or hedge against financial calamity should look past the short term chart patterns and be confident in the long term prospects of Gold.

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Tuesday, October 14, 2014

Property Narratives Using Data & Wording Obfuscation

In a recent article on Property Observer (Lies, damned lies and housing statistics) commentator Arek Drozda discusses Australian property statistics. He tells the reader many commentators write stories around property numbers that can't be relied on.
Drozda claims that "data does not lie". However, data is just a collection of facts and statistics for reference or analysis and, as Janine Skorsky of House of Cards says, "There is no arrangement of facts that is purely objective."
The above is my introduction to an article I wrote for publication on Property Observer in response to some recent observations by commentator Arek Drozda. You can read it in full here: Subjectivity, damned subjectivity and housing statistics.

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Wednesday, October 8, 2014

Property Professor Fudges Property Growth Numbers

Don't believe all the property stats you read on Twitter or view on TV. That's my warning as I watch The Property Professor (aka Peter Koulizos, who lectures on property investment and runs related courses) continue to mislead by publishing his miscalculated RP Data figures.
Last month I spotted The Professor on Twitter making some bold claims about prices in Australian capitals, such as:
"Melbourne dwelling prices have dropped 7.0% in the first 8 months of 2014. Ouch!"
"Sydney prices have dropped 0.8% in the first 8 months of 2014. 2014 is a very different year to 2013 for Sydney property owners!"
"Adel is the only capital city where dwelling prices increased over the first 8 months of 2014. It was only 1.0% but we'll take that!"
It was clear from what I'd seen via multiple housing price data providers (such as RP Data, Residex & ABS) that The Professor's claims had no place in reality, so I challenged him on Twitter:

I found that rather than using the 'year to date' figures that are published each month by RP Data, he was instead taking the median dwelling prices from the first page of each report and calculating the growth results manually.
Not only had these figures been published on Twitter, but in the middle of the year they also made local news!

These fudged figures do not reflect reality and thought I'd seen the last of The Professor's use of this methodology (after I'd highlighted the error of his ways)... but he's back this month with a new set of comments, including such corkers as:
"SYDNEY – Median House Price at 31/12/13 was $775,000. As of 30/9/14 it was $750,000. A DECREASE of 3.2%. No current property boom here!"
When RP Data's published year to date for Sydney shows: +9.8%
"MELB - Median House Price at 31/12/13 was $625,000. As of 30/9/14 it was $590,000. A DECREASE of 5.6%. No current property boom here!"
When RP Data's published year to date for Melbourne shows: +6.7%
And so on:

Here are the actual year to date figures from RP Data's latest report (Wednesday, October 1, 2014):

Professor, what are you doing? Please stop spreading ridiculous property figures!

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Friday, September 26, 2014

Why Serviceability ≠ Affordability (Australian Property)

Still today I see many commentators using the terms serviceability and affordability interchangeably in relation to Australian property. The most recent occasion I noticed was in a post from David Bassanese a week ago where he wrote:
A better measure of house price valuations – which at least allows for the structural change in interest rates over time, though not financial deregulation – is mortgage affordability.  As seen in the chart below, there has been no obvious structural worsening in mortgage affordability over recent decades. Assuming a 20% deposit, loan repayments to purchase the median-priced Australian house have averaged just over 30 per cent of average household disposable income since at least the mid-1980s.
And posted the following chart to support his assertion:
It shows that initial loan repayments on a median-priced house have remained fairly stable over time (as a percentage of household disposable income). The chart and commentary suggests that "affordability" was the same in the early 1990s as it is today (we have higher prices relative to income, but interest rates are lower), let's compare an example using figures between the two periods to see if affordability really is the same.
Based on Bassanese's house price to income ratio:

The ratio was around 3.5x in 1992 and 5.5x today. Keep in mind that other commentators who calculate these ratios use different methods, so while the ratio might change around a bit, the change between historical ratios and those today should be similar in a single set/series of numbers. Let's do the sums.
With a household on $100k. They save their deposit at a rate of 20% gross income and repay the loan at a fixed amount of $3,500 per month (using this mortgage calculator & interest rates from here to get my numbers below).
1992 Numbers: $350,000 purchase price (3.5x income)
Deposit (20%): $70,000. 3.5 years to save.
Interest rate: 11%
Loan amount: $280,000
Repayment: Loan is repaid in 12 years, 1 months. Total paid, $506,980.
2014 Numbers: $550,000 purchase price (5.5x income)
Deposit (20%): $110,000. 5.5 years to save.
Interest rate: 5.5%
Loan amount: $440,000
Repayment: Loan is repaid in 15 years, 8 months. Total paid, $657,061.
So even if interest rates had remained elevated the entire period of the loan, it still ends up more affordable over the long run to have double the interest rate, but lower price to income ratio. Not only that but it would be faster to save the deposit given that it's a lower amount (relative to income) and I haven't taken into account the higher interest rate on saving for the deposit which would have benefited the 1992 scenario. Costs such as stamp duty which are tied to the price paid would be lower too. Finally, higher interest rates tend to come with a higher rate of inflation, so the real value of the debt would be reduced faster as wages increased, meaning the buyer in 1992 would have found it easier to ramp up the level of repayment.
As I have mentioned in the past on housing affordability, I prefer the following basis as a definition for affordability:
"Afford: To manage or bear without disadvantage or risk to oneself."

It's clear that although initial loan serviceability might be similar with lower rates and higher prices, the buyer is also at a clear disadvantage over the term of the loan.
When considering affordability we need to take a holistic approach and not use a simple snapshot of a single repayment as the basis to make judgement calls on whether house prices or a mortgage used to purchase them is affordable. A mortgage is a long term commitment and shouldn't be treated so trivially by market commentators.

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Wednesday, August 20, 2014

Bitcoin Gets Capital Gains Tax Break, Why Not Gold?

Late last year ('Glenn Stevens Talks Bitcoin & Competing Currencies') I pointed out that Bitcoin effectively can't be used as a competing currency (likewise for foreign currency or other assets such as Gold) given that it is subject to Capital Gains Tax (CGT) and monitoring the value of Bitcoins as they are acquired and disposed of would not be practical:
"Can you just imagine the administrative nightmare that would result from performing regular transactions in a foreign currency and having to maintain a record of whether you made a gain or loss as a result of fluctuation in the currency markets? It is simply not practical. Bitcoin is not immune from the same requirements." - Bullion Baron
However, earlier today the Australian Tax Office (ATO) released a statement (ATO delivers guidance on Bitcoin) in regards to Bitcoins and their tax treatment. Further information is available on the following page 'Tax treatment of crypto-currencies in Australia – specifically bitcoin' which specifies the following in regards to Bitcoins used in personal transactions:
Using Bitcoin to pay for personal transactions
Generally, there will be no income tax or GST implications if you are not in business or carrying on an enterprise and you simply pay for goods or services in bitcoin (for example, acquiring personal goods or services on the internet using Bitcoin). Where you use bitcoin to purchase goods or services for personal use or consumption, any capital gain or loss from disposal of the bitcoin will be disregarded (as a personal use asset) provided the cost of the bitcoin is $10,000 or less.
The 'personal use asset' exemption would normally be reserved for items such as a boat, furniture, electrical goods or other household items which are exempt from CGT if purchased for less than $10,000.

The wording on the ATO website is somewhat ambiguous. Does the limit apply per year or can I buy low (to a maximum of $10,000 worth of Bitcoin) and spend high several times in the same financial year and still avoid CGT?

I think this is a good start and would like to see a similar CGT exemption for Gold (as I suggested last year in 'Let Australians Save in Gold Instead of Debt'). That said, I think the limit imposed is patronizing, why impose a limit at all if the Bitcoins are being purchased with the intention of spending them at a later time? Putting a $10,000 cap on the exemption limits the spending of Bitcoins to novelty use only, it wouldn't be adequate for someone having their income paid in Bitcoins, which was also covered on the site:
Paying salary or wages in bitcoins

Where an employee has a valid salary sacrifice arrangement with their employer to receive bitcoins as remuneration instead of Australian dollars, the payment of the bitcoins is a fringe benefit and the employer is subject to the provisions of the Fringe Benefits Tax Assessment Act.

In the absence of a valid salary sacrifice agreement, the remuneration is treated as normal salary or wages and the employer will need to meet their pay as you go obligations as usual.
I would like to see any monetary asset (Bitcoin, Gold or otherwise) that is saved for future consumption be exempt of Capital Gains Tax. That would allow us to truly have competing currencies in Australia. Being forced to save in a currency whose value is purposefully devalued (via central bank mandate to target 2-3% annual inflation) is madness, especially when interest earned on those savings is taxed and with the real cash rate already below 0.

Those who have purchased and sold Bitcoin specifically for investment are subject to CGT (or taxed as part of your income if traded in the business of regular profit-making):
Disposing of bitcoin acquired for investment

If you have acquired bitcoin as an investment, but are not carrying on a business of bitcoin investment, you will not be assessed on any profits resulting from the sale or be allowed any deductions for any losses made (however, capital gains tax could apply – although see the comments above about personal transactions). However, if your transactions amount to a profit-making undertaking or plan then the profits on disposal of the bitcoin will be assessable income.

There are no GST consequences where the bitcoin is not supplied or acquired in the course or furtherance of an enterprise you are carrying on.
There is another section for those in the business of mining Bitcoins:
Mining Bitcoin

Where you are in the business of mining bitcoin, any income that you derive from the transfer of the mined bitcoin to a third party would be included in your assessable income. Any expenses incurred in respect to the mining activity would be allowed as a deduction. Losses you make from the mining activity may also be subject to the non-commercial loss provisions.

Your bitcoin is trading stock and you are required to bring to account any bitcoin on hand at the end of each income year.

GST is payable on the supply of bitcoin made in the course or furtherance of your bitcoin mining enterprise. Input tax credits may be available for acquisitions made in carrying on your bitcoin mining enterprise.
The section that deals with ATMs and exchanges is probably the most off putting with an indication that businesses in this area will need to charge Goods and Services Tax (GST), likewise in the supply via mining as mentioned above:
Taxpayers conducting a bitcoin exchange (including bitcoin ATMs)

Where you are carrying on a business of buying and selling bitcoin as an exchange service, the proceeds you derive from the sale of bitcoin are included in assessable income. Any expenses incurred in respect to the exchange service, including the acquisition of bitcoin for sale, are allowed as a deduction. In these circumstances, the bitcoin is trading stock and you are required to bring to account any bitcoin on hand at the end of each income year.

GST is payable on a supply of bitcoin by you in the course or furtherance of your exchange service enterprise. Input tax credits are available for bitcoin acquired if the supply of bitcoin to you is a taxable supply.
This seems to put local Bitcoin exchange and supply businesses at a competitive disadvantage if they have to charge buyers a 10% premium. It would be likely to drive Australian Bitcoin buyers to international sources which don't charge GST.

It is good to see that the ATO has finally addressed Bitcoins for tax purposes, but I don't think they've done a particularly good job here.

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