Friday, January 31, 2014

Don't Encourage First Home Buyers To Speculate

A few years ago I wrote a post with a list of reasons that First Home Buyers (FHBs) might consider putting off a purchase, it included the following:
You may quickly outgrow your first home  
One idea that I seem to hear repeated often is that you should just 'buy whatever you can afford' when it comes to your first home, just 'get your foot in the door' they say and work your way up the property ladder. What the older generations might be failing to remember is that you may outgrow your first home very quickly. 
Imagine the situation where you've bought a 2 bedroom unit as your first home. Two years down the track and the casual relationship with your partner has taken a serious turn and you are looking to start a family (have kids). You may then be in a situation where you have to sell the existing property to fund the larger one. That likely means real estate commission costs (usually around 2% of sales price), stamp duty on the new home, possibly LMI (Lenders Mortgage Insurance) on the new loan if you will be borrowing on a LVR greater than 80% again. Not only that, but as per reason 1, you've possibly been paying a great deal more than renting to buy. 
Do the sums. Make sure you consider all possibilities that arise. You may be a lot better off by renting until you can afford a home that will last years no matter what life throws at you.
The general consensus is that FHBs should purchase their first home as a stepping stone. Just buy what you can afford for your first home and the capital growth will get you into your next (long term) home is a common meme thrown around in the mainstream media and by those who have benefited from unsustainable price growth in the past. 

The meme continues in this blog post from RP Data’s Cameron Kusher in which he uses his own personal example to show what is possible:
“Given this, the prospective first home buyer is, in most instances, going to have to make a sacrifice in order to enter into home ownership.  As I see it, first home buyers need to make one of two major sacrifices; either move away from their local area to an area where home values are more affordable in order to enter the market or buy something which is at the lower end of the local market (which will often be a unit rather than a house). The strategy for someone buying their first home should rarely be to buy at the suburbs median selling price; it should be to buy an entry level property.  Of course varying levels of deposit and income will dictate what the purchaser can reasonably afford to borrow and repay.  Over time, the first home buyer should see some capital growth and it would also be reasonable to expect that they should also experience an improvement in their employment conditions (more pay/promotion/new role) which would eventually help in assisting them to upgrade. 
Looking at my   first home buying experience, the above scenario parallels my own experience. I have to admit, the home was pretty horrible but it was in the inner city location I wanted. 
My first purchase was a two bedroom, one bathroom unit in Fortitude Valley in Brisbane.  The location was great but the unit was not so great.  The complex was largely utilised for short term accommodation and although the unit had two bedrooms and one bathroom, outside of those three rooms it had one further room which functioned as a kitchenette, lounge and dining room.  I purchased the property for $248k in July 2005 and sold the property in April 2010 for $334k effectively five years later.  At the time of purchase, the median unit price within the suburb was $309,240 and by the time of sale the median unit price in the suburb was $400,000. 
The unit was purchased at a price well below the suburb median and upon sale the price had increased by 35%.  In comparison the median sale price across Fortitude Valley had increased by a lower 29%.  At the time I was single so I also had a friend come and live with me which assisted in making the mortgage repayments. 
By the time I sold the property I had purchased a subsequent property which was a house, once again it was purchased at a price below the suburb’s median.  I had managed to make a profit on the sale of my first home and purchased a more expensive property, I had also benefited from an increase in salary over the time which made repayments easier.”
In Cameron’s example his home increased 35% over a 5 year period, well exceeding median wage growth even if his own personal situation resulted in a stronger increase. Price growth can’t exceed wages forever so of course there will be low (or negative) price growth periods while wages catch-up. For example the period following Cameron Kusher’s ownership in Fortitude Valley.

RP Data Price Chart for Fortitude Valley Units - Click Image To Enlarge
See above a 5 year period starting in 2005 has treated the owner to a strong period of growth, but a FHB starting in 2009 for a 5 year period is probably lucky to have broken even (on price alone) in the Fortitude Valley unit market, so from a financial perspective (once buying & selling costs are taken into account), they probably would have been better off renting and saving to buy a long term & more suitable home.

While renting is suitable and preferable in my situation, I would never discourage others who want the stability of ownership and are prepared to treat housing as a consumable (rather than an investment) from buying. If you have a healthy deposit (preferably one that will help you avoid LMI), fixed interest rate (or able to service higher interest rates), protect yourself (income protection, cash buffer, etc) and expect to stay in the property you purchase for the long term (until mortgage paid off), then it shouldn't matter what prices do (rise, fall or stagnate). 
Some people are happy to pay a premium for the stability and enjoyment they get from home ownership, perhaps down the track when starting a family my priorities will change and I will make the same decision. For now I will continue renting, it is far cheaper than the interest repayments would be for a mortgage if buying the equivalent, it provides more flexibility and there is a good chance that my housing requirements will change at some point in the next few years (so it's pointless buying now if I will only be looking to upgrade in a few years).
When I queried Cameron on Twitter about his decision to purchase a first home with a short term view, he said:
"I purchased assuming I would get some capital growth, build some equity and my financial position would improve."
The bottom line is that we shouldn't be encouraging First Homer Buyers to speculate. They shouldn’t purchase a home with a 5 year view that they will see capital growth and be able to flip the home for a profit as a stepping stone to a more suitable house in the future. 

Even if they see a little capital growth, it needs to exceed both the significant buying & selling costs along with the difference between the cost of renting vs buying to have been financially worthwhile doing so. They are the most vulnerable (financially) in the housing market, using high leverage and often have a poor understanding of financial products in general. We should be careful not to coerce them into taking unnecessary risks.

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Monday, January 27, 2014

Bitcoin: The First Crypto-Curreny, Not The Last & Only

I have been fairly vocal on Twitter about Bitcoin and last year wrote a couple of articles about the cryptocurrency. The first (Bitcoin Bubble or New Virtual Currency Paradigm?) covered the basics of the technology, discussed some of the risks and shared some comparisons with precious metals (which many were measuring it up against at the time). I ended on the note that we might be nearing the top of a bubble in price:
My gut tells me that at US$70 Bitcoins are probably closer to a short term bubble peak (given the short term nature of the rise) than at the base of an immediate move to $150 or other high price targets I have seen thrown around ($500+), but that doesn't mean they can't head higher (in the short or long term).
I got the short term call wrong, although I didn't discount the possibility of higher prices.

Click Chart To Enlarge
After an almost immediate move to $150, turning my gut (on this occasion) into a similar contrarian indicator to the Pascometer, the price retreated back under $100, before regaining it's composure over a few months and then soaring to over $1200. Recently the price has been fluctuating between around $900-1000.

The second post I wrote about Bitcoin covered some of the gaffes Glenn Stevens' (Governor, Reserve Bank of Australia) made about Bitcoin in an interview (Glenn Stevens Talks Bitcoin & Competing Currencies). I discussed the errors in his characterisation of Bitcoin, showed how we don't have competing currencies in Australia as he claimed and had a chuckle at this oxymoron:
Ironically Stevens ends his interview on a point, 'the ones [BB: currencies] that survive will be the ones that hold their value' and in the same breath says 'which is why we have an inflation target which we’re hitting'. How Stevens equates holding value with hitting an inflation target is beyond my comprehension, it seems more like an oxymoron.
Although I feel my posts have been relatively balanced, if you follow me on twitter or read my posts on Silver Stackers you could be forgiven for thinking that I'm anti-Bitcoin, in fact nothing could be further from the truth.

On one hand, I am a big fan of the Bitcoin protocol, the technology itself is innovative and has laid the ground work for some incredible advances in the way that we transfer value in the future (amongst other applications). The fact that a decentralised and secure payment system has been developed outside the traditional global banking system is fascinating.  On the other hand I am wary of those promoting Bitcoin, exaggerting it's benefits, talking as if it's 6 months away from mass adoption & expecting it to retain it's dominance over other cryptocurrencies forever.

To be fair I don't only cast a skeptical eye over the Bitcoin pumpers, I've also blogged extensively on precious metals commentary I don't agree with. For example, I questioned Andrew Maguire's central bank Gold buying figures, looked for non-conspiratorial explanations for the slow delivery of Germany's Gold from the United States and corrected inaccuracies in an article claiming we were nearing the end of the paper Gold market.

Exaggeration, conspiracy and irrational commentary abounds in the precious metals space, facts are distorted or ignored, comments are taken out of context and exploited by those trying to sell you their subscription trading service, market report or the physical metals themselves. I empathise with some of those in this space who are just trying get readers into an asset they think is essential to hold, but there is no way I can condone the tactics used (by some) to achieve their goals, the ends simply don't justify the means.

The cryptocurrency market (including Bitcoin and other cryptocurrencies, known by many as altcoins) shares some of the same exaggerated commentary as the precious metals sector, although arguably not to the same extent.

Most asset classes have highly emotive supporters prepared to pump them incessantly, but I suspect that the money / currency topics tend to attract the worst kind of this attention due to the 'nemesis' (i.e. fiat currencies and central banks) having such a large impact on our everyday lives.

One of the most common misrepresentations I see is this constant stream of businesses now 'accepting' Bitcoin in exchange for goods and services. Every time a large company accepts Bitcoin it's deemed the next nail in the coffin for fiat currencies and a watershed moment for Bitcoin. The reality is that most of these businesses organise Bitcoin conversion into fiat instantly using a payment processor such as BitPay.

Suggesting a business is 'accepting Bitcoin', when they are having it instantly converted to fiat, is a fallacy. As I pointed out on Twitter, a company would accept payment in just about anything provided there was a market and payment processor available to instantly convert it into the local fiat currency:

What businesses are really saying when use a payment processor, is that we want the purchasing power of Bitcoin owners, but are not really interested in holding the currency itself. This article from The Motley Fool explains how retailers benefit without any of the risks the consumers take with Bitcoin:
Overstock's partner on this is Coinbase, which allows the company to do an instant exchange from Bitcoin into dollars. Overstock CEO Patrick Byrne is a self-declared "true believer" in Bitcoin, but he and his team obviously understand that it is not yet a desirable asset for a publicly traded company (unless you are a Winklevoss and starting a publicly traded Bitcoin ETF). With zero regulatory infrastructure and wildly fluctuating value, it just doesn't make sense for Overstock to hold on to Bitcoin for more than a nanosecond.

Cash, at least in the foreseeable future, will remain king.

So what Overstock has done is benefit from all of the noise surrounding Bitcoin, and immediately mitigate the risk of actually dealing with it.
While Patrick Byrne claims to be a true believer in Bitcoin, an old saying comes to mind, about watching what they do, this exchange from a recent interview with Fortune:
Fortune: Do you own any bitcoins? Patrick Byrne: No. I own gold.
Fortune: Really, how much gold? Patrick Byrne: A lot.
Some have argued that in time businesses will accept Bitcoins, provide them to their suppliers, pay their employees in Bitcoin, essentially closing the loop:
They are forced to change out from bitcoin to fiat right now because their suppliers expect repayment in dollars, and employees expect wages in dollars. But that expectation is not set in stone.

The next big revolution will be when bitcoin takes the B2B market by storm when they realize they can settle accounts instantly, especially for international transactions and import/exporters.

When your suppliers are willing to take bitcoin, the next leap is when employees prefer being paid in bitcoin.

When that finally happens you have the closed loop and can do all your business in bitcoin without switching out--which will prove to be quite profitable over dealing in fiat. Reddit
However, for a closed loop to take place, it would mean that everyone is prepared to take the risk of price movements in the Bitcoin currency or utilise hedging. Imagine the inconvenience of being an employee paid in Bitcoins and not knowing what your pay packet would buy in two weeks when you received it. It would be like trying to perform daily transactions using a foreign currency, the difficulties of which (for Australian consumers) I pointed out in my last post on Bitcoin:
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, earlier this year the ATO commented specifically on the topic (although the comments have a business focus, it does not exempt individuals from the same requirements)...
Another regular way that Bitcoin supporters misrepresent the cryptocurrency is by comparing it's daily volume with that of PayPal, Western Union or other payment systems used by consumers to purchase goods or transfer currency. Coinometrics publishes these figures:

Click Image To Enlarge
But what is often ignored when making these comparisons is that it's not possible to separate the Bitcoin transactions which are speculative in nature vs those used for a genuine purpose such as purchasing goods and services. So comparing the two directly is disingenuous. A more valid comparison to make would be to compare the largest cryptocurrency payment processor, BitPay, who processed over $100 million worth of transactions in 2013 versus PayPal who processed $44 billion in the 3rd quarter alone.

It's impossible to know how many Bitcoin transactions are used for consumer purchases. A recent estimate in a Forbes article says buyers spent $500,000 worth of Bitcoins at Overstock since it started accepting them two weeks ago. That may sounds like a lot, but with Overstock revenues expected at $1.3 billion in 2013, we are talking about an annualised increase from Bitcoin of $13 million or 1% (assuming these buyers only went to Overstock due to their acceptance of Bitcoin).

Many of the so called advantages of Bitcoin only benefit one side of the transaction. For example, Bitcoin features non-reversible transactions, which can be a benefit for the business, but poses a risk to the consumer. This seems to be lost on some who claim that no trust is required in either direction when using Bitcoin:
It is a way to exchange money or assets between parties with no pre-existing trust: A string of numbers is sent over email or text message in the simplest case. The sender doesn’t need to know or trust the receiver or vice versa. Related, there are no chargebacks – this is the part that is literally like cash – if you have the money or the asset, you can pay with it; if you don’t, you can’t. Why Bitcoin Matters
Where an exchange occurs with Bitcoin going in one direction and goods or services going in the other, of course there has to be trust. Those arguing blindly for Bitcoin will normally introduce the potential for trusted third party transactions at this point, but I am yet to see this in practice for consumers and there are unknown side effects attached which could harm Bitcoins other advantages such as instant settlement and low cost.
From my observation, most of those who own Bitcoins are either technologists, those with a speculative interest in seeing the currency rise in value or those dissatisfied with the existing system which centralises money creation and control in the hands of the few (banks, governments), i.e. they have ideological reasons for owning it. I am yet to come across anyone who owns Bitcoin purely for the fact that it's a superior form of currency for online purchases or the transfer of value.

While Bitcoin is the largest cryptocurrency by far (market cap circa $11 billion), there are many other competitors that offer improvements or differences that appeal to various individuals tastes. They vary in size with market caps as small as $100k, to $50 million or more (the 20 largest are listed below via

Click Image To Enlarge
Some Bitcoin supporters argue that the first cryptocurrency is already too popular in the market and unlikely to be surpassed by a competitor due to it's ability to adapt and add new features. Another argument is that too much developement has already gone into Bitcoin for it to lose the top spot, but this is very short sighted given that many of the Bitcoin services, sites and apps in use or being developed could be modified to work with any cryptocurrency.

Primary issue I see with Bitcoin, is lack of stability in price. The biggest competition to Bitcoin may be evolution of a cryptocurrency which is stable in value, perhaps even one that is backed by another asset (such as Gold):
After extensive testing in the Pacific, KlickEx is pleased to announce the development of a new asset-backed and algorithmic crypto-currency for institutional and retail use. A stable, international risk-free asset is a key foundation for efficient financial markets, and KlickEx’s award winning interbank payment network has an exemplary track record in stability, and efficiency. Having eradicated the significant systematic deficiencies of Bitcoin, then bridged the portfolio limitations of the IMF’s SDR, the new base asset is a proactive response to recent negative public sentiment towards banking in general, and recent global events including The GFC, Euro-Crisis, BASEL II, III, and fiscal & political instability in Prime currencies. KlickEx At FinovateAsia
Or as speculated by Felix Salmon early last year, perhaps a cryptocurrency itself won't be the future, but rather a network that will facilitate transactions of any currency (Maybe Ripple has a chance or something similar):
A peer-to-peer payments system, allowing anybody on the internet to pay anybody else on the internet without having to sign up with some financial-services behemoth first, could revolutionize global commerce. It would have to be able to work with any currency, including bitcoin; it wouldn’t need its own unit of account. It would have to be flexible, too: some transactions would be cashlike and irreversible, while others would allow some kind of chargeback.

And, most importantly, it would work with, rather than against, today’s established monetary institutions...
...But whatever it looks like, in the end, we can be sure of one thing: it will owe a very large debt to Satoshi Nakamoto and his audacious attempt to invent a whole new currency. Bitcoin isn’t the future. But it has helped to light the way ahead.
Of course the Bitcoin purists won't like the sound of centralising an asset to back a cryptocurrency or the thought of involving existing financial institutions in the final solution, but the choice ultimately won't be theirs. The market will decide and I can't see the majority of people choosing a currency that puts them at a distinct disadvantage due it's wildly fluctuating price.

Betting on Bitcoin being the permanent global leader of cryptocurrencies is like putting your money on MySpace (in 2004) to be the leading social network (wouldn't have worked out too well). The cryptocurrency journey is just getting started. Take a punt if you like, but don't put all your eggs in the Bitcoin basket.

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Monday, January 13, 2014

If Gold Breaks Below THIS Line, Watch Out!

Where is the line in the sand... the technical uptrend, that if broken would decisively end the secular Gold bull market?

Mike Shedlock (aka Mish) of Sitka Pacific Capital Management puts it at around US$1000 on the monthly chart (source):

BofAML's Macneil Curry says a breakdown below $1180 will see critical long term support at $1087-1127 tested (source):

(click chart to enlarge)

Martin Armstrong says the 'Monthly Bearish Reversal' lies at 1152, below which a monthly closing will open the door to a further decline, potentially to technical support at $875 (source):

(click chart to enlarge)

GM Jenkins from Screwtape Files says Gold needs to hold a weekly close $1215 if the fundamental [sic] long term trend line is to remain intact (source):

(click chart to enlarge)

Greg Guenthner of Daily Reckoning thinks we've already dropped below an important technical level and the price is heading lower (source):

And finally, to revisit a previous bull market in Gold, here is the important technical level that was broken in the 1970s, which had no bearing on the final outcome (source):

(click chart to enlarge)

While charts can be useful for perspective & timing, I think it's important to remember that it's the environment and events yet to play out that will ultimately determine the fate of Gold, not a line someone has drawn on a chart.

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Thursday, January 9, 2014

Barry Ritholtz Mischaracterizes Gold Bugs

A recent article written by Barry Ritholtz titled ‘10 Reasons the Gold Bugs Lost Their Shirts’ highlights some important points that any investor would do well to consider, i.e.

‘Beware the Narrative’ – Don’t rely on stories that get you emotionally involved in a trade / investment.

‘Ignore History at Your Own Peril’ – Most things come into and out of fashion, what goes up usually comes down.

‘Leverage is Always Dangerous’ – The leverage involved in futures contracts runs the risk of margin calls if the trade doesn’t go your way.

‘What’s In the Price Already?’
– By the time rumours make their way to the average retail investor it's probably already priced in.

As Ritholtz says in the article, many of the tips can be applied to any investment, not just those who hold Gold.

However in my opinion he makes some critical mistakes in his analysis of Gold and those who hold it (‘gold bugs’).

Ritholtz says part way through the article:
"Like all commodities, gold is purchased via futures contracts."
This one sentence mischaracterizes a majority of those that I would consider to be 'gold bugs', who for the most part are wary of the futures market and other 'paper markets', sticking primarily with physical bullion, bars & coins (which don't even get a mention in the article). 

While I have seen the question posed on precious metals forums, "Should I take out a personal loan to buy precious metals?", it is far from a common query and usually met with a resounding "No". Gold bugs are rarely leveraged to the extent of futures traders (Ritholtz says typically this is 15 to 1), so are unlikely to 'lose their shirt' in the event of a large correction or crash.

He characterizes gold bugs as investors who are holding the metal specifically with the intent to make a fiat currency profit, when for many that is not the case.

In an article I wrote 12 months ago (Gold Speculator, Investor, Trader, Saver or Gambler?) I described five labels for those I see in the Gold space (it's likely this list could be expanded on). The purpose of Gold for these individuals will vary, from trading the metal for a profit, as insurance in the case of financial crisis or as a vehicle for transitioning wealth from the current monetary system to whatever comes next. 

Others again own Gold with the expectation they will need the metal for exchange of goods after a financial or monetary collapse (SHTF), does that sound like someone performing a trade (in the article Ritholtz claims 'Everything Eventually Becomes a Trade')?

One of the points made in the article gives the impression that gold bugs will usually hold 'no matter what':
Ask yourself, “What would make me reverse this position? What would make me sell this long or cover this short?” There is usually a long list of technical and fundamental answers. They may include break in support, a violation of a trendline, a decline in earnings, a slowing of growth, etc. Often, a simple modest price decrease is sufficient to get traders to cut their losses.

Yet many of the gold bugs I have spoken with over the past five years had no pain point. “I'll Stick With Gold” was a common refrain. There was no conceivable set of circumstances that could either reduce their ardor or their holdings in the metal.
While I am sure that there are a few of these types out there, I highly doubt that it represents a majority of gold bugs. Ritholtz is probably not posing the right scenario for the gold bug to reconsider their holding. For example if we were to see anything that significantly impacted the relatively stable supply of the metal relative to total stock, e.g. a significant advancement in mining technology that increased new annual mine supply from 1.6% to 20% or if the central banks all unanimously decided to sell all their Gold holdings (flooding 40,000 tonnes into a 4,000 tonne per annum market) then I think we would see significant divestment out of Gold even by some of the hardcore gold bugs. However, their response to such a question is more likely to be 'it would never happen' rather than actually addressing what they would do if it did.

Another observation that Ritholtz makes (my emphasis):
Gold has run up only be to trounced in repeated massive selloffs: 1915-20, 1941, 1947, 1951-66, 1974-76, 1981, 1983-85, 1987-2000 and 2008.
During the years I've bolded above Gold was a fixed price in US Dollars, so I'm not even sure what he is referring to when he claims it saw 'massive sell offs' during those periods (the other dates align with Gold price corrections which we saw post closure of the Gold window in 1971).

Ritholtz's characterization of gold bugs as those holding leveraged futures with the intention to turn a buck reminds of me this story dug up from the archives of 'Another' posted on FOFOA recently:
A gentleman leans over the fence and tells his neighbor that gold is going to rise in price from its current $300. As the person on the other side of the fence thinks differently, they both agree to a binding bet. In three months, we will settle up with a payment of the change in the price of one hundred ounces of gold. Whatever it rises, the "bull" collects that amount. Likewise, whatever it falls, the "bear" collects from the bull. Each puts a $1500 payment guarantee into a common shoe box and gives it to another neighbor for safekeeping.


As an observer of the above, we have just witnessed the creation of a wager not unlike a comex futures contract. On each side of the fence stands a long and a short, that together create an open interest of one contract. Neither has any intention of buying gold, nor do they expect physical gold to be a part of this bet. Yet, at cocktail parties and on public internet forums, one claims to have "bought gold" and the other states that he "sold gold".

To build a further understanding of this transaction: Both of these gentlemen, probably don't have the $30,000+/- to buy or deliver 100 ounces of gold. Human nature being as it is, if they did have that much, they would most likely increase the bet to ten or twenty contracts. Clearly, the intent of this paper market, is to bet on the price of gold as it is determined by the buying and selling of other physical traders. The western public should take these trades for the concept they truly represent. "I (the long side) bet on the "price" of gold not because we need or want the physical metal. Rather, my wager is that others will need real gold to protect themselves from bad monetary systems. In fulfilling that "need to own", these others will drive up the dollar price and I will make money while working within the confines of our good monetary system." The shorts make the opposite bet, in that they think the world monetary system will work itself out and induce "the others" to sell all their gold. That is, gold they bought in the first place, because they did not know that our money managers could repair the world financial system.

Yes, today Western longs and shorts are playing out these two views of the gold market. Yet, both sides are using paper gold bets to represent their beliefs. Truly, the major majority of this market does not buy or sell physical gold to represent their investment concepts. There are a few that buy coins and bullion, but, even in their large amounts, it is only a drop in the paper gold bucket.

This, my friends, is the very nature of western trading of gold. The mindset is to treat it as a concept for making currency, not protecting existing wealth.
I wouldn't call these neighbours 'gold bugs', really they are just a couple of punters who happen to think they know what the price of Gold will do.

On a final note and just to live up to the characterization that Ritholtz gives gold bugs (in the section titled 'Attacking the Skeptics'), lending some credibility to his profiling of us, I think he is a sell out, likely to be in the pocket of the Federal Reserve and a patsy for the administration.

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