Not Everything Is As It Seems


Will there be fireworks on Australia Day? Our inner six year old hopes so. We fondly remember our first fireworks show in 1979 in Estes Park, Colorado. Boom! And then a splash of colour across the sky. It was sensory overload for our tiny brain. We didn’t have a name for the sensation back then. We just enjoyed it and clapped our hands like a goofy child and yelled, “Do it again!”

“Do it again!,” we find ourselves shouting at the financial markets some twenty seven years in a row, brain no larger and our joy different in nature, but undiminished. Record highs are exploding off the front pages of newspapers all around the globe in colourful green numbers like 12,621 on the Dow, 5,723 on the ASX/200, and 20,791 in Hong Kong.

It’s not just stocks either. “World commercial property hits a high,” reports Jim Pickard from London. “The international commercial property market attracted record levels of investment last year, with $US643 billion ($814 billion) in stock changing hands – a jump of 33 per cent on the previous year. In spite of widespread predictions that the global boom is unsustainable, institutions and private investors have continued to pour money into shopping centres, offices and industrial parks. Europe and Asia saw strong growth last year, with volumes up 50 per cent and 48 per cent respectively, according to a survey by real estate consultants Cushman & Wakefield. The trend comes amid a surge in both property prices and deal volumes that can be traced back to the stock market collapse of six years ago.”

Has it really been six years since the despondency of the tech wreck? Has it really been six years since the shock, sadness, and anger of 9/11? You’d have to work hard to remember what those times were like, to remember the confusion and sense of dread about the world we woke up too in late 2001. The way people felt then, their guarded sense of the future, has all but vanished in the contagious optimism of higher asset prices. The world may be less safer today than it was six years ago, but if you ask stock markets, there’s never been less risk or more reward to be had for the average investor.

If you go beyond skin deep you find plenty of evidence that not everything is as it seems. “Only last week we learnt that our national credit card bill tallied up to $37.3 billion, and that’s a record. In the past two years it has risen by $4 billion and then $5 billion,” we read on-line this morning. “Associate Professor Steve Keen, from the School of Economics & Finance at the University of Western Sydney, says this spending spree can’t last. Economists see the past 15 years of economic growth as the longest boom in Australian economic history. Prof Keen sees it differently.”

“It has been the longest debt-driven, speculative bubble in Australian economic history,” he argues. ‘Back in 1975, private debt – the sum of business loans, mortgages and personal loans — was equivalent to 20 per cent of GDP. It’s now 147 per cent of GDP – more than seven times as big.’ Prof Keen points out that the ratio has been rising at roughly 4 per cent each year, which means it’s doubling roughly every 18 years.”

But everyone is getting richer, right? Who cares if liabilities are doubling once a generation? Assets are growing even faster! It’s all about the rate, not the total.

We actually haven’t heard anyone argue the above, that as long as you increase your wealth faster than your debt, the size of your debt is unimportant. Intuitively, at the beer gut level, the average bloke in the street knows better. He knows that how much debt you can afford to carry comes down to how much interest you can afford to pay on it out of your wallet. He also knows that you sleep better at night when you don’t owe the bank-or anyone else-vast sums of your future income.

Are times really that good? It depends on who you ask. But as we were walking down St. Kilda Road this morning we realized the need to cultivate our appreciation for things we’d rather ignore. Nurture your sense of indifference. It pays to do so. What do we mean?

In investing, the opportunities that deserve your attention the most are the ones that typically leave you least excited, almost annoyed really. You hear about them and you would rather move on to something that gets your blood boiling. But it’s the completely mundane and plain stories, the ones so forgettable that most people…forget them, that typically have the most untapped value.

We’ve seen it happen time and again in the last ten years, and always kick ourselves for not paying more attention to the boring things. Japan, where our friend Steve Sjuggerud is right now, is one of those boring/annoying things. As a know-it-all news-junkie, we like to think there’s nothing good happening in Japan we don’t already know about it. We are annoyed to have to think about it. It seems boring, mired in mediocrity and still shaking off the effects of a 15-year property slump. Wouldn’t it be more exciting to invest in Dubai? Probably. But we’re going to pay more attention to our indifference in the next few months and see where it takes us.

Speaking of indifference, or at least lack of awareness, we read in today’s paper that, “Oil Search Ltd says it is not aware of any reason for a rise in its share price, such as a takeover approach, but admits that higher oil prices are likely to translate into higher profits. In a response to a stock exchange query on a rise in its share price from $3.32 on January 23 to $3.57 yesterday, Oil Search says it is not aware of any reason for the heavy trading.”

We can practically hear Oil Search Ltd. (ASX: OSH) mumbling to itself, “No, no. Nobody has called. No letters in the mail. I’ve just been busy pumping oil, banking profits, you know, it’s what I do, who I am. What’s that? Well yes, maybe I do feel a little lonely. Certainly it would be nice to be asked out once in a while. Who isn’t flattered by those rich, handsome, flashy private equiteers? But we musn’t count on those sorts of things in life. Our business is oil, not looking pretty for trophy-wife shopping capitalists. Now if you’ll excuse me, I have work to do.” Of course companies can’t talk. But if they could, this is how we imagine Oil Search would sound. And really, it sounds quite sensible.

If Newcrest Mining Limited (ASX: NCM) could talk it might brag a little this afternoon. “Newcrest Mining Ltd reported a one per cent rise in gold production to 384,285 ounces for the group in the December quarter,” reports today’s Australian.” Gold, incidentally, hit a seven-week high in trading earlier today in the futures market.

Ah yes the future. It’s as good as gold. First, there is investment demand. According to Bloomberg, “Investment demand for gold may grow as exchange- traded funds become more popular, analysts say. So-called ETFs linked to the price of the metal that trade in New York, London, Singapore, Mexico and France have already attracted a combined $11 billion since the first was introduced in November 2004.”

But the key to gold’s future may be its past, brining us back to 1979. “From 1976 to 1979 the price of gold rose within a well defined trend channel until August 1979, when gold broke above the trend channel twice hitting the $320 level. Soon after the double break out, the gold price rose to $870 US in a period of just 5 months,” according to an article at

That $870 number is kind of deceiving, however, if you’re wondering where gold would go today, if and when it makes a new high. When you adjust for official measures of inflation (using U.S. CPI data) gold would have to go past US$2,201 to make a new high. We’ve posted a chart of the historic gold price adjusted for inflation here.

In practical terms though, it means our official prediction of gold $2,000 is probably modest. It’s at least $200 too low, if gold simply makes a new high. But if we are right and the U.S. dollar, sometime later this year, shows its true colours, then the new gold high will be much higher than the old gold high.

You might think all of this is irrelevant, given that official inflation data in Australia and the U.K. indicate that prices are no longer rising fast enough to worry tidy central bankers. After all, the energy component of inflation has eased off quite a bit with high oil prices. If we are at the end of the tightening cycle of interest rates, then how can we reasonably expect gold to keep rising as a hedge against inflation?

Here we let you in on a little secret. We are not reasonable men here at the Old Hat Factory. We are keenly aware that markets are neither reasonable nor efficient. At the extreme ends of their boom and bust cycles, markets are manic and depressive, respectively. On any other day, this might lead us to a bi-polar theory of asset prices. But we will spare you. For now, we will merely say that gold is reliable because it is not a human brain. It does not get excited, depressed, despondent, or euphoric. It just sits there and looks pretty, if a little slow on the uptake.

And so while the rationale, reasonable thing to conclude from official central bank announcements is that inflation is contained and the economy is a perfectly tuned machine, we are listening to voice of indifference mumbling in the corner. It speaks to us and says, “Watch out mate, all hell is about to break loose. The heavy yellow stuff is good ballast in heavy financial seas. You might want to take up a few armfuls against this sea of insane asset pricing.”

The reasonable part of our brain realized that putting heavy things in your pocket on stormy seas makes it highly likely you’ll sink to the bottom and take a liquid dirt nap in Davey Jone’s locker. Unless, that is, the ocean drains from beneath your feet. But then, metaphors are not reality are they? They are only guideposts. And any way you’d like to describe it, right now, we would be very, very careful.

And one final note. Who will win Australian of the year? We admit we have no idea what the qualifications are. And we probably don’t even get a vote, since we’re an American. But if we did get a vote, we’d vote for Taj al-Din al-Hilali. The sheik gets everyone all shook up. He keeps us thinking, asking how much intolerance we can tolerate in a liberal society.

He’s also a living symbol that in a free society, sometimes people do and say things with their freedom that you don’t like, but that you ought not make illegal. He’s also a great example that people with the freedom to say what they want often have nothing valuable to say. The right to an opinion is not the same as an opinion that actually deserves respect.

We always agreed with the saying that sunlight is the best disinfectant, although it’s probably better to throw rancid meat out altogether. If you allow people to show their true colours, eventually, they won’t be able to help themselves. They’ll show their cards. And it’s not possible for them pretend to be something else forever. Or, put another way, give them enough rope…and they’ll find a way to hang themselves…provided they don’t try and hang you first. This delicate calculation is why Abraham Lincoln referred to the core principles of the American experiment as a “proposition.” Propositions require proving, and are not just axioms or symbols to be celebrated once a year.

And for those of you who won’t be joining us tomorrow, Happy Australia Day! Be sure to vote for Australian of the Year on the poll on the right side of your screen.

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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