Stick a Fork In It

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–Well this should be interesting. The EU/IMF bailout of Ireland is not going off without a hitch. The UK’s Telegraph reports that Green party, which currently supports Ireland’s government, might withdraw that support and call for new elections in January. This would call into doubt the ability of the current government not only to execute a deal with the EU and the IMF but also to pursue its four-year austerity program.

–What a mess. We’ll get to how Ireland and Australia are similar in a moment. But first, please recall the words of the great philosopher of the New York Yankees, Yogi Berra. He once said, “When you come to a fork in the road, take it.”

–Today’s fork in the financial road leads down two different paths. One path is continued U.S. dollar devaluation and a strategic migration to emerging market assets (under the assumption that the BRIICS nations will eventually have to allow for currency appreciation…or face rampant food and fuel inflation). This trade favours gold, commodities, and tangible assets in general.

–But remember what happened in 2008? The Global Financial Crisis actually led to a massive rally in the U.S. dollar. Emerging markets got hammered. The “risk” trades financed with cheap greenbacks were reversed and commodities took a shellacking as well.

–Could that happen again? The boys at Knight Research think it’s going to happen again, but even bigger and badder this time around. In a recent research note, they wrote, “We believe the structural and cyclical terms of global trade have finally reached their tipping point. This will catalyse a wholesale change in sentiment and a historic repositioning of risk assets. The emerging market global growth story is over.”

–This is the fork Murray has been preparing for in the Slipstream trader. It would mean falling indexes in Australia which would of course mean falling components of those indexes. Knight Research elaborates on this fork:

The game is over. Presently, we believe that the broad-based resurgence of investor confidence in the emerging market and secular bull market in commodities will end badly; proving that the rally which commenced in Q2 2009, was in fact an “echo bubble” facilitated by massive-and unsustainable-stimuli from the Chinese Government.

We believe that the end of the Great Consumer Credit Cycle and the vast structural differences in the terms of trade between the United States, the EU, and China, have finally caught up with the secular bull thesis on Emerging Market and Commodities. Quite ironically, the Fed’s aggressive policies will likely prove to be the catalyst which breaks China’s unbridled expansion of credit and non-economic growth, ushering in a wholesale rebalancing of risk assets.

–This is not a lukewarm prediction. It would quite obviously be mega bearish for the Aussie dollar and for commodities. And thus far, there’s not much evidence to support that giant reversal is afoot that is more bearish for emerging markets than it is for the U.S. dollar. It’s a fork in the road, though. So we have to take it and see where it leads.

–There ARE a few factors supporting the “Game Over” theme. One is that Ireland’s woes are not the last of the Eurozone’s problems. There is Greece. There is Spain. And really, Ireland is not even done and dusted yet. To some extent, Euro weakness is dollar bullish and contributes to the “Game Over” theme.

–But the bigger factor is Chinese tightening, or just your basic traditional popping massive credit bubble. There are early signs of that. Last week China raised reserve requirements on banks again. And Citigroup agrees with our assessment that rising food prices in China could be bearish for metals.

–By the way, if this scenario is right, it’s going to make Ken Henry look like a fool for believing that mining is in a secular rather cyclical bull market. He’s planning on the boom to end all booms. But it could be the same old bust that comes at the end of every credit cycle. Why doesn’t Henry see that? He’s not exactly a miner is he…or a geologist…or an entrepreneur…or an investor…or an Austrian economist.

–China’s State Council is talking a big game on controlling inflation. Does it mean China is quickly shifting away from a bias toward export growth toward an inflation fighting bias? That’s the big question. If it does mean that, you can expect lower commodity prices.

–For example, three-month copper on the London Metals Exchange fell overnight. The news preceding the drop was that refined copper imports to China fell by a third last month. Comex December copper traded lower too, near $3.75/lb.

–We’re going to have Dr. Alex what he thinks about this. But we can guess. He probably loves it. He just got back from another site visit in Africa to a copper project. If you’re a Diggers and Drillers reader don’t worry. You’ve already read about this company. It’s not a new recommendation.

–Alex has done his homework on the companies he’s recommended. Weakness in the copper price invariably follows through to the shares. If you’re a secular metals bull, you believe this lowers your average purchase price on the shares most likely to benefit from rising prices. If you’re a bear, well…you’re a bear. Go dance.

–Alex, of course, has taken the other fork in the road. This fork is for those who’ve realised the end of the dollar standard in the global money system is likely to be bullish for real assets, despite your reflexive dollar rallies. Europe’s chronic and structural problems add an element of dollar support. But the long term story on this fork is to favour “real assets” over paper money.

–Which brings us back to Ireland and Australia. Irelands bank’s went all in on the Irish property market. When the bubble burst, the banks were left holding the back (a huge mortgage book). The bag was so heavy, in fact, it broke their back. So the government had to pick them up. And the bag was too big for the government to pick up too, especially given rising borrowing costs for countries at Europe’s periphery.

–Could that ever happen in Australia? Could banks with massive over-exposure to domestic property be caught out by losses and unable to borrow from overseas except at much higher rates? And could the government be forced to step in and cover the bank at the cost of its own good credit?
–Nah. That could never happen here.

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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Comments

  1. I’m a leaning towards the fork of the bear (based on a punt rather than knowledge). Speaking of which if that happens, and price deflation occurs I was thinking of putting some cash into Federal Australian Government Bonds (apparently underwritten by the Reserve Bank).

    Does anyone invest in them? What are your experiences with them?

    Richo (the Second)
    November 23, 2010
    Reply
  2. “–Nah. That could never happen here.*”

    Jeez, Dan, after years of telling us it was imminent!
    Look at the queue of disappointed bears… . :D

    * What’s missing @ DRA is the sarcasm emoticon. ;)

    Reply
  3. I reckon we have to get a correction soon so that AUD gold can go higher. This is the most important thing in the world :)
    ;) ;)

    Reply
  4. Well, you’re probably correct, Lachlan.

    I had thought the most important thing in the world was a necessity to improve the written and oral English of a tide of economic refugees from imploding Northern Hemisphere nations; but after some thought realised The Correction We Have to Have… and $6K gold… will definitely be major events in Australian History. Party on… . ;)

    Reply
  5. I will still be happy with $3000AUD/Oz for Gold :)

    Stillgotshoeson
    November 23, 2010
    Reply
  6. Sorry BP. An evil clown made me do it ;)
    Honestly though I do see that the AUD and risk has been very strong to parabolic and corrections are inevitable and possibly soon to happen. However I do not think we will have a long term top here, not at all. Commods, AUD and metals will stay strong in my opinion due to Bens obsession with ink. Even if a top/trend change were to emerge it would have to take a fair period to play out after new highs in various things.

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  7. Up to 20% correction in median house value on the eastern side of Australia and Gold at 3KAUD/Oz Is a good position to see our economy get to.. cleansing of excess debt but not terminal for the economy.. 6kAUD/Oz + for Gold and 40% + reduction in median house prices for Australia would not be pleasant and I really hope it DOES NOT get that bad..

    A “blip” on the economy and then a climb back to prosperity… Not a drop in to the abyss with darkness for a very long time.. no thanks.. I am not that bearish.. Still Optimistic for the future.

    Stillgotshoeson
    November 23, 2010
    Reply
  8. Hey Shoes.
    I am having a great season and will have more dough for some punts soon but no time to study them at present. Sold DGO for 85% gain (13.5c) recently and my other shares are all above water. I suppose this share euphoria is another reason to look for a correction…ie buying opportunity.

    Reply
  9. Good job Lachlan.. I have 1 I am expecting 300% from over the next 12 months..

    Why am I not all in then? Some would ask.. My reply is simple… I might be wrong..and I am not that greedy.. Greed is the cause of many a downfall.

    Stillgotshoeson
    November 23, 2010
    Reply
  10. Free and open markets do not exist any-more… Fraud by ‘banksters’ and big manipulative operators (USA government and owners of the USA FED have formed a Fascist regime that is almost unassailable…

    I live in hope that Australia will join in on the ‘correctionist game’ and be the first to declare that the AU$ will be tied to gold,,, and adjusted from time to time to retain realistic exchange rates and be set initially at AU$1900.00 per ounce of 9999 pure gold… How often the link to gold will be adjusted will depend on the rate of HYPERINFLATION in other parts of the world…

    It is patently stupid to link any currency to another fiat currency as all are intrinsically worth NOTHING and carrying huge debts… A link to gold makes sense and does not necessarily demand holding a significant gold reserve (Little Johnny Howard sold Australia’s anyway) – at near the bottom of the market…. Australia’s fiat currency was tied to a basket of other paper but Keating floated it….

    Now is the time to tie the AU$ to something tangible… Au$1900 = 1 troy ounce of pure gold… google “Lies and Witchcraft” for further discourse on the GEC

    Reply
  11. Well, certainly 300% isn’t greedy!~ Add that to a 55% rise in gold and Euan’s yer uncle, Shoes. ;)

    Reply
  12. And a 220% rise, why you’d be into that house!~ :D

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  13. “The emerging market global growth story is over.” – That’s a gutsy call! Did they say it’s over for 5 months; Or for 5 years; Or for 5 decades; Or for 5 centuries I wonder?

    Reply
  14. Comment by Biker Pete on 23 November 2010:

    Well, certainly 300% isn’t greedy!~ Add that to a 55% rise in gold and Euan’s yer uncle, Shoes.

    I am certain THEY WILL rise in value… Only have $8500 worth of them.

    If I was greedy I would have $500000 worth of them.. because these shares WILL rise in value. Maybe even double as early as March/April next year….but like I said..I am not greedy.

    Fletcher Christian is the only clue I will give at this stage… ;)

    Stillgotshoeson
    November 23, 2010
    Reply
  15. Whatever happens in Australia it won’t be on the same scale of bad as other nations for one reason – Australia’s central bank has some balls. Not as much as Germany, but more than anyone else.

    Daniel Newhouse
    November 23, 2010
    Reply
  16. Some farmers sympathise with their livestock but thats not why they keep them. The herd will pay for their own upkeep….but then, nothing new under the sun.

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  17. Alright Shoes. I reckon your share is trading around 10c and it is headed for the… high seas…. the trend is up, rallied on high volume a year ago then consolidated and starting to break away again now….sound like it?

    Reply
  18. Spanish bonds are dropping and Germany is alarmed. That is the elephant in the European room and the one that will tip the game and break the Euro. NZ was also quietly downgraded by Moodies amongst the Irish debacle which already reprices their NZ bank funding and starts twisting the sword into our 4 pillar bank balance sheets (they own the major NZ banks as branch operations off their balance sheets). Our 4 pillars will be insolvent on an NZ asset price bust alone when an Irish style and level of crisis plays out there.

    NZ has already responded offering “covered bonds” (first dibs on retail deposits) in Europe. And now you know why it was on 4 pillar lips here. Suncorp got upgraded to A+ but the best they could get was 2.5 year bonds on 900 million because the price is ugly. Remember when the average for bonds was 7+ years?

    Anyway it was enough to take profits on the kiwi. To much headwind for the RBA and 4 pillars to drag it down to where they need it in my humble estimation. If Spain-Europe proves not to blow it will be time to revisit.

    That slow “build stake in the dips” and take dividends strategy on Namoi Cotton on the back of the NTA and seasonal “must come good eventually” factor has been getting the tick lately. Cotton prices won’t last but secured markets in Indonesia off long term supply deals and taking a bit of speculative selling into China on the increased production should turn next Feb’s posted result into a smile. As long as they don’t do too much hedging trying to lock in long prices with bogus counterparties or predicting supply on the back of rain that might not fall next year, then it looks good. Farming’s not for the faint hearted though.

    Reply
  19. “Whatever happens in Australia it won’t be on the same scale of bad as other nations for one reason – Australia’s central bank has some balls. Not as much as Germany, but more than anyone else.”

    What they might have in balls, they lack in capability. Their pockets are not deep enough prop up the dollar and would not be able to prop up the whole mortgage sector, so, if China exhales or takes a hit, then the carry unwinds over currency risk to the massive hedges. As the currency drops the ability for mortgage lenders to get cheap funding off shore is reduced (like in 2008). With likely job losses and reduced income from exports (to say, China) the Banks would be vulnerable to a rise in defaults arising from unemployment \ or bank runs.

    This is not a prediction, just a risk as I see it. Now with DR reporting 80% of China’s GDP coming from the Chinese Gov, and China entering in to a currency war we could very well see such a blip occur. Don’t forget what happened in 2008 to one of the big four. Unemployment was barely even moving compared to 88. I was working for the golden boy at the time and all we heard about were ‘capital reserves’. Had the reserve forced the mortgage lenders to increase reserves since then? No. Same risk at 2008, but the bubble here is now a bit bigger.

    Possibly of interest to many here, around the corner, here in Leichhardt a pair of 3 small br duplex’s made of pine and blueboard (no garages, 12sqm back yard, galley kitchen) just sold for a touch under 1m each. You can rent it out for around $750. Even if 750 was sustainable, no expectation of capital increase means a 100% investment loan of around 500k would be needed to break even at today’s interest. To me that is telling of real value and the fact that there is too much money in this market. Once the local gen-x yuppies no longer see negative gearing gains as the path to wealth and fortune we could see a decent price correction. All that’s needed for that is a change in perception, not even a change in employment. Of course, those same gen-x yuppies are half working for the banks or banking IT partners anyway so it’s self reinforcing if unemployment increases. (I’m now the ‘poor’ ex yuppie as I hold no debt, lol)

    My view is that if we see a deflationary wave hit the globe there will be carnage here. Our banks are packed up to the eyeballs with residential debt and the heaviest debts are run by those in the most specialised roles and those that benefit from discretionary spending, in short the most likely to fall over in a recession.

    Has anyone noticed the quickening in market cycles?

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  20. “My view is that if we see a deflationary wave hit the globe there will be carnage here.”

    You’re safer here, Chris!~ :D

    Reply
  21. Comment by Chris in IT on 24 November 2010:

    Once the local gen-x yuppies no longer see negative gearing gains as the path to wealth and fortune we could see a decent price correction.

    I share a similiar view Chris… Melbourne and Sydney especially. Many “property investors” in these two cities that have been willing to get 2.5% to 4% Gross Yields on million dollar properties in the belief that these properties are going to rise 15% 20% a year in value so the “loss” of cash flow in the interim is worth the pain… When the capital gain is no longer happening or worse going negative I think many will dump and run.

    Stillgotshoeson
    November 24, 2010
    Reply
  22. “I think many will dump and run.”

    I’m not sure there’s a great deal of capital gain to be made in any of our capital cities right now.

    Nor do I think folk who have paid over a mil are likely to sell for a $200K discount… . The most likely event in that scenario is to hold.

    The most predictable distressed sales are likely to involve:

    Sudden unemployment

    Marital issues

    Lower income families.

    With a son moving to Melbourne, we’d welcome the kind of discounts you’re hoping for, but the really good stuff will be tightly held through good times and bad. It may not appreciate, but dramatic falls are unlikely… .

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  23. Is there the equivalent of a margin call in real estate here, if the property value drops below loan value?

    If so that could lead to more sales as times go on as well.

    If Australa can keep its market together long enough, and not get too restrictive on the flow of capital, we may well find that capital inflows maintain prices better than we anticipate.

    What we need to do is to lever up in productive assets at a rate matching our deleverage in property. Probably not easy, but worth looking into.

    Reply
  24. “With a son moving to Melbourne, we’d welcome the kind of discounts you’re hoping for, but the really good stuff will be tightly held through good times and bad. It may not appreciate, but dramatic falls are unlikely” – And if Great Depression II comes Biker, those with desirable properties and significant cash holdings, just use a bit of their cash to put a few partitions in their desirable properties plus an ensuite or two and rent them out at a significantly improved return just like last time maybe?

    Still beats holding stocks and bonds for mine. But freely admit that I was ‘brainwashed’ from a very young and tender age … Not that I still ain’t ‘young ‘n tender’ of course! :D

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  25. The Kiwis have acknowledged none of their 29 underground coal miners are likely to come out of it. That was always a chance. Risky and tough game. A tragic day for Kiwis and Aussies both. Extremely sincere condolences to all the families.

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  26. “I think many will dump and run.”

    Well, you just have to ask why a bloke who could get a $700K loan would then accept a $200K loss in preference to actually making 2.5% annual profit… .

    Investor: “OK, it looks like I’ve made a mistake, buying at the peak. I’m only making 2.5% p.a., plus my tax write-offs. I’d better sell for a $200K loss!”

    Tough times don’t last. Tough people do. We all make mistakes.
    Why compound them? A $200K capital loss is only marginally useful against a million dollar CG win. Why would anyone sell, rather than hold?
    Just isn’t logical, is it?!~ :D

    Reply
  27. “I think many will dump and run.”

    Well, you just have to ask why a bloke who could get a $700K loan would then accept a $200K loss in preference to actually making 2.5% annual profit plus tax write-offs … .

    A property at a gross yield of >9.5%. Let say interest rates are now 7ish%. BP could you enlighten us where this might be in reality land, thats nice yield. Of course if its 500k now that means its yield would be around 13%. A quick look at average rental yields didnt help me find it. Or has this old duffa missed something.

    I think we agree its investors like these that pose the threat “here in Leichhardt a pair of 3 small br duplex’s made of pine and blueboard (no garages, 12sqm back yard, galley kitchen) just sold for a touch under 1m each. You can rent it out for around $750. Even if 750 was sustainable, no expectation of capital increase means a 100% investment loan of around 500k would be needed to break even at today’s interest.”

    Reply
  28. Comment by Chris on 24 November 2010:

    Is there the equivalent of a margin call in real estate here, if the property value drops below loan value?

    Not really sure Chris… Before it gets to that stage some may find themselves up for compulsory mortgage insurance…

    Most (All?)banks require you to have mortgage if you borrow more than 80% of the house value.. There would be a fair few “investors” out there I am sure that have used the equity in the family home to pay a deposit on an investment property and not have had to pay this mortgage insurance. Only one house they could probably come up with the $1500.. If they are an astute investor leveraged to the hilt on multiple properties, they may not have the cash flow to find 6,7 or more thousand bucks..

    Stillgotshoeson
    November 25, 2010
    Reply
  29. Comment by Biker Pete on 24 November 2010:

    Well, you just have to ask why a bloke who could get a $700K loan would then accept a $200K loss in preference to actually making 2.5% annual profit… .

    Just isn’t logical, is it?!~ :D

    The market is driven by fear and greed, both property investment and shares…

    Fear and Greed make otherwise logical people do illogical things.

    Mr and Mrs property investors have used the marital homes equity to fund an investment property… they have recently (2 years ago)purchased in an upper middle class suburb because they have seen the spectacular gains of 15% 20% a year and decide they want a piece of this action.. House has gone up 30% since they bought it but now the market has turned.. House is not getting any capital growth, or has dropped 10% already… cash flow is tight because they are extended to the maximum limit, it’s 9 months till tax time…
    Sell and lock in the profit?
    Wait and see (hope)?

    Couple above are in a lucky position, they have made money… they can sell and take a profit if the cash flow position is too hard for them…

    Couple B.. Same scenario but purchased 3 months ago… different story.
    The more recent one has purchased a house with high leveraged position the worse any correction will impact…

    Stillgotshoeson
    November 25, 2010
    Reply
  30. “The market is driven by fear and greed, both property investment and shares…”

    It’s a perception we tend to accept without question. It reasons that capital gain is _always_ the primary goal. A comfortable return which permits a desirable lifestyle may also be a driver.

    Yes, desperate people do illogical things at times. In LA, I’ve bought vintage guitars from folk who could not find their next month’s rent.
    I should probably have added drugs to the list of reasons people sell below value… .

    But for a moment consider the scenario you first described:

    “…Melbourne and Sydney especially. Many “property investors” in these two cities that have been willing to get 2.5% to 4% Gross Yields on million dollar properties…”

    What sense would it make to lose $200K, plus sales commissions, instantly; rather than continue to make 2.5% – 4% gross?

    It’s not always about fear and greed, Shoes. You yourself noted, anticipating a 300% profit: “I am not that greedy.. Greed is the cause of many a downfall.” I think that even in Melbourne, many a property investor, holding onto a small gross return and annual tax windfall, might comment: “I am not that fearful.. Fear is the cause of many a downfall.”
    But if a terrified property investor wants to sell our son a million-dollar Melbourne apartment for $800K, we give our blessing to the deal! :D

    Reply
  31. Economists in the US have just downgraded the economic outlook for 2011. I don’t think there is a light at the end of the tunnel yet.

    Reply
  32. Invest in what you know best… For me I can always investin business, but vast majority of people do not have the knowledge and idea about value of anything else than property because almost everyone can relate to that – paying rent,expenses with repairs, rates, etc. Shares have become commonplace and seem so easy, yet many people have no idea about companies they invest in. Frightening, really. to quote or paraphrase Warren Buffet – “you can only find value or create value”. People who have less idea try to find value, well, it’s like digging for gold – many people in gold rush era got rich, but many more just survived and gone back to whatever else they were doing before moving to the goldfields. They had to go back to creating value! It is actually “work” that makes the world go around, don;t let anyone tell you otherwise… Hoving said that, I have this really cool idea for a business that I’d like to expand nationally in the next few years ;-)

    Reply
  33. What sense would it make to lose $200K, plus sales commissions, instantly; rather than continue to make 2.5% – 4% gross?

    Where did you get this 200k figure from?

    Eveyones tipping point will be different… 50k 75k 90k..
    What ever the tipping point these houses coming on market will effect the values of the surrounding homes that are not even on market… the first point of time these investors/owners may know their properties have dropped in value is when they get the insurance renewal from ripuoff insurance saying the house is “X” value when last year is was “Y”

    Stillgotshoeson
    November 25, 2010
    Reply
  34. I took your figure of a million, Shoes… and deducted the 20% you cited. $200K is still a fifth of a million isn’t it? I know inflation is a problem, but I thought fractions and percentages were still fairly safe… . ;)

    In actual fact, you need to reassess your insurance perceptions. Our insurer _raises_ the value insured by 6% annually. When I queried this recently, arguing that this is a flat spell, they were adamant. If you think I’m incorrect here, please advise the name of an insurer who is citing _lower_ insurance values. If there is such a beastie, we’d like to talk to it. :D

    Reply
  35. Chris, ‘margin calls’ don’t exist in property. However the only person I’ve ever personally met who _lost_ on property, lost through margin calls.

    Just prior to the GFC, he amped up his shareholdings. He was leveraged to the max. As the market fell, he held, as one after the other of his margin calls POPped. He lost not only his investment property, but his home.

    Ironically, this same bloke is now a property bear. Has to be.
    He simply can’t buy back in.

    Reply
  36. Roy: “A property at a gross yield of >9.5%. Let say interest rates are now 7ish%. BP could you enlighten us where this might be in reality land, thats nice yield. Of course if its 500k now that means its yield would be around 13%. A quick look at average rental yields didnt help me find it. Or has this old duffa missed something.”

    Sorry, Roy, I don’t understand. Shoes was discussing a gross yield of 2.5% – 4%. I was a little surprised to see yields that high on a million-dollar property. Most of the 4X2X2s we build now come in under $400K all up.
    We make less than 10% annually on some we built 2005 – 2007 for under $300K all up; so I can’t defend the figures Shoes supplies. That’s not to say his yield figures are incorrect. He knows Melbourne much, much better than I do… .

    Reply
  37. Shoes,
    Household insurance policies use replacement value as the basis of settlement. Market value may drop, but re-building costs can certainly keep increasing in a dropping housing market.
    I’m off tomorrow, and I’ll be looking in a few real estate windows, particularly while I’m in Miami, to get a firsthand feel for that market.
    Shall report back.
    Cheers everybody.

    Reply

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