Love. Gold.

  • Hyperbolic…until it isn’t
  • Accepting the challenge
  • Only the name is different
  • From bonds to equities
  • Goodbye to the Aussie backyard
  • Australia getting richer, but not any fairer

 

Even on a family holiday, work and investing is never far from our mind.

So after a visit to the Canadian parliament, here in Ottawa, we couldn’t resist strolling down the road to the Royal Canadian Mint.

And once there, we couldn’t resist a photo opportunity with a 12kg-plus gold bar (channelling our inner Jim Rickards):


 

At current market rates, you’re looking at more than US$500,000-worth of lovely gold. That’s around AU$682,000-worth.

We always enjoy having a bit of fun with the anti-gold crowd with things like this. They always claim that gold is just a trinket…that it’s worthless…that it’s an anachronistic relic of the past. But what do you think would be their reaction if you offered to give them a 12-kilo bar of gold?

Do you think they’d still believe gold was worthless…or a trinket? Or do you think they’d rip your arms off to get it?

Yes, we know the answer too.

Markets

Overnight, the Dow Jones Industrial Average gained 14.8 points, or 0.07%.

The S&P 500 closed up 4.54 points, for a 0.19% gain.

In Europe, the Euro Stoxx 50 index added 16.99 points, or 0.49%. Meanwhile, the FTSE 100 fell 0.39%, and Germany’s DAX index gained 0.11%.

In Asian markets, Japan’s Nikkei 225 index is up 144.89 points, or 0.78%. China’s CSI 300 is up 0.34%.

In Australia, the S&P/ASX 200 is up/down 5.20 points, or 0.09%.

On the commodities markets, West Texas Intermediate crude oil is US$52.54 per barrel. Brent crude is US$55.68 per barrel.

Gold is trading for US$1,264.51 (AU$1,679.64) per troy ounce. Silver is US$18.41 (AU$24.45) per troy ounce.

The Aussie dollar is worth 75.31 US cents.

Hyperbolic…until it isn’t

We’re no fan of the Aussie banks. We’re not the only ones.

As The Age reports, Australian Securities & Investment Commission top dog Greg Medcraft may be on the same page:

The head of the corporate regulator says he is still uncovering “some pretty appalling things” when conducting surveillance on Australian banks.

Australian Securities and Investments Commission Chairman Greg Medcraft said banks still had a way to go to restore the trust of their customers, and while at a board level banks seem to “get it”, on the ground there are still issues.

“I am still really troubled,” Mr Medcraft said. “What we’ve seen in the foreign exchange, the banking bill allegations, life insurance, responsible lending, what we see in financial advice…what troubles me is when we go and look, we still uncover pretty bad conduct.”

“Many of the things we find is legacy issues, but quite frankly when we go and do surveillance we still see some pretty appalling things.”

The most troubling thing of all is the one thing Mr Medcraft didn’t mention: the cash banking that banks hold against savings. We doubt if more than one in 10,000 savers realises just how little cash banks hold.

Sure, most folks understand that bank vaults aren’t bulging at the seams with cash and coins. But we doubt if they realise that Aussie banks hold less than three cents in physical cash for every dollar saved.

It means that in the event of a financial meltdown, if savers demanded the banks pay out the money savers hold in their accounts, the banks wouldn’t be able to do it. The banks would have to close their doors. There would be a bank ‘run’.

And the Reserve Bank of Australia wouldn’t be able to print the physical notes or strike the physical coins fast enough.

If that sounds a little hyperbolic, well, of course it does. Many things sound hyperbolic…until they actually happen. Warnings of passenger jets flying into skyscrapers would have sounded hyperbolic in 2000.

One year later, not so much.

The prospect of gold trading at US$800 per ounce would have sounded hyperbolic in 1967. 15 years later, not so much.

And a prediction in 1913 that the death of a ‘C’ class European royal would cause the deadliest war in the history of the world (until that time) would also have sounded hyperbolic.

Again, by 1918, not so much.

Our point? The idea that Australia’s banking system could collapse, causing irreparable damage and harm to the economy, to savings, and to people’s lives, is unthinkable to most Aussies. They have no concept that such a thing could happen.

And yet, a brief glance at history, including many occasions in Australian history, shows that the banking system regularly becomes vulnerable. And in each of those occasions it happens when banks extend too much credit…with much of that credit flowing into property.

There is nothing that we can see to suggest that the current credit-fuelled property and banking boom should end in anything other than a credit-fuelled property and banking bust.

That’s another reason we like gold.

Accepting the challenge

We seem to be copping it left, right and centre from subscribers at the moment.

Subscriber Terry B writes:

I am not surprised you don’t like Tesla but it does surprise me that you publish biased and misleading information in support of your view and then recommend that people short the company.

In your article you state that Tesla cannot make a profit selling premium-priced cars.  If you had bothered to actually do any research it is not hard to find that Tesla actually make gross profit of around US$20,000 PER CAR on their sales of Model S and X cars.  The reason for the overall loss is the huge investment in R&D and the new factories for battery and model 3 production. If they weren’t pursuing that development they would be showing a nice profit from those sales.

Also the points from Business Insider are highly USA biased — last time I checked fuel efficient cars were selling just fine in pretty much every market except possibly the USA.  As for a lack of demand for the Model 3 sedan the company is holding something like 400,000 orders (with paid deposits) before the car has even started shipping – that doesn’t exactly seem like a lack of demand.  Can you name one other car that has ever had that many pre-orders before it was even released?  Of course Tesla is also working on the Model Y which will be an SUV style vehicle built on the same platform as the 3 (just as the X shares the same platform as the S) so there will be an option for those that don’t want a sedan.  Finally I wouldn’t classify the Model 3 as a small sedan – it is roughly the size of the BMW 5 series sedan.

Is the company high risk?  Yes it certainly is — Musk has bet the whole company on the success of the Model 3 so if that car fails then you are probably right and the shares will go to zero.  However if it succeeds and they do hit their production target (which I think is ambitious but certainly possible) they will essentially go from a minor player to producing almost the same number of cars as Ford USA (and remember the 2018 production will be almost all USA bound — overseas deliveries of Model 3 are likely not to start until late 2018). Tesla will also enjoy the benefit of the first mover advantage in the electric car business and other companies are going to find it hard to catch up given the cost advantages Tesla will have with their Gigafactory (unless one of the others can come up with a better battery technology which is certainly possible). They also seem to have the most capable self driving system in a production car which could also be a huge competitive advantage.

It would be a brave person indeed who bets against Elon but if you wanted to put your money where your mouth is I would be happy to have a friendly wager with you and I will back Tesla to succeed.

We’ll accept Terry B’s wager. We’ll make it the usual bet. [Ed note: See the movie Trading Places.]

Of course, it wouldn’t be reader mail if we didn’t have at least some friendly back and forth.

On Terry B’s point about Tesla Inc. [NASDAQ:TSLA] being profitable, we’d point out that, if it wasn’t for the R&D spending, Tesla wouldn’t have a product to sell.

In other words, the R&D isn’t an incidental expense, it’s a core expense. Not only that, but car manufacturing is highly capital intensive. High capital costs occur each and every year. Producing a new or updated model isn’t as simple as flicking a switch.

It requires re-engineering, new designs, and perhaps even new machinery. Just ask Ford Motor Company [NYSE:F] and General Motors Company [NYSE:GM]. It’s why both businesses, along with most other car companies, have such small margins.

Why should anyone believe Tesla will be any different? Of course, Tesla could stop R&D, and in the short-term it would give them a pop in profits, due to lower expenses. But that wouldn’t last long, because any pause in reinvestment would put the company behind its competitors…so it would have to ramp up spending again.

Although so far, the more Tesla spends in R&D, the bigger its losses. So that’s not working either. That’s another reason we consider it to be a crappy company.

On another note, check out this data from Greencarreports.com:


chart image
Source: Greencarreports.com
Click to enlarge

Look at that. Canada, a country with a population of 36 million people, has bought fewer than 2,500 electric cars so far this year. Tesla has sold a whopping 414 vehicles in Canada in the first two months of the year.

You’ll forgive us if our excitement fails to rise above the level of a Canadian pancake on a sidewalk.

Only the name is different

The Trump Trade takes a new turn.

As Bloomberg reports:

The U.S. launched a cruise missile attack against Syria two days after Bashar al-Assad’s regime used poison gas to kill scores of civilians, an act that drew international condemnation and that President Donald Trump called “an affront to humanity.”

During his election campaign, Donald Trump portrayed himself as a non-interventionist.

But, like his Republican predecessor, George W Bush, when the opportunity came to meddle in foreign conflicts, it was just too much to resist.

And as Bloomberg also reported, ‘Gold Surges as U.S. Launches Missile Strikes Against Syria’.

The mainstream Trump Trade involved buying stocks; specifically, big blue-chip stocks. Our Trump Trade was always different. It involved buying gold, and, for leverage, buying speculative gold stocks.

With the gold price currently up more than 1.1% since the Syria strikes this afternoon, we’d say our Trump Trade remains active. Details here.

Today’s guest essayist

This week, we’ve run guest spots from our team here at Port Phillip Publishing.

It’s an opportunity for them to showcase themselves and their ideas. Today, Callum Newman takes up the guest spot. Callum has his own take on the markets, using a mixture of technical analysis and fundamental trend analysis.

Whatever the subject, he always has something interesting to say, and does a good job saying it, too. Read on for Callum’s take today…

Cheers,
Kris

From Bonds to Equities…

Callum Newman

I happened to see something extremely important this week. And yet, for most people, it was almost certainly entirely unremarkable.

It was the portfolio breakdown of Japan’s Government Pension Investment (GPIF) Fund.

Don’t yawn — this fund controls over $US1 trillion in assets.

Here’s the deal: The zero interest rate policy from the Bank of Japan is forcing this fund to change its allocation mix. It’s shifted out of bonds and further into stocks.

In 2014 the GPIF held 48% of its assets in Japanese government bonds.

As of December 2016, that’s now down to 33%.

It’s split the difference between two sectors: Japanese shares, and overseas shares.

Markets are never static. The bonds GPIF holds have different time lengths. As some ‘mature’, the Japanese government pays them off and auctions new bonds with fresh maturities and payments.

The fund managers have to decide what to do. Do they reinvest the money back into the bond market or allocate it elsewhere?

The GPIF set new limits in 2014 on their portfolio breakdown. They raised their exposure to shares.

They may need to do it again. The GPIF has to earn a certain return to pay out its obligations.

The odds of them doing that by buying Japanese government bonds are not good.

They have a choice: Earn nothing in Japanese government bonds or take on higher risk in either Japanese stocks or foreign assets.

It appears the GPIF is directing new cash from bond redemptions into short-term assets.

These short-term asset holdings are now at the second highest level on record.

That looks to me like the GPIF is waiting while it assesses what to do. You see, back in 2014, the ‘reflation’ trade in Japan was expecting to take Japanese yields higher. It hasn’t.

That’s leaving Japanese asset managers with a difficult choice. They can’t get the return they thought they could.

But investing overseas means taking on currency risk. That can be hedged, but at further cost.

Regardless, they may have no choice.

GPIF head honcho Norihiro Takahashi has already expressed an interest in Donald Trump’s infrastructure plans. Infrastructure assets can give him what he needs — stable cash flows over the long term.

What’s true of the US is also true of Australia. Should the government decide to further invest in infrastructure, there’s plenty of Japanese investment capital around that can fund it.

Part of this money could — and I emphasise the ‘could’ here — flow into Australian stocks.

The Australian stock market currently trades on a dividend yield of 4%.

That’s about average historically. See for yourself…


chart image
Source: MarketIndex.com.au
Click to enlarge

But notice how it has often gone much lower over the years. There’s certainly the potential for that to happen again.

What’s true of Japan is true of asset managers worldwide.

Here’s a list of 10-year bond yields from some major developed markets.

If you bought these bonds now, this is how much yield you’d get for your money…

UK: 1.10%

Japan: 0.05%

Germany: 0.26%

US: 2.34%

You can see where further demand for US Treasuries can come from here too.

But asset managers in Europe, the UK and Japan are left with little choice but to look outside the bond market to generate the returns they need.

Any investor holding maturing bonds is going to face the same dilemma as Japanese fund managers do now, unless government yields move up significantly.

Now, there’s no guarantee any of this money will come into Australia. Only that it could.

It may head into US, or European, or Chinese stocks. But, to my mind, there’s plenty of money that could still go into stock markets worldwide.

Don’t jump off the bull market bandwagon yet.

Goodbye to the Aussie backyard

In a recent issue of Cycles, Trends and Forecasts, we pointed out that the great dream of a big backyard in Australia is becoming a lot harder realise — and certainly a lot more expensive.

Surging land values mean that the once-famed quarter-acre block is really no longer an option for the average wage earner — close to the capital cities on the east coast, anyway.

And yet that’s exactly what most families want. Parents want their kids to grow up with a garden — safe and secure — to play in.

We told our subscribers to look for suburbs with big blocks and old houses with development potential. Those types of properties are in demand from genuine home-owning buyers — but also developers.

Of course, any developer usually immediately knocks down the house and puts up several units or townhouses.

But we can see the underlying trend driving this from recent figures relating to lot sizes.

They’re shrinking.

Median lot sizes have fallen 10% in Sydney and 5% in Melbourne.

This is one way land prices can keep rising. Either by allowing more units on the same land, or by allowing higher (as in height limits) development.

The advice that you should look for the biggest blocks you can find in the right areas still holds true.

Developers will have no choice but to eke out more revenues from the land they have.

Australia getting richer, but not any fairer

We hear about gigantic debts all the time. They’re all over the world, and constantly evoke fears of another major financial crash.

And there’s certainly plenty of debt right here in Australia. We’re infamous for having the second highest ratio of private sector debt to GDP in the world.

The other side of the balance sheet doesn’t attract nearly as many headlines.

Here it is in a nutshell: Australia is a rich country, and getting richer.

Last week, the Reserve Bank of Australia revealed household wealth hit a record $11.7 trillion last quarter.

Household debts have risen 32% in the last five years, but household assets have gone up even faster, at 51%.

This is mostly thanks to the rise in house prices and superannuation.

Here’s how the RBA summed it up:


chart image
Source: Reserve Bank
Click to enlarge

Cash holdings topped $1 trillion for the first time ever too. That’s a lot of money that could come out to drive all sorts of spending.

However, part of the rise in deposits is because households are using offset accounts against their loans, which makes for an interesting dynamic.

According to The Australian, Westpac has suggested that factoring this in means Australian households’ net levels of debt are still below the 2007 peak. Analysis and data here is actually rather opaque, considering the importance of these numbers.

It does mean we have to be a bit more diligent than simply swallowing the headlines, especially when it comes to the prospect of rising rates crashing the property market. There looks to be a buffer here.

There’s a further point to this: Australia may be getting richer, but that does not mean it’s getting fairer.

Note this point from the Australian Bureau of Statistics regarding the most recent rise in household net worth: Most of the gains came from a $247 billion increase in home and land values.

If you don’t own a part of those properties, this rise in wealth is mostly meaningless to you. You’re just left with the weakest income growth seen in years.

You can see part of how the rich get richer here. They have the cash flow to gear into real estate to capture these gains. Big super balances can cash in on rising share markets worldwide.

This is why you must have exposure to asset markets — as aggressively as your temperament and finances allow. Wage earners are left for a life of mediocrity as far as wealth-building is concerned.

Even more galling, the Reserve Bank is on the lookout for big ‘pay hikes’ as a risk to inflation. In other words, it’s OK for house prices to go through the roof, but not wages. Oh no, that’s inflationary!

You have to put yourself on the side of the asset owners. The system will grind your money and savings into the dust otherwise. The data keeps showing it.

That means building exposure to property and stocks.

Don’t wait around for the world to end.

Best wishes,

Callum Newman