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$6 Million Dollar Homes and $10,000 Gold!

07 April 2017

Whilst not as headline grabbing nor as strong a start to the year as we witnessed in 2016, Q1 of 2017 has been kind to precious metal investors, with gold and silver prices rising by 7.88% and 13.20% in USD terms respectively.

Given the over 6% rise in the value of the Australian dollar vs. the US dollar over the quarter, price growth was more contained for precious metal in AUD, with gold rising 1.50%, whilst silver was up by 6.50%.

You can see these returns in the table below. 

Source: ABC Bullion

Platinum and Palladium also enjoyed relatively strong starts to the year, making for a good quarter for investors across the whole precious metals complex.
In terms of the intra-quarter performance, the movement in the gold price in both AUD and USD across the past three months is captured in the graph below, with gold rising by close to USD $100 an ounce in the first two months of the year, before pulling all the way back toward USD $1,200 an ounce by mid to late March. 

As you can see, gold held firm at that USD $1,200 an ounce level, with the last 10 trading days of the quarter were particularly rewarding, with the yellow metal putting on close to $50 an ounce in USD terms. 

The move to close out the quarter was exceeded in Australian dollar terms, with the local currency pulling back over the past couple of weeks, after at one point threatening to break out above $0.78 versus the US Dollar.

Despite the solid return that we’ve seen in precious metals these past three months, there has been nowhere near the enthusiasm nor attention on the market that we saw last year, when gold’s glistening start to the year saw JP Morgan announce a “new bull market in gold”.

We put the comparatively low profile rally in precious metals this year down to a number of key factors. Firstly, Brexit and Trump are now reality, not potential ‘black swans’, which they were in 2016.

A year ago, markets were nervous, whereas today, they’ve processed and dealt with them. Article 50 has been triggered, and Trump has spent a couple of months in the White House, without any major geopolitical flare up (though the situation in Syria is fast detoriorating with news of US airstrikes) or financial market crash.

Secondly, there is much greater optimism around growth and corporate earnings, much of which is related to Trump and his low tax/regulation busting/pro-business agenda. That has been a major boost for equity market valuations and returns, which has to one degree or another limited the demand for risk-off assets like gold.

It’s important to remember that even here in Australia, the ASX has gone from below 5,000 points in February 2016 (when the gold price rally was in all the headlines) to over 5,800 points as it stands today. That is a quite monumental rally, and is visible in the chart below, which shows both the decline in equity markets from early 2015 to early 2016, and the subsequent rally we’ve seen in the past 12 months. 

ASX 200 From December 2014 to March 2017

Source: Australian Stock Exchange

Given the rally in risk assets, as well as the relatively hawkish Fed, it is no surprise that there isn’t quite the same appetite that there was for gold as there was for gold at this time last year.

Indeed, one could argue that the rally we’ve seen in Q1 2017 for gold is even more impressive, given the lack of enthusiasm for precious metals in the marketplace right now. It’s proved very resilient even without a major macro catalyst to push it higher in the last three months.

Short-term, we are neutral on the outlook for gold in USD, though if it can decisively push through the USD $1,260-USD $1,270oz range, we think it will go on to test USD $1,300oz in relatively short-time.  

Either way, the chart below shows how important a juncture we’re coming to in the gold market, with the 60 day and 200 day moving average looking to converge around the USD $1,260 ounce level.

There are no guarantees, but the chart does look somewhat similar to what we saw back in early 2009, with the 60 day moving average looking like it will soon cross over the 200 day moving average, with the latter turning higher too.

In Australian dollar terms, we are more optimistic, owing to expected weakness in the AUD.

Spreads on yields between US and Australian government debt continue to decline, and are back at levels last seen 15 years ago, when the Australian dollar was closer to USD $0.50 than the USD $0.75 it’s sitting at today. This can be seen clearly in the chart below. 

Australian interest rate markets are starting to warm to the idea that the RBA will end up having to cut interest rates again (a move we’ve long expected, not that we advocate it), though cash futures still indicate rates will be heading in an upward direction by next year.

This is wrong in our view, and will lead to a decline in the AUD once the market reappraises the likely direction of domestic interest rates. 

Debt Challenge Getting Worse
Most interesting chart of the week definitely goes to the team at the Institute of International Finance (IIF), whose global debt monitor for April 2017 highlighted clearly the worsening debt to GDP ratios in both mature (developed) and emerging markets.

As you can see from the below, debt in developed markets has risen from USD $56 trillion in 2006, to USD $160 trillion by end 2016, an increase of over USD $100 trillion, with debt now pushing 400% of GDP.

The situation is just as alarming in emerging markets, with debt to GDP ratios rising by more than 100% over the past 20 years, and debt levels themselves rising by the better part of USD $50 trillion, with most of that debt accruing in the last 10 years alone. 

In reality, what these ratios highlight is not so much a debt crisis (debt is in and of itself neither a good nor bad thing), as an unproductive asset crisis, with the world awash in misallocated capital.

Had the monies that have been borrowed over the past 20 years been productively invested, then output would be much higher, and the ratios between debt and GDP would not be anywhere near as alarming as they are.

The chart above highlights the alarming and unsustainable path we’re on. Debt and asset write offs, either via contractual abrogation, inflation, or some combination of the two, are the only way out.

$6 Million Homes and $10,000 Gold!
This week we couldn’t help but notice a great article in Business Insider, which referenced some research from demographers McCrindle, who forecast that homes in both Sydney and Melbourne will cost more than $6m in 2037, should current price growth rates be extrapolated into the future.

Looking at the last twenty years, the report noted that:
  • The average Sydney house price has increased more than five-fold to $1,190,390 from $233,250 in 1997
  • Melbourne prices are up more than six times to $943,100 from $142,000
  • In 20 years, average annual full-time earnings have not quite doubled to $82,784 from $42,010 in 1997
  • In 1996, the average Sydney house was 5.6 times average annual earnings while in Melbourne it was an affordable 3.4 times
  • Today, Sydney homes cost more than 14 times average earnings and in Melbourne more than 11 times
The rise in house prices in Melbourne and Sydney, as well as other major capital cities is included in the chart below, with the authors noting that; “Young people today need almost three times the purchasing power that their parents needed to buy the average place.” 

Going forward, the idea that the average house will cost more than $6m is absurd, in that there is only so high the multiple of income that a house costs can possibly go. Having said that, given the impact that inflation has on the value of money itself, higher nominal prices over time are indeed very likely.
To that end, we’ve looked at what the price of an Australian house might be in 2037, assuming no ‘real’ capital growth over the next twenty years, though we’ve also assumed they do keep up with the average rate of inflation, which has averaged 5.4% since 1970.
Note that we’ve calculated the average house price today by weighting the 2017 average price of each city by the population in each city, so Sydney, with a population of 5 million, is 31% of the 16.2 million people living in the cities mentioned in table above.
This gives us an average Australian capital city house price of $861,050 today, which would “grow” to $2,465,135 in nominal terms by 2037. That also sounds like a crazy number, though it does illustrate just how inflation works, turning impossible sounding numbers into mathematical certainties over time.
Interestingly enough, were gold to match its historical return figures over the next twenty years, then it would be trading at over AUD $9,000 an ounce in 2037, though its “real” gain in terms of purchasing power would obviously be much lower than the nominal gain. 

The RBA Talks Housing, and Bank Notes!
Continuing on with the housing theme and there has been no shortage of talk about an Australian housing bubble in the financial news media this week. The following image, which came from an article in the widely read CuffeLinks financial news website, captures the mood neatly. 

Wall to Wall media coverage

The government, the RBA, ASIC and APRA have all been in the news with their latest views on the housing market, with an overall view that investor loan growth needs to be contained, lending standards need more rigorous oversight, and the banks likely need to hold more capital.

Many financial market commentators have also weighed in, with quite a view trying to make the argument that the primary cause of Australia’s extraordinarily expensive housing market is a lack of supply.

Whilst there is no doubt that limited supply of certain types of housing in certain areas is a factor, we think it is patently wrong to focus on supply as the primary driver of our housing market.
Australia’s record high debt to income ratios, bank lending preferences, risk weightings, and government policy (on everything from CGT discounts, negative gearing to asset tests for pensions) are far bigger drivers in our view.

To help put the debt to income ratios in perspective, consider the chart below, which shows business vs. household debt as a percentage of GDP in Australia, with a time period covering nearly 170 years. 

Source: Cuffelinks; “Debt Binge main cause of house price rises” – April 5th 2017

As you can see, ever since the 1970s, Australian households have continued to lever up, leaving us in the dangerous position we are in today.

If supply really was the major issue, and the market had not moved well beyond fundamentals, then yields would be much higher on property than they are, and rental growth would have been much closer to the growth in housing values over the past couple of decades.

That has of course not been the case.

Furthermore, were housing affordability issues primarily caused by limited supply, then there would arguably be no need for the Council of Financial Regulators (RBA, ASIC, APRA, etc.) to be issuing the warnings they are, nor pressuring the banks and the government to change their lending practices and housing policies respectively.

One other snippet of interesting information from the RBA governor’s speech was his discussion around the opening of the RBA’s new banknote distribution centre and vault in outer Melbourne (its nice to know we still manufacture something in Australia).

Whilst central banks can and do create money out of thin air these days, they do take the security of the bank notes themselves very seriously, with new $5 notes already in the marketplace, which will be followed by new $10 notes in September this year and new $50 notes in 2018, according the speech.

The new security features of these notes will supposedly make it harder for counterfeiters (yes, yes, the irony is rich), with the RBA stating that the new vault is its first major investment in banknote storage and distribution for decades.

The data points I found most interesting about this section of the speech were the fact that, according the RBA governor:
  • There are 1.5 billion banknotes on issue in Australia
  • This works out at 62 per person in Australia
  • The value of banknotes, relative to GDP, is at its highest point in 50 years
Interesting data points when one considers the incredible leap forward made in the last few years re tap and pay technology, declining ATM use, and all the noise about a cashless society. 

Talking Gold with Port Phillip Publishing
To finish off this week’s update, I wanted to re-link to a podcast we recorded with Kris Sayce from Port Phillip Publishing.

The discussion focused on all things precious metal related, including:
  • The core reasons to include gold in a portfolio
  • Interest rate hikes and their impact on the gold price
  • Why Australian investment professionals continue to overlook gold
  • Analysis of the pros and cons of physical gold re gold ETFs
  • The “case” for $10,000 gold and $25 beer
  • Potential asset allocations for gold in a portfolio
  • Why silver is likely to outperform in the years ahead
We also discussed the opportunities for investing in gold in Australia, including using superannuation, and the ABC Bullion Gold Saver, which has proved a very popular product with clients at ABC Bullion since it was first launched in May 2016.

You can access this podcast here.

Until next time,
Jordan Eliseo

This publication is for educational purposes only and should not be considered either general or personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help of a licensed financial adviser. Performance is historical, performance may vary, and past performance is not necessarily indicative of future performance. Any prices, quotes, or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness.