Bernanke is trying to tell the market he wants to ease off on the rate of those purchases at some point. His communication policy hasn’t gone down too well, and market interest rates are heading higher as speculators panic. This could threaten weak US economic growth in the coming quarters. It’s already under pressure from a roughly US$400 billion contraction in the Federal budget this fiscal year.

While the risks to the US economy are well known, the impact of tighter US monetary conditions on China are not. So in today’s Reckoning we’ll take a look at what Bernanke's tapering, real or otherwise, means for Australia's largest trading partner.

If you’re sick of hearing us bang on about China's economy (and we know some people are) you may want to stop reading now. We got this in our inbox the other day:

‘The impossible challenge would be for Greg Canavan to write just one page on anything without trying to empty a bucket of shit on China!!

‘Give it a rest Greg and try to peddle your newsletters by other threats.’

Well, we gave it a rest yesterday. Today we feel rejuvenated. So we’ll get stuck into it.

But don’t mistake our China bashing for anything more than concern for the enormity of the problems there and the potential impact on Australia. Because the impact will be huge. It’s just that we’ve had it so good for so long, the Australian commentariat have no imagination when it comes to the potential economic problems we face.

We’ll give you a small example of Australia's economic complacency. Our New Zealand colleague recently visited the office here in Melbourne. He stayed at a hotel about 4kms away. One morning, in trying to get in to work, about four cab drivers refused the fare. Only a belligerent concierge eventually forced a cabbie to take the fare. Not every trip is a ride to the airport, boys!

And as economic clouds begin to gather on Australia’s horizon, there are increasing calls about the possibility of Australia slipping into recession for the first time in over 20 years. These ‘doomsayers’ have elicited a patronising response from people like Treasurer Wayne Swan. They’re accused of inciting fears, talking down the economy and — this one is our favourite — ‘talking the country into recession’.

You know the saying ‘ignorance is bliss’, right? Well, the politicians and entrenched interests in this country (or any country for that matter) want to keep you in a blissful state so they can stay right where they are. Enlightening you is not a part of their job description. And they really don’t like it when others try to enlighten you. It upsets their narrative. 

So getting back to China. We’re not trying to fear-monger or drop a bucket of faeces on the place. We’re trying to dig deep into the morass created by a credit boom and trying to work out what it means for you.

The rise of China's economy began around 2003. Ultra-low interest rates in the US kick-started the boom. Because China pegged its currency to the US dollar, it effectively imported easy US monetary policy.

You can see the effect of this in China’s accumulation of foreign exchange reserves (mostly US dollars, and euros too). China began 2003 with reserves of around $US350 billion. In the space of just 10 years, those reserves have ballooned to around US$3.5 trillion — a 10-fold increase.

These reserves, purchased with newly printed yuan in order to keep the exchange rate low, provided the fuel for China to engineer its own credit boom in response to the 2008 credit crisis. The boom got underway in 2009 and is still going. Fitch ratings agency says it’s ‘unprecedented in modern world history’.

Credit bubbles can continue for longer than nearly anyone expects them too. And they go on so long that most observers simply cannot see a catalyst to end the boom. But Fed tapering, or simply threats to taper, could be the catalyst that sends the China boom bust.

That’s because the threat of tighter monetary policy, or, to be more precise, the threat of ‘less loose’ monetary policy, causes a reversal in speculative capital flows. Such a reversal puts pressure on the most fragile parts of the financial sector.

And you’re seeing evidence of that pressure in China's economy right now. A key measure of banking sector liquidity, the interbank lending rate known as SHIBOR, has surged in recent weeks. That tells you that cash is tight, and no one really wants to lend to each other at low rates. The higher lending rates reflect the higher perceived risk in the system.

And it’s not just perceived risk. A few weeks ago, there was a technical default in the banking system as China Everbright Bank couldn’t come up with the cash to repay a loan on time.

These are warning signs, in the same way that the failure of various sub-prime lending vehicles in 2007 was a warning sign of the looming credit crisis. If it follows the same path China's economy will have a very hard landing and Australia will feel the full brunt of it. For better or worse, we’ve hitched our iron ore wagon onto the tail of the red dragon. What happens in China will matter here…big time.

That’s not fear-mongering. That’s reality. If you think China can manage the fallout you’re not thinking. The US, with the most sophisticated capital markets in the world and a huge amount of self-interested parties trying to save the system, only just managed to pull it off. How is it that China will avert a similar fate?

We don't know how events will pan out from here. We just know it's better to have your eyes wide open than eyes wide shut. Ignorance is bliss while the going is good…but it can be a wealth destroyer when things change.  

Regards,
Greg Canavan
for The Daily Reckoning Australia

From the Archives…

Truth or Dare Time for the Investment Industry
14-06-13 – Vern Gowdie

The Launch of Revolutionary Tech Investor
13-06-13 – Kris Sayce

The Architecture of Oppression
12-06-13 ­– Dan Denning

The Upside of a Dive to 85 for the Australian Dollar
11-06-13 – Dan Denning

Courting Controversy Over Australian Property
10-06-13 – Dan Denning

• The Next Bubble in China’s Economy
• China’s Economy – How the Devil is in the Detail
• China’s Monetary Policy
• China’s Export Growth is Growing Old
• China’s Great Old Credit Boom

The lithically-minded visitor is delighted. He can admire stones all he wants. But the global-warming enthusiast would have been disappointed with this past weekend. Even the stones shivered. In mid-June the days are as long as an arctic night...and just as cold.

Yes, the chilly wind whipped down the Royal Mile and kept going for many miles more. The rain came down at an angle. Tourists bent into it trying to keep themselves moving ahead. Wrapped in sweaters, scarves, hats and coats, they crowded into the castle and the tea shops.

The poor North Americans didn't know what had hit them. In their shorts and tee-shirts, they must have wondered if they had gone through some strange time warp. They were not six hours ahead of time at home...they were six months ahead. It felt like bleak December, not sweet midsummer.

‘Of course, the big concern everybody has now is how we are going to get out of this,’ said Gillian Tett.

We found ourselves onstage on Friday with Gillian, an assistant editor at the Financial Times. She was not talking about getting out of Edinburgh or avoiding the inclement weather. She was talking about QE and ZIRP, the Federal Reserve's EZ money policies...which currently increase the US monetary base about 100 times faster than the growth of the economy.

The occasion was the annual Financial Luncheon put on by the Prince's Trust in Edinburgh. The committee had asked Gillian... and your editor...to speak.

You already know what your editor said. He pointed out that central banks' monetary policies had become a kind of financial Doomsday Device.

Hold the button down too long and it is almost impossible to stop. Because the longer the Federal Reserve hands out the cheap credit, the more zombies get in line to take advantage of it.

As time goes on, more and more people want to see the program continue...and fewer can survive if it doesn't.

Some rely on ZIRP to roll over their debt.

Some count on low mortgage rates to build, sell, or buy houses.

Some depend on the Federal Reserve to finance government deficits and keep money flowing to the growing Zombie Class – including banks, Wall Street, disabled people, food stamp recipients, military contractors, retirees and chiselers, layabouts, and schemers of all sorts.

Almost nobody wants to turn off the tap.Gillian had a more measured outlook.

‘I met with Alan Greenspan and Paul Volcker in Washington last week,’ she began.

That must have been interesting, we thought. A real contrast. An honest, stand-up guy and a snivelly schmuck together in the same room.

‘The real issue on everyone's mind is the same. How can you get back to normalcy? Debt levels will have to go down. It will have to happen someday. But how?

‘The good news is that it can happen without a major calamity. It's already been done once – after World War II. Back then average sovereign debt-to-GDP levels were nearly 100%.

‘What happened then was also a form of repression... but it was barely noticed. Inflation rates rose while bond yields remained low and the economy grew. This had the effect of reducing the real value of debt without triggering an economic shutdown.

‘This was not the intended, or expressed goal of central bankers at the time. But the result was that much of the war debt was inflated away. Debt levels went to normal levels after a few years. And then interest rates could rise.’

How about that, we thought to ourselves. The Federal Reserve was successful by accident. Probably the only way it has ever been successful. Gillian went on...

‘The calculations I have seen suggest that the same thing could happen now. But it will take at least seven years to achieve this sort of ‘soft landing’.

‘The trouble is, landing a plane over a seven year period is a very difficult thing to do. There are two presidential election campaigns in that period. It is hard to imagine that the economy, the markets, the Fed, and the federal government will be able to keep themselves headed in the right direction for that long. It would be nice to think this soft-landing could happen. But I don't think it is very realistic.’

Gillian didn't mention it. But the ‘soft landing’ she described could only happen if the pilot were willing... and able.

Ben Bernanke and his team are neither.

As we pointed out in our talk, the last time the Fed voluntarily achieved a landing of any sort was when Paul Volcker was at the controls.

Volcker was an exceptionally confident and courageous Fed chief. And President Reagan had his back. Even so, it was a close run. The economy went into the worst recession since World War II. So great was the pain...and so intense the furor against Volcker...that he was burned in effigy in Washington.

Mr. Bernanke, had he the brains and cajones to ‘pull a Volcker’, would probably be burned in New York.

(Nobody seemed to get the joke in Edinburgh, either.)

But anything is possible. And, as we pointed out on Friday, Mr. Market is an exceptionally unpredictable dude. Just when you think you have him figured out, he will sneak around behind you... and do something entirely unexpected.

Stay tuned...

Regards,

Bill Bonner
for The Daily Reckoning Australia

From the Archives…

Truth or Dare Time for the Investment Industry
14-06-13 – Vern Gowdie

The Launch of Revolutionary Tech Investor
13-06-13 – Kris Sayce

The Architecture of Oppression
12-06-13 ­– Dan Denning

The Upside of a Dive to 85 for the Australian Dollar
11-06-13 – Dan Denning

Courting Controversy Over Australian Property
10-06-13 – Dan Denning

• Volcker, the Last Central Banker in America to Have Any Real Integrity
• The Stinging Reproach of a Former Fed Chairman
• Ben Bernanke’s Hot Money
• More Background Noise From Ben Bernanke
• How to Survive Inside China’s Financial System

I asked him about the backstory to the company. It turns out that he moved in 2008, six months before the U.S. real estate markets blew up. He left to escape the worst of it. How did he know that the downturn was coming? His answer came quickly: ‘The yield curve inverted.’

Fascinating.

I was just reading about this very indicator in Mark Skousen's new book, A Viennese Waltz Down Wall Street. Here, Skousen, investor and economist, explains how the teachings of the Austrian School provide some excellent rules of thumb that allow us to anticipate, and act on, the big turns in the business cycle.

In the Austrian view tracing back a century ago, interest rates indicate the preference for goods sooner, rather than later. If you don’t have the money to get the stuff, you borrow for some period of time. Borrowers pay a higher rate if their payback term is longer.

That’s because the risk is higher — who knows what’s going to happen in 30 years? — and lenders expect a higher payoff to wait longer for their money.

So naturally, the yield curve should show lower overnight rates than five-year, 10-year, or 30-year rates. That’s why the normal yield curve is positive — that is, upward sloping to the right.

What does it mean for the yield curve to be negative? It’s a bit like water running uphill. You can be pretty sure that there is some seismic shift going on. Usually, it means a Federal Reserve tightening. Or it could mean that investors are expecting bankruptcies in the future. It is highly predictive of a coming recession.

When it happens, you can also be sure that hordes of television pundits and economists will emerge to say that there is nothing unusual here. It is a perfectly normal thing, and it’s even healthy — certainly nothing to be alarmed about.

My friend Skinner knew better. How? He had been reading the work of F.A. Hayek and Ludwig von Mises for years. He knew that there are certain constants in economic forces that do not change, no matter what government does.

In fact, government and central bank attempts to manipulate the market can have exactly the opposite effect of the advertised results. TV pundits are quick to agree with everything the Fed does. To spot the policy errors requires special knowledge that comes from reading sound economics.

That doesn’t mean that once you learn economics, you can predict the exact timing of events. In fact, this is also one of the observations of the Austrian School: There are no predictable quantitative relationships in the world of human action. This too differs from the mainstream view, which is forever seeking the magic formula to predict price movements.

I like the way Skousen describes financial markets. He says that prices in markets are like a dance. There are patterns and habits at work. But there are also surprises and improvisations going on. That’s part of the spirit of dance too.

But the crucial thing here is that it takes two people to coordinate their moves in a dance, just as in markets, it takes buyers and sellers to make a price. Financial markets bring people together to their mutual benefit.

Nice image, isn’t it? It’s one that he elaborates on at length. In the course of his argument, he criticizes other points of view that don’t account for human decision-making and don’t account for the parameters of those decisions as set by economic reality.

For example, just as dancers can’t start flying, markets can’t sustain parabolic price increases in one sector forever, even with Fed intervention.

Why did Skinner choose Chile as his home? Well, he knew it to be the most pro-enterprise country in Latin America, at least so far as he could tell. His reading in the Austrian tradition helped him see why this is important.

And he likes Latin America because it is the new world and doesn’t have economies bogged down by bad habits and massive welfare and regulatory bureaucracies. There is far less sludge in the system to harm economic growth. For this reason, he is very bullish on the whole region — and bearish on the U.S. and Europe.

This too reminds me of something else explored in the Skousen book. He discusses how institutions affect economic growth and can help people make better predictions about coming economic booms.

A regime that is friendly to free enterprise might lower taxes or cut regulations. Even a little bit helps. Economies are like sponges for this stuff. Just a bit of encouragement — or, more precisely, just a bit of relaxation of the fetters — can spark huge economic booms.

This is why Skousen strongly suggests following the politics of a country to understand its economic future. He goes so far as to slightly scold fellow Austrians for holding a permanent bearish view on economies.

He says that this point of view causes investors to miss economic booms such as, say, those in the 1980s and 2000s. And he is right to this extent: If your goal is to play the markets, it makes sense to be able to discern their upside, as well as their downside.

Monetary policy figures in here substantially. As Skousen says, an economy without a huge debt overhang that is emerging from rough economic times can find itself on an upswing if the Fed is pumping money at a rapid pace.

Under this rule, you might have bought stocks in 2009. The problem is that this approach to economic policy cannot last. It creates new problems that cry out for correction. The tricky thing is to be able to spot the turning points.

What do Austrian economics imply about today’s precarious situation? Well, the Federal Reserve is making loud noises about pulling back its stimulus program. If the drug of new money is cut off, we could see short-term rates rise and blow up the balance sheets of many businesses, not to mention governments.

The beauty of the Austrian School is, fundamentally, this: it sees economics as an extension of human choice. There is nothing mechanical and predictable about it. But there are certain patterns that emerge just from the logic of human action itself.

Skousen’s purpose here is to elucidate that logic and illustrate it with examples from the business pages. The results are interesting: You can gain insight into both worlds. In this book, the rubber of finance truly does meet the road of economics.

I’m intrigued at the confidence with which my friend Skinner took the step to move. Five years later, he has a thriving business and a happy life. He only did it once he had intellectually seceded from mainstream thinking. But just as important, he did it with the aid of solid economic thinking.

Now with Skousen’s book A Viennese Waltz Down Wall Street, anyone can gain access to that knowledge. A selection like this makes a mighty contribution.

Regards,

Jeffrey Tucker
for The Daily Reckoning Australia

From the Archives…

Truth or Dare Time for the Investment Industry
14-06-13 – Vern Gowdie

The Launch of Revolutionary Tech Investor
13-06-13 – Kris Sayce

The Architecture of Oppression
12-06-13 ­– Dan Denning

The Upside of a Dive to 85 for the Australian Dollar
11-06-13 – Dan Denning

Courting Controversy Over Australian Property
10-06-13 – Dan Denning

• Where is the Yield Curve Pointing?
• Economics By and For Human Beings
• The Mistake-Correction Cycle of Real World Economics
• Business Cycle Theory Explained by Joseph Schumpeter
• The Real Wealth of Civilization

Right then, what’s in store for this week? Well, for a change, all eyes are firmly focused on the US Federal Reserve. This cabal of central bankers meet on Tuesday and Wednesday in the US to privately wonder what in God's name is going on…to contemplate the damage they have wrought across the world…and to nervously guess what move they should make next.

Of course, the minutes to the meeting will emerge a month later showing conviction and confidence in any decision made and discussion had. If you don’t really know what you’re doing, you at least should sound like you do.

After all, this is one big confidence game the Federal Reserve is playing. And lately, maintaining confidence has been a bit of a problem for the institution that sets the global price of credit. With all their unconventional monetary actions over the years, they have now got themselves into a spot of bother.

They're creating plenty of asset price inflation, but not much in the way of sustainable economic growth. They have come to the belated realisation that increasing asset market speculation is bad for the economy. It actually makes things worse!

So in order to keep this speculation in check, Fed Chairman Ben Bernanke has introduced the word ‘taper’ into financial markets. As in he will soon (but not too soon) ‘taper’ the pace of asset purchases to wean markets off their heavy dependence on the Federal Reserve.

Like most things espoused by the Federal Reserve's largely academic board, it sounds good in theory. But markets couldn't give a hoot about theory. So they'll be listening intently to Bernanke's press conference following the board meeting this week. It he utters the wrong words, or gets the phrasing wrong, we could be in for a wild ride.

The market is already very nervous. Yields on US Treasury bonds are rising. Over the last 12 months, yields have jumped from 1.6% to around 2.2%. This is representative of monetary tightening across the board.

The chart below shows a sharp jump in the 30-year fixed rate mortgage.     

US Mortgage Rates Spiking Higher

This next chart shows a spike in the borrowing costs for below investment grade corporates. With or without Ben Bernanke and the Federal Reserve, financial conditions are getting tighter.

Below Investment Grade Corporate Rates Spiking Higher

And emerging markets have felt the effect of monetary tightening emanating from the world’s largest economy and manager of the global reserve currency.

Since peaking in January this year, the Brazilian market is down a whopping 22% and Mexico’s bourse is off 14%. Asia is not far behind. Chinese stocks are down 13.5% from the peak in February, while Thailand (-10.8%), the Philippines (-15.6%), Indonesia (-8.7%) and India (-6.1%) are all down from their highs in May.

Now this might just be a correction and nothing to worry about. After all, interest rates are still incredibly low from a historical point of view. You could just be seeing a pullback following a central bank induced liquidity melt-up earlier in the year.

But given the inherent instability in the system…and the fact that nothing has changed to correct the problems that brought about the first big credit crisis in 2007, we would be inclined to take the recent market action as a warning sign of trouble to come.

To understand why, you need to understand how the financial system ‘works’. The US economy is the source of global liquidity. Due to massive US budget and trade deficits, US dollars (in the form of Treasury and mortgage securities) flow out into the world. Countries that stand to benefit the most from the deficit spending soak up the flow of dollars with, in many cases, newly created domestic money and credit.

This has the effect of both financing over-consumption in the US and building up the foreign exchange reserves of the country in question…reserves which the domestic banking system can then use as a base to expand its own credit creation activities. It’s a liquidity-creating positive feedback loop.

While the US economy, buoyed by cheap money, continues to spew ever increasing amounts of greenbacks into the financial system, and emerging market export-dependent countries continue to mop up those greenbacks and increase their ‘foreign-exchange’ reserves, credit and equity markets will tend to inflate.   

But this global dynamic relies on confidence in the ‘system’ to go on creating enough dollars and credit to keep the asset inflation going. And we think that confidence is beginning to wane.

So even though interest rates may still be historically low, it’s the change in rates you should be looking at. And compared to a few months ago, financial conditions are now tighter. And tighter conditions in the US mean tighter conditions around the world. Monetary tightening doesn’t usually inspire confidence amongst financial speculators.

Don’t forget, the US fiscal consolidation plays a large part in this too. For the past five years, the US government has churned out $1 trillion plus budget deficits. But government spending is set to contract sharply following the repeal of the Bush-era tax cuts and some changes to spending. 

The Congressional Budget Office (CBO) now projects that the federal budget deficit will total $642 billion in 2013 and $560 billion in 2014. Last year, the CBO estimated that the deficit would remain over $1 trillion in 2013 and reach $924 billion in 2014.

That’s quite a tightening. The supply of new Treasuries is still high, but it’s the change that’s important and if the government can hit the CBO forecasts (unlikely) it will represent a significant fiscal contraction over this year and the next.

So you’ve got monetary and fiscal tightening going on behind the scenes, combined with hugely inflated, derivative driven asset market casinos where the players want to keep on rolling the dice.

But maybe not all the players. Perhaps what we’ve seen over the past month or so is the ‘smart money’ taking their chips off the table and exiting the building. When this occurred in past tightening phases, it was a prelude to a crash…more on this tomorrow. 

Regards,
Greg Canavan
for The Daily Reckoning Australia

From the Archives…

Truth or Dare Time for the Investment Industry
14-06-13 – Vern Gowdie

The Launch of Revolutionary Tech Investor
13-06-13 – Kris Sayce

The Architecture of Oppression
12-06-13 ­– Dan Denning

The Upside of a Dive to 85 for the Australian Dollar
11-06-13 – Dan Denning

Courting Controversy Over Australian Property
10-06-13 – Dan Denning

• Fed Up with The Federal Reserve
• Federal Reserve and the Huge Tsunamis of Money
• Greenspan and His Demented Federal Reserve Chairmanship
• US Dollar As Reserve Currency Not Working Very Well
• The Federal Reserve Doesn’t Exist to Help Everyone Else

The biggest stimulus program of all time — the Second World War — had come to an end. Millions of soldiers and defence industry employees were out on the streets looking for a job. Most economists and investors thought they'd never find one.

They thought the war had pulled the economy out of the Great Depression. Now that the war was over, they expected it would fall back into its depressed state.

And they believed that interest rates — which had been falling for nearly a quarter of a century — were a forward indicator. Instead, they turned out to be nothing of the sort. The low interest rates of 1946–50 reflected the past, not the future.

The GIs went to work. They took out their wartime savings and started businesses...and families. Soon, the economy was booming.

And interest rates rose...

In fact, interest rates in the US rose for the next quarter century...until the early 1980s.
And once again, investors who looked at interest rates for a hint of what lay ahead were misled. The high rates — the Federal Reserve funds rate was at 21% at one point — reflected the rising inflation rates of the 1960s and 1970s...not the lower inflation that lay ahead.

And here we are. Another quarter century has gone by — and more! Once again, interest rates are at record lows. In fact, they are now close to where they were when we were born.

That's a complete roundtrip!

And once again, they tell us more about the past than the future. They are rising. From the New York Times:

‘It has been a reliable fact of life for investors, corporations and ordinary borrowers: interest rates, for the most part, keep heading lower.

‘But all of that may be about to change. For prospective homeowners, the cost of mortgages has been going up in recent weeks. Governments are also facing the prospect of higher borrowing costs down the road, and they are projecting increases to their debt burdens. Savers with money in bank accounts, on the other hand, have the prospect of finally earning more than a pittance on their deposits. [...]

‘Over the last few months [...] investors and banks have been demanding higher payments for their loans, pushing up interest rates and bond yields.

‘"I think you all should be ready, because rates are going to go up,” Jamie Dimon, the chief executive of JPMorgan Chase, told a financial industry conference at the Waldorf-Astoria Hotel in Manhattan on Tuesday.

‘As investors brace themselves for a new era of higher interest rates, global markets in bonds, currencies and stocks have experienced spasms of turmoil. On Tuesday, the catalyst for the market's volatility was disappointment over the Bank of Japan's decision not to take new steps to address rising bond yields. That heightened worries that other central banks – the Federal Reserve in particular – will soon pull back on pumping money into the financial system.’

We have been witnessing a fight between Mr. Bernanke and Mr. Market. We know who will win it. Mr. Market always wins in the long run. But we have no idea when...or how...he will win.

The latest news from the bond market suggests he is hitting Mr. Bernanke right where it hurts. Bond yields will go up. Mr. Bernanke will go down.

But watch out. Mr. Market is a wily and cunning fighter. He never likes to win his battles in a straightforward way. Instead, he dodges. He feints.

He fools us all...

Regards,

Bill Bonner
for The Daily Reckoning Australia

From the Archives…

Truth or Dare Time for the Investment Industry
14-06-13 – Vern Gowdie

The Launch of Revolutionary Tech Investor
13-06-13 – Kris Sayce

The Architecture of Oppression
12-06-13 ­– Dan Denning

The Upside of a Dive to 85 for the Australian Dollar
11-06-13 – Dan Denning

Courting Controversy Over Australian Property
10-06-13 – Dan Denning

• Next Stop for the US Economy: Train Wreck!
• Why a Real US Recovery Would Mean Disaster for the Economy
• Could this be the Market Mini Meltdown Before ‘The Big One’ Hits?
• Central Bankers Encourage Debt Booms That Become Debt Bombs
• All Eyes on The US Federal Reserve

Per the Christie's fact sheet, the bracelet contains 599 grams (over 21 ounces) of gold. Also, according to Christie's write-up, this item ‘clearly demonstrates the technological advancements of the Iron Age,’ including the use of high-temperature furnaces and intricate tools specialized for metalworking

What is the bracelet worth?

Just the gold alone would fetch about $32,000 at current prices. Then there's the value of piece as both art and a historical artefact. Thus, the bracelet sold in London, at Christie's, for nearly $805,000.

What's the lesson? If archaeologists are correct — let alone the Christie's auctioneers — then gold and precious metals have been a haven for wealth protection for millennia. Still, why discuss this ancient Lusitanian bracelet?

Because there's an important lesson here. This 3,000-year-old relic is more than just a museum curio. It speaks volumes about why we should respect one of mankind's oldest forms of money, and not walk away from gold in the face of its recent price decline.

Indeed, the mainstream media is all but reading last rites over gold. Yet I foresee new opportunities, and I don't mean mere ‘walking dead’ investment analogies. No, I believe that, like that bracelet from Lusitania, gold will continue to come out of the ground and offer great wealth and security to those who are brave enough to stick with it.

Rumours of Gold's Demise Have Been Greatly Exaggerated

What did Mark Twain once remark about his obituary, published in a local newspaper? He said, ‘Reports of my death have been greatly exaggerated.’ It's the same thing with gold.

We've had a superb, 10-year run for gold pricing. Yet we recently experienced a big sell-down. After a decade-long, relatively steady rise, gold prices plummeted from the $1,700 range per ounce to $1,400.

Media accounts — many from the usual suspects — relate that gold is no longer a safe haven for either wealth protection or long-term gains in the face of global inflation. This line of anti-gold argument seems to have popped up on the screen exactly when investors everywhere seek a safe haven in rough economic seas. Like the man says, be careful what you read in the newspapers.

In a curious twist of fate, while the ‘paper’ price for gold plummeted, buyers everywhere walked into gold shops and souks and walked out with everything they could carry. Chinese buyers scooped up physical gold literally with both hands.

What's happening in China reflects what's happening across the world. Individuals are protecting themselves against an oncoming monetary storm. At the retail level, people are buying gold, and lots of it.

From my perspective, it's a harbinger of things to come, and one of the few times you'll ever see ‘small guy’ investors take a position ahead of the so-called ‘Big Money’. That is, usually, the little guy is late to the party. Not now.

The Big Gold Mining Smackdown

The divergence between paper gold and physical metal helps explain what happened with ‘Big Mining’ in recent months. Consider some of the top names, like Barrick Gold or Freeport-McMoRan Copper & Gold.

Gold, silver, copper and base metal miners have all had a tough spring in the share trading pits, losing significant value. It was a smackdown worthy of professional wrestling at its best. What happened?

Well, there's a strong disconnect between the nominal paper price for gold and personal demand for physical metal. Thus, large institutional money has exited the mining space.

That is, gold (and by extension, gold miners) may be an investment for individuals over the long haul, but in the short term, people who run big, institutional money don't see it that way. They fail to see what they call ‘growth’ in the sector and head for the exits.

Right now, large money managers, pension funds, hedge funds, etc., are choosing to buy government and corporate bonds, and bondlike equities, rather than gold. Institutional money has taken the Dow Jones index up to 15,000 and more, while walking away from gold, which — see the Christie's auction, above — has been a store of wealth since long before the days of the Roman Empire.

There's an ‘apples and oranges’ investment issue here. Individual investors can think long term, even over generations. Individuals, however, are not constrained like pension funds, with quarterly performance mandates — for example, ‘assumptions’ of 8% annual returns in a world of Sahara-like overall yields.

Thus, individuals make long-term choices to protect their wealth in gold. Meanwhile, institutions and other Big Money buffaloes follow their herd instinct.

Regards,

Bryon King
for The Daily Reckoning Australia

From the Archives…

Truth or Dare Time for the Investment Industry
14-06-13 – Vern Gowdie

The Launch of Revolutionary Tech Investor
13-06-13 – Kris Sayce

The Architecture of Oppression
12-06-13 ­– Dan Denning

The Upside of a Dive to 85 for the Australian Dollar
11-06-13 – Dan Denning

Courting Controversy Over Australian Property
10-06-13 – Dan Denning

• Gold is the Investment for the Individual
• The Price of Gold is Low – But It Won’t Stay There Forever!
• Investors to Silver: “Let’s Get Physical”
• Should You Put Gold Into Your IRA?
• Why Modern Money Doesn’t Compare to Old Fashioned Silver

It's an oil play in the Texas Midland Basin. It may have recoverable resources up to 50 billion barrels using the new oil extraction technologies.

Peter Tertzakian, the chief economist at ARC Financial, puts it all in context. I give the full quote because it is, to say the least, a stunner:

'Today's North American oil boom, if sustainable, takes us back to the discovery atmosphere of the 1950s and '60s. The potential is hardly limited to the Spraberry/Wolfcamp. North Dakota's headlining Bakken play is conjectured to contain over 10 billion barrels, while the Eagle Ford Shale could be up to 25 billion. If oil follows the path of natural gas, there are likely to be several more 'sweet' mega-plays, including prolific ones germinating in Canada, that could collectively stack up to be the most significant era of reserve additions in the 155-year history of the industry.'

As the late Harry Caray would say, 'Holy cow!'

This oil boom in the US is still young. It still befuddles most geologist types, who can't quite fathom how the cards have changed the game so fast. Since 2008, US oil production is up 43%. It's not long now before the US actually produces more than it burns. It could happen before the year is out. Five years ago, such thoughts would've have brought jeers.

Take a look at this chart from The Wall Street Journal:

Click to enlarge

This wasn't supposed to happen. The geologists said so!

I keep telling people this is a technological revolution. Technological revolutions destroy paradigms. They break things. You have to throw away the old assumptions. They won't work now. This oil boom is a game changer.

Whatever estimates exist, they will surely prove way too low. Technology only gets better and better. Experience tells us how these things work. My favourite example is Kern River.

In 1899, when discovered, experts thought only 10% of its modest production would be recovered. In 1942, the field still held 54 million barrels of recoverable oil - after producing 278 million barrels. Over the next 44 years, it would produce 736 million more barrels. At that point, it had 970 million barrels remaining.

The history of oil is full of Kern Rivers. In light of that long experience, the new discoveries are particularly huge.

Needless to say, it is hard to be bullish on oil with such discoveries in the US alone. And Canada still has its vast oil sands. 'Still a formidable source of supply,' Tertzakian notes, 'but the tight-oil revolution is marginalizing its once awesome size to something that's merely big among others.'

Look at what's going on in the rest of the world. At the Value Investing Congress, Geoffrey Batt, of Euphrates Advisors, talked about the humongous reserves in Iraq.

'Iraq has 150 billion barrels of proven, low-cost oil reserves, the fourth largest in the world,' Batt said. 'Estimates of proven reserves reach as high as 214 billion barrels, which would give Iraq the second-largest reserves in the world, after Venezuela and Saudi Arabia.' Iraqi oil fields require little cash to bring online and are the cheapest in the world to operate once in production. Iraqis can produce oil for as little as $2 a barrel.'

Skeptics will scoff at Iraq, as they did as the Bakken and all the rest. They will be wrong. The oil will come out.

I still haven't talked about discoveries off the coast of Africa or in the South China Sea or Brazil or many other places around the world rich in oil.

'All this is disquieting to oil producers everywhere,' Tertzakian continues, 'especially with retreating Chinese demand growth. Who should be most concerned about this remarkable renaissance? The Saudis? The oil sands producers? Other exporters to the U.S.? Or maybe even the American producers themselves...The jury is out for determining winners and losers.'

I like Peter Tertzakian's work. I have ever since I read his book A Thousand Barrels a Second: The Coming Oil Break Point and the Challenge Facing an Energy-Dependent World. That was in 2006. His thesis was spot on. Oil prices soared.

But he is unlike so many oil commentators who are too often mere cheerleaders for the black stuff. Tertzakian was perceptive. He recognized the revolution in oil and natural gas. Early.

I heard him speak at an oil conference in late 2011. His talk had an impact on me then. Afterward, I wrote: 'His levelheaded and thoughtful presentation blew some of the froth off the beer of the oil crowd by challenging long-held (and largely unexamined) bullish assumptions.'

He made airtight cases for a number of then heretical ideas: that the world could kick its oil addiction by meaningful amounts; that Chinese oil consumption would slow; that American and Canadian oil production would grow - a lot. It was a great talk. Gutsy in how it went against the consensus, it was also well supported with great examples and analysis.

So I have learned not to discount Mr. Tertzakian when it comes to oil and gas.

In the face of all that new production and all those new discoveries, I am not a bull on oil prices. It may be too early to tell the winners and losers among the producers of oil. But there is one clear winner: the users of oil.

Regards,

Chris Mayer
for The Daily Reckoning Australia

From the Archives...

A Disguised Depression in the US Economy
7-06-13 - Bill Bonner

A Genuine Economic Recovery Requires a Genuine Bust
6-06-13 - Greg Canavan

Why it's Going to Get Ugly When Interest Rates Rise Again
5-06-13 - Greg Canavan

Big Trouble in the Australian Economy... Everybody Relax
4-06-13 - Greg Canavan

Why Growth Stocks Could be the New Target of the Big Money Hunt
3-06-13 - Dan Denning

• Pemex and Mexican Peak Oil Equal Expensive Oil
• How to Buy Crude Oil for US$2 a Barrel
• Peak Oil – The Rewards
• What’s the Deal With Oil Prices?
• Peak Oil: Supply Data Doesn’t Lie

Now over to your Weekend Daily Reckoning...

From Nick Hubble in Albert Park:

Before we identify the thief of your capital gains, a quick note to make sure you don't miss out on tomorrow's instalment of the revolution. What revolution?

The one that features telepathic communications, predicting and avoiding the risks to your health  in retirement, and a third mystery technology that promises to cut the travel time between Sydney to London to four hours. You read that right.

And it's not crazy...it's a real project being developed right now by a billionaire with an incredible track record. All will be revealed tomorrow.

Keep an eye on your inbox this weekend for the innovations which could revolutionise business, pleasure and your everyday life.

But, if you haven't already, it's probably best to start with the introduction. It explains your part in the revolution. You'll also find out how it can make you money with the help of our newest addition to the editorial team to guide you through.

Tech guru Sam Volkering and stock tipper Kris Sayce have thrown their lot behind a new service which has them more excited than the 3D printer which arrived in the office last week. You'll be hearing more about that soon too...

But the future only makes sense in the context of the past. So what happened to the money you were supposed to make from the stock market these last few years?

Have you noticed the dismal performance of our Australian index compared to everyone else's? For the last four years of 'recovery', the ASX200 has been underperforming the Germans, Americans, English, Chinese and, yes, even the Japanese!

Our market's in dark blue, down there at the bottom:

Despite our wonderful mining boom, unemployment rate and world's best treasurer - *cough* -  Australian investors are being left behind. But enough moaning, who's to blame? Who stole your capital gains?

Hint: It was an Aussie.

No, this isn't a rant against the ATO or Wayne Swan. We're not even blaming Dave Warner or James Hird. We've got a different Aussie in mind - the Australian dollar.

You see, the Australian stock market has actually been doing rather well. Just not priced in Aussie dollars.

If you were to throw in the gains in the Aussie dollar, that would move the ASX200 to be smack bang in the middle of all those squiggly lines in the chart above.

In other words, if you measure our stock market's performance from the point of view of an American, German or Englishman (God forbid) it's performed very well. That might sound like a 'walked into a bar' joke, but it's really more of a fast one being pulled on us Aussies.

It's a fast one that's difficult to avoid. If you wanted to escape Australia's underperforming market and invest in one of those stock markets that have been rocketing away, you would've done poorly anyway. As soon as you move your money back to Australian dollars, the gains would be reduced.

Unfortunately, you're not a foreigner investing in Australia. So the Aussie dollar's rise has stolen your capital gains from you. Or at least it's hidden them.

But the good news is, the tide is turning. The Australian dollar may soon give your gains back. The bad news is, that's very unlikely, in the short term at least.

You see, the Aussie dollar is likely to tumble at the same time as our stock market does. Both our currency and our stock market are considered 'risk assets'. People invest in them and sell out for the same reasons. So a falling Australian dollar won't happen alongside a rising stock market. It will happen alongside a falling stock market.

The move in the Aussie might take the bite out of a falling market, but that's as good as it will get. Just as the dollar mitigated the rising market, it will mitigate the falling one. That doesn't answer how far or fast the fall will be though.

However, some stocks benefit from currency moves more than others. If you can find those stocks which benefit, you can make the most of the currency's moves.

Why is Australia's Biggest Bear Buying Resource Stocks?

Greg Canavan's trilogy is complete. It will hit the box office next week. Apart from his film crew, nobody knows what he's going to say. But, going by the first two acts, the third is going to be a ripper.

Word is, he's gone bullish on resource stocks. Although it would probably be more accurate to say he's now less bearish than he's been in the past few years.

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That's a surprise to say the least. Greg's previous two instalments were about the end of the resource boom and economic trouble in China - the source of Australia's resource demand. He's been known as the office's China bear ever since.

But now he's a happy bear. You see, Greg waits for the porridge to be the perfect temperature before he buys stocks. And a Chinese slowdown could be exactly what he needs to put his subscribers dry powder to work.

In his newsletter Sound Money. Sound Investments., Greg recommends ahigh allocation to cash alongside his other recommendations. What's the point of a newsletter telling you to hold cash? Well, holding cash could turn out to be a great trade if it's put to work at the right time.

Buying the pride and joy of Australia's economy when they're cheap would be a lovely position to be in. But to get cheap, share prices have to fall first, which they are clearly doing in the resource space.

But back to the currency thief. Part of Greg's predictions include a falling Australian dollar. And he can't wait to see the effect it will have on the stocks he's ready to pounce on. The mining stocks in particular.

Because commodities are priced in US dollars, an Aussie resource company's earnings rise in Aussie dollar terms as the Aussie dollar falls.

So here's the scenario Greg reckons is shaping up: Stock markets are shaping up for a crash, or as he puts it, shares will become good value. The Aussie dollar will tumble too. As a result, the earnings of decent Aussie resource companies will rise in Australian dollar terms. Combine the three and you have a value investor's dream scenario.

While the rest of us fret over a falling market, Greg is getting ready to pounce.

Until next week,

Nickolai Hubble.
The Daily Reckoning Weekend Edition

ALSO THIS WEEK in The Daily Reckoning Australia...

The Launch of Revolutionary Tech Investor
By Kris Sayce

I'm really excited about this project. It's truly like nothing else we've ever published. If like me you're sick of reading about central bankers and government bailouts, and you'd rather read about technology and biotechnology breakthroughs, Revolutionary Tech Investor will be a refreshing change. It will be a banker-free zone

The Architecture of Oppression
By Dan Denning

Anytime the intelligence agencies of a country use secret courts to mine your private digital data without your consent - and without any suspicion of a crime - then you are no longer living in a free society. You're living in a police state. And the tendency of all regimes that accumulate too much power is to abuse it. That's the threat you face now.

What Turns a Great Technology into a Great Technology Business?
By Sam Volkering

In this current global economic environment, a lot of businesses are struggling. There's a lot of doom and gloom about. Yet it seems every other day there's a story about successful technology companies making billions of dollars...But what takes a company from being worth nothing with a great technology to, a billion dollar business?

What Crime Lies Behind Booz Allen Hamilton
By Bill Bonner

Booz Allen earned $1.3 billion pretending to protect approximately nobody from a mostly non-existent threat. What it was actually doing was helping the feds snoop on the law-abiding people who pay the bills.

• Why the Australian Dollar is Not as Strong as You Think
• The Upside of a Dive to 85 for the Australian Dollar
• Credit and Credibility II: The Aussie Dollar
• Nothing More than Feelings… For the Aussie Dollar
• Dividends – How to Combine Reliable Income and Capital Gains

Look no further than the 22% fall in Japan’s Nikkei since it peaked in late May. That’s an impressive little bear market in such a short time. But then, the Japanese are famous for their efficiency. And yesterday was no different. The Nikkei 225 fell 6.5% for the session.

The index is now back to its early April lows. In other words, it’s back to where it was before new Bank of Japan head honcho Haruhiko Kuroda unveiled his grand plans for ending deflation in Japan. All his hot air succeeded in doing was pumping up stocks until all the air whooshed out in a few short weeks.

Whoosh!

Source: StockCharts

But weeks like this will challenge the truisms of the investment industry. Our Family Wealth editor Vern Gowdie — who knows a thing or two about how the investment industry promotes itself — takes a closer look at the relationship between stocks prices and debt levels in one of today's other articles. Vern’s working on a new project with us about how to preserve and grow family wealth during a secular bear market. Stay tuned.

In the meantime, not to pick over the scabs of a fresh wound, but the reader mail on Remembering the Future, our joint venture with economic forecaster Phil Anderson, continues to pour in. Warning! If you are not interested in the property debate, or Phil’s forecast for Australian house prices, you should quit reading now. Seriously. Quit. Just skip this article and head to Vern’s essay. This is your last chance.

Now, if you’re still with us, then welcome back. We have very little to say on the matter that we haven’t already said. But we will make one final point, before getting to the reader mail. And it has to do with transparency, a real battle of ideas, and the risks and rewards of independent publishing.

It’s incredible to us that a reader could think an independent publishing company could lose credibility by publishing a controversial idea. The whole point of not being accountable to advertisers is that we’re free to publish the ideas that are thought provoking and possibly useful. To shy away from controversy in order to avoid causing offence would make us…politicians.

But really, it looks a source of the outrage and incredulity is that Phil’s view on the direction of Aussie house prices is in direct contrast to the view put forward by your editor and several other Daily Reckoning analysts over the years. Have we all changed our tune in order to sell a DVD?

Certainly not. Ask the property bears around here and you’ll find they’re as committed as ever. But you’ll also find they had no objection to publishing Phil’s research because it reaffirms the point that we don’t have a company line that we ask our analysts to tow. We simply ask them to think hard, write well, and try to come up with ideas you’ll find useful.

And at the end of the day, that’s who ultimately decides our fate: you. The great thing about the online publishing business it’s that it’s completely transparent. We couldn’t hide if we tried. And we don’t want to hide, because then you couldn’t find us!

We want Australian investors to find us. We want you to read the various analysts we publish. We want you to think for yourself about your financial future — because nobody else will take it as seriously as you do. And ultimately, we want to publish ideas you find useful.

Mind you, we have no more insight than the next guy about what ideas will ultimately prove correct. But we’re going to work hard and think hard. And in the end, that’s why we’re proud of the product we’ve produced with Phil. It’s already made people think, even if some of those thoughts weren’t particularly nice.

But don’t take our word for it. Below are the good, the bad, and the ugly from your fellow readers. Some of them have bought the DVD and already watched it. Some have unsubscribed and don’t want anything to do with us ever again. In the interest of transparency, here’s what they all had to say.

‘Just wanted to thank Phil, the team at Port Phillip Publishing, for the amazing information on the Remembering the Future DVD. It is so empowering to get such credible analysis that makes sense, and that we can use to hopefully position ourselves better financially into the future.

‘Now all I want is someone to give me analysis on where are the likely places in Australia to see the greatest capital growth!! Has Phil done that analysis?

‘I will definitely check out his web site!

‘Thanks

Lucy’

We’ll check with Phil on your question Lucy. By all means check out his website at http://www.businesscycles.biz/

‘Gidday.

‘So a bunch of property bears are selling info from a property bull. If he is correct it indicates that Port Phillip Publishing didn't know what they were talking about this whole time.

‘But at least you can stand up and say ‘We told ya so’". If he is wrong, you can still stand up and say, ‘We Told ya so.’

‘All the while selling products, that, at least something must be right. But you guys are different to the mainstream financial brokers. Aren't you?

‘Nobody can forecast. But everybody can jump up and say SEE ! When something happens.
At least you are earning an income while the investments are in the toilet.

‘I have 3 subscriptions with you guys. I have had a couple of winners. But most not.

‘I am keeping them for now in a hope that something /anything will turn my disappointment around. But if you try to sell me info on how tulips are the next boom, I'm outta here.

‘I dare you to publish that.

‘Lots of love
C.’

Told ya we’re for transparency.

‘Hi,

‘I disagree with Phil Anderson’s cycle theory  and how it relates to current circumstances, I'll tell you why in a moment.

‘First, I wish to congratulate Port Philip Publishing for including this story, why?

‘Because it shows that PPP are living up to their philosophy of an 'open editorial ideal'.

‘By allowing & encouraging their staff and newsletter contributors to have their own views and ideas, and to present a whole range of differing ideas to the readers of PPP, this is good for your business and good for your readers.

‘It helps to promote more informed decision making, after all, the world around us is made up of all kinds of people with different ideas, knowledge and experience. I don't wish to live in a bubble and be fed only one line of thought.

‘Regarding Phil's cycle theory…he states that Australia's housing goes through a 14 year boom, followed by a 4 year downturn.

‘If this is correct, then theoretically Australia should still be in the throes of a boom, in fact, it should still have about 4 years to go! But this doesn't seem to be the case.

‘In south east Queensland, the housing boom kicked off at the end of 2002, it basically flattened out 7 years later by 2009 and hasn't really gone anywhere since, essentially maintaining its very high 'median multiple' - significantly unaffordable, ratio.

‘To have a 14 year boom cycle we should still be going strong and not turning down until around 2016/17!

‘His theory also didn't seem to factor in the recent GFC.

‘The other idea which bothers me, and I've only read PPP's brief on Phil's theory, is that he is using centuries of historical cycles, which is fine, to a point but has he taken into account the unprecedented current situation of phenomenal money printing and market manipulation in the US, China, Japan & Europe.

‘Does his theory truly support the scenario that Australia and the world can maintain further major private debt burdens through increased easy credit?

‘Regards

Tony V.’

All good questions. Phil’s basic view is that the banks will create as much credit as society allows and that this credit will result in an increase in land values. We discussed some of these issues in a Q&A session in March. You can watch that here.

‘Hey are you for real? Who paid you off to dribble such crap? Are you blind to what is going on in the world? This is by far the worst pile of trash that you guys have printed to date. I thought you guys had a handle on what is really going on but it is clear that you really have none. The housing property cycle cannot and will not do what it has done in the last thirty years. It is economically unfeasible.

‘The price growth you are expecting will outstrip the availability of money so therefore your theory is flawed. Printed money backed by nothing does not and will never have the same value it had prior to printing. And the other assumption you made about history, is that we are now outside of what history has told us. The economic plan is vastly different to when these assumptions were made. Are you a Labor supporter? Or are you being paid big money to try and keep the property sector flourishing by telling crap to get people to invest on your words???

‘B.F.’

Your editor can’t legally vote in Australia, and wouldn’t if he could. The only people that pay us are our subscribers. We have at least one fewer of them, by all appearances.

‘Ordered the DVD of Remembering the Future  and can’t wait to view. Comments like its ‘Bullshit’ and ‘you guys are losing credibility with this one’ just don’t cut it for me. Though I’m a newbie to the crazy world of Investing due to setting up my own SMSF, I’ve received a much better education from my PPP subscriptions than any Financial Planner or Fund Manager could offer in a million years.

‘I bet the knockers haven’t viewed or read the details of Phil Anderson’s conclusions, don’t knock what you haven’t got a clue about. I also read with interest Greg Canavan’s views of the Property markets dropping before they rise again, I don’t think that’s completely out of line with Phil’s statements.

One thing is for certain in our existence (apart from taxes and death) is that history DOES and always will repeat itself, I’m in a phase of soaking up every bit of Investment strategy advice (with a grain of salt off course) to build up my own portfolio decisions and strategies and don’t believe knocking so and so or the next guy will lead me closer to my own goals. Take in as much as you can from all the experts to provide you the ammo to create your OWN path. Keep up the good work guys.

‘Cheers

A.O.’

Huzzah!

‘I have read the pitch on the property boom that is about to hit Australia, and that it is following the cycles of the US and the UK. I've been impressed by the analysis and your courage to release something you have largely been opposed to for years.

‘I am also tempted to buy the DVD, but have always been anti direct property investment, other than the family home. I have one question. Does the analysis apply to New Zealand? Where do we fit in the property cycle, or are we so small that no one, including Phil, has done any work on it?

‘I read the Daily Reckoning every day, have done for several years, and have subscribed to Diggers and Drillers for three years, but haven't dipped my toes into the water with any of the recommendations yet. I enjoy your largely contrarian approach. It more than balances the rubbish we get from conventional press most of the time.

‘An early response would be appreciated.

‘Kind Regards

Graeme O.’

Thanks for the letter Graeme. We’re doing a follow up Q&A and will ask Phil about whether his analysis applies to New Zealand.

‘Hi Dan Denning,

‘Just wanted to put in my two cents worth.

‘The problem I have with a new property boom is this. 

‘Where does the money come for the purchase of properties come to push the prices back up?

‘The beginning of the last boom around the late 1990’s the average house in most suburbs i.e. three bedroom fibro house cost around 2 and a half or so years of minimum wages.

‘Now they cost around 8 years of minimum wage. So either the money has to come via investors from overseas and that would only happen after a massive devaluation of our currency against the USD or the wages have to surge dramatically to give the potential for ordinary people to purchase again and this would not happen until unemployment dropped after a major increase. Australia has some of the highest wages in the world which only currency devaluation will correct.

‘We have not had high unemployment and the last boom has left us with low interest rates still. Most people do not wish to keep getting themselves deeper and deeper into debt.

‘So either the wages go up or the interest rates plummet with the banks being willing to lend more money. The later depends on the overseas money market staying open to low % interest rates as a wage increase is unlikely while Australia is trying to recover from a crash in exports.

‘I suspect we will see a drop in interest rates by the RBA as the inflation drops then just when we least need it there will be a surge in overseas % rates leaving many people in Australia exposed to massive loans and repayments increases.

‘If the currency drops to 40 or 50cents US in the Aus$ there may be major buyers come in an purchase for rental purposes.

‘Currency moves always tend to overshoot.

‘My friend in St. Petersburg, Florida says that a major overseas buyer came in during a bottom in the real estate market last year 2012 and purchased 700 houses at around USD $100,000 to $120,000 ea.( from a high of $ 270,000 USD each during the boom years.)

‘Buyers like this are happy to purchase hold houses get a return then sell off for a small capital gain and take their money back overseas for a large tax free currency gain when the overreaction or currency devaluation levels out or starts to climb back due to improved exports and small business manufacturing finally picks back up.

‘This also happened in Melbourne during the global financial crisis. Buyers came in at 60 to 70 cents US in the Aus. They bought cheap. Prices went up at least 20 % and the currency went up to US 1.10 to the Aus. They sold out many properties and returned their money for +20% property gain plus 60% currency gain on top of that. They also collected rents over this period. CGT Tax on the property gain but not on the currency gain when reverting to the USD. Not a bad return for 2 years or so from 2008 to 2010.

‘I do not believe the price of property can surge much higher until there has been a major pull back. This would take a couple of years at least.

‘Regards,

Ian P’

And finally.

‘Hi Dan

‘I have been a subscriber to your newsletter for some years and the latest Courting Property Controversy was of interest as I have followed Phil Anderson’s business ventures with interest over the years and I am pleased to hear he is doing well in Melbourne.

‘I am a Real Estate Agent in his home town I also have a graph which came under the notice of the public in 1872 and was prepared by a Mr Tritch the numbers have an uncanny similarity to Phil's.

‘I received it in a newsletter which I was subscribing to in the early 1960s it was similar to yours no internet then it was a typed booklet.

‘I have found over the years in real estate and confirmed by many developers personally that the profits they made over time was from the rising land value only and the reason I believe real estate will continue to hold its value is building costs have increased and the population is growing.

‘I look forward to your next column

‘Kind Regards,

Tony L.’

Thanks Tony. Send the graph though if you could. It sounds interesting. Your editor’s next column will be in three weeks. We’re headed to America to visit family, take a holiday, and see whether the real estate recovery there is for real. Until then!

Regards,
Dan Denning
for The Daily Reckoning Australia

From the Archives…

A Disguised Depression in the US Economy
7-06-13 – Bill Bonner

A Genuine Economic Recovery Requires a Genuine Bust
6-06-13 – Greg Canavan

Why it’s Going to Get Ugly When Interest Rates Rise Again
5-06-13 ­– Greg Canavan

Big Trouble in the Australian Economy… Everybody Relax
4-06-13 – Greg Canavan

Why Growth Stocks Could be the New Target of the Big Money Hunt
3-06-13 – Dan Denning

• House Prices First, Stocks Second.
• Courting Controversy Over Australian Property
• Reckoning on the Perils and Potential of Property
• Reader Mail: Is the DR Contradictory? Are We Hustlers?
• Why Growth Stocks Could be the New Target of the Big Money Hunt

To highlight the strong correlation between the fortunes of the financial sector and credit booms, let’s look at two images. The first from Hoisington Investment Management is titled ‘US Total Debt since 1870’.

The second graph was obtained from Thomas Philippon’s, November 2008 research paper titled ‘The Evolution of the US Financial Industry from 1860 to 2007: Theory and Evidence’.

The evidence in both credit bubbles is clear. Rising debt levels were the wind beneath the wings of the financial industry. There is, however, one significant difference between now and the 1930’s peak in the US financial industry. This time around the investment industry is far larger and more sophisticated than it was in the ‘Roaring 20’s’.

In today’s investment industry we have institutional and boutique fund managers; hedge funds; investment administration services; industry superannuation funds; self-managed superannuation funds; online broking services; options trading programmes; financial planners; share brokers and the list goes on.

The credit bubble combined with technology spawned a multi, multi-billion dollar industry. A lot of people have their livelihoods and capital tied up in this industry. Call it survival or self-interest, but there is no way they will go down without a fight.

If we look to the past to possibly divine the future, we see the US financial industry went from being 6% of GDP in 1930 to less than 2% of GDP in 1950. Over a twenty-year period the industry contracted more than 65%.

As revenues stagnate, businesses aligned to the financial sector will look to maintain profitability by reducing costs. This is evident in job losses in retail banks, investment banks and share broking firms.

If the global share markets follow in the steps of the past two major credit contractions — The Great Depression and Japan post-1990 — revenues will fall substantially and the recent job losses will be the tip of the iceberg.

Let’s take one step back and look at the period leading up to the market top in 2007; the investment industry had an easy story to tell.  Share markets had returned on average 15% per annum (growth plus dividends) for nearly 25 years. Interest rates had fallen from over 16% to around 4%. Little persuasion was needed to encourage investors to swap their cash for shares.

It was like ‘stealing candy from a baby’. There were the occasional hiccups in the growth story — the 1987 crash and the 2000 ‘tech wreck’ — but the recovery after these periods were used as evidence to convince doubters of the market’s resilience — ‘in the long term shares always go up’.

Revenue streams were based on a percentage of funds invested. All industry participants clipped the ticket and enjoyed rising levels of income and profitability.

It is more than five years since the market topped out in late 2007. The massive amounts of central bank intervention underwrote the market recovery — until cracks started appearing recently. An uneasy calm has descended over markets, and industry revenues have been ‘treading water’.

Investors are in two minds as to whether they sell now, realise their gains or losses and go to the safety of cash OR stay with their allocation to shares (and possibly buy more) and hope for the market to deliver on its much-hyped promise of delivering in the long term. The conditioning from 25-years of rising markets still holds enough sway to make the latter a viable proposition.

In this period of ‘stability’ the investment industry’s marketing efforts have moved into overdrive.

There have been countless articles headlined with common themes like: ‘shares under-valued’;  ‘high dividend yield stocks to buy’; ‘maintain a long term share market view’; ‘invest in value stocks’; ‘protect your portfolio with defensive stocks’;  ‘is there a better time to invest in the market?’ and they go on and on ‘ad nauseum’.

The main thrust of the industry’s marketing message is best summarised as: ‘shares are under-valued or fairly valued and it is either a bad time to sell or a good time to buy’.

No stone is being left unturned in the efforts to convince investors to stay the investment course.

As stated earlier, the industry players are fighting for their survival. They know a mass exodus (stampede) from market related investments will deliver the industry the same fate as the Thanksgiving turkey.

There are two points worth considering with the current predicament the industry finds itself in:

1. It is obvious the fortune of the share market plays an integral role in the investment industry’s prospects. The severe and longer than expected downturn (sparked by the GFC) has exposed the industry as being basically a one-trick pony. If the share market goes lame, then the circus is largely over.
2. Do you ever recall hearing the analysts, industry commentators and economists who are now telling us the market is reasonably valued, making any pronouncements in 2007 about the market being over-valued? Ah, the sounds of silence.

The next serious market downturn will truly test the belief systems, of both investors and the industry players, that were forged during the 1982–2007 secular bull market.

Does the industry dare tell the truth about the share market’s long term (secular) cycles to enable investors to make an informed choices or will it continue to bury its head in the sand and use selective data to support its own interests ahead of yours?

Regards,

Vern Gowdie
for The Daily Reckoning Australia

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