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property market

Global Property Bubble Starting to Deflate

 

Right around the world some of the premier cities for real estate investment are flashing red warning signals that the global property price run up facilitated by central banks dropping interest rates through the floor and printing trillions in extra currency units is approaching its end.

In cities like Melbourne, Sydney, London, Toronto, Beijing and New York sales are falling and prices have started to slip. Given central banks goal of driving economic growth through asset price bubbles, a policy which they doubled down on in the period since 2008 any stall out in either property or equities is a cause for alarm.

 

In Australia, because of the decades long boom in real estate prices, any prediction of an end to the ever rising trend in house prices has typically been laughed off. Australia suffered much less from the 2008 crisis than countries like the UK, USA and Ireland and consequently did not get a much needed house price correction back then either. As a result Australia today is massively exposed to a house price correction on an even larger scale than the current bubbles in US and western european property markets. Australia has now had 11 consecutive months of house price declines and if weakening Chinese activity in Australian real estate is any guide this process is only beginning.

 

In the USA the Federal Reserve has made the market believe that is in complete control of all events and this has driven stock markets to absurd levels. Look at the crazy valuations on loss making companies like Tesla (loses money on every car it sells) and Netflix (loses more money the more content it produces). So fear has gone and greed dominates. This has spread into the real estate and in San Francisco for example, house prices increased by over 200000 US dollars in the first six months of 2018. This means that the average house price in San Francisco is now over 1.6 million dollars compared with the insane bubble high of 2007 when it reached 895k in US dollars before crashing in 2008. Doesn’t take a genius to figure out that this is another even more preposterous bubble than we had in 2008 and the prognosis for prices in San Fran is extremely grim. Because this is the epicentre of the asset price bubble the boom in the stock market and startups since the fed dropped rates to zero and blasted trllions of dollars into the economy has attracted wealthy Chinese and Russian investors by the boatload and free funding has ramped up activity in the high tech and startups sector. But as the Fed tries to raise rates and overseas investment from China in particular starts to fall off San Francisco is walking a tightrope. This particular tightrope is going to look ever more vulnerable as investors and home buyers become more aware of trends in the majority of global real real estate markets.

 

In New York, Manhatten is the most expensive and desirable borough in which to live. Here prices have been falling since the start of the year and this trend shows no sign of reversing. Large amounts of new inventory are coming onto the market in Manhatten just as buyers are getting cold feet. As a result of inventory rising and sales falling by almost 20% in the last 12 months prices have come off over 7.5% in the last 3 months alone. Surprisingly this is happening even while the US economy is supposedly firing on all cylinders.

 

In Beijing, home price sales and prices are starting to stall as the Chinese government has brought in new restrictions on mortgages and introduced buying curbs which has taken a lot of the steam out of the sector and now many developers are offering properties in new developments for sale at asking prices less than those sold in previous phases and less than existing home prices. A huge concern for the Chinese property market is the insane levels of debt that now permeate their economy. Debt to gdp has risen from 141% in 2008 to 256% in 2017. The problem is that Chinese debt levels are high but comparable to developed economies like the USA, UK and Italy. But China is not a developed economy itself and only ranks as a middle income country. This means it has maxed out on debt with a much lower capacity to repay that debt which is likely to strangle growth and economic development in the years ahead. And weakness in China will have huge spillover effects on property prices around the world as Chinese investors spend less on overpriced international real estate. Interestingly the IMF has identified 43 historical instances where the credit to gdp ratio increased by more than 30% in any 5 year period. All but 5 of these resulted in a financial crisis or growth slowdown. Whats makes the odds even worse for China is the fact that debt was already at an elevated level in 2008 and debt to gdp has risen not by 30% since then but by almost twice that amount at 54%.

 

This brings us to London. London real estate transaction volumes have just dropped back below 2007 levels even though house prices have risen by 62% since 2007 in the British capital. However since 2014 a different price trend has emerged and prices in London’s best boroughs are off about 18% since then. Also developers have delivered large volumes of multimillion dollar apartments to the market in the last few years creating a glut of high end properties in a weakening real estate market while there is still a shortage of property at the low end of the market. Reuters found analysts were expecting price declines this year and next due to Brexit and they rated the chance of a real crash at 1 in 3 over the next few years. Linking the dots globally would suggest that market participants are overrating local factors like Brexit and underrating the importance of global trends. Just like all the other markets we’ve looked at London is in a bubble and Brexit might well just be the excuse the market is using to start letting the air out of this particular balloon.  

 

And what about Dublin? Just this week, headlines emerged about flatlining prices in Ireland’s capital. Again, as seems typical, only local factors are considered to explain these trends despite the suspiciously similar trend of flatlining or falling prices seen internationally. In Ireland, the explanation is that central bank curbs on mortgages introduced in the last few years have made houses unaffordable for new buyers as they simply can’t get mortgages large enough to buy at current house price averages. This is a big factor (but not the only one), but the solution is not to relax mortgage lending standards which will further exacerbate the existing house price bubble. Part of the solution is to maintain standards for lending and let house prices come down to better reflect wage levels. The surest indicator of a bubble is when property price growth hugely exceeds wage growth and general inflation and sadly that has been the case (again) in Ireland over the last several years. The only realistic way out of this trap is to let the heat out of the market and let prices start falling again although the current market narrative does not even recognise the possibility that prices might be in a bubble that needs to subside.

Gold and silver markets have suffered as these bubbles have inflated as investors confidence in central banks has soared in the last several years. As investors have focused on stock markets and property markets getting inflated by insane interest rate policies and trillions of euros and dollars these markets have again bubbled up to stratospheric valuations exceeding the highs of 2007 prior to the last crisis. Given the current setup of the international financial system there is no other way for central banks to respond to economic crisis but by blowing more bubbles. For the last few years this policy has looked vindicated. But what happens as these new bubbles start to unwind? There is clear evidence of this happening already in real estate internationally although we do not yet see it in stock markets. What will happen to central banks credibility when the next downturn is even more severe than what was evaded in 2008? And what will happen to gold and silver prices in that scenario?

Federal Reserve announcement

Fed fails to taper implications for gold and silver

Last week the Federal Reserve announced to a surprised financial community that there would be no reduction in money printing this month. The markets had priced in a 5 to 10 billion reduction in the Fed’s 85 billion USD a month of QE which has been channelled into mortgage backed securities and US treasuries to support the US housing and government debt markets and thus keep interest rates at abnormally low levels. Since there has been such a strong drum roll of media commentary about the apparently improving prospects for the US economy and Bernanke has been talking about reducing QE for the last few months there was a consensus on wall street that the the Federal Reserve would act to taper in September.

This didn’t happen as Bernanke acknowledged that economic data was not firm enough to suggest the US economy could move forward without its sugar high of 85 billion every month. Bernanke is dead right in his assessment. Without the 85 billion, interest rates would accelerate their move higher – a trend which began as soon as the taper talk began to emanate from the Fed. This would quickly cause cracks and a new more spectacular collapse in the housing sector as mortgages become completely unaffordable for new buyers and house owners with large mortgages are forced to default on their loans. Given the already bad data on loan defaults for homeowners it’s clear that housing is one of the most vulnerable sectors when interest rates start to rise. And rise they will – nothing goes on forever and the lowest rates in history will not continue indefinitely.

More worrying than this is the effect on the US debt market – rates in the bond market started to rise as soon as the taper began to be mentioned. No private buyers want to be in the train wreck that is the US debt market if the biggest buyer in town, the Federal Reserve is trying to pull out – without their monthly purchases keeping bond prices up and rates down the private market will act as all markets should and try to find the correct price for US debt – that means much lower bond prices and much higher yields until private buyers are satisfied they are being adequately compensated for purchasing US debt – which contrary to popular comment, is not risk free. If the US government has to go cap in hand to the private debt markets the US government will quickly be exposed as being insolvent – never mind the US housing market, this is the elephant in the room and Fed needs to keep him hidden as long as possible.

Housing and US government debt alone are two issues enough to make any taper from the Federal Reserve extremely unlikely – once a government or central bank starts down this money printing track they quickly find there is almost no way out. But there are other problems too – the employment situation in the US appears to paint a far too rosy picture, something Bernanke himself admitted when he pointed out that huge numbers of people seem to have dropped out of the workforce entirely in the last year, meaning they are no longer counted in the unemployment numbers thus the 7.4% unemployment percentage is unrealistically low. Even with those jobs which were created the majority were part time service industry jobs (thank you Obamacare!) rather than high quality well paid full time positions in manufacturing etc.

The stock markets have had a great year, but if the Feds actions this month tell us anything, it’s that the general economy, 5 years after the crash of 2008 is still in a precarious position. Without the Federal Reserve’s intervention in the mortgage backed security market there would be no housing recovery and without that who would really consider the US to be on the way back? But if stocks and housing keep going up while nothing else in the economy suggests they should be, it’s evidence that these two sectors are again going into dangerous territory and without ongoing QE from the Fed they would again be heading for burst bubble territory. The debt collector came knocking on the Feds door in 2008 and Bernanke shut the door and told everyone to keep quiet so maybe he’d go away – this week Bernanke risked a peek out side that same door again and found the debt collector was still sitting there waiting for his payment. The spectre of a deflationary depression looms large in the Fed’s thinking even as Bernanke approaches the end of his term – this is the biggest guarantee that we are on the road to endless QE.

Although both gold and silver have been in a correction since September last year and the stock market has moved forward strongly in this last year, the shaky foundation on which the stock market has advanced suggests that when the stock market falters gold and silver could be set for a strong rebound as the investment market realises it has overestimated the strength of the US economy by a wide margin. At the moment everyone, including the Fed, seems to have forgotten that it is not possible to re-inflate old bubbles and keep them inflated. I would expect that everyone is going to get a good dose of economic realism on this same topic. The only way real estate and stocks are going to avoid a nasty pullback at this point is an ever increasing commitment to QE (never mind an actual taper) and an acceleration in inflation – but even in that scenario both real estate and stocks will lose comparative value to other asset classes such as gold and silver. The parallels between this period and the pullback in gold and silver in 1975 and 1976 are illuminating – gold was off 50% in that 2 year period but from the end of 1976 to 1980 it went up a further 500%. History doesn’t necessarily repeat but if often rhymes.

10 Reasons to Buy Silver now...

10 Reasons to Buy Silver now

10 Reasons to Buy Silver now

  1. Silver is undervalued relative to gold – one ounce of gold currently buys 53.2 ounces of  silver and the normal historical average is about 17 ounces of silver to 1 ounce of gold
  2. Silver has underperformed gold since April 2011. Every period of underperformance in the silver price has been followed by a significant period of outperformance of silver versus gold in this 11 year bull market in the metals for example the silver price dropped 19.5% in euro terms in 2008 but bounced back in 2009 (up 44%) and 2010 (up 91%)
  3. Every down year in the silver price has been followed by at least one and usually 2 or 3 strong up years – 2011 was a rare down year, 2012 looks set to be a solid up year and the likelihood is that 2013 will be a very strong up year in the silver price
  4. Our clients can purchase legal tender silver coins VAT free through our sister company ‘buy silver OU’  based in Tallinn in Estonia.
  5. If gold offers capital protection in a time of wide-scale wealth destruction silver offers the prospects of significant capital accumulation
  6. Silver is up over 19% per annum on average since 2002 – this compares to gold being up 15% per annum on average in the same time frame.
  7. The US elections – regardless of who wins the presidential election in the US that country will continue to run trillion dollar deficits and will continue to print money to finance that deficit rather than slashing government to help the US economy recover its former vigour. Once the elections are over the market will focus on the ‘fiscal cliff’ – this is highly supportive of gold prices and by extension, is extremely bullish for silver over the next 6 to 12 months.
  8. Spain – budget deficits exceeding 9% last year and still growing as the Spanish government struggles to stem capital flight and loss of confidence in that countries banks means the next European bailout is a matter of when not if. And that means more wobbles in the Eurozone and the Euro currency meaning the value of that currency will fall along with the dollar versus the precious metals.
  9. Mario Draghi’s commitment to ‘unlimited bond buying’ – the money to do this has to be printed alongside Bernanke ‘open ended’ purchasing of mortgage backed securities until there is a noticeable improvement in the labour market in the US. More money printing means higher priced gold and silver over the next several years.
  10. Mass market apathy – the main investment market now respects gold and silver as investments but remains lukewarm on actually allocating significant portions of their portfolios to the metals. The general direction of media and investor interest is still in stocks and property despite the fact that the metals have trashed these asset classes in the last decade. The factors that have driven this outperformance remain in place and are arguably stronger now than ever – massive money printing, overly large government and public sectors, massive debt overhangs at individual and government levels. Despite this there is misplaced optimism that western economies are turning the corner and improving – this is complete nonsense and the deteriorating debt situations of countries like Ireland, the US and Spain tells the real truth.  Silver will be a huge beneficiary of these trends and those who ignore short term noise (US elections, Irelands return to debt markets etc) and focus on long term fundamentals will deservedly capture big returns over the next decade.