The Ultimate Bubble

By Neil Charnock    Jul 26 2010 8:57AM www.goldoz.com.au

I purchased my first property in 1977 which was an empty block of land east of Melbourne and it cost $5,000.  Six months later I bought the one next door for the same figure and in 1981 I bought my first house closer to the city, a modest three bedroom weatherboard for $41,000. Twenty six years later this home sold for $550,000+ and has continued to rise until lately, only faltering as interest rates climbed.

This amounts to an inflated value of 1,341% or 13.41 times the value 28 years ago. Back then I was able to borrow four times my average bank balance over 12 months. This meant I needed a deposit of just over 20% plus legal fees to buy that home. I am not going to tell you housing is the ultimate bubble in this article as I would not dare appear to attack this great Aussie institution. People get angry if you do this to their dreams. If it is a bubble then I will leave it up to those who are over exposed to this asset class to do their own research and come to their own conclusions. I mention housing value inflation over 28 years to introduce a touch of reality to two prominent writers here in Australia.

In this article I am not even going to tell you about the greatest debt bubble in history and how it was unravelling like a slow motion train wreck until the fateful events of last week. I just issued an emergency issue of the GoldOz newsletter because the bond markets are in a state of shock and confusion. This has massive ramifications for the Eurozone and gold however I want to cover something else about gold today.

I want to tell you about a Sydney Morning Herald - Business Day article I read which had been published back on the 28th June 2010. I will put the link at the bottom of this article to comply with web publishing rules for some sites. This is a highly important article in some ways because it indicates main stream sentiment about gold and came from a highly respected financial commentator Michael Pascoe. Mr. Pascoe has done a fantastic job of informing the Australian public about a range of financial matters over many years and I applaud his work in general however I disagree with most of the content of that article.

The article talks about Macquarie Banks interest rate strategist Rory Robertson who apparently stated that we should forget about any talk of a bubble in Australian housing or US Treasuries. Mr. Robertson apparently won a (fun) bet with Steve Keen (economist) who has forecast a 40% fall in Australian capital city housing prices on a peak to trough basis.

Mr. Keen underestimated the Governments ability to maintain inflationary policy like new home owner’s grants (increased in response to the 2008 crisis), cash handouts and negative gearing. Mr. Keen has already paid the debt and taken the loss by walking from Canberra to Mt Kosciusko. He took his stance in response to the $1T+ housing debt here and learned how hard it is to time a short sell. Mr Robertson is also predicting a fall in property however way under 20%.

Now to my point and the important implications of the article I am referring to. Rory Robinson has now stated that “punters” should be sceptical of the rise in gold from $260 to $1250 in a bubble watch article to his clients. Rory is wise enough to state: ''It is the very nature of bubbles that drives prices well beyond what most observers see as reasonable. Accordingly, the price of gold over time could jump to multiples of its current elevated price, before reversing''.

Essentially he is stating the obvious and having a two way bet so nothing startling there to report. The really interesting aspect of the article is the language used and the message Michael Pascoe has promoted in the article. It is also about the message sent to the “punters” (not my words) about gold at this time.

For a start the headline is “Gold price a bubble waiting to pop”. This is a little misleading when you read the actual statement by Rory as he made an each way bet. How long is a piece of string? Gold may go up by multiples from here is not exactly a firm statement even if it was placed in the context of statements about the ‘huge’ rise in the gold price since 2001.

Firstly let’s look at that statement. Those of you that know the gold markets well enough will understand that gold was pushed down from 1997 by a few powerful parties using short selling on a massive scale. To illustrate my point one of the outcomes was the emergence of Barrick Gold Corporation which grew from a very small operation into one of the world’s largest gold companies on the back of profits from this practice. One could argue that without the use of synthetic derivatives and the leveraged pre-sale of in ground gold resources the gold price would never have dipped below US$400.

In this case we have seen a tripling of the price of gold in 10 years or if you leave this adjustment out we have seen a five fold increase in the same time period. Peak to peak from 1980 we have seen US$850 to US$1250 which is a “massive” (?) rise of 47% in 30 years. Remember that during this time the house I bought appreciated by 1300%.  I want to know why housing is not in a bubble, when gold apparently is, when gold is up 47% and houses are up 13 times or 1300%?

Emotive language in the media

The next statement by Michael Pascoe that caught my eye was: “Fresh from winning his bet on Australian housing prices, Robertson is taking on a much more rabid bunch in the gold bug faithful - a broad church that ranges from the inflation-fearful to the Armageddon brigade forecasting the end of civilisation as we know it.”

This was closely followed by an excerpt from Rory Robinson: ''The interesting thing about gold - beyond it being a much-loved 'pretty rock' that several generations ago was at the centre of the global financial system - is that it has no `running yield', so there is no anchor, no firm benchmark for valuation.”

Either Rory is not aware or he is just stirring us.  In the case of the former, somebody should tell him that Central Banks are net buyers of gold as of this year in present time. So much for that argument how false can you get?  He may be right about running yield however gold has returned an average of over 10% per year in capital appreciation over the past 10 years so there has hardly been any need for a direct yield has there. A quick geology lesson might reveal for him that gold is not a rock either it is a metal.  I know he was joking in that statement however it is still a derogatory gold comment.

The fact that he is making such statements and that Pascoe is reporting them in such an emotive manner smacks of a market that is not in a bubble at all. Are we really a rabid bunch that belong to the Church (does he imply ‘cult’ perhaps) of Gold?  I prefer to look at monetary policy and the ramifications, supply and demand and other fundamental issues when I report on gold. These factors were left out of the article in question because they are too mainstream and don’t make good press when you are trying to make us all out as a bunch of loonies sitting around wearing tin foils hats.

The fact is that we have been right about debt and financial upheaval. We will become much more right over the coming years. As a group we saw the 2008 crash coming for several years and may have looked like Dr Keen before it actually eventuated. We have been right about the price of gold as well which is probably why he stated: “But it's a brave soul who takes on the gold bugs, particularly when it's seemed they've been right for the past decade.”

Even in this admission he used the words “seemed right” which an invalidation of pure fact. With blatant bias like this it is no wonder Pascoe selected this quote as well: ''For some anticipating extraordinary financial and societal turmoil down the track, gold fits into a portfolio rather nicely alongside automatic rifles, cases of ammo and beans, and hilltop bunkers.''  Has he looked at Greece or Hungry lately?

Poor misinformed public

No wonder the average citizen is not savvy to gold yet and have been running out buying more investment property over the past 18 months. This has slowed lately due to the tightening of credit but still they marvel about the strong asset performance and limitless demand for housing. When you see high profile respected personalities like Michael Pascoe reporting on gold in this manner no wonder people are sceptical. No wonder the general public have been selling their gold at stands placed all over shopping centres.

The fact that this group of commentators use such emotive language is proof, in my opinion, of the fact that this is not a bubble. If gold were in a bubble you would see reporting such as we now see on housing. Nobody (except contrarians) can see a bubble when it is mature they are overwhelmed with greed. These bubbles are generated over extended time periods which give the impression that this is the “new normal”.

Commentators in the main stream media are all cheerleaders at this stage of a bull market. Everybody is an ‘expert’ on property now and they were experts on dot com stocks at the height of that bubble too. Why does Mr Pascoe publicly invalidate the hard fact that we have been absolutely correct to date?  Is it the fact that the Australian banking system is more exposed to mortgage debt than any other nation? Is it that he has been such a loud supporter of housing over recent years, or busy bagging gold out?

I believe we are now in for a hit on gold in an asset sell off now brought forward by events of last week which are now unfolding. I will release an article on this subject in the next few days. Gold is still in a long term trend and this will continue well past the correction we are about to face. 

Good trading / investing.

Neil Charnock

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Neil Charnock is not a registered investment advisor. He is an experienced private investor who, in addition to his essay publication offerings, has now assembled a highly experienced panel to assist in the presentation of various research information services. The opinions and statements made in the above publication are the result of extensive research and are believed to be accurate and from reliable sources. The contents are his current opinion only, further more conditions may cause these opinions to change without notice. The insights herein published are made solely for international and educational purposes. The contents in this publication are not to be construed as solicitation or recommendation to be used for formulation of investment decisions in any type of market whatsoever. WARNING share market investment or speculation is a high risk activity. Investors enter such activity at their own risk and must conduct their own due diligence to research and verify all aspects of any investment decision, if necessary seeking competent professional assistance.