A Common Sense Approach to Picking Gold Miners

A lot of my early posts on this site were about gold (& silver) mining shares, covering which I owned or was looking at in the precious metals space (& why). Over the years I’ve had a number of people email, ask in person, direct message me (on Facebook/Twitter) about gold mining shares, asking for my advice on which miners they should buy, opinions on specific companies or whether it’s time to re-enter the market. My replies have remained relatively broad (& probably unhelpful), because I haven’t spent very much time researching or keeping track of companies in the precious metals space for around 4-5 years. I held some long term gold miner positions in my super (unfortunately given the price trend!) and in 2013/2015 I spent a little time looking at some options adding NST & SLR/MML. Thankfully the rise in these 3 has far more than made up for the losses in the others I hold.

I thought I would write a quick post on how I narrowed down and compared gold miners in the past (2009-2011), which will hopefully provide some ideas for those interested in the gold miner sector who want to take a punt. I am not a fund manager and have no experience in the mining industry, so most of the below is just a common sense approach I took as an individual investor. A lot of the below was simply learned along the way over several years speculating.

Suffice to say if you do not share my view that the price of gold is headed higher over the next couple of years, it would probably be a waste of time reading past this point. My view is that gold miners will provide leveraged exposure to a continuing secular (& new cyclical) bull market in the price of gold. If you think this is another false move or that the price of gold isn't likely to head much higher, then avoid owning gold mining stocks at all.

I am going to look at what are considered nano/micro-cap (capitalisation) stocks. This is the riskiest end of the market (but also the most potential for lucrative gains), so DYODD and don’t consider any companies I narrow it down to here as an invitation to buy. They should make up only a very small percentage of your portfolio. I don’t own any of the companies listed below, however may buy/sell any of them in the future at various times. I prefer researching this end of the market (<$200M market capitalisation) because their finances are often simpler, they have fewer projects and other moving parts which can make peer comparison easier. You can take a similar approach when comparing larger gold miners, but you probably won't need to dig as deep into the specifics (e.g. if they have a $100M in cash, you probably don’t need to be checking their cash burn rate to see if they have enough to last the next two quarters). To balance your exposure to gold mining companies you may choose a handful of companies in each size range, for example 6-12 nano/micro-cap companies (spread your risk!), 3-4 mid-cap and 1-2 large-cap miners.

Here is the basic agenda:

1. Find a list of gold miners

2. Narrow selection based on quantitative criteria

3. Narrow selection based on qualitative criteria

4. Choose the companies you will consider buying

5. Find a good entry point

6. (…)

7. Take profit (or cut your losses)

And here we go…

Find a list of gold miners

The list of gold miners you want to consider will depend on your situation. You may want to only consider those on your local stock exchange. You may only be able to consider those in the ASX300 if you are in Australia and looking to buy using a superannuation fund which allows direct share investment. As an Australian investor wanting to stick with those available on the ASX I find a Gold Nerds subscription an invaluable time saver and tool (you will see why later as we narrow the selection). If you want to compile your own spreadsheet (making it easier to compare the stocks) Gold Nerds handily has a list of the companies they cover on their website (see here) or try Mining Feeds / Junior Miners for broader lists which cover miners in other countries along with Australia (don’t rely on any list to be 100% complete or accurate).

Narrow selection based on quantitative criteria

Here is where having a spreadsheet like Gold Nerds or having created your own with the relevant information makes things easier. We can narrow down our list in a variety of ways, for example limiting those we look at by market cap, gold reserves or cash. Here is a quick list on what I will be using to narrow the selection of miners (using the Gold Nerds spreadsheet):

• Less than $25M market capitalisation (as above, looking for nano/micro-cap stocks)
• Cash holdings of more than $1M (looking for cash that will last for at least 2 quarters) 
• Market cap more than $2M (to avoid absolute bottom of the barrel stocks, probably best avoided) 
• Share price higher than .001 (to avoid companies whose shareholders may value it less, but can’t price that in)
• 75%+ in Gold (as opposed to having Gold as a side show to other minerals)

Here's how the list looks after the following factors are taken into account (narrowing a list of 200+ companies to 40):

Click Table to Enlarge

Keep in mind that some of these may change with regular updates. For example sorting based on market capitalisation, you may find that stocks fall into and out of your selection based on share price movement from one day to the next, so you may want to run these checks over a period of days or even weeks to ensure all relevant companies are captured. Another option is to use a buffer approach, for example instead of searching for companies with a market capitalisation under $25M, bump it up to $30-35M.

This isn’t an exhaustive list of quantitative comparisons you might consider. For example some other relevant data to check for:

• How many listed shares do they have? (low share price, high number of shares can be indicative of significant past dilution)
• How many listed and unlisted options do they have?
• If the company is producing, what is their cash costs (per ounce mined)? Total costs? Net profit? Earnings per share?
• What size is their JORC mineral resource? Ore reserve? What is the grade?
• How long will their cash last?

The relevant questions may depend on the stage of the company (explorer, developer or producer). In the nano/micro-cap space you won’t have many companies producing (or even nearly at that stage), so some of the above questions won’t be relevant.

Remember you are not trying to calculate the absolute best miner/explorer in your list, but typically a group of the best among their peers. So the measures you use here to narrow the field are more about ruling out the worst. 

Narrow selection based on qualitative criteria

This is probably the more difficult measure to narrow the selection. Quantitative data can be relatively easy to compare (e.g. Debt too high? Forget it. Not enough cash to fund the next quarter? Too risky.), but qualitative is where you need to review various aspects of the company where it may not be so easy to choose one over the other. Also you may need to review some of the quantitative findings in a qualitative manner.

For example, perhaps they have a high number of shares issued… many junior mining companies have had to issue a lot of shares over the past few years just to survive. Did they raise capital in a responsible manner (minimising dilution of existing shareholders where possible)? Did they provide an opportunity for all shareholders to take part (through a Share Purchase Plan)? Did institutional buyers retain their shares in the company or just flog them off (or still trying to sell them, creating a supply overhang which may keep the share price low)? If they have a low number of shares on issue, is that just because they’ve had a share consolidation recently?

Some of the numbers may not be directly comparable, for example a low-grade body of gold bearing ore close to the surface may be far more lucrative than a deep high-grade vein style deposit which can be costlier and more difficult to mine.

The easiest way to work through this review and selection process would be to come up with a set of questions that you think are important and work through them for each company. Some areas you may look at:

Management/Directors

• What relevant experience do they have? (Many small company directors are lawyers/accountants)
• How long have they been with the company? (Recent changes in management can be a warning signal)
• What are they being paid? (I typically prefer companies where exploration expenditure exceeds administration costs) 
• How many are there (relative to size of the company)? (Does a small cap company with 1 project need 6 directors?)
• Are they looking after the little guy? (SPPs instead of only institutional placements when raising capital)
• Are they marketing the company? (Investor presentations, conference appearances)
• Do they deliver what they say they will? (Time frames for drilling results or development milestones)
• Do they have a significant stake in the company? (If they aren’t prepared to invest their money, why invest yours?)

Mineral Resource/Ore Reserves

• Do they have a resource/reserve? Does it comply with the JORC code? (Some may use less reliable international measures)
• What is the grade of the resource? How does that grade compare with similar mine types which are currently producing?
• Is the resource spread over multiple deposits or in one location?
• Are resource upgrades expected?
• Is there a large enough resource/reserve to justify development? (Answer often lies in a mining feasibility study)
• How long has the company had the resource? (If the resource was defined 10 years ago is there any sign it will be developed?)
• Has the discovery cost of existing resource been justifiable? (May give indication of viability to extend resource/reserve)
• How many years’ worth of mining will their resource/reserve last?
• Is it likely current resources can be converted to reserves?
• What other minerals have been detected and of value if mining occurs? (e.g. Silver, lead, copper credits may offset production costs)

Cash/Finance

• How much cash do they have? (Check balance from quarterly report then add any $ from placements/minus estimated expenditure)
• What’s their rate of cash burn? How long will their cash last? (Less than 2 quarters and you’re at high risk of near term dilution)
• If they have a significant cash balance, what are their plans for it?
• Do they have any liabilities (loans)? Any outstanding accounts? Hedging?
• Do they have a financing facility which dilutes the share base? (Often a bad sign if a company resorts to this type of financing)
• If an advanced explorer how will they fund development/plant costs?

Exploration/Drilling Results

• What drilling results do they have due soon? (Which could be a catalyst to send the share price higher) 
• What is the grade, length, depth of past drilling results? Is it open along strike? (Could indicate more positive news to come)
• Are they funded for upcoming drilling programs?

Tenement/Project (Including History)

• Has the project got a history of mining? Was it successful? (Attempts may have been made by other companies to explore/mine the same project or deposit)
• Have any companies gone into administration mining the same project? What will the current company do avoid the same?
• Has the price of gold risen enough to consider the project viability again? (Despite any past failings)
• Does the company own 100% of each tenement/project or only part of? (May need to split profit or pay royalties)
• Where is the project located and does its geographical location pose substantial sovereign risk? (See KCN on the ASX)
• Is their tenement/project in a region known for gold exploration, development and production? (i.e. Supportive local government)
• Has there been any local protests or concerns raised in relation to the company or project?
• Are there underutilized plants nearby? (They may be able to truck ore to process it without incurring mine development costs themselves)

Production

• Are they meeting or exceeding projected targets? If not, why not?
• If they are exceeding targets, why? Is there room for further improvement along these lines?
• Are they returning dividends to shareholders? Is this in their best interest or would they get more value reinvesting into further exploration?

I can’t go through all the questions you need to be looking at (and they will change depending on the stage the company is at). For the most part it’s not about writing down the answer for each of these to compare with their peers, but instead being aware of this type of information to get an understanding of each company to rate and compare their overall quality.

Something else to consider is the liquidity of the company. Some of the small cap resource companies might be tightly held leaving only a small number that can be publicly traded, this can cause liquidity issues in the event you want to sell with large gaps up and down in price when it changes hands. An example of this is RND on the ASX:

Click Table to Enlarge

Not that companies like this aren't worth considering, but it's an additional risk to be aware of and given the choice between this and another gold miner you think will perform similarly as well, you're best to go with the one easiest to buy and sell.

Another method of research I can recommend is to visit online forums and read through the history of discussion on the companies you’re looking at. A good one for ASX listed companies is Hot Copper. You do need to be aware that many users on the site are posting there simply to ramp the company/ies they are holding at any particular time, but you can often get a feel for investor sentiment by reading the threads or discover potential problems (or even positive aspects) that you may have missed when performing the above due diligence.

Choose the companies you will consider buying

If you’ve been over the above and feel out of your depth, don’t worry. If you are new to the stock market or even new specifically to resource companies, then it’s a lot to think about and learn. If you feel uncomfortable selecting companies based on narrowing your selection above, then either keep your position size very small while you continue to learn or you could consider an index which will expose you to a variety of gold miners without needing to pick them specifically. I don’t believe there is any index on the ASX that will give you exposure to those which make up the XGD (S&P/ASX All Ordinaries Gold Index), however I was recently made aware there is a ticker on the ASX (GDX) which attempts to track the performance of the NYSE Arca Gold Miners Index (before fees/expenses), you can read more about the VanEck Vectors Gold Miners ETF here.

Assuming you have been able to narrow down your selection to a smaller number of companies that fit your criteria, you can put them all on to the watch list of your share trading platform (I would hope that you'd narrow down the example list of 40 above to around 10-20 max). From this point forward you just need to watch share price and any market updates provided through announcements which may affect your interest in buying them (for example they may end up outside of your criteria).

Find a good entry point

What do I mean by a good entry point? In my mind you don’t have to be a professional technical analysis trader to apply a common sense approach (or rules) when entering positions in the stocks you are watching. Don’t chase the price. Keep a cool head and don’t get emotional. You may be better off buying a breakout if the stock price has been crawling along at a low price for a period of time. I would recommend taking a look at the trading rules of Assad Tannous of Asenna Wealth published here (also follow him on Twitter, he presents a very cool, calm and collected approach to trading).

The share price of many gold miners has soared over the past 6 months. I expect they will continue to rise over the next couple of years along with the price of gold (hence interest in exposure to the sector), however that doesn’t mean there won’t be corrections along the way or even long boring flat periods. BTFD (Buy The F*cking Dip), don’t BTFP (Buy The F*cking Peak). Average in if you think it may go lower.

With a recent decline in the price of gold, gold mining stocks have taken a beating over the last couple of weeks with the XGD declining around 13% from it's recent peak and the RSI suggesting it's as oversold as other recent corrections (not to say that it can't be longer and deeper on this occasion):

Click Table to Enlarge

There's a chance that a reasonable BTFD opportunity is already upon us, but it's best to look at the charts of those in your watch list for the best opportunities.

(…)

This step is a reference to a South Park meme. In the episode the gnomes are stealing children’s underwear for the purpose of “profit” with no real plan. If you follow the above and below you most certainly do have a plan, so really it’s just a matter of waiting to see what happens at this point. Continue to monitor the companies you own (particularly for any  company announcements). If something of substance changes which has the potential to impact on price you may choose to sell and switch into another company that measures up.

Take profit (or cut your losses)

Through trial and error I have found this step is one of the most difficult, but you should always have an exit plan. My plan owning gold miners is to hold them as leveraged exposure to a rising gold price I expect to see in the years ahead. Chances are that any small mistakes will make a negligible difference (if you’ve spread your risk over multiple stocks) with most companies ‘rising with the tide’ and hopefully careful selection results in a few which will significantly outperform.

If you pick a company and unexpected news causes them to tank, consider selling and taking the hit rather than marrying yourself to a company and riding them into the dirt. A bad drill result or three may be worth holding through, but (for example) if you’re holding a company who has begun production where the grades expected are not being achieved through the mill, this can be a precursor to needing to revisit their ore reserves and mining profitability.

Taking profit is also important. As I said at the start, my view is to ride these companies as leverage to a rising gold price, so my time frame to hold may be years in some cases, but that doesn't mean it's not a good idea to take some profit off the table along the way.

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Good luck. I hope providing this structured approach to picking gold mining companies has been of benefit to you. Any commemts, suggestions or feedback (positive or constructive) is welcome in the comments section below. Would be particularly interested to know if any readers invested in this space have any of the stocks in the table above and if so their reasons for owning over peers...

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Screw the Taxpayer: ATO Compels GST on Bullion

Iceblue's (pseudonym) face screwed up as he read the letter in front of him. It was early March and the Australian Tax Office (ATO) had just written advising of an upcoming audit they intended to conduct on his business, South Gippsland Bullion (SGB). They noted their intent to inspect transactions covering the last several years of trading. He was probably thinking "Why me?" (wouldn't we all under such circumstances), but he may also have been aware that many other bullion dealers have faced similar scrutiny over the past 12-18 months with an industry wide series of audits being performed.

When the audit results arrived in mid May, advising that goods and services tax (GST) should be applied to the bullion products SGB sold, it would leave Iceblue with no choice but to close his doors (figuratively speaking given it was primarily run as an online business). The wording of the letter is ambiguous to say the least. It throws into question an assumed understanding in the bullion industry of what products should have GST applied, as industry veteran Bron Suchecki put it "..the arguments that the ATO now seem to be putting forward do not adhere to the understanding the industry had about what was bullion vs collectible."

GST is not applicable to bullion when sold in investment grade form. "What does that mean?" I hear you ask. Well, it's complicated and the results of this audit make the answers even less clear. You can read the Goods and Services Tax Ruling (GSTR) 2003/10 on what constitutes 'precious metal' for the purposes of sections 38-385 and 40-100 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act). In the letter sent to Iceblue finalising the audit the ATO highlighted the following passages of the above ruling:

In paragraph 8 of GSTR 2003/10 (The Ruling) the definition for precious metal identifies the metals and fineness that is set down in section 195-1 of the GST Act. Namely, 'precious metal' means:

(a) gold (in an investment form) of at least 99.5% fineness; or

(b) silver (in an investment form) of at least 99.9% fineness; or

(c) platinum (in an investment form) of at least 99% fineness.

The tradeable form is identified in paragraph 22: Bars, wafers and bullion coins are the physical forms in which the metals gold, silver and platinum are traded on the international bullion market for those metals. These are therefore forms of those metals that are capable of being traded on the international bullion market.

The term 'investment form' is considered in several paragraphs of the Ruling. In paragraph 29 a summary is provided:

- To summarise the above, for gold, silver or platinum to be in an investment form for the purposes of the GST Act, it must be in a form that:

- is capable of being traded on the international bullion market, that is, it must be a bar, wafer or coin;

- bears a mark or characteristic accepted as identifying and guaranteeing its fineness and quality; and

- is usually traded at a price that is determined by reference to the spot price of the metal it contains.

Paragraph 12 of the Ruling refers to items where: 'The price is not determined solely by the metal value of the coin. The price is determined by reference to the spot price and by reference to the quality of the physical characteristics of the coin. The latter indicates that proof coins are not traded for the metal value only and therefore 'indicates that they do not have the character of the metal, but rather the character of manufactured articles, that is, coins made from the metal. This means that proof coins are not precious metal.'

Paragraph 42 of the Ruling differentiates between the retail market and bullion markets: There are coins, such as some commemorative coins, that are marketed in the retail market as 'bullion' coins because they are made from bullion. Such coins are not bullion coins for the purposes of this Ruling. Whether a coin is precious metal does not depend on whether the coin is called a bullion coin or a proof or numismatic coin. The relevant test is not what the coin is called but whether it has the character of the metal. This will be determined, as noted above, by whether it is traded for its metal content or for other reasons.

The ATO's primary focus was on the 'Series of Dissent' (SoD) silver rounds of which SGB had several issues minted through manufacturer SBA Amalgamated. They zeroed in on the marketing used by SGB to sell these rounds, specifically referencing the wording around a strict mintage limit, that they won't be reproduced (with dies destroyed once the mintage was complete) and professionally commissioned artwork which adorned the pieces (among other characteristics).

The ATO also quoted something Iceblue had written on the forum Silver Stackers, pointing out he had called the round a 'collectible piece', however this was done so in the context of explaining that Aussie made rounds can't really compete with bullion pricing (i.e. with bullion products manufactured overseas or in larger quantities).

SGB sold the rounds on an individual basis for around $14 over spot, with a $9 manufacturing cost. The $5 profit was reduced to $1 per round when a buyer purchased in quantities of 100 or greater. The price of the rounds was adjusted in reference to the prevailing spot price. The rounds were priced as bullion, not a proof or collectors coin even if the characteristics or marketing made it attractive to collectors. They just had a higher premium due to the local manufacturing costs.

In my view the SoD rounds met the three criteria required to be considered investment form (and exempt from GST). They were capable of being traded on the international market (once you take the size of the transaction into consideration it's likely many small bullion dealers would purchase the round), they were marked with fineness and quality and traded at a price that was referenced to the spot price.

Perhaps the most worrying aspect of the letter was not even the initial focus on the SoD rounds, but what reads like an afterthought highlighting other products which the ATO does not consider to be GST exempt (explicitly quoted below):

"Coins and bars produced by different mints which also have added characteristics and are in the retail market would not satisfy the definition of 'precious metal'.

Likewise other items sold by [SGB] are sold in a retail market and are differentiated by mint brand and various characteristics including themed year of productions, animals, religious periods, lunar year characters, country."

The ATO goes on to highlight a particular lunar product which is typically sold on the retail market for twice the prevailing spot price, but their wording seems to suggest that any product with 'added characteristics' such as a themed coin may in fact not satisfy the definition of 'precious metal' and be exempt from GST.

Long term readers of my articles would know that I specifically highlight many of the Perth Mint bullion coins as worthwhile investments due to their pleasing designs, low mintage and being individually capsuled. These are many of the same characteristics that the SGB SoD series had. It appears to be these and other characteristics which the ATO is now suggesting should result in GST being applied to bullion products.

In my mind it would make much more sense for the ATO to simplify these rules and remove all ambiguity. Reducing the test to purity of the metal (which should be lowered or exceptions made for 22k gold coins and government issued silver coins) and a maximum premium that can be charged (e.g. less than 100% markup over spot), along with the basic form being a wafer, round/coin or bar. Though my fear is they go the other way and increase the scope of GST on bullion.

There's a good chance this industry crack down and audits stem from the GST gold fraud which has been rife through Australia for some years. I am told (on good authority by industry insiders) that this practice is not only ongoing, but likely the number of people taking advantage of the loophole has increased.

Instead of seeing tangible results from the ATO on the investigation into real fraud costing the country hundreds of millions in lost revenue at a time of focus on fiscal responsibility, we see them putting a small, legitimate and innovative business under the microscope and then crushing them under their proverbial boot. Really the message from the ATO can be summarised from a slogan which was coincidentally minted on one of the SoD rounds... screw the taxpayer (well at least those who are investing in or selling physical bullion).

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Rights and Wrongs of Labor's Negative Gearing Policy

Last year I wrote a post on negative gearing (The Politics of Negative Gearing), finishing on this note:

"Despite housing affordability being a hot topic at the last federal election, neither of the major parties had any policy specifically directed at tackling it. Though quarantining negative gearing to new builds or removing it completely would only be one part of a solution to tackle the problem, Abbott has made it quite clear that he's not interested in a sensible debate on the matter. Last month Labor released a discussion paper aimed at informing Labor’s Housing Affordability Strategy (to be taken to the next election). I'd expect that with the right mix of policies directed to tackling housing affordability and the right attitude, Labor might just have an edge that could help them secure a win at the next federal election."

Recently Labor released their policy on negative gearing (along with reducing the capital gains tax discount) and it has been making plenty of headlines since.

For a long time negative gearing has been considered a sacred cow, but it was obvious with housing affordability concerns growing that something would need to change and we are nearing a point where even the 'untouchables' of our tax system may end up being manhandled (if not as a result of this election, then perhaps the next). Sentiment and polls have moved in Labor's favour following their policy announcement, but not yet decisively enough to win them an election.

Sadly some of those who have been campaigning for changes to negative gearing for as long as I have are blinded by the shiny coating of Labor's policy and are not interested in looking under the bonnet at the details.

The subject of negative gearing brings out a very black and white argument from most. Both those for and against negative gearing changes seem content spreading any research they can to support their particular side, without any consideration to the accuracy. For example the Liberal Party was quick to highlight the details from a BIS Shrapnel report and connect them to Labor's policy even though the details modeled were not all the same as Labor's policy. Similarly those in support of Labor's policy have suggested independent modeling from Ben Phillips is a 'slam dunk' in support of that policy despite the fact that it doesn't account for behaviour changes, doesn't consider the accounting impacts (such as carrying forward losses) and doesn't differentiate between the types of income investors negatively gear against (i.e. wage vs investment, so at face value it doesn't appear to model Labor's policy either).

I have tried to take a more objective approach even though I am in favour of changes to negative gearing in order to reduce investor demand in the housing market. We do need to take care when changing the rules which govern our $6 trillion housing market. Negative gearing should only be removed or changed with an objective in mind and it should only be changed if we are confident the legislative changes will achieve that objective. With that basis I present what I consider to be the rights and wrongs of Labor's negative gearing policy (because it's far from perfect).

Firstly, what Labor got right...

☑ Making the first move

Changes to negative gearing are something that have been raised regularly in political discourse, but not to the point where a major political party was ready to take a policy to an election (in recent history). Labor released a discussion paper on housing affordability in early 2015 and now have a policy to change negative gearing (and capital gains tax) to improve the same. Whether you agree or disagree with the policy (or parts of it), there is no question that it is a brave move and Labor deserves applause for taking the issue seriously and being the first to bring forward firm policy for consideration.

☑ Tackling housing affordability

Some may be surprised that I support changes to negative gearing, which essentially results in higher taxes for investors (at least in the short term). I come from a position that government controls essentially all levers affecting the housing market (see Who's to Blame for Australia's Expensive Property?), if that degree of control over the market is to continue (and I would be all for a change to that), then government needs to take responsibility for the outcomes of their policy, such as the reduction in housing affordability and home ownership rates (source).

Click Chart to Enlarge

Abolishing (or changes to) negative gearing isn't a one policy fix to housing affordability, but it will reduce investor demand by removing an incentive and reduce the level of debt they can carry/prices they are prepared to pay.

Click Chart to Enlarge

Secondly, what Labor got right/wrong depending on how you view it...

☒ / ☑ Grandfathering existing investors who are negatively geared

As Jordan Eliseo pointed out in a recent post, grandfathering existing investors is unfair:

..it hardly seems fair to say to 1.3 million Australians that they can keep a tax lurk that will be closed forever more to the remaining 20 million plus Australians, the great majority of whom are nowhere near as well off financially as a large portion of those who will get to keep the sweetheart deal in perpetuity.

If it is bad policy it should be junked outright.

It could also pull forward demand as is highlighted by Eliseo, if the policy is introduced at a future date investors may rush out to buy before the cutoff.

However not grandfathering investors is also unfair to those who've made significant decisions based on the current taxation settings.

Also, it's likely a policy change wouldn't get wide enough support without the grandfathering of existing investors.

☒ / ☑ Allowing negative gearing for new builds

There are well-intentioned reasons for allowing negative gearing (against salary/wages) to continue for new construction. It has the potential to encourage investors to provide and drive new supply. That means jobs and a boost to economic growth.

The downside to encouraging more new residential construction is that many say we already have an oversupply, particularly in the apartment market. Such a policy could broaden the oversupply to other types of housing and/or increase the oversupply of apartments, which I expect would lead to a collapse in prices. An oversupply of property has been one characteristic of other global housing bubbles which have collapsed.

Lastly (but not least), what Labor got wrong...

☒ It will help to repair the budget

Labor's policy document states that:

Two specific tax deductions – negative gearing and capital gains subsidies – are both significant calls on the budget and are growing at a rapid rate.

However, negative gearing shouldn't be seen as a budget boon for reasons I have highlighted in the past:

The reality is that an end to negative gearing for property wouldn't be a huge budgetary boon (as these commentators have suggested). Most advocating for it's removal suggest a 'grandfathered' approach, which means properties already owned by investors aren't affected (until the asset is sold). Even when investors make a purchase (following negative gearing's removal), any losses which would have previously been deducted in the same financial year against other income could be carried forward to claim against future income or profit from the same asset class (property). While it might delay when deductions are made (and some investors may not make a future profit in property meaning it never is), improving the government budget in the short term, it's long term impact would be negligible.

Furthermore, it's likely that over time investors would adjust their expectations and reasons for investing in property. Currently a large number of investors buy for the tax advantages that negative gearing (and other tax breaks) offers. 

It's removal would result in a lower number of investors prepared to speculatively purchase at higher prices knowing that (as it stands now) low yields (& resulting losses) are partially offset by a tax deduction against other income at the end of the financial year (or as they go for those investors using an Income Tax Withholding Variation). Over time this would likely result in a normalisation of rent to price ratios so that fewer investment property purchases would be loss making from the outset.

Other than the carried forward losses and behaviour changes, we also have to consider that Labor's policy doesn't necessarily stop an investor from negatively gearing an established property if they have other income (that doesn't fall under salary / wages) against which they can claim their property related losses (covered in more detail below).

☒ Only stops losses claimed against salary/wages 

Some have tried to claim that negative gearing (as it relates to property) is only those net losses which are claimed against salary / wages, but that is not the case. The ATO makes it quite clear:

A rental property is negatively geared if it is purchased with the assistance of borrowed funds and the net rental income, after deducting other expenses, is less than the interest on the borrowings.

The overall taxation result of a negatively geared property is that a net rental loss arises. In this case, you may be able to claim a deduction for the full amount of rental expenses against your rental and other income (such as salary, wages or business income) when you complete your tax return for the relevant income year. Where the other income is not sufficient to absorb the loss it is carried forward to the next tax year.

Labor's definition and policy appears to only affect those offsetting losses against salary / wage income:

The investor can deduct any losses associated with the investment from their salary and wage income.

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This will mean that taxpayers will continue to be able to deduct net rental losses against their wage income, providing the losses come from newly constructed housing.

This suggests investors will be able to continue buying established homes and negatively gearing those losses against income other than wages. Granted salary and wages are the largest income item, but there is plenty of other income that property losses could be offset against. Look at this table from the ATO (showing 2013-2014), rental losses are minuscule compared to the other income they could be offset against:

Click Table to Enlarge

Based on the information we have available I am not convinced we can conclude (with certainty) that negative gearing of established houses will reduce with Labor's policy.

☒ It could increase rents in desirable (established) suburbs

Some have made the point that negative gearing won't increase rents because even if the pool of rental housing reduces due to fewer investors (in the established market), these houses have to be sold to someone, i.e. one less investor is one new home owner. They also highlight that increased investor participation in new builds will expand the rental supply.

I agree with those comments and would think it unlikely rents in aggregate increase as a result of Labor's policy, however... while median rents may see downward pressure or a lack of growth, the ability for investors to negatively gear new properties could create a distortion where most of that downward pressure on rents is in the outer suburbs (where the number of rental properties will increase), while inner/sought after suburbs with mostly established housing stock see rents rise as natural attrition of existing established investors reduces the pool of available rental properties. Yes that means an increase in owner occupiers in those suburbs, but those who can’t afford to buy in those suburbs may be left to pay higher rents or be forced to move to less desirable suburbs.

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As you can see, while well intentioned Labor's policy is far from ideal, in fact we can't even be sure it will achieve what it sets out to. Sadly many of those who want negative gearing to go are defending Labor's policy without giving it the careful consideration it needs. Here's hoping that changes as we near the election or if Labor does get into office, then I hope they review their policy and make the changes required to meet an objective of improved housing affordability and a higher home ownership rate.

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