Defining a Housing Bubble

When the prices of securities or other assets rise so sharply and at such a sustained rate that they exceed valuations justified by fundamentals, making a sudden collapse likely - at which point the bubble "bursts". - Financial Times

A spike in asset values within a particular industry, commodity, or asset class. A speculative bubble is usually caused by exaggerated expectations of future growth, price appreciation, or other events that could cause an increase in asset values. This drives trading volumes higher, and as more investors rally around the heightened expectation, buyers outnumber sellers, pushing prices beyond what an objective analysis of intrinsic value would suggest. The bubble is not completed until prices fall back down to normalized levels; this usually involves a period of steep decline in price during which most investors panic and sell out of their investments. - Investopedia

A bubble is an upward price movement over an extended period of fifteen to forty months that then implodes. - Charles Kindleberger

A lot of people have been using the term ‘bubble’ to describe the Australian housing market, others say we don’t have one and Former Treasury secretary Martin Parkinson recently suggested it was the wrong question to be asking (i.e. do we have a bubble?), a comment I recently agreed with.

The problem with debating whether or not we have a bubble is that, like the term affordability, it’s definition is subjective.

I provided a few definitions of an 'asset bubble' above, one thing they all have in common is the need for the eventual ‘pop’. So analysts, economists, bloggers, property commentators and perma-bears can rave on all they like about a housing bubble in Australia, but the proof of having had one will be when and if it bursts.

That leaves us with a question though, what size and speed of decline do we need to see in order to confirm the bubble? The above definitions use terms that indicate a quick outcome, 'sudden collapse', 'steep decline', 'panic' and 'implodes', these all indicate a fast and substantial decline. I think anyone arguing that the 'Australian housing bubble' will burst by a slow paced, long term decline in price (real or nominal) is not really describing the bursting of a bubble at all, but rather a slow revaluation of the asset based on the deteriorating fundamentals.

Here is a chart I posted on Twitter over the weekend (click to enlarge):

I would suggest one of these cities had an obviously bubble (Las Vegas) which was confirmed by the bursting price, but what of the other two cities? In my opinion Boston's price decline was not a bursting housing bubble (it's decline was not steep and sudden as it was in Las Vegas), but rather was impacted by the conditions caused by the GFC and credit conditions resulting form the bursting of housing bubbles elsewhere in the United States and was probably overdue some sort of correction. That might also be the case for Adelaide (included on the above chart) and some other Australian cities which aren't experiencing strong price growth.

At it's peak the United States had a bifurcated housing market just as we have in Australia now with unsustainable rates of annual price growth in Sydney and Melbourne, but only moderate growth (at best, if not negative) in most other locations. Cameron Kusher posted a great chart on Twitter recently which highlights differences in price growth since the GFC.

Capital city home value growth since GFC - Dec-08 to Sep-15

Is 10-15% growth over (almost) 7 years the sort of price increase you'd expect to see in an 'asset bubble'?

Now I'm not arguing that Australian property (anywhere) is cheap or affordable (see the first few charts in this post), there is no doubt in my mind that it's historically and globally expensive, but that doesn't mean that every Australian capital city is in a bubble (and going to pop), nor that the Australian housing market should be considered a bubble as a whole.

There's a good chance it will be years before we can confirm whether any Australian capitals are in a property bubble right now or simply expensive/somewhat overvalued. My best guess is that Sydney and Melbourne could be in bubbles and peak this year experiencing a steep decline in price over the years ahead, but some other Australian cities like Adelaide and Brisbane I expect may only experience modest declines. For example if Adelaide saw a 10% nominal decline into 2017 (which I think is a possibility given weak economic factors), then it would result in growth having been 0% over the previous 9 years.

Whatever lies ahead I wish more commentators would define what they consider a bubble to be, because it's become clear to me that some individuals have a completely different opinion of what the term means.

Not sure HnH really understands what an asset bubble is (consensus view) given this comment: http://t.co/NPJncrAVRD pic.twitter.com/A3uaZh4K02

— Bullion Baron (@BullionBaron) September 25, 2015

If you have a view on what differentiates expensive or overvalued property to an actual property bubble and what we will need to see from Australian property prices (or in one of the capitals) to confirm we've had one here then I'd be interested to hear your opinion in the comments below...

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Who's to Blame for Australia's Expensive Property?

Picture a science lab with a square metal table in the centre. On top of the table lies an intricate wooden maze. The maze itself is completely enclosed. In the middle of the maze, at the end of the one way walled passage, is a block of cheese. In a small cage not far from the maze is a rat, who hasn't been fed for a day and whose nose is going haywire smelling the nearby cheese. The three researchers (who were responsible for building the maze) are standing nearby, one of them removes the rodent from the cage and places it into the maze, soon after which the rat finds it's way to the cheese and consumes it.

I would liken this scenario to the Australian property market, where the researchers represent the three levels of government (federal, state and local), the maze walls are policies they've introduced, cheese symbolises investment properties and for the purpose of this exercise the rat is us, investors (though it could also represent other home buyers who are also herded by government policy).

Now you may think human investors are smarter than a rat, but history shows us that time and time again we will rush toward the cheese (investment returns) often foregoing rational thought in order to do so. Just take the recent bubble and crash in the Chinese stock market (Shanghai Stock Exchange Composite Index pictured below), which was largely driven by retail investors and fuelled by margin lending.

Shanghai Stock Exchange Composite Index

If you spoke to the rat, told it not to eat the cheese from the maze, you are about as likely to receive a positive response as if you told investors (as a group, there are some investors who do act rationally as individuals) to only bid the price of an asset to a sensible valuation before stopping.

Historically (at least since the 1960's) home ownership rates have been fairly stable at around 70%, but this has since declined slightly to 68% in the 2011 ABS census and recent investor lending statistics indicate that it's probably getting worse with investor finance overtaking that of owner occupiers (lacking the balance of historical ratios).

The argument over whether Australian property is in a bubble is beside the point, as Former Treasury secretary Martin Parkinson said, "Do we have a bubble? I think that's the wrong question to be asking. The real question is why are house prices so high?" 

There's no denying that Australian property is expensive, so who do we hold accountable?

I hold no animosity toward investors who buy property. Sure there are landlords who do the wrong thing from time to time, but as a group they are just acting in unison because it makes sense to them, in an effort to better their personal situation and largely due to the policies implemented by government. Blaming them for making home prices expensive is a bit like getting angry at a rat for navigating the maze and eating the cheese. The stage has been set, barriers and incentives have been put in place for investors to take advantage of the situation, why wouldn’t we expect them to do so?

The invisible influence of government policy, at least much less obvious than solid walls, is controlling almost every aspect of the property market, on both the supply and demand sides. 

On the demand side they influence the cost of servicing a mortgage using the Reserve Bank of Australia (RBA) Cash Rate Target, regulate bank lending through the Australian Prudential Regulation Authority (APRA), encourage specific segments of the market to participate in transactions by using incentives (such as the First Home Owners & Downsizing Grants) and set the rules that allow foreign investors to buy our homes.

Tax policy can also contribute to demand, a strong rise in property prices followed the introduction of the 50 per cent capital gains tax discount (having held an asset for 12 months) suggests it was an inflection point for an increase in investor interest in property, also illustrated by the flood of investor finance that followed the change in 2000.

Negative gearing, whilst also available for other assets, further exacerbates demand for property, making it cheaper to service the negative cash flow of a mortgage, allowing investors to pay higher prices, buy sooner than they may have otherwise and carry a larger portfolio of properties.

It’s not only the demand side that government policy affects, supply too is impacted as government controls what land is available to build on, the building types that are allowed on that land, they set the fees and taxes associated with building, as well as on the sale of a newly constructed home and ensure the undertaking meets strict standards and a lengthy application process, all of which can contribute to increasing the cost of and deter bringing new supply to market.

On top of policies they implemented prior, since the Global Finance Crisis (GFC) the government has also intervened at times in ways that have both indirectly and directly boosted the property market. Examples include guarantees that were introduced to protect our banks (e.g. wholesale funding and deposits), the RBA taking on tranches of mortgage backed securities to support lending and the introduction of a temporary First Home Owners Boost which according to Treasury Executive Minutes, “was designed to encourage people who had already been saving for a home to bring forward their purchase and prevent the collapse of the housing market.”

I've seen investors who've benefited from this generous environment complain that no changes should be made to the status quo, the "free market", the suggestion of which is laughable. 

The government can and should act to reduce speculative demand and increase supply (if warranted) in the Australian property market, with a view to lower prices and improving affordability. Even the Liberal Party of Australia's Federal Constitution in Part II (Objectives, section n) says:

"...in which family life is seen as fundamental to the well-being of society, and in which every family is enabled to live in and preferably to own a comfortable home at reasonable cost, and with adequate community amenities."

Not that this objective is embraced by senior members of the Liberal Party such as Prime Minister (Tony Abbott) or Treasurer (Joe Hockey). Joe Hockey recently said “If housing was unaffordable in Sydney no one would be buying it, but people are still purchasing housing,” and Tony Abbott welcomed rising prices, clearly not seeing the contradiction with affordability, "I want housing to be affordable but nevertheless, I also want house prices to be modestly increasing." Neither seem to have a solid grasp of what constitutes 'reasonable cost'.

If you want someone to blame for Australia's expensive property, turn your eye away from the property investor / speculator, they are just another rat in the same maze as the rest of us. It's government policy at fault and that is what needs to change. With change of policy will come a change in investor behaviour.

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Gold Correction: 1970s vs Today - Miners In Trouble?

The current Gold correction is closing in on the length of the rout that we saw in the middle of the 1970s bull market. However, the current correction is mild in comparison if we look at the percentages lost from peak.

Below figures have been calculated using the London AM Fix, intraday prices would show slightly different results. Historical data courtesy of Perth Mint's website. The number on the x-axis is total number of days with a London AM Fix published, so doesn't include weekends and other non-trading days.

Click Chart to Enlarge

After peaking in the final few days of 1974, Gold started dropping from US$197.50 to a final low around 20 months later at $103.05 (48% decline, which is represented by the blue line in the chart above). 

The price in the trough of the correction was below the mining costs for many Gold miners and impacted their profits (Financial Post):

Gold Mining Costs in 1975

There's no way to pinpoint an exact reason for any short term price fluctuations in Gold, but the size of the drop into the 1976 low was most likely influenced by the start of the IMF Gold sales, selling around third of their holdings:

Auctions and "restitution" sales (1976–80). The IMF sold approximately one-third (50 million ounces) of its then-existing gold holdings following an agreement by its member countries to reduce the role of gold in the international monetary system. Half of this amount was sold in restitution to member countries at the then-official price of SDR 35 per ounce; the other half was auctioned to the market to finance the Trust Fund, which supported concessional lending by the IMF to low-income countries.

I'm not sure how prevalent technical chart analysis was by individual investors & traders at the time, but no doubt the almost halving in price back then would have had some pointing to broken levels of support, Fibonacci ratios or their proprietary system which pointed to end of the bull market. Even Milton Friedman said that while unpredictable he anticipated Gold to trade in a range between $90 and $140 (this article when Gold was at $107, a month before the final low):

Milton Friedman on Gold in 1976

Little did those with a bearish outlook know that a rally was just about to take place which would add nearly 50% to the price of Gold in 7 months with a final parabolic climax not long after which took the price from $170 to $850 (5x) in 2 short years.

After peaking more recently in September 2011 at $1896.50 (as earlier, figures are all London AM Fix, intraday peak was $1920), the price dropped fast, followed by drifting sideways for around 15 months and has recently started falling again after piercing support at $1500.

Of course Gold's current correction may not have played it's course yet. To match the length of the midpoint correction in the 1970s bull market Gold would need to continue correcting for another 2-3 weeks. To match the 48% decline Gold would need to drop to around $985 (a highly unlikely scenario in my opinion).

As we saw in the 1970's price rout these lower prices are putting extreme pressure on the profitability of Gold mining companies (ABC News):

Gold miners in Western Australia are calling on the State Government to provide the sector with royalty relief until prices improve.

The managing director of Pilbara miner Northern Star Resources, Bill Beament, says many of the state's gold miners are high cost producers struggling to make money amidst wildly fluctuating values.

He says if prices do not improve, many miners could go out of business.

The slump shocked the industry which had already seen local producers, Navigator Resources and Kentor Minerals go into administration and other smaller miners merge.

Mr Beament says while he operates a high grade, low cost mine, he's one of the few in WA.

"Even before the gold price dropped around Easter, we saw two gold producers in WA go into administration so that started showing that some of the high cost producers, some of the marginal ones out there, are really going to struggle," he said.

"If the gold price hangs around this price, sub $1,400 an ounce, we [the industry] could be in trouble, there's a lot of marginal producers out there, this could send a lot of them to the wall."

While there are Gold miners with lower costs internationally, most Australian miners have costs well above the $1000 level (SMH):

A recent Bell Potter survey of 15 mid-tier Australian producers showed that total production costs averaged $1170 an ounce.

Bell Potter analyst Mark Paterson said five of those 15 would be marginal at the present price.

JPMorgan gold analyst Joseph Kim reckons the gold miners under his coverage have ‘‘all in’’ production costs of between $1050 to $1130 per ounce.

But he stresses that companies have numerous individual mines that are more expensive to run than that, such as Newcrest Mining’s Hidden Valley mine in Papua New Guinea, Oceanagold’s Reefton mine in New Zealand, Evolution Mining’s Edna May mine in Western Australia and Alacer Gold’s assets near Kalgoorlie.

‘‘In our view, persistent weakness in gold could result  in  revisions  to  life  of  mine  production  plans  and  scheduling, or even outright closures, as miners react to revised economics under lower gold price,’’ he wrote.

Worth noting that the cash costs reported by many Gold miners to attract investors often does not show the true picture:

Any sustained lull in Gold around AUD$1300-1400 (or lower) is likely to impact heavily on Australia's Gold mining sector. The squeeze in margins is already reducing the profitability of Gold miners and being reflected in their share prices (as it was in the 1970s, see below Barron's Gold Mining Index):

Click Chart to Enlarge -

As reported by Leith on MacroBusiness Gold exports account for around 7% of our commodity exports (by value). Not only is a lower Gold price bad for the mining companies themselves (and their shareholders), it's also a blow to the Australian economy & Government budget (revenues).

Click Chart to Enlarge

Australia is the worlds second largest Gold producer, behind only China who are net importers of Gold. Given Australia's national interest in having a high level of Gold exports & miner profitability, it defies sensible reason that economists such as Stephen Koukoulas would try and knock the metal, in fact he should have reason to cheer it higher.

Where the Gold price goes from here will be decided by the market rather than charts or history repeating exactly. While the costs to mine Gold are unlikely to provide any support in way of a "price floor" in the short term (new mine supply only adds a small percentage to overall supply each year), the immense scramble for physical (and resultant retail shortages) suggests that there are buyers prepared to step in front of the falling knife and buy at current levels. That may not indicate we've seen the low if the futures market takes spot lower, but given that this buying has been occurring from India, to Japan, to China, to the US and in Australia I would say there is good reason to expect the price won't fall much further, certainly not to the sub $1000 level that would be required to match the 48% correction seen in 1976 (and for Koukoulas to win our bet).

As these charts from Tiho at The Short Side of Long show, we could still have a long way to go if the gains of this bull market are to match that we saw 30 years ago.

Gold vs Stocks in the 1970's:

Click Chart to Enlarge

Gold vs Stocks in the 2000's:

Click Chart to Enlarge

While there is no guarantee we get another blow-off top, as has been the theme of this blog since it's inception, it's my opinion that Gold will head higher into a similar bubble peak. The metal won't race into a parabolic move without taking the miners with it (eventually) and by the end of the bull market it is my opinion their after total costs profits will be measured in thousands of dollar per ounce rather than hundreds. No doubt there will be more casualties between now and then though, make sure you pick any Gold miners carefully.

You can follow me on Twitter. I'm usually sharing links and opinions daily (@BullionBaron). You can also CLICK HERE to signup for free email updates.

 

BB.

 

Bitcoin Bubble or New Virtual Currency Paradigm?

Will speculating on the Bitcoin mania make you rich?

Bitcoins have been making headlines on mainstream news sites, on blogs and even on precious metal forums recently and with good reason given the vertical rise in price per Bitcoin:

Bitcoin: Market Price (USD)

But is this rise part of a bubble or a new paradigm for virtual currencies as their utility increases and becomes more mainstream?

There is a lot of speculation that the Bitcoin mania has been a result of the recent Cyrpus crisis, however much of this speculation was due to an increase in app downloads in a single country where iPhones do not have a large market share:

This was spotted by BGR writer Tero Kuittinen, who noted that three iOS apps -- Bitcoin Gold, Bitcoin Ticker and Bitcoin App -- each jumped up the App Store charts in Spain, all on the same day, as the news broke from Cyprus. Compare their download histories to those from a country like the UK and it's clear that the upward trend is more pronounced in the more at-risk nation. Bitcoin Gold's all-time high ranking of 83 in Spain came on 17 March; for Bitcoin Ticker, 68 on 17 March; Bitcoin App reached a high of 147 on 19 March. The highest rankings for those apps in the UK are lower -- 293, 201 and 48 -- and they were all records set months or even years ago. Indeed, there hasn't been any kind of correlation between the Cyprus news and an uptick in Bitcoin app interest in the UK, going from this.

The huge caveat to this, though, is that the iPhone's market share in Spain is tiny, at roughly four percent of the total smartphone market as of mid-2012. Only a percentage of people who trade Bitcoins will trade or keep up to date with prices on their smartphones, too. A spike in iOS app downloads in one Eurozone country is a terribly small sample from which to draw conclusions about whether the Eurozone crisis is driving more people across the continent to Bitcoins. Wired

It seems more likely to me that the increase in Bitcoin app activity was a result of the surge in Bitcoin price that had recently taken the price to all new highs by the 17th of March, the further rally which took the price to levels above US$50 (which probably sparked even more interest) & the crash that had occurred several days earlier due to a glitch in the blocks/programming.

Click to Enlarge: Timeline of Events, 2 Months

With this number of events all occurring in unison, it's not hard to see there were other reasons for the increase in Bitcoin activity, other than finding a safe haven currency to avoid depositor haircuts as some have speculated was the case.

For those who are not familiar with Bitcoins, they are a virtual currency. First created in 2009, they can be transacted peer to peer and through exchanges such as the most popular Mt.Gox. Their creation is not controlled by a central authority, their supply is expanded with the use of a mathematical algorithm.

The price of a Bitcoin has risen from around US$10 to over US$70 in the space of 4 months. Some might call that a bubble with little more thought given, but scratch under the surface of the price and there could be valid reasons for the increase in price.

One of the reasons for the large rise in price is a combination of a slowing number of them being added to circulation:

Bitcoin: Total Bitcoins in Circulation

Starting from 2009 the number of Bitcoins generated every 10 minutes was roughly 50, every 210,000 generations (approximately 4 years) the creation rate drops in half (50, 25, 12.5, etc), the number of Bitcoins in circulation will never number more than 21 million:

Total Bitcoins Over Time

As is evident from the above charts, the first halving of Bitcoin inflation has taken place toward the end of 2012, near the recent price lows and start of the rally which culminated in the parabolic spike. Plenty of speculation on what would happen (including expectations of a rising price) was taking place last year:

The implications to this are huge and for the most part unknowable.  There are two ways I can see it going;-

    - Mining is a delicate balance of difficulty vs electricity costs, the price of bitcoin depends on the electricity cost to generate those coins so if the cost to generate a bitcoin increases the price of a bitcoin rises to match.
    - People stop mining bitcoin because the cost outweighs the return and the difficulty of generating a bitcoin (currently at 3368767) plummets until it is once again profitable to mine.

I believe that it will be a mix of both, I think the price will rise and the difficulty will drop but that is just me speculating.  The truth is we are in for an interesting time, I don’t even want to factor in the new bitcoin mining hardware (ASIC) that seem to be about to hit the market. MineForeman

Can the halving of creation rate alone justify a 7x rise in the price of Bitcoins? Probably not by itself.

Along with the halving of creation rate, we've also seen the number of transactions and unique addresses used for transactions rise (together these numbers indicate an increasing number of people using Bitcoin rather than increase in number of addresses used per person):

Bitcoin: Number of Transactions Per Day

Bitcoin: Number of Unique Bitcoin Addresses Used

An increased number of people using Bitcoin has resulted in a "network effect" where it's value has risen as demand increases:

In economics and business, a network effect (also called network externality or demand-side economies of scale) is the effect that one user of a good or service has on the value of that product to other people. When network effect is present, the value of a product or service is dependent on the number of others using it.

The classic example is the telephone. The more people own telephones, the more valuable the telephone is to each owner. This creates a positive externality because a user may purchase a telephone without intending to create value for other users, but does so in any case. Online social networks work in the same way, with sites like Twitter, Facebook, and Google+ becoming more useful as more users join.

The expression "network effect" is applied most commonly to positive network externalities as in the case of the telephone. Negative network externalities can also occur, where more users make a product less valuable, but are more commonly referred to as "congestion" (as in traffic congestion or network congestion).

Over time, positive network effects can create a bandwagon effect as the network becomes more valuable and more people join, in a positive feedback loop. Wikipedia

The network effect can very much apply to currencies, especially so where the Government/central banks can't increase the number of currency units to meet demand, so Gold has also benefited from the network effect over the bull market as an increasing number of people want to own it, but where there is no easy way to increase the amount (while Gold doesn't have a known limit like Bitcoin, there are other reasons we can't dig more up on a whim including declining grades available to mine).

Despite the positives for Bitcoin, there are still risks which have the potential to impact on price.

ASIC(s) - Application Specific Integrated Circuits are essentially specialised computer chips designed for mining Bitcoins in the most efficient way possible. To date much of the Bitcoin mining that occurs has been via powerful computers which also have a high running cost (e.g. gaming rigs with specific graphics cards which lend themselves to the process), but with these new systems comes lower entry& running costs which will result in more competition... how much effect this will have on the price of Bitcoins is yet to be seen as consumer ASICs have only started shipping early this year (read more here). They could have a dampening effect on the price in the short term (lower cost to mine), but then as they become more common the competition will force a reduction in the profits for the early adopters, driving the cost to mine higher again.

Regulation -  Recent news out of the US includes threats of regulation of the BitCoin market:

The U.S. is applying money-laundering rules to "virtual currencies," amid growing concern that new forms of cash bought on the Internet are being used to fund illicit activities.

The move means that firms that issue or exchange the increasingly popular online cash will now be regulated in a similar manner as traditional money-order providers such as Western Union Co. WU +1.04% They would have new bookkeeping requirements and mandatory reporting for transactions of more than $10,000.

Moreover, firms that receive legal tender in exchange for online currencies or anyone conducting a transaction on someone else's behalf would be subject to new scrutiny, said proponents of Internet currencies. Wall Street Journal

As transacting the currency can occur peer to peer, there is little any one Government could do to stamp out use, however if the large exchanges (where currency for Bitcoin swaps take place) were targeted, there is the potential for it to have a negative effect on the ease of use and market for Bitcoins.

Hacking - The most obvious risk to a virtual currency is the risk of storing them. Hold them on your local computer and they are at risk if you accidentally delete them or your hard drive crashes. There is also the potential someone could hack into your computer and transfer them out if you haven't stored them securely enough. The problem is that all transactions are irreversible and difficult to trace, so once they are gone it's unlikely you will see them again. Not only are criminals targeting individuals who hold Bitcoins, but also exchanges and sites offering online stored wallets/Bitcoins. As the value of Bitcoins increases so will the sophistication and efforts of criminals to steal them. It was a hacked exchange which resulted in the 2011 crash in price (from a peak just above US$30):

Click to Enlarge: Bitcoin Chart Showing 2011 Crash and Today's Boom

The Bitcoin community faced another crisis on Sunday afternoon as the price of the currency on the most popular exchange, Mt.Gox, fell from $17 to pennies in a matter of minutes. Trading was quickly suspended and visitors to the home page were redirected to a statement blaming the crash on a compromised user account. Mt.Gox's Mark Karpeles said that the exchange would be taken offline to give administrators time to roll back the suspect transactions.

The extent of the compromise became clear when a copy of Mt.Gox's user database began circulating online. The file included username, email addres, and hashed password for thousands of Mt.Gox users. Karpeles's statement was updated to acknowledge the breach. He warned users who have re-used the Mt.Gox passwords on other sites to change them. Ars Technica

The increase in value of Bitcoins (market capitalisation of all Bitcoins rose from just over $100m to almost $800m with the recent price rise) is likely to paint a larger target on the Bitcoin exchanges and people with a large number of Bitcoins in their virtual wallets. Who knows what sort of exchange hacks or malicious code could end up affecting the Bitcoin market in a negative way.

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So all this said, with rational reasons for an increase in price (although perhaps not to the extent it has) is the Bullion Baron about to run out and purchase some Bitcoins and hope their utility and in turn value continues to increase? Not likely. The main problem I see for the investor/speculator (see this post for my definitions) is that there is no accurate way to value the Bitcoin and while precious metals are much the same, there are several key differences:

• Precious metals are a physical commodity, Bitcoins are a virtual currency.
• Precious metals have history spanning thousands of years as money and a store of value, Bitcoins have a few short & volatile years as a virtual currency.
• Precious metals have utility outside of monetary use (industrial, jewellery, etc), Bitcoins are only useful as a currency used in transactions.
• Precious metals are more easily purchased (at least that is the case in Australia, from my experience).
• Precious metals have a history of cycling in value against other assets such as oil, stocks & land, Bitcoins have no such history.

They do also have some similarities:

• Neither have a governing body/central authority that can produce them in unlimited quantities.  
• They are both a limited resource (Gold by it's natural occurrence in the earths crust and Bitcoins by the algorithm which controls the number created).
• Both will be harder and more expensive to mine over time (Gold due to decreasing grades and rising input costs, Bitcoins due to increased competition, technology advances and the reducing number created until peak 21m reached).
• Precious metals and Bitcoins are both seen as a threat to official currencies and are likely to see action as a result (more regulation).

There is no reason to expect that Bitcoins will act as a store of value over the long term, but then if their popularity continues to increase then likely so will their price over the long term. The number of sites and services that can be used with Bitcoins is increasing regularly, there is quite an extensive list here: Spend Bitcoins and there has even been news of Bitcoin ATMs to make funding your account even easier:

Zach Harvey has an ambitious plan to accelerate adoption of the Internet's favorite alternative currency: installing in thousands of bars, restaurants, and grocery stores ATMs that will let you buy Bitcoins anonymously.

It's the opposite of a traditional automated teller that dispenses currency. Instead, these Bitcoin ATMs will accept dollar bills -- using the same validation mechanism as vending machines -- and instantly convert the amount to Bitcoins and deposit the result in your account. CNET

My gut tells me that at US$70 Bitcoins are probably closer to a short term bubble peak (given the short term nature of the rise) than at the base of an immediate move to $150 or other high price targets I have seen thrown around ($500+), but that doesn't mean they can't head higher (in the short or long term). 

I think to a degree the price in the short term will depend a lot on who is holding Bitcoins and for what purpose. If there are a lot of speculators or people storing large amounts with no reason to transact then a move to sell and take profit could drive the price lower. If there are few of these types though and the price is being driven higher by a genuine need for Bitcoins for use in transactions then the price could keep moving higher.

Personally though even if I thought Bitcoins were undervalued, after rising 700%, their risks and weaknesses would stop me from putting any significant amount of money into them, a couple of thousand dollars maybe for a punt, but nothing serious. Although they have similarities to precious metals, they are far from a replacement.

You can follow me on Twitter. I'm usually sharing links and opinions daily (@BullionBaron). You can also CLICK HERE to signup for free email updates.

BB.

 

Stephen Koukoulas on Gold, beans & vending machines

For those not familiar with Stephen Koukoulas he is an economist who has (in the past) worked as an economic advisor to the Prime Minister (of Australia) as well as Chief Economist for two major banks and currently runs his own advisement firm Market Economics. I believe he also makes regular appearances on business news and mainstream media channels. He is quite active on Twitter as @TheKouk. His articles promote/support a Keynesian approach to resolving the crisis we face today and he has been quite vocal (negatively) on Gold over the last half of this year. Here are some tweets on the subject:

Summary: Gold has zero yield and is expensive to hold.

Summary: Gold as a security asset is the equivalent of a can of beans.

Summary: Gold is a dud investment in AUD terms taking into account yield and cost to hold.

Summary: Republicans are freaks (or perhaps just those advocating a Gold standard?). Gold standard is equivalent of burning witches. A soya bean standard would be better. Gold is like every other commodity.

Summary: Gold has no fundamental basis as a store of wealth.

Summary: Moving to a Gold standard will not solve any fundamental problems.

Summary: Gold a bubble. Iron ore rises 60% in a couple of months and no mention of bubble.

 Summary: Gold is in a bubble because it's sold out of vending machines.

So let's take a look at these sound bites one by one.

Gold has zero yield and is expensive to hold.

Well from a personal investment perspective Koukoulas is correct, Gold doesn't pay a yield if you buy and hold the physical metal. At least not in Australia. Up until recently those depositing Gold with banks in Vietnam were paid interest, however that has recently changed. Central Banks and institutional Gold owners may be able to lease their holdings for a small return (Gold Lease Rate). Last financial year the RBA returned approximately $200k from leasing Gold, however they don't advise the cost to store it with Bank of England (99.9% of Australia's Gold stored with the Bank of England is a story I broke a week ago).

As for expensive to hold... that is debatable as it depends on whether you want to hold and store the metal yourself and cost may vary depending on scale and investment size. Someone with only a small amount of Gold may feel comfortable holding it at their home and it may be covered under their contents insurance (e.g. CGU covers cash & bullion up to $1500). Assuming we are talking a larger (investment sized) amount, safety deposit boxes with local banks can be rented for various prices, some for as little as $15-20 per month could store half a million in Gold bars quite easily (+ insurance on top if you want). Alternatively various storage options are available with bullion dealers these days at low cost, for example Bullion Money's basic allocated storage is $11 per ounce per year, this works out to around 0.7% holding cost per year with Gold at AUD$1600. It's not a lot to spend for peace of mind. Last I checked my superannuation account was hitting my pocket for more than this in fees when they don't even manage my allocations (most invested in direct equities). So if Koukoulas thinks that Gold is "expensive to hold", perhaps he can clarify, in comparison to what?

Gold as a security asset is the equivalent of a can of beans.

When Chris Becker (The Prince from Macro Business) suggested Gold was a security asset, Koukoulas said so is a can of beans which has doubled in price over the last 10 years. He then suggests that you could eat them if the price goes down. I think Koukoulas misunderstood what Becker meant by a security asset, in a past post this was the explanation provided: I treat physical gold as a “Type Zero” security asset, a small insurance hedge against financial instability – a “Minsky Metal”. Do beans rise in value during periods of financial instability? Probably only in the case we saw a complete melt down of the financial system, resulting in a breakdown of society.

For the record Becker's treatment of Gold is not for everyone. As recently pointed out by FOFOA, Gold plays many roles depending on how it's used by those buying it:

If we could get everyone in the West to vote in this poll, I think "gold is an investment" would win in a landslide. If we could get everyone in the precious metals blogosphere to vote, then "gold is money" would probably win. So, to most Westerners, gold is an investment. To the gold bugs and HMS crowd, gold is money. And to the bullion banks, gold is a currency (ISO code XAU) upon which credit is issued and traded. So what did A/FOA mean by the statement that gold is wealth, not any of these other things? I mean, surely gold is whatever its users think it is, subjective use value and all, right?

Actually, that's exactly right! Gold is whatever its users think it is. And the point A/FOA was driving at was that the vast majority of the above-ground gold, today somewhere around 165,000 tonnes, is held by people who understand it as wealth. FOFOA

Not all buyers/holders of Gold are holding it as the end of world apocalypse ticket that Koukoulas seems to imply in his comments. 

Gold is a dud investment in AUD terms taking into account yield and cost to hold.

Hmmm... Gold priced in AUD is a dud investment? Over what time frame?

Over 3, 5 or 10 year periods Gold has performed exceptionally well, priced in Australian Dollars and basically any other currency. Granted it has performed better in USD and some other currencies than in the AUD, but a 10.9% annual return over 10 years is nothing to sneeze at. Even if we threw in a cost to hold at 0.7% (tax deductible) it's still a great return and comes with taxation advantages that put it ahead of cash (50% CGT discount if held longer than 12 months). Koukoulas, please explain?

Republicans are freaks (or perhaps just those advocating a Gold standard?). Gold standard is equivalent of burning witches. A soya bean standard would be better. Gold is like every other commodity.

Koukoulas likes to complain when others use labels or names, but he seems to do it quite regularly with the Gold crowd (and for other "fringe" groups such as the Tea Party movement), calling them "freaks" and "loonies".

I'm not sure what he meant by equivalent to burning witches, but I assume he simply meant that it was an outdated practice with no relevance in today's modern society. Those advocating a return to sound money are generally just looking for monetary policy which is based on a stable and sustainable foundation. Gold is not a perfect solution, but if it had continued post 1971 it's likely to have restricted governments from running massive budgets deficits, which has (several decades later) resulted in many countries with unsustainable debt to GDP levels. It's scary that suggesting we return to sound monetary policy today is compared by Keynesian economists such as Koukoulas to burning witches, rather they would prefer to have the same men and policies that got us into this mess try and get us out.

Gold is like every other commodity? I think not. It's Golds unique properties which have seen it used as money or a store of value for thousands of years, it's durable, divisible, consistent, convenient, and has value in and of itself.

Apart from it's physical attributes Gold is very different from commodities in another way... most mined and refined Gold in history is still in an easily retrieved form, where other commodities are generally consumed and above ground supply remains minimal (or where there is ample above ground supply it suppresses the price):

Of course there are other difference as well, but this post is starting to turn from long post into thesis in size. Bottom line is that suggesting Gold is the same as other commodities is showing ignorance of facts and history.

Gold has no fundamental basis as a store of wealth.

Gold has been used for thousands of years as a store of wealth. Many of Gold's unique physical qualities make it the perfect store of wealth/value (see YouTube clip posted in the last section). Individuals, institutions and banks have used it as such throughout history. If not being used as a store of value (in the form of reserves) to protect from currency debasement, perhaps Koukoulas could explain why there are many central banks adding to their positions today? The below from Wikipedia:

A gold reserve is the gold held by a central bank or nation intended as a store of value and as a guarantee to redeem promises to pay depositors, note holders (e.g., paper money), or trading peers, or to secure a currency.

Perhaps Koukoulas could provide an example of ANY other asset which transcends both time and geographical location as a store of value in the same way that Gold has and does?

Moving to a Gold standard will not solve any fundamental problems.

As pointed out by @ShervinD (and discussed above), it would have made it difficult for governments to issue excessive amounts of bonds had we remained on a Gold standard. A return to a Gold standard today by the United States would probably not be feasible, but a change to the monetary system whereby Gold was used as a point of reference (such as discussed in my recent post on Freegold) or to restrict the amount of fiat issued globally would solve many fundamental problems. Koukoulas appears to believe that infinite money in a world restricted by finite resources isn't a fundamental problem worth solving...

Gold a bubble. Iron ore rises 60% in a couple of months and no mention of bubble.

I found it amusing that Koukoulas referred to Gold as a bubble and in the next breath was talking about another commodity which has risen much higher than Gold (in percentage terms) over the past decade (as well as a 60% spike in recent months), that is iron ore:

As an asset with no yield it becomes difficult to substantiate whether Gold is over, under or fairly valued at any one point in time (in hindsight one can draw a conclusion from what the price has done, e.g. Gold in 1980 was clearly a bubble, which was made obvious after the peak when it collapsed roughly 50% in 3 months). 

One of the valuation methods I have used on this blog is comparing it in a ratio with other assets, such as to oil, houses or stocks. Another interesting measurement is to compare an ounce of Gold with Australia's weekly wage, which results in a ratio today around middle of the road.

Other methods of identifying whether Gold is in a bubble is to compare the value of Gold assets as a percentage of all financial assets to previous peaks, this chart only shows to 2009, so the percentage would be higher today, but still well below any previous peaks:

In the tweet that Koukoulas said Gold was in a bubble, he also said that it would deflate to less than $1000. I hope for Australia's sake that it does not as cash costs for many Australian Gold producers are not much lower, it would put a lot of marginal producers out of business:

Mr Holland said industry cash costs in Australia were about $US800 to $US850 an ounce, which was 20 per cent to 25 per cent higher than the average across the global gold industry.

"It is probably also one of the reasons you've seen gold production go down 30 or 40 per cent. Australia used to produce 450 tonnes a year; it's now down to 300." The Australian

And Gold is an important export for Australia:

Australia’s major export – iron ore (22% share) – and third biggest export – gold (7% share) – rose by $882 million and $158 million respectively,  whereas Australia’s second and fourth biggest exports – coal (15% share) and gas (5% share) – fell by -$300 million and -$29 million respectively over the month (see below chart). Macro Business

I followed up asking for the reasons that Koukoulas thought Gold was in a bubble to which I had the response...

Gold is in a bubble because it's sold out of vending machines.

Anecdotal increases in Gold's visibility to the public can point toward a bubble like mentality, but is the Gold vending machine really anything more than a convenient (albeit expensive) way to buy Gold? By the same logic should we make the presumption that stocks are in a bubble because I can buy them via an App on my mobile phone? Or cash is in a bubble because I can draw it out of an automatic teller machine in a similar way to drawing Gold out of a vending machine?

This is certainly a point of view I didn't understand and when I questioned Koukoulas for some substance to his comments that Gold was a bubble he responded that he would "Get back to me". Granted it's the holiday season, so I'm not expecting a response tomorrow, but a post or article from Koukoulas on why Gold is a bubble and perhaps to clear up some of the ambiguity around his other comments (if he feels he has been taken out of context) above would make for some interesting reading...


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It's concerning to see that popular economists who have led our banks and country still have such a poor understanding of Gold. At least that seems to be the case in many western economies. Economists and finance officials in China and other eastern countries clearly have a grasp on the importance of Gold:

In 2009, State Council advisor, Ji said that a team of experts from Shanghai and Beijing had set up a task force to consider expanding China’s gold reserves. Ji was quoted as saying "we suggested that China's gold reserves should reach 6,000 tons in the next 3-5 years and perhaps 10,000 tons in 8-10 years”. Zero Hedge

Even Koukoulas can see that emerging economies/policies will have a greater impact on Australia and the rest of the world in the future:

These are extraordinary changes. They reinforce the scenario that in the next 10 to 20 years, trends on the Shanghai or Mumbai stock exchanges will be as important, if not more important, that what happens on Wall Street. It means that in the not-too-distant future, policy changes in Indonesia will be more important that in the UK, France and even Germany.

As a demonstration of the rising living standards and the closing of the gap between developing and developed countries, the OECD estimates that average GDP per capita will grow by around 3 per cent per annum over the next 50 years, a stark outperformance relative to the average 1.7 per cent in the OECD area.

The bottom line of this, according to the OECD, is that “GDP per capita in the poorest economies (in 2011) more than quadruples … whereas it only doubles in the richest economies. China and India will experience more than a seven-fold increase of their income per capita by 2060.”

It is Asia, so very clearly, where Australia needs to maintain and build its economic, investment and cultural engagement. It seems so obvious.

Let’s hope that government, business and the general population of Australia warm to these trends. Europe, the US and the UK will still be nice places to visit, but the economic future is at our doorstep, a point confirmed by the OECD report. Stephen Koukoulas, Business Spectator

So why shouldn't the west also warm to the importance that China, India, Russia and other countries place in Gold?

Given all the above comments from Stephen Koukoulas and little facts provided to backup his presumptions, assumptions, rhetoric and opinions about Gold I was pleasantly surprised to see that he would be turning a new leaf and sticking with the facts in the new year:

That is assuming he was looking to take this approach himself as well as hold others to the same account... that's a good New Years resolution that @TheKouk will be sticking with, I look forward to this as well as his comeback post on why Gold is in a bubble at $1665.

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BB.