Archive for June, 2007

What can tip Australia into a downward property price spiral?

Saturday, June 30th, 2007

Back in our previous article, Can Australia?s deflating property bubble deflate even further?, we said that:

How will a further house price deflation work out on the ground? It will start with mortgage repayment delinquencies, which will result in increased foreclosures. This will lead to lending institutions repossessing homes and having to urgently sell them to the market to recover losses incurred by bad mortgage debts. As we all know, such importunate sale rarely fetch a good price for the seller. When that happens, through the principle of imputed valuation (see Spectre of deflation on the concept of ?imputed valuation?), a minority of house sale will lead to a downward revaluation on the rest of the housing stocks. If the downward movement is strong enough, it may trigger a race among these sellers to get rid of their houses?a feedback effect.

Today, we read a report in the Sydney Morning Herald: Surge in families forced to sell their homes:

Because so many mortgagee auctions were in a weak market, they are probably putting downward pressure on prices. Mr Dhillon said he sold a house in Macquarie Fields for $287,750 last year, but a similar home in the same street sold at a mortgagee auction for $220,000 last month.

With the Australian debt levels so high, a recession (with an accompanied increase in unemployment) will result in more distress property sales and further downward pressure on property prices. In such a scenario, what is happening right now in Western and South-Western Sydney can be extended to the rest of Australia.

Sub-prime fears return

Thursday, June 28th, 2007

Back in March this year, in Complacency! Market shrugging off sub-prime concerns, we criticized one financial news commentator, who was a prime example of the market’s complacency on the unfolding sub-prime problem. By now, you would have read about the crisis at Bear Stearns, which had to fork out billions of dollars to bail out some of its hedge funds that defaulted on debt securities going bad due to the sub-prime crisis in the US (see How did the US sub-prime lenders get into trouble?). Perhaps there are more hedge funds waiting to implode from the same malaise? That is why the market is feeling edgy lately.

We believe there will be more volatility in the days to come.

Bank for International Settlements warns of another Great Depression

Tuesday, June 26th, 2007

In our previous article, Epic, unprecedented inflation, we mentioned that:

How much longer will the roaring global economy fly? We do not know the answer, for this boom may last longer than what we anticipated. However, please note that in the entire history of humanity, all bubbles (and we repeat, ALL) burst in the end. Thus, a global painful hangover will ensue?the greater the boom, the more painful the eventual bust. This is the theme that we had repeated many times.

Thus, do not be surprised if a second Great Depression were to strike.

Today, we are glad that fellow Austrian School economists in the Bank for International Settlements (BIS), which is sometimes called the ?central bankers? central bank,? spoke out the same thing in their annual report. Mind you, the BIS is one of the world’s pre-eminent financial institutions.

How to take advantage of an impending crash- Part 4: asymmetric payoff

Tuesday, June 26th, 2007

In our previous article, How to take advantage of an impending crash- Part 3: ultra-conservative approach, we mentioned one conservative strategy. Today, we will introduce a short-term trading strategy?asymmetric payoff. Please note that our previous article, How to take advantage of an impending crash- Part 2: understanding a subtlety, contains pre-requisite understanding for this article.

The basic idea behind the asymmetric payoff strategy is simple. First, you structure your bet in the market such that if you lose the bet, your loss is very tiny, but if you win, your gain is very massive. Next, you bet that the market will crash within a specific period of time. If you lose that bet, place another bet for the next period of time. You do this repeatedly until the day of the Black Swan event when your profit overwhelmingly overshadows your accumulated small losses.

Obviously, the disadvantage of this strategy is that it requires fortitude to absorb small losses indefinitely while waiting for a highly rewarding final vindication in the end.

The next question is, how do you implement such bets in practice? We will slowly reveal the answer in the next series of articles on how to implement asymmetric payoff bets.

Hence, today we conclude this series. One final note: each of these strategies has its time and purpose?even the risky one mentioned in How to take advantage of an impending crash- Part 1: the risky way can be used when the bull market ultimately turns over into a bear market after the crash. Therefore, it is not necessary to restrict yourself to only one strategy. With planning, you can include each one of them in your grand overall strategy.

Will the China boom go in a straight line?

Monday, June 25th, 2007
Today, one of the common stories we hear is this: since China is an ascendant superpower, its demand for commodities will increase in the decades to come, and hence, the commodities super-cycle will have a lot more room to go for a very long time.

We agree with the generalities of this story. True, we believe that China still has plenty of room to grow and its demand for natural resources on planet Earth will have to increase in the decades to come.

However, the market always latches on to the generalities of a story and takes a simplistic projection of the story too far into the indefinite future. What do we mean by that? Put it simply, we do not believe that the rise of China will take on the path of a straight line. Instead, there will be ups and downs, booms and bust and progress and setbacks. Anytime when the path does not look like a straight line upwards and take a temporary dive, the market will flip to the other extreme of this story and project extreme pessimism into the indefinite future. In other words, the market always looks at one side of the boom and completely ignores the flip side. Is the current Chinese boom completely void of danger? Take a read at Flip side of the boom: China could face Japan-style debt crisis, analysts warn. Can China?s growth completely independent on the health of the US economy? We guess not.

As we wrote this article, this article came to our mind: China to pull the plug?.

How to take advantage of an impending crash- Part 3: ultra-conservative approach

Saturday, June 23rd, 2007

In our previous article, How to take advantage of an impending crash- Part 2: understanding a subtlety, we mentioned about understanding the crucial subtlety in today?s current market conditions. Now that you are armed with this understanding, let us consider some strategies. Please note that we are not in the business of giving financial advice. Therefore, the strategies that we are going to mention are neither endorsements nor recommendations?please consult your financial advisers before making any financial decisions.

Today, we will examine an ultra-conservative strategy?Liquidate and Wait. We will not judge this strategy to be ?good? or ?bad? because whether it is the former or latter will depend on your personal circumstances, personality, risk-tolerance and temperament. But if you are the sort who is particularly risk-adverse, perhaps this strategy may be suitable for you.

For this strategy, the first step is to ask yourself what you think the aftermath of the Great Crash III will be. The answer to this question will affect your investment decisions (more on that later). We can think of three models for the aftermath?1929, 1987 and Germany-1920s. Since we cannot foretell the future, our guess is that the aftermath may not follow exactly on any one of these models. In fact, it may be a hybrid of these models (and something else), or perhaps something no one in this world can see today. But these models serve as a useful tool to help us understand what may come in the future.

  1. The main idea behind the 1929 model is deflation. In the Great Depression (that began with The Great Crash of 1929), there was asset deflation and economic hardship among the populace. It was said that it took a year for the effects of the great stock market crash of 1929 to be felt by the average person on the street.
  2. For the 1987 model, the magnitude of the stock market crash of 1987 greatly surpassed that of 1929. It was the greatest one-day decline since 1929 in stock market history. There is an air of mystery with regards to the 1987 crash. Up till today, no one really knows why it happened. Fortunately, a global economic depression did not ensure, and by 1989, stock markets had recovered.
  3. The main idea behind the Germany-1920s model is hyperinflation, which is also what Zimbabwe is experiencing right now.

The next step for this strategy is to identify assets that you would like to own at the right price. Your choice of assets will be affected by what you believe the aftermath of the Great Crash III will be. If you believe that hyperinflation will occur, then it is a priority to accumulate gold. If you follow the 1929 model, then strong businesses that can thrive in tough economic environment will be your priority. Our article, Inflation or deflation first? holds some of our thoughts in this matter.

The third step of this strategy is to liquidate a portion of your assets and wait for the crash.

The final step is to buy up the assets that you had identified in the second step after the Great Crash III.

What is the main weakness of this strategy?

The Great Crash III may take quite a long while to arrive. Keeping your assets in the form of fiat money (while you wait for it) will mean that they will lose their value through the ravages of monetary inflation (see Epic, unprecedented inflation) in the meantime.

Is there yet another strategy to take advantage of an impending crash? Keep in tune! It will be interest!

Mainstream & politician’s nonsense on asset-driven ‘wealth’

Friday, June 22nd, 2007

Today, we saw this article, Household debt hits record in the mainstream media. In that article, Prime Minister John Howard was saying that the ?heavier debt burden reflected rising affluence.?

Alas, we can indeed trust politicians to say things that tickle the ears of their electorate!

Further down the article, it conveyed the idea that despite the increasing debt burden, asset prices are still rising and therefore, wealth is increasing.

Again, this is another example of the media not doing its proper job. We counsel that they read these two articles:

Myth of asset-driven growth
The myth of financial asset ?investments? as savings

How to take advantage of an impending crash- Part 2: understanding a subtlety

Tuesday, June 19th, 2007

In our previous article, How to take advantage of an impending crash- Part 1: the risky way, we used a bad strategy as a negative example to show you how NOT to go about seeking to profit from the coming Great Crash III.

In the days to come, we will show you some better strategies. Before you can appreciate why that previous strategy (the negative example) is a bad one and why the ones that we are going to show you are safer, you have to make sure that you understand a subtlety. It is easy to fail to see it, which can be detrimental to your wealth. So, here it goes…

If someone asks us, ?Is the market going to go up or is it going to come down?? a simple and direct answer of ?Up? or ?Down? will be too simplistic to reveal a subtlety. Back in How dangerous are credit derivatives?, we quoted a document from the Reserve Bank of Australia (RBA):

… It is possible that the very developments that have contributed to the increased robustness of the financial system to most events, through the wider dispersion of risk, could actually amplify the disruption following a serious shock….

This implies two things:

  1. In today?s market, the probability of the market going up is higher than the probability of it coming down. Hence, it is rightly called a bull market.
  2. But should it come down (which is unlikely), it can collapse at extremely great speed and magnitude.

Hence, the stronger and longer this uptrend continues, the greater in magnitude and speed (as in volatility, not timing) the Great Crash III will be. Hence, the coming Great Crash III is a Black Swan event?an improbable but colossal impact event. Note: For those who are interested in the subject of Black Swan, we highly recommend Nassim Nicholas Taleb?s book: The Black Swan: The Impact of the Highly Improbable.

The problem with Black Swans is that much of the world?s financial models have blind spots with regards to it (see Expect the unexpected with risk models that can?t anticipate the future). For us, as investors, it will be a folly to assume away Black Swans.

How to take advantage of an impending crash- Part 1: the risky way

Monday, June 18th, 2007
Back in Epic, unprecedented inflation, we mentioned that the world is right now in the midst of an epic asset price bubble. As we warned before, in the entire history of humanity, ALL bubbles eventually burst. When that happens, it will manifest itself as a ?surprise? crash. When that happens, the delusional optimism among the masses will be given a shocking reality check. The Great Crash of 1929 is an example. Alas, since most of humanity are not even born yet in 1929, the important lessons of this Great Crash lies largely forgotten.

Now, the next question is: if you really believe that the Great Crash III (the second one is 1987) is coming, how are you going to profit from it? Today, we will suggest one way to do it?the most risky and foolhardy way?take it as a negative lesson i.e. how not to invest.

This bad strategy goes like this: you make a bet that the Great Crash III will happen in a particular month and enter a short sell position. In case you do not know, short selling means borrowing stocks that you do not own and selling them in the market. After the stock price fall, you buy them back at the lower price to return to the original owner of the stock. But what if the stock price rises instead? You make a loss as you are forced to buy the stock back at a higher price to repay it.

Why is this strategy really bad?

As we said before in Crash alert?to short the stock market or not?,

Well, if you decide to short the market, remember that you are going against the trend of the market. Many short sellers lost their shirts by being wrong on the timing of the coming crash and were forced to buy back stocks in panic to cover their short positions.

If you short sell stocks, you can still lose a lot of money even if you are right about the event but wrong on the event?s timing.

Currently, we are in a bubbly bull market. Therefore, the probability of stock price rising is higher than the probability of it falling. This will go on until the Great Crash III happens. The problem is that no one in this world knows exactly when it will come. It could come tomorrow or next week. Or next month. Or next year.

No one really knows.

But rest assured, though it may tarry, it would surely come. As each day pass by, the day of the Great Crash III gets nearer. What are the better ways to profit from the coming Great Crash III? Keep in tune!

Mortgage rates rising

Saturday, June 16th, 2007

The recent sell-off in Treasury bonds resulted in a spike in long-term bond yields. That in turn caused a spike in mortgage rates (see this news report: Mortgage rates: biggest spike in 4 years). No prize for guessing what this will do to the US housing market.