Metals going off!

Base metal prices are up massively. We might see record highs on the Australian sharemarket tomorrow (although if interest rates rise then who knows). So much for the bear market! See Kitco metals for current prices.

Will the shine go off the gold?

I once had a theory, and when I told it to my colleagues they laughed at me. But I have found someone who shares this theory with me!

Lazy Man, guest poster at Consumerism Commentary has this theory that Gold isn't all it's cracked up to be. I tend to agree.

Here's my (some call stupid) theory.

Gold is seen as somewhere safe to park your money when things aren't looking too crash hot. For example, in times of war and high inflation, gold prices usually increase. This is due to the ancient tradition of gold being traded as a currency.

However, you need to think of what gold really is. Gold, like copper, zinc, lead, tin & silver is a metal. It is a good conductor and most females believe it looks pretty on their hands. That's it really. It's practical uses are relatively limited, and whilst its not the most abundant metal, it's certainly not the rarest. You can't build a house out if it, you can't build a road out of it.

So, I think you see where I'm getting to. Gold, at around $650US an ounce is very expensive for what you can do with it. 70% of gold is used for cosmetic use only, so it's practical demand is really not very high. In fact Wikipedia (and we know Wikipedia is ALWAYS right) says that approximately 20% of gold above ground (ie, gold that has been mined) is held in reserve within central banks. The reason for such huge reserves is firstly because back in the day most currencies were pegged to the price of gold, and secondly because I think Governments hold onto it just in case of a doomsday event, where paper currencies become worthless, they have something to exchange for goods and services.

The Indians have a fond affection of gold, so I can only imagine that as their economy grows and more people join the middle class that their demand of gold will increase, but somehow I don't think this demand is going to greatly increase price. Lazy Man has predicted that demand for gold will decrease as a jewellery item because his wife/girlfriend doesn't like it. However, with the gold I see on women in the world (and a lot of men!) I can't say I agree. The price of gold, unlike other metals does not follow trends on supply and demand, but more on the state of the world/economy.

However, this day and age, where you can click a button to buy another currency, does gold need to be used as this security blanket? If I believe that my currency is going to depreciate due to inflation I can buy another currency that I do not believe this will happen to. If i think our economy's going down the shute, I'll buy consumer staple shares. If I think we're going to war I'll buy shares in metal producers (who knows, we might see gold plated guns and grenades?). At the end of the day my gold bullion (or someone elses) isn't going to provide me with income.

In short, I believe it's time for the world to move away from its fixation on gold as a commodity and look at its real practical value. However, call me a conspiracy theorist, but with 20% of the gold in the world sitting in Government vaults, something makes me doubt the central bankers of the world aren't going to let gold fall to $10 an ounce.

For the record, this graph shows the rise in price of gold in the last few years. I wouldn't mind a few nuggets sitting under my bed. I first unveiled my theory to my colleagues in January 2006. Gold prices have since risen about 30%. Shares in Lihir Gold (who they were trying to talk me into investing in) have risen around 50% over the same period. I'd love to come back to this post in a few years and gold prices are down the bottom of this chart. I doubt it though!

*Edit - I just came across this article by David Potts. He doesn't seem to agree with my theory!

So much for that "downward pressure"

A couple of weeks ago I posted on how the long term trends indicated we were going to see more Red days than Green days on the stock market. Well, the market has all but recovered all of these losses!

The US Dow Jones Index is still around 300 points off the high set in February, but the Aussie All Ordinaries is less than 100 points off the pace, partly pushed up by stronger metals and oil... after all, we are the world's quarry.

The rush to get money into super over the coming months may mean more green than red. Concerning, given that prices might not be reflecting fundamentals, but more simply, supply and demand. A short supply of Blue Chip stocks and a lot of money to be invested, means that prices are being pushed up not because greater profits are expected by the companies, but because there is simply nowhere else for the money to go!

The good news for investors is that there will be plenty more money going into the sharemarket than will be going out, so this climb may continue, however, I am still cautious and think there might be more volatility to come.

When tax free share income isn't really tax free... and how to make it tax free!

I was having a bit of a heated discussion with a fella the other day about tax effectiveness of share investing. I offered him advice on how to make his shares even more tax effective, but I'm not sure he understood.

His argument was that he could earn $75,000 a year from his portfolio of shares and not pay a cent tax. This of course is because he holds a portfolio of shares that pay fully franked dividends. Meaning, he is entitled to a 30% tax rebate on this income in the form of imputation credits, and as he is on the 30% marginal tax rate, he pays no tax. He then said to me, "Why should I bother with these tax free pensions when I'm receiving tax free income anyway. I agreed, YOU are not paying tax, however SOMEONE IS. By restructuring your affairs, you can get the tax back!

You see, the reason most share income from blue chip stocks contains this 30% credit, is because companies have already paid tax on this income, at the company tax rate, which not suprisinly, is 30%. So, whilst the investor isn't paying tax out of their own pocket, they effectively are, as tax is being withheld before they actually see the income (dividend).

My proposal to this investor (he was over 60), was to get his direct share portfolio into a Self Managed Super Fund (I didn't address Capital Gains Tax, but this would definitely have to be looked at), and then he had two options, leave the funds in the growth phase of super, in which case income is taxed at 15%, or convert it to an allocated pensions, from 1 July, draw the minimum income which is 4%, and whilst within pension the fund pays NO TAX on earnings.

These imputation credits will then be credited back to the fund, which means the tax is basically being paid back and the investment will truly become tax free. If it stays in the growth phase of super, you're looking at half the credit coming back (super pays tax on income at 15%), or if its in pension, the whole credit basically gets added onto returns.

Put simply, if your shares are within the pension phase and you are receiving a dividend yield of 5% fully franked, you're dividend all of a sudden becomes about 7.15%. Pretty good huh!

Kitco - graph metals price and reserves

As most share investors would know, many Australian share prices are heavily linked to prices of base metals. After all, Australia is really the world's quarry.

There are many sites and sources out there that show the prices of metals on a day by day basis. I have always referred to my broker, Commsec's site. However, all this shows is price, not reserves, and it can be difficult to find price graphs for the period you want.

Bring on Kitco Base Metals. This site shows you everything you need to know about base metal prices and current reserves. Simply click on the "charts" section on the left hand side, choose the historical chart you want (eg, Zinc), and there you go. A range of price charts, as well as the all important current warehouse reserves.

A handy site if you have an interest in resource stocks.

More downward pressure to come?

The US stock market closed remarkably lower last night, due to weak retail data and what has been referred to as a "lending crisis". Have we seen the dead cat bounce, with more downward movement to come on world markets?

During the first market sell off a couple of weeks ago, I saw an interesting chart presented by Alan Kohler. He plotted the Dow Jones Index over the last 3 years. What he showed was a tight trading range, which has been broken in the last 3 months of the current bull run.


I have attempted to replicate the diagram, using the Australian All Ordinaries Index. As it can be seen, this trading range has rarely been broken within the last 3 years, and when it has been broken, it hasn't taken long to correct itself.

What this indicates, is that we may see more downward movement, possibly down as low as 5,400 points. If the uptrend for the last week continues, it may spell the end of the current trading range. I think not however.

Expect to see more red today, an possible more red in the coming weeks!

Timing the Markets

I previously posted about timing the market versus time in the market.

Robyn Bowerman has an interesting post on opportunity cost of mis-timing the market. Basically, if you miss the best 20 days of trading in a decade you will halve your return. Robyn doesn't get into the details on if you miss the worst 20 days of trading, what your returns would be, but I'd guess your return would be close to doubled.

The moral of the story is however, you really don't know when the best and worst days are, so invest for the long term!

The Good, The Bad, and the Bull Run

It was only yesterday that I posted on how we have had an incredible Bull Run over the last 4 months, and it was only a matter of time until there was a slip up along the way.

Quite often, it only takes one small trigger for the domino effect that is falling share markets across the world. Today we saw after whispers that the Chinese Government, in an attempt to slow down growth, will begin taxing capital gains on shares bought and sold on the Chinese share market. This triggered the largest sell off on the Chinese market in 10 years, followed by the largest in the US and Australian markets since September 11.

So, investors that have panicked to sell off their investments and place them in super (of which possibly close to 50% is invested in Australian equities), today saw thousands wiped off the values of their super. I am now kicking myself that I didn't practice what I preach and Short Sell the S&P ASX 200 Index yesterday.

What is Ironic is that those cautious investors who have been sitting on the fence, waiting for the legislation to be passed through Parliament finally got the news they have been waiting for this morning. The super changes that have been proposed have been signed off by the Senate and are now Law. Good news coming to those who wait, or just a fortunate coincidence of events?

Is the Bull Run finally over? Most think not. The market is likely simply correct to more sustainable levels, consolidate for a while, and run again when we've all forgotten about the issues of today. Such is the nature of the beast.

It's all about time in the market AND timing the market

If you've seen a Financial Planner you are likely to have heard this one: "It's about time in the market, not timing the market". Basically this means don't worry about what the market is priced at, if its over or underpriced. This doesn't matter. Just get your money in the market for the long term and over time you will be better off than those who trade in and out trying to pick "peaks" and "troughs" in the market.

This definitely makes sense, as who can tell when the right time to invest is?

However, I have recently, as part of a Post Graduate Diploma, studied Technical Analysis. When I told my colleagues I was taking on this subject, they laughed at me. Technical Analysis goes against all the fundamentals that as a Financial Planner and Economist I should believe in. At university they talk about it like it's a black art of some sort . However, I've always been interested in charting and wanted to better understand how to analyse charts, so took on this course.

For the uninitiated, Technical Analysis involves examining price action to determine changes in the supply and demand balance. In other words, using charts to determine whether to buy or sell securities. A common misunderstanding is Technical Analysis uses past prices to predict future prices. There's definitely more to Technical Analysis than this, with Behavioural Finance a major factor in Technical Analysis.

My growing understanding of Technical Analysis, has led me to believe that Technical Analysis can be used to "Time the Market". It's definitely not foolproof, but if you pick the right triggers, you can use Technical Analysis as well as Fundamentals to invest. For example, lets say I like the fundamentals of BHP and want to buy them for the long term. I can undertake some Technical Analysis and decide that I think in the next month it will fall by 10%. Then wait around and get in at a discount to what I would get in otherwise. Obviously I could be wrong and it never reaches the low that I predict, but that's the risk you take.

I remember a client last year decided to invest $500,000 in Australian Share managed funds through his margin loan. This was in early May, 2006. If you think back a while you might remember a correction of around 10% soon after this. So within a matter of weeks, this guy's portfolio was now worth around $450,000. Now, assuming a return of 10% per annum, over 10 years, the portfolio invested prior to the correction would be worth $1,167,184, a gain of $667,184 over the period. If he had of waited a month or so, the portfolio would be worth $1,296,871, an increase of $796,871 over the period. This is a net gain of $129,687 more than the other strategy.

An extra 20% return just to pick the right time to enter the market? I'll take that thankyou!

Seller's Remorse

Buyer's remorse, as defined by Wikipedia, is an emotional condition whereby a person feels remorse or regret after the purchase of an item. Something I quite often get after forking out for that new gadget and realising soon after that I didn't really need it.

Seller's remorse on the other hand, usually occurs when someone sells their home. The place where they have lived for a large part of their life is no longer theirs. Have they done the right thing? Who knows!

Today I had seller's remorse of another kind. In August last year I took a punt on a Uranium explorer. I didn't put a lot of money in, enough that if it went well I would be happy, but enough that if it things went belly up, I wouldn't be slitting my wrists. Well, in about 6 months, I have more than quadrupled my original investment. I didn't in my wildest dreams expect this.

I feel the Australian market as a whole has become quite overheated in recent times. The S&P ASX 200 has just cracked through 6000 points, with the All Ordinaries closely behind it. It was only late September that the market was under 5000 points. This sort of growth can't be sustainable. During this time these Uranium explorers, who are still earning no money, and are unlikely to start mining for at least another 5 years have been running hot. All purely based on speculation that Uranium is actually the Commodity of the future. Is Uranium the commodity of the future? Who knows... I'm sure the people of Chernoble would think not.

So, today, as the All S&P 200 broke through 6000 points and people starting asking the question of will we see 7000 points by year end, I did what I wasn't expecting to do so soon, I hit the sell button on my Uranium shares. I wanted to hold for 12 months to get my 50% capital gains deduction, but it looks like I'll be providing Peter Costello with a few more bucks for the next Federal Budget. As some say, "It ain't so bad having to pay tax".

Immediately after I sold it hit me. This share that I had enjoyed a wild ride on for 6 months was no longer in my possession. Those days of watching the difference in open and closing prices of over 10% are gone. What had I done??? This stock might still have a long way to run! Not only that, but I've got to hand over part of my winnings to the Government! There's no reversing a decision like this.

However, now I sit back, with the cold hard cash in my hands (well, in my bank account in 3 days anyway) and feel relieved that common sense had overcome greed. Like many of those burnt in the dot-com boom & bust that soon followed, at least I know I didn't hold too long.

Time will tell if this was the right decision. I know for sure that I will be doing something more sensible with this money, like investing in an established stock or managed fund. I will report on the progress and if I actually have made the right decision!

Property Is the Best Share Investment

The age old argument, property or shares. "You can't lose money from bricks and mortar" or "You can't sell a room of your property". Most retail investors fit into one of the two categories. I'm not going to take sides here, but I have done well out of shares (and managed funds) and have never invested in property.

Anyway, this topic isn't trying to weigh in to the debate. I want to discuss the huge advantage that property investment has over share investment. It's all to do with the ways you can borrow to invest, with the major advantage being tied to the banks' lending criteria.

Why Borrow to Invest?

Borrowing to invest involves using money that's not yours (ie, the bank's), to invest in property, shares or other investments. In Australia, interest payments are generally tax deductible and capital gains, if the asset is held for more than 12 months have a 50% discount applied to them. Therefore, by borrowing to invest, you can gain access to capital gains on money that's not really your's, whilst getting a tax deduction for your interest payments. Sounds pretty good hey? Of course, the disadvantage is that by investing with money that's not yours, if the value of the investment falls your potential losses are much higher!

Types of loans?

I'll start with property. This is a simple one. I'm going to focus on residential property, as this is what the typical 'mum and dad' will be investing in. If you want to purchase a property you go to the bank and take out a mortgage. Now there are numerous types of mortages, ones with offsets or lines of credits attached, but at the end of the day a mortgage is a mortgage. You put down a deposit. In the old days the banks required a 20% deposit for a mortgage, but competition has reduced that. From some dodgy brothers loan providers you can borrow 100% of the value of the property. Once you get below deposits of 20%, you're usually up for mortgage lenders insurance though, which protects the lender if you default on your loan.

Shares aren't as straight forward as property. There are many ways to borrow to invest in shares. These involve margin loans, protected portfolio loans, internally geared managed funds and using home equity to borrow to invest. The most common form of borrowing is the margin loan and is what I will focus on here. A margin loan shares some similarities as a home mortgage, in that you put down cash or shares as security or a 'deposit', you can then borrow to purchase shares. Generally with a margin loan, you must put down 30% deposit and can then borrow the remaining 70%. For example, lets say you have $30,000 in cash. You can use these funds to invest in BHP shares and then borrow another $70,000 and invest this. Making your entire exposure $100,000. The other point of interest with a margin loan is that if the value of your portfolio falls by a certain amount, you get hit with a margin call. A margin call requires additional funds to be deposited or shares to be sold to bring the portfolio back up the the allowed lending ratio.

Why property?

I can hear you all screaming at me now. Why buy property when it means dealing with dodgy tentants and dodgier real estate agents. Where's the liquidity? Shares provide better long term capital growth. I know, I know. It's not me who's spruiking property, its the lenders.

You see, the potential gains on something where you only have to put 10% deposit down are much greater than that where you have to put 30% deposit down.

An example will explain it better.

Lets say you've been in your professional career a few years and have $30,000 saved, currently sitting in cash. You want to invest this for the long term and seek some solid capital growth. You can deal with short term fluctuations and are not going to lose sleep at night if the value of your investment drops. Right, we've now established you're a suitable candidate for gearing (borrowing to invest).

You see the lender at your local bank. They tell you that with your $30,000, you can borrow $270,000 to invest in an investment property. Therefore having total capital of $300,000. This means you basically put down 10% and the bank lends you the other 90%.

You then see your friendly financial adviser. They tell you that with your $30,000, you can borrow only $70,000 and invest the total in shares. Therefore, you put down 30% and borrow the other 70%.

Lets say your investment property and shares average a return of 8% per annum over a 10 year period and all income is reinvested (you can't reinvest rent income I know, but we're talking hypotheticals). We will also ignore tax and interest. At the end of 10 years, your property has generated you wealth of $647,678 - $270,000 = $377,678 or a return on your original capital of 1259%! You're geared share investment has generated wealth of $215,893 - $70,000 = $145,893, a return on original capital of 486%, nowhere near that of your property.

It can be seen that the lending 'rules' on property investment make it a very attractive investment! A cheaper interest rate than a margin loan makes it look even better.

"Thats it, I'm getting rid of my shares and buying as much property as possible!"

Hang on a minute, lets be realistic here! Share investment has a lot of advantages over property investment. Firstly, my numbers are distorted, as by borrowing more, you are liable to pay more interest on your loan. I have ignored this for my example as tax deductibility of interest payments makes it a difficult calculation to make. Secondly (and this is a big one), in reality how are you going to reinvest your rental income from your investment property? Whereas its extremely simple to reinvest your dividends on your shares. Most top 200 companies have dividend reinvestment options and all managed funds certainly do. This helps to increase the compounding effect of share investment and ensures you don't just spend the money when you get it.

Shares provide a liquidity that doesn't exist in property, are easier to diversify in and require less active decision making than property. I know which one I'd rather invest in!!

Time for the lenders to get real

The major lenders still have this old time mentality that shares are risky investments and property is a risk free investment. They lend at higher ratios and charge lower interest rates than margin loans provide. My argument (and hopefully yours by now) is that shares are the less risky investment! You can easily diversify, there's liquidity and you're leaving the major decisions up to professional CEO's.

My challenge is for a lender out there to provide a facility, like a property mortgage, that allows well diversified portfolios to be geared into at high ratios, without the need for margin call for short term volatility, at an interest rate that is represented by the low long term risk of a well diversified share portfolio.

Until this day, the property investor will always have at least one argument against the share investor.