Wednesday, 29 April 2015 02:31

Australia has a property bubble now in 2015

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We recently spoke to Roger Montgomergy (Sky Business News/Montgomery Fund) about whether he believes Australia is in a Property Bubble.  Here is the interview.
















Transcript of video

Australia has a property bubble.

Mark Draper: Here with the Roger Montgomery from Montgomery funds. Thanks for joining us Roger.

Roger Montgomery: It’s a pleasure mate.

Mark Draper: Now when taxi drivers start talking to me in Sydney about the property market, it makes me very nervous. Are we about to see a property crash or what do you think it’s at?

Roger Montgomery: Well, at the timing of it, we are definitely in a boom. Is it a bubble? I’m leaning towards yes but it’s not a forty-five degree angle or anything like that but definitely, we are hitting, we’ve got the key ingredients in place, in fact, the key ingredients for a bubble being placed now for probably twelve months to eighteen months. We have now got some ridiculous prices being paid for property, I’ll give you some examples, so there was a block of flats in Mosman in Sydney that were being auctioned, five apartments that the total income, the gross income from the five apartments was $139,000 dollars and the block sold for $3.5 million dollars on 139 million dollars of income and of course there was maintenance involved and help with keeping the tenants happy. A good friend of mine is one of the largest property shopping centre and commercial real estate owners in Australia and privately run business. He has a building leased to a major bank in Melbourne for ten years, so a blue chip tenant for ten years and if he tries to sell that property, he can get about six thousand dollars a square metre. In a city resident, let me put this into perspective. In a city CBD residential real estate in Melbourne is selling for over $10,500 a square metre and in Sydney $15,500 a square metre and usually you don’t have a blue chip tenant so prices are definitely heady and it’s simply a function of low interest rates. Let me give you some other statistics, 43% of all home loans, residential mortgages taken out are interest only…

Mark Draper: Is that across Australia or New South Wales?

Roger Montgomery: It’s across Australia. Across Australia, interest only and then you’ve got for example the mortgage, the residential mortgage debt to disposable income in a recession we had to have in the 1980’s, it was about 30…1990’s, 1991, it was about 35%. That ratio is now 140%. At a time when interest rates are at zero or very close to zero and it may as well be…

Mark Draper: Because in the 1990’s they were…

Roger Montgomery: They were very high, 18% and so understandably people have taken on more debt but if interest rates go up, the income that you are earning doesn’t rise to pay the higher interest rate, so that’s the problem when you’ve got so much of people’s disposable income paying off a mortgage, so I’ll give you an example. 25 year loan, 80% LVR, at current interest rates, that first year when you are paying off that mortgage, that is taking up using a median house and a median income, about 75% to 80% of disposable income is going to service that mortgage.

Mark Draper: Wow.

Roger Montgomery: And think about what happens when interest rates go up, or worse, interest rates don’t go up, they stay low for a long time because the economy is truly sick and people start losing their jobs and that is the really big concern that if the United States raises rates too early, we will get a repeat of 1937, we will get a double dip recession and the reason why that is a problem is because the previous recessions, and remember the United States are seven years into its growth cycle, and most growth cycles last about seven years. It is now seven years. If they raise rates and the economy slides into a recession again, well in previous recessions the Federal Reserve has cut rates by 3% to 4%, 300 to 400 basis points, when rates are zero there is not that room, so what happens after that and that is a big problem because the reason why I relate that back to Australia is because Australia growth is tied to China’s growth, China’s growth is tied to the United States’ growth and Europe. Europe isn’t going well, Japan isn’t going well, the United States might go into recession if they raise rates too soon so that can be a big problem for property investors. In any event there is no doubt that the basic rule of investing is true, the higher the price you pay, the lower your return.

Mark Draper: That is certainly good advice Roger and in terms of thinking about property, what would your advice be for bank shareholders that are arguably leverage to the Australian property price.

Roger Montgomery: So it is important to understand that the highest risk mortgages where the LVR (Loan to Valuation Ratio) is higher than 80% or 85%, there is usually mortgage insurance taken out so that derisks the highest risk mortgages for the bank and that places it on the likes of Genworth and GIO or QBE rather and so they’re the ones that you need to be worried about from a business perspective rather than the banks. Having said that though sentiment will turn against the banks and the share prices might suffer but that could be an opportunity to buy them cheap again so the business performance might not suffer as much as the share price performance.

Mark Draper: Right. Thank you very much for your time. It is a hot topic. It is a hot market over here in New South Wales. We appreciate it.

Roger Montgomery: It’s a pleasure. Thanks mate.


The Eurogroup of finance ministers and central bankers met in Riga last Friday amidst (accurate) speculation that little progress would be made towards reaching an agreement between the Greek government and its creditors on the measures Greece must (re)commit to in order that the long-delayed bailout tranche of EUR7.2bn be released – enabling Greece to meet upcoming debt repayments and other commitments.

Riga, of course, is the capital of Latvia, whose 2008 credit and budget crisis resulted in an IMF bailout conditional on harsh austerity measures that reined in the budget deficit. But the consequent cuts to spending, wages, pensions and services, plus tax hikes required as part of that bailout saw the economy shrink a staggering 18% in 2009. The social cost was devastatingly high, with traditional industries wiped out, unemployment quadrupling to over 20%, and the emigration of 10% of the labour force – mostly the younger generation.

Through it all, the Latvian Lat peg to the euro was maintained – an easy fix via devaluing the currency to boost competitiveness was eschewed. Despite widespread community resentment and bitter recriminations, political fallout was not enough to derail the austerity/bailout program, and in 2011, Latvia regained access to financial markets. In 2014, with an economy smaller than in 2008 but growing again, Latvia joined the euro – "proof" to some that austerity works and brings its own rewards.

The no doubt coincidental location of the April 24 Greece meeting may have taunted some participants and given encouragement to others, but no complex financial crisis is ever the same. The first Greek bailout in May 2010 came 18 months after Latvia's; and 18 months thereafter, in late 2011, as Latvia exited its bailout, popular kickback against the clumsy brutality of the Greek bailout and the contagion it fuelled threatened the breakdown of the Eurozone itself – by then on the verge of entering a drawn out recession.

Compromise, debt restructuring, political change, audacious policy-making and the return of risk appetite over the next three years saw the Eurozone crisis subside and economic growth return, even in Greece. But after five years of recession, the Greek people in January voted in a new government with a mandate to stay in the Euro under renegotiated, less-austere conditions.

The Syriza-led coalition, governing Greece for the first time, appears to have a mandate that is undeliverable. It has drawn on its historical ties with Greece's socialist past to nurture links with Russia and argue for the Ukraine sanctions to be eased, throwing a spanner in the works of European foreign policy unity in one of several clumsy attempts at finding a bargaining chip for the bailout talks. After much bad blood in negotiations, agreement was reached on 20 Feb to extend the bailout program by 4 months rather than the 6 months requested by Greece. It was conditional on Greece delivering a list of promised reforms for the next 4 years, such as boosting tax receipts and cuts to government payments, including pensions and privatization.

No bailout disbursements have yet been made because no comprehensive and detailed list of measures has yet been provided by the new administration that is acceptable to the creditors who are not prepared to wear any further haircut. The deadline for Greece to submit its reform plans has been moved back several times and now seems to be June 30, when the bailout is due to be indefinitely suspended – whether funds have been disbursed to Greece or not.

Although Greece raised limited funds in the short-term market in early April and made a closely watched EUR450mn payment on 9 April, its fiscal position is fragile. The government has taken steps to draw on funds held by public entities such as local councils and public pension funds in addition to rolling over short-dated debt, which is bought by Greek banks using funding from the Bank of Greece (BoG). The BoG in turn is drawing on the ECB’s Emergency Liquidity Assistance program (ELA), through which it lends to Eurozone member central banks so long as it regards the emergency request as being due to temporary liquidity constraints – not solvency.

Greek banks are under ongoing pressure from deposit withdrawal. At the 15 April press conference, ECB President Draghi said ECB exposure to Greece was EUR110bn; last week the ECB was reportedly considering pulling the plug on this support for the Greek banks, but it remains in place for now.

What's next?

Westpac’s base case is that both sides of the table, the troika lenders and Greek government, are sufficiently averse to a Greek default and/or exit from the Eurozone that they will eventually reach agreement. (This includes the ECB officials insisting that EMU exit is not an option).

Both sides should be able to present a deal as a victory: Greece would receive the delayed funds, while the lenders could cite a list of tough-looking fiscal reform promises by Greece. Most of the movement would probably have to come on the Greek side: it should finally commit to stronger reforms as the least-worst of a range of unattractive options, including yet more elections or leaving the Eurozone (which opinion polls in Greece continue to reject). The catch hidden in this scenario is that no further creditor participation (i.e. debt write-downs) condemns Greece and its creditors to further iterations of current events, with the country's debt burden (including the bailout loans) simply unsustainable into the medium term. A deal by June 30 just starts the clock ticking ahead of the next bailout showdown.

If a deal is not reached, or seems impossible, speculation that the ECB will withdraw the emergency bank funding would trigger a renewed run on Greek bank deposits, quite possibly even ahead of any default by the government. The government would impose capital controls, effectively suspending the fiat characteristics of the euro – the first step towards abandoning the currency. Financial and economic chaos in Greece would ensue, albeit with limited contagion elsewhere in the Eurozone.

Whether or not Greece leaves the Eurozone soon after would depend on a range of political decisions across the region, but policymakers have made it fairly clear that, whatever the official rhetoric, preparations and planning are underway to deal with the quite significant risk that the irrevocability of the euro is soon tested. It could be argued that such a tumultuous event could, over time, engender a more favourable set of economic outcomes for both Greece and the broader Eurozone.

EUR/USD rallied on the Feb deal and should find some support on an agreement to release funds to Greece, whether that is in May or June. But the overarching driver of EUR/USD should be relative monetary policy, which points the pair lower multi-month – our year-end target is 1.02.

Key dates

End-April Greek government to pay EUR1.7bn public sector wages and pensions

11 May Eurogroup meeting

12 May Greece owes EUR763mn to IMF

5 June Greece owes EUR312mn to IMF

12 June Greece owes EUR351mn to IMF

16 Jun Greece owes EUR576mn to IMF

18 June Eurogroup meeting

30 June End of 4 month conditional extension to bailout program


Article supplied by Westpac Economics

The Conversation

Gordon Mackenzie, UNSW Australia Business School

In announcing it would change the way is superannuation is taxed if elected, Labor has grasped the superannuation reform nettle by the hand.

Labor says it wants to change superannuation to redress what it considers are inequities in the current system that substantially benefits wealthier superannuants.

Briefly, they are proposing two additional taxes: first, those on incomes over $250,000 would pay an extra 15%, in addition to the 15% already payable, on contributions to their super. Second, super fund earnings over $75,000 per annum would be taxed at 15%. These would not start until 2017 and any gains from assets that funds already own would be excluded.

How it works now

It’s worthwhile to first get a base-line on how super is taxed now. It is often said that super tax is one of the most complicated of all taxes, but simply put, super can be taxed at three points: 15% when you contribute, 15% on annual earnings and, if you take it out before you turn 60, depending on the amount, it might be zero or 15% on a lump sum, or at marginal tax rates less 15% on a pension, but no further tax after age 60.

In effect then, you will have only paid 15% tax on your super received after age 60 and, more importantly, the fund will not have paid tax on its annual earnings after age 60 if it is paying you a pension.

Given that is the way super is currently taxed, one view of the proposed increase in tax on contributions if income is over $250,000 and on fund income over $75,000 pa is, in effect, putting “progressivity” (or more progressivity in the case of the 15% contributions tax) into the super tax system.

Progressivity simply means the wealthy you are, the higher rate of tax you pay.

In the current system the fact there are no fund or benefit taxes after the age of 60 acts as an incentive for people to take a pension rather than a lump sum.

But before 2007, encouraged to put as much after tax money into their super as they could, superannuants built up large balances. At the time, when they took the earnings out, they paid the highest tax rate above what was deemed as a certain reasonable amount.

But under current rules, the earnings after 60 on those large amounts are not taxed, either in the fund or when paid.

Proposal to tax the wealthier

The proposal to tax fund income has been seen before, when in 2013 Labor proposed that it apply from $100,000, which translated to a fund account of A$2 million.

The superannuation industry had real problems with that proposal because it would cause them (and fund members) significant administration costs. For example, a lot of people have more than one fund and the only people who know what the aggregate income of all those funds are is the Australian Taxation Office, and even then they don’t know until two years after the event because that is how long it takes for them to get the data.

Also, how do you deal with tax on fund income that has built up over a long time? This problem is called “bunching”: if you had got the gains progressively each year you wouldn’t have had any tax, but because they are all “bunched” into one year you have to pay tax.

Taxing retirement income over $75,000

Another problem is how you measure the $75,000 per annum of income? Is it on a member account basis, or total fund income divided by all the accounts, and is it only on income that the trustee credits to the member - or all income earned by the trustee?

On the other hand, excluding existing accrued gains is sensible from a number of perspectives - it’s easy to do and it means that gains accruing before the tax commences will not be taxed (another “bunching” issue).

The fund tax starts at $75,000 on the basis that an account of $1.5 million would earn that, it only affects 60,000 people and it won’t affect full or part time age pensioners.

As noted, the previous proposal of taxing fund income over $100,000 was based on the assumption that you needed $2 million in your account to earn that, in which case it was a reasonable threshold. The Association of Superannuation Funds of Australia (ASFA) has suggested that the tax should only be paid on earnings from accounts over $2.5 million, as they considered that a reasonable figure to fund your retirement.

A 2017 start date will create planning opportunities, such as people transferring some of their super balance to their spouse - “income splitting” in other words.

Through the super courses we have been asked by Chartered Accountants and the CPA to provide for their members, we are being told that some people - particularly those with self-managed super funds - are already planning for taxation of fund income by selling and “reacquiring” their assets - which means they will pay zero tax when they finally get rid of the asset.

(As an aside, it works this way: my super fund bought 100 shares 10 years ago at $1 per share. In 2015 the shares are worth $10 per share - a $9 gain. The fund, which is paying a pension so it doesn’t pay tax now on the gain ($9 per share) if it sold the shares, expects that it (the fund) will pay tax in 2017.

What it will do is sell the shares now, realise a $9 per share gain which is not taxed and then buy the shares back at $10. So it sold the shares for $10 and bought them back for $10. When it ultimately sells the shares in 2018, say, the gain it will pay tax on is calculated on the $10 that it paid for them in 2015, not the $1 that it paid in 2005.)

Will Labor’s policy deliver what it promises?

Overall then, Labor’s proposals raise a couple of questions. First, the super industry has already made it clear that a fund tax will probably not work, so just changing the threshold hasn’t addressed that problem. In any case, assuming it does come in, it will distort where funds invest as it will be a bigger incentive for funds to invest in Australian companies paying imputation credits that can reduce the tax bill.

In terms of the additional 15% contributions tax, given that the maximum someone over 50 can contribute without paying more tax is $35,000, the government will only collect an additional $5,250 per person, but there are not that many people earning over $250,000. It is 170,000 of 23 million people.

It would have been good to have some deeper explanation of both these thresholds other than just the number of Australians who are going to pay more tax. Is that what is considered a reasonable tax-free retirement, for example?

Anecdotes we’ve garnered from our work with the accounting professions suggests some elderly clients are getting large untaxed pensions which they do not know what to do with and, to be frank, would not be averse to paying some tax. If that is correct, then the real issue is, at what threshold?

Finally, would these changes make super fairer and more equitable? Probably not in a meaningful way. It’s just tinkering around the edges and making a complex retirement funding system more complex.

This article was originally published on The Conversation. Read the original article.

Aeron Hurt, WHO Collaborating Centre for Reference and Research on Influenza

It’s that time of year again when scientists and doctors make predictions about the impending influenza (flu) season and we must decide whether to go out and get the flu vaccine.

The government-funded flu vaccine will be available from 20 April, a month later than most years, as the vaccine has been reformulated to cover a new strain. But some GPs may offer the vaccine privately before then.

So, who should consider getting the vaccine and who gets it for free? And are we really in for a bad flu season in Australia?

How does the vaccine work?

The flu vaccine helps prevent us from getting the flu each season. It contains dead, broken-up bits of flu viruses that are expected to circulate during the upcoming season.

Once injected into our arms, the pieces of dead virus stimulate our body’s immune response to produce antibodies, which act as a defence that can rapidly swing into action when a live flu virus infects our nose and throat.

Because the viruses in the vaccine are dead, they can’t give us flu.

What’s new about flu vaccines in 2015?

For the first time, Indigenous children are able to access free flu vaccine in Australia.

This is important because Aboriginal and Torres Strait Islander children are five times more likely to be hospitalised with flu and pneumonia than non-Indigenous children. Indigenous children are also 17 times more likely to die from flu or pneumonia than non-Indigenous children.

Australia’s vaccine has been updated to protect against the harmful new A(H3N2) viruses. El Alvi/Flickr, CC BY

This year a new flu vaccine, known as “quadrivalent”, will be available. This type of vaccine contains four flu viruses compared with three in the normal trivalent vaccine. The additional flu strain provides extra insurance that may be useful if unexpected viruses begin to circulate.

However, it’s likely that the standard trivalent vaccine will cover the great majority of the flu A and B strains expected to circulate in Australia this winter.

The quadrivalent vaccine won’t be available via the government’s free flu vaccine program and will be more expensive than the standard trivalent vaccine if purchasing it privately.

Who should get the flu vaccine?

For certain members of the community, catching flu can lead to severe illness or death. It is these “high-risk” groups (listed below) that should actively avoid catching it. Getting the flu vaccine is a major step towards achieving protection from flu.

Certain groups of individuals at high risk of developing severe illness or complications if infected with flu are eligible for free flu vaccine via the federal government. These are:

  • Anyone aged 65 years or over

  • Aboriginal and Torres Strait Islander people aged 15 years or over

  • Aboriginal and Torres Strait Islander children aged between six months and five years

  • Pregnant women

  • Anyone with with medical conditions that can lead to severe influenza, including people with heart disease, severe asthma and diabetes. A full list of eligible medical conditions can be found here.

Within the over-65 age group, a high proportion of people are vaccinated (more than 70%).

But although the flu vaccine is provided free of charge to vulnerable people, many still don’t get it. Less than 30% of pregnant women and Indigenous people receive the flu vaccine. Only half of those with medical conditions that can lead to severe influenza get vaccinated.


Fit, healthy children can’t always fight off a flu. Chaikom/Flickr

Although not included in the government’s free flu vaccine program, children under the age of two years are also highly susceptible to flu.

Once infected with flu, young kids are more likely to be hospitalised with severe illness than those in the over 65 age group. About half of young children who die from the flu are otherwise healthy with no underlying medical conditions or known risk factors.

Most children who die from flu are not vaccinated. Therefore the idea that fit, healthy infants can simply “fight off” a flu infection without any problem is not always true.

Another benefit of preventing flu in children is that it reduces the spread of infections to other vulnerable family members such as grandparents.

What’s in store for us this winter?

The one predictable thing about flu, is that it is unpredictable! However, we often look to the northern hemipshere’s winter flu season to give some insights into what might be expected here.

The recent flu season in the United States and most of Europe was dominated by the A(H3N2) strain of flu. This virus has historically been associated with increased severity in the elderly.

There has been a lot of media coverage about bad vaccine match in the northern hemisphere. This is because most of the serious influenza was caused by the A(H3N2) viruses which had changed over the five to six months when the vaccine producers were manufacturing the vaccine. But the other components of the vaccine were well matched.

Our vaccine has been updated to protect Australians against the new A(H3N2) viruses.

So, if you or a loved one fall within the high-risk groups described above, getting the vaccine remains the most effective way to avoid the inconvenience and potentially severe health risks of the flu – and passing it on.

This article was originally published on The Conversation. Read the original article.

The Government recently released its Intergenerational report which occurs once every 5 years.  The report is designed to provide Government with a basis in which to formulate long term policy (one must be careful not to laugh out loud at this point).

One of the glaring aspects of this report revolves around the ageing of Australia's population and here we provide some of the charts contained in the Intergenerational Report that highlight this ageing profile.

First the good news, which is on average we are going to be living longer.

Some key points from this table are that males born now can expect to reach 91.5 years old, but in 40 years they should expect to live until over age 95.  From a retirement perspective, those men who reach the retirement age of 60 currently can expect to live for a further 26.4 years (29 years for women), but in 40 years time it is expected that a 60 year old male will have over 31 years in retirement (over 33 years for women).

This tells us that people are going to have to save more for retirement as they are likely to be living longer in retirement.  Joint replacements are going to be in huge demand as the body will be required to last longer than at anytime in modern history. Divorce rates may increase as those who reach retirement will have over 30 years to live whereas in 1975, their retirement years were likely to be almost half, resulting in people staying together unhappily because 'there's not much time left anyway'.

The proportion of the population of those over age 65 is going to materially increase which can be seen in the next chart, and of particular interest (from a medical expense perspective) is the growing band of over 85 year olds.


From a different viewpoint, the future number of people living beyond 100 years is going to put pressure on the Royal Family and our politicians to recognise 100th birthdays as the number of centenarians is forecast to grow from under 5,000 today to almost 40,000 by 2055.  Perhaps 100 will be the new 80?

Finally, and one of the most hard hitting chart is the one that shows how many people of working age 15-64 will exist to support those over the age of 65.  In 1975 there were 7.3 people aged between 15-64 (assumingly paying taxes and working) to support 1 person over the age of 65 (who had a relatively short life expectancy by today's standard).

In 2025 that number will fall to 3.7 people aged between 15-64 supporting one person over the age of 65.

It is forecast that by 2055, the number of working people will fall to 2.7 persons for every person over the age of 65.

This is critical as the level of Government spending per person is at its peak for those over age 65, as it allocates money for age pension payments and also for medical expenditure. So Government spending is potentially in for a triple whammy in that there is forecast to be

1. a higher proportion of the population over 65 which contribute less tax but cost more,

2. those over age 65 are forecast to live longer, so not only do they cost the Government more, but will cost more for longer

3. the number of people in the workforce compared to those retired is forecast to drop dramatically - and those working are likely to be unhappy if taxes rise to support the retiree population.

You will also note from the chart below, that spending on children is also high, although not as high as those over 65, as Government spending comes in the form of education costs (largely).


Ablert Einsten's definition of insanity was to "keep doing the same thing over and over, and expect a different result".  We would argue that many government policies in the area of healthcare, taxation and welfare were structured decades ago, and if Australia continues to do the same things over and over in light of the population changes that are forecast, then we are insane.

Government policy is going to have to change to meet the demands of the changing nature of Australia's population.

Investors will need to consider this, particularly when investing in businesses that are partly funded by Government (read healthcare) as government priorities and spending ability will most certainly change over time. 

Investors should also turn their mind toward some of the other effects of an ageing population with respect to demand for things that retirees seek such as travel, healthcare and demand for financial services.  There is also very likely an impact on the residential property market when retirees look to downsize their houses.

We encourage readers to look at the intergenerational report, not that we expect much in the way of action from the current political leaders in the short term, (from all sides of politics), but at some stage Australia is going to have to position itself for these changes.







An institutional friend once defined a mine as a "hole in the ground with a liar at the top".  While clearly Australia's largest export earners revolve around mining, this remark struck caution into me.  There is more to be cautious about with the resources sector and iron ore in particular than a simple throw away line however.


With 60% of world iron ore shipped to China, investors need to consider that the Chinese economy is undergoing change, and its construction and use of steel is slowing.  The fundamentals of iron ore supply and demand have changed and has already caused a massive drop in the price of iron ore, which can be seen in the chart below.  Just a few years ago the iron ore price was almost $200 per tonne, and now hovers around $60 per tonne (US).



With Chinese demand for iron ore significantly different to that of a few years ago, we have also witnessed a significant uptick in production of iron ore.  Slowing demand and rising production has now resulted in an iron ore glut, which obviously has depressed the price.  Investors need to ask themselves whether this is likely to rebound quickly or whether lower prices are to remain part of the environment for some time.  The graph below forecasts iron ore demand (black line) and overlays iron ore supply from global players.  The grey shaded part above the solid line shows the level of oversupply in the iron ore market that is forecast until the end of this decade.  It is difficult to see iron ore prices rise given these fundamentals.  While BHP and RIO's cost of production remains below $60 per tonne (implying that their production remains profitable), the same can not be said of the small to medium sized players.



This not only impacts the mining companies themselves as they receive a lower price for their iron ore, but also has the flow on effect on companies that provide services to the mining companies.  We are currently witnessing most mining companies cutting costs as their margins are eroded by lower prices and some of the simpler costs to cut involve reducing the expenditure on mining services contractors and other capital expenditure.  Australia is also toward the end of completion of several large LNG projects that involve large amounts of capital expenditure, but are likely to complete in the next couple of years.  This means that the capital expenditure in the mining sector, which has already come off its all time high, is likely to have further to fall.  This is evidenced in the chart below.



So not only are we cautious about owning mining companies themselves, we are also very cautious about investing in companies that provide services to the mining sector.  While some of this bad news is clearly already priced in, we are of the view that a catalyst to increase resources prices and stimulate capital expenditure in the mining sector is not on the horizon.



This information is of a general nature only and neither represents nor is intended to be personal advice on any particular matter. We strongly suggest that no person should act specifically on the basis of the information contained herein, but should obtain appropriate professional advice based upon their own personal circumstances including personal financial advice from a licensed financial adviser and legal advice. Fortnum Private Wealth Pty Ltd ABN 54 139 889 535 AFSL 357306

Friday, 06 March 2015 06:04

The Future of the Oil Price

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With permission from Platinum Asset Management, we bring you their views on the future for the oil price.


Scott Gilchrist talks with Douglas Isles about the oil price and what is the likely outcome for it on a medium term view.


Tuesday, 03 March 2015 07:16

Bubbles and the corruption of risk

Written by

I have previously warned that the combination of the demographic avalanche of retiring baby boomers, low interest rates and a disproportionately large amount of their wealth in cash would mean that stocks and property would continue to rise for a while. I call it ‘The Boom We Have to Have.’ But like all booms, this one will also bust.

These conditions, especially low rates forcing a big part of the population into riskier products, corrupt investors’ sense of risk. Rising prices amid a wave of buying reinforces the behaviour of investors and their brokers who believe their thesis is correct.

New listings and credit point to problems

I am not alone in the view that at some point in the next six to eighteen months, there is a real chance that baby boomer retirement plans may sink thanks to their inability to avoid repeating the investment mistakes of their past. Stanley Druckenmiller is an American hedge fund manager, famous for being the lead portfolio manager for George Soros’s Quantum Fund. In 2010, Druckenmiller handed back the billions he had been managing for 30 years through his firm Duquesne Capital. He remains a noted philanthropist, keen golfer and speaker on the global investment and macroeconomic circuit.

Druckenmiller should be heeded. He observed that low rates have skewed peoples’ sense of risk, particularly in two markets – new share listings (IPO’s) and credit. He pointed out that 80% of companies listed in 2014 have “never made a dime”. In 1999, just before the tech crash, that number was 83%.

(As an aside, over the Christmas break, I read You Only Have To Be Right Once: The Unprecedented Rise of the Instant Tech Billionaires. Including Twitter, Facebook, Instagram, the book was a who’s who of the world’s biggest tech companies and the backgrounds to their stunning rises. But I couldn’t help noticing that all the references to billions had little or nothing to do with profits or in some cases even revenues. Some of the businesses discussed, which were sold for billions, not only had no revenue but no revenue model either).

Druckenmiller had another warning on credit markets. Last year, speaking on CNBC, Druckenmiller said, “When I look at credit … corporate credit is growing at a record rate, far faster than it grew in 2007. And S&P pointed out that 70% of debt issued has a B-rating or worse. To put that in perspective, in the ’90s, that number was 31%. Do you remember the hullabaloo in 2007 about covenant-light loans? Companies issued $100 billion of them in 2007, and 38% was B-rated. This year we’re going to $300 billion, up from $260 billion last year and $90 billion a year earlier, and 58% of them were B-rated.”

At the more recent speech, Druckenmiller also observed, “There are some really weird things going on in the credit market … but there are already early signs starting to emerge. And if I had a message out here, I know you’re frustrated about zero rates, I know that it’s so tempting to go ahead and make investments and it looks good for today, but when this thing ends … I think it could end very badly.”

Why is Druckenmiller so worried? It’s simple. If interest rates rise, many investors in corporate debt will want to exit at the wrong time. Australian investors in bank hybrids and corporate bonds (G8 Education is a recent example of a popular corporate bond issuer) should consider the warning too. And if interest rates don’t rise, but the economy weakens significantly, then some industries will be unable to cover their debt costs. Either way, investors will face problems at some stage.

Low rates support asset prices

Low interest rates are here to stay for a while and that will support asset prices. Eventually however the price of those assets (stocks and property) will be pushed way too high (we think a strong bull market is likely for some part of this year) as people panic buy amid a fear of missing out when their income is eroded from low rates on cash. After that, a large number of investors will, sadly, suffer financially again – from buying too late and paying too much.

There is a way to avoid it. You must be invested in high quality businesses with bright prospects and buy them when they are cheap. We can think of only a handful of stocks that meet this criteria currently. When we cannot find such opportunities, the only safe alternative is cash (even though rates are low) and we are 20-30% invested in cash at the moment.

If you are invested in a high-performing fund that is fully invested in stocks like REA Group (P/E ratio 44 times), Dominos Pizza (68 times), or many of the expensive stocks below, consider switching at least some of your retirement nest egg to a larger cash weighting. The cash won’t make your investment 100% immune to a declining market but it will allow additional purchases at cheaper prices, which offers the opportunity to significantly reduce the time to recovery. In Table 1, PER is Price to Earnings ratio.

Table 1. Expensive stocks? You be the judge…

RM Picture1 270215Of course if interest rates stay at zero, the party could last a while yet, but as I have warned previously, be sure to be dancing close to the door in case you need to leave. Druckenmiller refers to a “phony asset bubble”, with a bunch of investors ploughing money into assets which will “pop”. Then we’ll see how many people are still enjoying the party.

Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management

Monday, 23 February 2015 20:14

Greece stares at apocalypse, and retreats

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Greece stares financial apocalypse in the face, and retreats

By Remy Davison, Monash University

Crisis postponed. On Friday, Greece, the European Union (EU) and the International Monetary Fund (IMF) brokered a four-month extension of bailout loans to the newly-installed government of Alexis Tsipras.

Greece’s bureaucrats now have just 48 hours – until 23 February – to pull together a list of reform proposals. These must be approved by the Eurogroup, comprising all of the eurozone’s finance ministers.

Since the Syriza coalition’s election in January this year, Prime Minister Tsipras and his finance minister, ex-Sydney University economist Yanis Varoufakis, have engaged in a tough, no-compromises approach to their EU partners.

But the harsh reality of politics meant compromise was inevitable. Unsurprisingly, the weaker player – Athens – ultimately retreated, unwilling to pull the trigger that would usher in a financial apocalypse.

Thus, Tsipras and Varoufakis find themselves in a most unenviable position: on the one hand, they must deliver some kind of victory to placate their supporters at home. But, on the hand, both men must know the painful reality: resistance is futile.

Regardless of how Varoufakis paints this internecine European struggle – making economic policy as if people matter – the irresistible logic of the situation is that Greece has scarcely any room for manoeuvre, and the most Tsipras and Varoufakis can hope for are minor concessions and weekend extensions. Which is precisely what happened this week.

Zero option

The stand-off between Greece and Europe’s paymaster, Germany, which has insisted upon strict conditionality for the €240 billion bailouts obtained by Athens during the multiple 2009–12 eurozone crises, ultimately led to the rise of Syriza as a domestic political force.

In 2005, Syriza could barely attract 4% of the electoral vote. Seven years later, the Tsipras-led Syriza narrowly lost the 2012 election. Crumbling support for New Democracy, led by conservative Antonis Samaras, meant Tsipras was effectively prime minister-in-waiting, as voters turned decisively against Samaras’ harsh austerity regime. By May 2014, the European Parliamentary elections confirmed the groundswell of support for Tsipras and Syriza.

In December 2014, Syriza forced an early election by orchestrating a minor constitutional crisis. Tsipras swept to power in January this year, promising an end to austerity and renegotiation of the bailout condition, while pledging that Athens would remain in the eurozone.

This final point is critical: at no point have Tsipras or Varoufakis ever suggested Greece would exit the eurozone. Nor have they indicated any desire to withdraw from the EU. The reasons are obvious: since 1981, with one exception, Greece has been a net recipient of transfers from the EU budget. In 2013, Athens received over €7 billion euro, while paying in less than €2 billion. These fiscal transfers range from agricultural subsidies to regional development funding.

But perhaps more importantly, Germany is the largest net contributor to the EU budget, paying almost €30 billion in 2013. And it is Germany’s massive current account surplus that allows its banks to be the eurozone’s largest creditor institutions.

Thus, it is scarcely surprising that Berlin not only wants the biggest say over how the EU budget is disbursed, it also has by far the greatest influence over eurozone policy, which means Greek politicians will be forced to convince sceptical German policy makers that Syriza will honour the bailout conditions signed by previous governments.

The German conundrum

The most implacable obstacle in Tsipras’ and Varoufakis’ path is Wolfgang Schaeuble, former tax inspector, and Germany’s iron minister of finance. Varoufakis’ and Schaeuble’s relationship did not begin well. At their first summit, Schaeuble said the two had “agreed to disagree". Varoufakis swiftly countered that they did not even agree on that.

A note of caution: if you think Germany speaks with one voice on Greece and the eurozone crisis, think again. Since the 1990s, German institutions and political parties have been torn asunder by the divisions caused by what former EU monetary affairs official Bernard Connolly labelled “the dirty war for Europe’s money".

As Connolly notes, Europe can have a “transfer union” (in which Germany pays other states’ welfare bills via fiscal disbursements) or it can have a “fiscal union”, where EU member states follow a German system of fiscal confederalism characterised by disciplined monetary policy, mandatory low-inflation targets and strictly-policed public deficits and borrowing.

This is Germany’s Pareto-optimal model of how a European monetary and fiscal system should operate. It has been articulated ad nauseam by conservative economists for over two decades. Yet, it exists only in theory. But in 2012, Europe moved a cautious step closer to that model with the promulgation of the Fiscal Compact (in force 2014).

However, Germany is divided into at least three camps: anti-euro currency crusaders (mostly university professors and their comrades at the Bundesbank); reluctant participants in the eurozone (the now politically-irrelevant Free Democrats); and those that drove Germany away from the all-conquering deutschmark to embrace the euro currency union in the first place: German industry.

The latter group are the most important. German governments never do anything without consulting industry first, a situation that hasn’t really changed since Frederick the Great. In the global recession of the early 1990s, German industry nearly went broke as the deutschmark (DM) towered over its EU and North American counterparts.

The bill for German unification and the refurbishment of east Germany was DM3 trillion (six times the Bundesbank and the Finance ministry’s original estimate). Daimler-Benz, Germany’s largest industrial combine, gazed into the abyss in 1994; BMW sank billions into ill-considered British automotive ventures and faced huge losses by 1999, the euro currency’s first year of operation.

The chief problem was the exchange rate: the strong DM caused German wage bills to skyrocket, rendering exports uncompetitive. What was needed was an internal devaluation to decrease the cost of German wage labour and reduce the global price of German exports. The euro worked spectacularly well in this respect, losing 30% of its value during its first 18 months of operation (1999–2001). Furthermore, the extension of the EU Single Market to eastern Europe from 2004 saw Germany invest heavily in industrial plant in the EU’s eastern periphery, thus deriving innumerable benefits from low-wage, skilled-labour economies situated within easy reach of the German border.

But the euro had precisely the opposite effect upon Greece when it acceded to the eurozone in 2001. It caused an internal appreciation, meaning Greeks suddenly gained considerably greater purchasing power than they had enjoyed under the drachma. The euro also meant the public and private sectors could borrow in both Eurobond and third-country markets at much lower rates of interest. Markets also assumed there would be no sovereign defaults as the European Central Bank (ECB) could act as the lender of last resort, despite the fact that the ECB’s charter expressly forbids this role. Consequently, this provided an incentive to predominantly French and German banks to lend to Greece and the rest of the EU’s southern periphery: Spain, Portugal, Italy and Ireland.

This is why Germany will not and cannot afford to allow the eurozone to collapse. Quite simply, it is immersed in the politics of national interest. Instead of off-loading the PIIGS in 2012 and cutting its losses, Berlin responded, belatedly, with due diligence: strict austerity underpinning bailout conditions; a fiscal compact; a financial transaction tax; and, reluctantly, with misgivings, quantitative easing by the ECB.

No Grexit?

Despite the re-emergence of rumours of a “Grexit”, the news of Greece’s imminent departure from the eurozone has been greatly exaggerated. This is not to say that an orderly exit by Greece could never occur in the future, but it is unlikely precisely because it is in neither Germany nor Greece’s interest for a rupture in the eurozone to occur. This is why the Germans and the French, whose private bank leverage as a proportion of GDP dwarfed that of Lehman’s or Bear Stearns, could not countenance the implosion of the EU currency union in 2012.

First, Greece will not leave the eurozone voluntarily. No Syriza or New Democracy politician is advocating that. Bundesbank officials may cattily brief journalists that it is only a matter of time before Greece is unceremoniously ejected, but the Bundesbank detests the finance ministry, while institutional resentment of the disappearance of the DM in 1999, and its consequential impact upon the Bundesbank’s loss of prestige runs deep in Frankfurt.

Second, a key point worth repeating is that nothing has changed in the EU treaties since the international financial crisis struck the eurozone in 2009. There is no legal mechanism under Article 50 of the Lisbon Treaty that permits a member state to exit the eurozone, unless that state withdraws altogether from the EU. No state has ever withdrawn from the EU.

Third, there is another reason why Greece has no incentive to abandon the euro system and return to the drachma. Fear of a stalemate between Syriza and the Troika has seen Greek business and investors quietly transferring over €2 billion per day in deposits out of Greek financial institutions. The reason is that if a compromise is not reached over the coming months, Greek banks will run out of cash, leading to a shutdown of the financial system. Even more sobering would be the fact that 25% unemployment, a lost youth generation, slashed pensions, structural reform and five years of painful austerity would have all been for nought.

Tsipras and Varoufakis know this only too well. They were elected to save Greece. Not to bury it.

The Conversation

This article was originally published on The Conversation. Read the original article.

Wednesday, 18 February 2015 10:58

RBA February minutes - more rate cuts likely

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The minutes of the Monetary Policy meeting of the Reserve Bank Board for February provide further insight into the Board’s thinking behind the decision to cut rates. This complements the Statement on Monetary Policy (SoMP) and the Governor’s testimony to the House of Representatives Standing Committee on Economics.

This is a difficult document to write given that the case needs to be made for the rate cut but most readers will be much more interested in the forward guidance.

The most important forward guidance which the Bank has delivered so far has been to assume “market pricing” for the interest rate outlook in its forecasts for the SoMP. At that time the market had priced in a further 25bp cut by May – by adopting that pricing it was implied that the Bank fully expected to cut rates again and certainly by May.

With the announcement that Australia’s unemployment rate had jumped from 6.1% to 6.4% in January, markets moved to aggressively embrace prospects for a cut by March.

A key issue is whether the Bank sees that adverse development as reason to further downgrade its already pessimistic outlook for the labour market or is inclined to dismiss it as “one month” volatility. Certainly it was a shocking move and one that , at least, would confirm their concern with the labour market.

Last week in writing on the Westpac-Melbourne Institute Index of Consumer Sentiment in February we noted: “For now, we are comfortable to maintain our original call [made on December 4] that the Bank would cut in both February and March. However we recognise that a perfectly respectable case can be made for the Bank to pause for a month or two to assess developments in the housing market”.

This observation is further supported in the minutes with the use of the sentence ( which first appeared in the SoMP) : “Given the large increases in housing prices in some cities and ongoing strength in lending to investors in housing assets members also agreed that developments in the housing market would bear careful monitoring”.

On the other hand , the Governor gave a balanced view on the housing market in his recent parliamentary testimony,” Price rises in Sydney are very strong, and they are pretty solid in Melbourne. On the other hand they are much more mixed elsewhere. Excluding Sydney, the rise for Australia as a whole over the past year was about 5 per cent. That is a healthy pace but not alarming.”

The sense of the Bank waiting a month or two for the follow-up cut is further strengthened by the following sentence in the minutes: “In deciding the timing of such a change members assessed arguments for acting at this meeting or at the following meeting. On balance, they judged that moving at this meeting which offered the opportunity of early additional communication in the forthcoming Statement on Monetary Policy was the preferred course.” This could, but not necessarily should, be interpreted that, at the time of the meeting, the board wanted one or the other but not both months.

“Communication” was always our argument for beginning the easing cycle in February rather than waiting for March.

Given that we have held the” February to be followed by March” call since December 4, on balance, we still see that as the best policy and the most likely outcome.

However, as noted above, waiting for a month or two would not come as a significant surprise.

Other incentives to wait, if the Bank is uncertain, would be to assess momentum in the December quarter with the national accounts that will be released on the day after the March meeting.

A major cost in delaying the next move is that the Australian dollar might start responding to a benign rates outlook. Note that the AUD has already traded back up to near USD 0.78 , its level prior to the February rate cut.

Commentary in the minutes pointed out that markets had, at the time, priced the Fed’s first rate hike back to year’s end whereas the governor in his testimony predicted,” in a few months from now”. This updated view on the FED might encourage the Bank to wait on the assumption that further downward pressure will exerted on the AUD. However, that adjustment should already have happened given the strong conviction in markets now that the FED is readying to move in June.

The key point is that the reasons given by the Bank in its recent communications , including the minutes, justify more than one move in total .; “ restrained pace of wage increases;”; “ low rates of inflation likely to be sustained”;” a lower exchange rate was likely to be needed” ;”fewer indications of near term strengthening in growth than previous forecasts would have implied” ;”unemployment rate likely to peak a little ( and later) than in the previous forecast”.

Indeed the risks are much more skewed to more than two moves in total rather than no more moves at all.

Certainly international investors see Australia’s rate structure as being far too high even with a cash rate of 2.25%.


These minutes , on balance, cast more doubt on a follow up move in March. While a March move to follow up February has been our core call since December 4 we can see that “ a respectable case can be made for the Bank to pause for a month or two “ but a second cut still seems extremely likely.

For now, we maintain our original call , particularly watching the AUD over the course of the next few weeks. It is our view that the Bank has considerable scope to ease further and the best policy is to maintain downward pressure on the AUD. The somewhat uncertain outlook for rates which is implied in these minutes might prove to be counter-productive in delivering the Bank it’s likely USD 0.75 target.

That may become apparent over the course of the next few weeks


Bill Evans

Chief Economist Westpac