The eternal truth in the investment world is that every asset-class goes through boom and bust cycles, which typically last for several years. However, it is ironic that towards the end of any bull-market, when the risk is extreme, optimism towards the booming asset-class is usually at a record-high! On the other hand, during the final phase of a bear-market, when the downside risk is limited, the asset which is selling at a huge discount is always neglected and hated by the public! The reason for this irrational behaviour is that most people find it hard to foresee and accept change. The conditions which have been prevalent for a long-time are considered to be permanent and investment decisions are made accordingly.
In the late 1990's, the entire world was in love with "new era" inspired by technology. Fund managers, economists, media commentators and even the shoe-shine boys were drooling over the prospects of retiring young, thanks to their Microsoft and Intel shares. Of course, that turned out to be the worst time to be invested in the hype as the technology shares came crashing down to earth in March 2000. Back then, I recognised that commodities were on the bargain table relative to financial assets. Therefore, I started buying precious metals but most people thought that I had been affected by the "Millennium Bug"! "Why are you buying gold? I lost a lot of money in gold 15-20 years ago and I'll never touch it again," were comments I often heard. Once again, the great majority failed to identify change, thereby ignoring the birth of a new bull-market.
Once the great technology bubble burst and the US slipped into a recession, the central bankers decided to fight the slump by lowering interest-rates to a multi-decade low. In the US, interest-rates were pulled down to a miniscule 1%. As the cost of borrowing came down, Americans turned to real-estate as the next sure thing. Real-estate prices surged as demand rose due to cheap and abundant credit. As home prices continued to rise, Americans started using their real-estate as collateral to borrow money. Falling interest-rates and appreciating home values also created an explosion in re-financing activity and the US embarked on a gigantic spending-spree. It is worth noting that over the recent years, Americans extracted a ridiculous amount of equity from their homes (Figure 1). In fact, since the beginning of this decade, Americans extracted a whopping US$4.6 trillion! Figure 1 also highlights the negative savings rate in the US, which confirms my view that the loans taken out against homes weren't saved for the proverbial rainy day; instead the money was spent on consumption.
Figure 1: Americans using their homes as ATM's!
The above recklessness has put the US economy in a precarious situation. Interest-rates are now rising all over the world and after a multi-month pause, I expect interest-rates to continue their upward trend. So far, the Federal Reserve has raised rates 17-times to 5.25% and the impact is already being felt on American real-estate. I'm afraid, the property industry in the US is falling into a serious recession. In June, new home sales fell to 1.49 million units, the lowest since November 2004 and down 18.1% from the record-high of 1.81 million units during January 2006. Furthermore, the supply of US-homes for sale has recently jumped to a multi-decade high. In summary, rising-interest rates are starting to bite into the real-estate boom and trouble may be on the horizon.
I've been warning about housing for several months now and still urge you to get rid of your investment properties. In my opinion, we are in the final stages of the housing-boom and (once again) the majority of people can't foresee this change. The warning flags are everywhere! Recently, the stocks of major US-homebuilding companies declined sharply and I consider this an ominous development. The S&P 500 Homebuilding Index is down 46.2% from its July 2005 record-high! Such a major sell-off in this sector is the market's way of forecasting deteriorating business conditions ahead in the real-estate industry. Moreover, if US-housing slips into a recession and prices decline, consumption will also be badly hurt due an abrupt ending of the re-financing boom. Remember, consumption accounts for roughly 70% of GDP growth in the US and any slowdown in this department may send its entire economy into a recession.
Furthermore, it is my observation that apart from the US, real-estate is generally overvalued in the majority of nations. Due to poor wage-growth and rising interest-rates, housing simply isn't affordable anymore and may deflate over the coming months as demand continues to evaporate. So, to re-iterate, my sincere advice to you is to liquidate your leveraged properties and invest in the world of natural resources where the bull-market is still in its infancy! A mega change is currently underway and over the coming years, I envisage major capital flows from financial assets to commodities.
In my view, every investor must allocate 20-25% of their total net-worth to precious metals. This may sound extreme but in a world where central bankers continue to inflate the supply of money, gold and other precious metals offer the best wealth protection. Over the coming years, I expect the various central banks to print a ridiculous amount of money. The US faces a $46 trillion debt monster and the only way it can remain solvent and pay-off its debt is through monetary inflation. Remember, the easiest way to repay debt is by diluting the purchasing power of each unit of money. So, through monetary inflation, the $46 trillion dollars the US owes today may not "feel" like $46 trillion in 10 years time! To complicate matters further, due to globalisation and international trade, no country wants a strong currency. So, if every nation continues to print money in order to keep its own currency weak against a fundamentally weak US-dollar, the entire basket of "paper" currencies will decline against precious metals whose supply can't be increased ad infinitum.
Precious metals are in a gigantic bull-market, which is likely to continue for as long as monetary inflation remains the norm. For sure, no bull-market continues to rise forever and each boom is punctuated with multi-month consolidations. After a stellar multi-month surge, the precious metals bull-market witnessed a vicious yet normal pull-back in May. In my opinion, the worst is behind us now and this is an ideal time to add to your positions in precious metals. After a few more weeks of consolidation, I anticipate another strong advance over the coming 6-9 months. The rising geo-political tensions and a possible conflict between the US and Iran may cause precious metals to really shine in the period ahead. Back in 1980, on an inflation-adjusted basis, gold peaked at $2,100 per ounce and silver peaked above $100 per ounce. Today, you can buy gold at $630 per ounce and silver at $12.5 per ounce - absolute bargains, given the money and credit growth we've seen over the past 26 years!
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