Loose Wallets Sink Ships

How bad is it? Bad.

In many previous articles, I explained the obvious: that the Canadian housing market is grossly overpriced - driven by low interest rates and personal debt - and ripe for a crash.

Many disagreed. Those who disagreed most strongly were, unsurprisingly, those who had bought rental properties or first homes within the last 3 years (for the reason why, see Cognitive Dissonance). Yet, what was obvious to some is slowly becoming obvious to all: the Canadian housing market is sinking.

A recent press release by the Bank of Canada was brutally straightforward: “The slowing since the spring in resale, renovation, and new home construction activity has been driven by a number of factors, including the passing of pent-up and pulled-forward demand; the expiration of the federal Home Renovation Tax Credit in January; the tightening of standards for government-backed insured mortgages that came into effect in April; the introduction of the HST in Ontario and British Columbia in July; declining affordability; and subdued income growth.” This painful laundry list is the reality of the Canadian housing market today.

The demise of the housing market has received surprisingly little coverage in Canadian news. In fact, a recent headline in the Financial Post (Ottawa ponders further tightening of mortgage rules) suggests that the housing market is still hot and may require cooling.

Canadian personal debt levels, which have risen along with the housing market, have been a cause of great concern for the Bank of Canada for some time. Again, the Bank of Canada has been blunt, noting that “Canadian households have now collectively run a net financial deficit for 37 consecutive quarters. That is, their investment in housing has outstripped their total savings for over nine straight years.” The Bank of Canada concludes in a single line, “This cannot continue.”

Debt levels have reached the point where any further increase in interest rates – which may be necessary to combat inflation – will strain Canadian families. If inflation rises, the BOC may be forced to raise interest rates and push those citizens who are now “just hanging on” into bankruptcy.

The Canadian housing market’s decline is just beginning. How long this process will take is anyone’s guess, but it will likely be measured in years, not months. A decline in value of an asset class this large ensures no quick recovery.

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To review the progression...

The Canadian Housing Market
Canadian Debt II
Spin City
The Canadian Housing Bubble - CREA to the Rescue
The Canadian Real Estate Market: Trouble in the Pipeline
Canadian Real Estate: Stick a Fork in It

The Bank of Canada - Employment in a Modest Recovery
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"Results - Fall 2010

The Canadian Real Estate Association says first-time home buying activity is slowing. What’s happening in your region?

I’m seeing more first-time homebuyers this year - 24%
I’m seeing fewer first-time homebuyers this year - 66%
I haven’t noticed a change - 10%

Genworth Financial Canada - The Homeownership CompanyPrime Source"

A recent poll by Genworth Financial Corp, given to mortgage brokers and bankers across Canada
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The Retail Gold Rush

Gold bullion is at record highs, and is set to rocket still higher. At least, this is the official sentiment of The London Bullion Market Association. But with prices already at record highs, is this the time to buy gold or the time to sell it?



There are two reasons commonly given to buy gold now. The first is that gold is a store of value. That is, although inflation eats away at the value of currencies, gold has a value that cannot be taken away. The second reason is that uncertainty drives gold prices higher, and today’s markets are certainly uncertain.

Gold is indeed a store of value, a currency, a component of jewelry and electronics, and more. The problem is that gold – like other commodities - usually keeps up with inflation and the business cycle but does not exceed it. In the past 3 years, however, gold has exceeded inflation greatly. Fear and speculation are the drivers of gold prices now.

Earlier this year, we saw the advent of gold-to-go machines. These vending machines hold a quote for 10 minutes, then scan the market and recalculate so the customer is always getting an up to date (but marked up) price. In Europe, these machines can be found in airports, hotels, and even supermarkets. For me, the gold-to-go machine marked the entry of retail “stupid money” into the market - money that arrives too late and stays too long.

If gold vending machines weren’t enough, consider the rise of solid or yellow gold miniatures. A few years ago, gold miniatures were an exclusive novelty. These days, the windows of high-end Chinese jewelry stores are loaded with solid gold rabbits, dragons, boars, oxen, and popular cartoon characters. The miniatures are popular with Chinese, since they offer a way to store wealth for posterity while simultaneously flaunting it.

The final sign of the gold peak is the de-hedging process of the gold producers themselves. In order to reduce income fluctuations caused by changing gold prices, most gold producers partially hedge their gold using futures or options. For example, companies buy futures that go up in value when gold goes down, and that go down in value when gold goes up. By hedging with futures, companies will not benefit as much from rising prices, but they will also not get stung by falling prices (arguably more important for profitable companies).

This year, many major gold producers have greatly reduced or even stopped hedging in the expectation of forever-rising prices. Barrick Gold, AngloGold Ashanti, Gold Fields and other companies have reduced their gold hedging by millions of ounces.

So, is gold going to drop? Should you short it?

At this point, there is still widespread fear all over the world, and this is partially justified by a worldwide housing bubble and precarious economies. Shorting gold at this point is probably not justified. However, neither is jumping on the bandwagon.

Gold prices are high – really high. Both as an investment and as a novelty, gold is more popular now than it has been in a very long time. I would refrain from buying. If you already own gold, consider selling some.

If you believe the world's currencies are being debased and you need to protect yourself, buy producers of commodities that have uses beyond merely a store of value - such as oil, uranium, lithium, and copper.

Buying something at the peak of its popularity is not always a stupid financial move, but statistics are against you.

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"My dear girl, there are some things that just aren't done, such as drinking Dom Perignon '53 above the temperature of 38 degrees Fahrenheit."

Sean Connery as James Bond, GoldFinger, 1964

Rare Earth Metals – China’s Trump Card?

Historical enemies Japan and China are at it again, this time about a disputed territory in the Diaoyu islands (known as the Senkaku islands in Japan).

On Sept 7th, two Japanese coast guard ships collided with a Chinese fishing vessel (or perhaps spy ship, since fishing vessels are used as spy ships by many nations). The Chinese captain (agent?) is now incarcerated in Japan, and Chinese officials are demanding his release.

There are many uninhabited "islands" in the oceans East of Japan, some of which are no more than lumps of rock a few inches above sea level, surrounded by concrete and tetrapods so they don’t wash away. The islands are important, of course, because whoever owns them can claim the surrounding mineral rights. At least, this is the presumption, despite a UN convention that “rocks that cannot sustain human or economic life of their own shall have no exclusive economic zone…”

What is interesting about this most recent incident is that China may be playing the “rare earth metals trump card" to end the conflict.

Rare earth metals are used in batteries, wind turbines, lasers, cell phones and other high-tech devices. In this latest diplomatic incident, China's customs clearance of rare earth metals into Japan has been “delayed.” China of course denies that they have implemented a trade ban.

Since China produces the vast majority of the world’s rare earth metals (more than 97% by some estimates), rare earth could become a handy negotiating tool for China in the future.

There is no doubt that rare earth metals - and therefore rare earth mining - will be an important area for investors to watch in the years to come.
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See also:

Govt Probing China's Rare Earth Trade Embargo

China will never waiver on issue of sovereignty: experts

Chinese people's willingness to travel to Japan drops amid diplomatic dispute

China denies tightening rare earth trade

Mabuchi worried about China fallout
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“Life is really simple, but we insist on making it complicated.”

Confucius
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