Monday 22 February 2010

Gold Priced in GBP – February 2010 Update

I am currently forced to buy gold priced in GBP for my retirement investing strategy as this is where my earnings from employment occurs. I t therefore makes sense to look at how gold has performed over the years priced in local currency.

At the time of writing this post the announcement has just been made that the government’s net borrowings for January are dire at £4.34 billion compared with last year’s surplus of £5.3 billion. This looks to have caused the GBP to weaken to 1.557 to the USD and even with the International Monetary Fund (IMF) declaring that they intend to sell 191.3 tons making gold priced in GBP to be currently £715.57.

In absolute terms gold has never been this expensive when looking back over historic average monthly data since 1979. However there has been a lot of inflation over this period and so as always I will look at the real (inflation) adjusted price of gold over this period which is my chart today. The inflation dataset that I will use is the UK retail prices index (RPI).

This chart shows a very different story. Since 1979 we have seen two higher real peaks. The first was £840.89 in 1983 and the second was £1043.39 back in 1980. These peaks are 18% and 46% higher respectively than today’s price suggesting that there is still plenty of potential upside.

The trend line of the chart suggest gold today at only £248.20 and the historical average real gold price from 1979 is £429.50. So by both these measures gold looks over priced in GBP terms.

History suggests that gold has significant potential upside from its price today and given that I am underweight gold against my desired low charge portfolio I think I am going to buy some more. I will of course update the blog when this occurs.

As always DYOR.

Assumptions include:
- Last Gold price actual taken on the 18 February 2010
- All other prices are month averages.
- February ‘10 inflation is extrapolated.

Sunday 21 February 2010

Australian Stock Market – February 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I am using a cyclically adjusted PE ratio for the ASX 200 to attempt to value the Australian Stock Market. The method used is based on that developed by Yale Professor Robert Shiller. I will call it the ASX 200 PE10 and it is the ratio of Real (ie after inflation) Monthly Prices and the 10 Year Real (ie after inflation) Average Earnings. For my Australian Equities I will use a nominal ASX 200 PE10 value of 16 to equate to when I hold 21% Australian Equities. On a linear scale I will target 30% less stocks when the ASX 200 PE10 average is ASX 200 PE10 average + 10 = 26 and will own 30% more stocks when the ASX 200 PE10 average is PE10 average -10 = 6.

Chart 1 plots the ASX 200 PE10. Key points this month are:
ASX 200 PE10 = 18.2 which is down from 18.8 last month. My target Australian Equities target is now 19.6% which is up from 19.2% last month.

ASX 200 PE10 Average = 22.8

ASX 200 PE10 20 Percentile = 17.3

ASX 200 PE10 80 Percentile = 27.7

ASX 200 PE10 Correlation with Real ASX 200 Price = 0.81

Chart 2 plots further reinforces why I am using this method. While the R^2 is low at 0.1433 there appears to be a trend suggesting that the return in the following year is dependent on the ASX 200 PE10 value. Using the trend line with a PE10 of 18.2 results in a 1 year expected real (after inflation) earnings projection of 13.3%. The correlation of the data in chart 2 is -0.38.

Chart 3 plots Real (after inflation) Earnings and Real Dividends. Dividends and Earnings both remain below the trend line. Earnings also remain very close to that of Dividends. What this means is that currently Australian companies are using nearly all their Earnings just to fund the Dividends. Yet the trend line suggests typically clear distance between the two with the trend lines running almost parallel. I ask the same question as last month. Where is the money for investments going to come from?

As always DYOR.

Assumptions include:
- All figures are taken from official data from the Reserve Bank of Australia.
- February price is the 17 February ’10 market close.
- February Earnings and Dividends are assumed to be the same as the January numbers
- Inflation data from January to February ’10 is estimated.

Saturday 20 February 2010

“How Lloyds TSB is helping first time buyers”

I was amazed but unfortunately not surprised to see the methods that Lloyds TSB (which is being propped up by my taxes) is using to try and cajole first time buyers into the UK housing market. The product being peddled justified a four page advertisement in a major London newspaper and is called the Lend a Hand Mortgage.

The advertisement starts with “as a response to the current market conditions, the Lend a Hand Mortgage is giving first time buyers the opportunity to get help with their mortgage from family and friends.” From what I read it doesn’t look like that great a deal to me.

Lloyds claim that “in 1999, 592,000 first time buyers completed mortgages, by last year it had fallen to 193,000, according to the Council of Mortgage Lenders,” My chart today demonstrates clearly one of the big drivers of why this has occurred. For the year 1999 the ratio of Nationwide Historical House Prices to the Average Earnings Index (LNMM) was an average 742.7 and in 2009 this had risen to 1139.1. That means affordability has reduced by 53%. This un-affordability has been caused by the very same banks that are creating products like that advertised extending ever easier credit which is what put us in the current mess we are in today.

The mortgage advertisement goes on to say “even as recently as a couple of years ago, it was much easier to get a mortgage... and it was not uncommon to get a 100% mortgage that didn’t need a deposit.” As we all now know that was just foolish. I’m still amazed this occurred. If you can’t put together a deposit for a mortgage just how did the banks expect people to be able to afford to repay that mortgage. Additionally the banks were counting on property never decreasing in value plunging people into negative equity. Even the most naive banker by spending 10 minutes on the internet could have found historical data that showed how false this assumption was.

Some more data provided in the mortgage advertisement states that “according to the Council of Mortgage lenders, in July last year 80% of first time buyers were turning to their parents for help, up from 50% in February.” To have included this Lloyds clearly think that this adds to the sell. What’s it saying? Everyone else is doing so you should to? Personally I find that a terrible statistic and quite sad. House prices are so over valued compared to earnings that it is almost impossible for a first home buyer to buy a roof to put over their heads without external support. Basic human needs are food, clothing and shelter. Now we are in a situation where one of the basic human needs is now unobtainable without support. What type of country are we living in?

So how does this product work? Let’s say you want to buy a house for £100,000. As the first home buyer you offer up 5% (£5,000) worth of deposit and your ‘helper’ offers up 20% (£20,000) which is placed in a savings account earning rate of 4.15% for 42 months. Then by magic the first home buyer is able to be given a mortgage of 95% (£95,000) at 5.69% fixed until March 2013 if you don’t pay a product fee (whatever that is). Let’s analyse this a little:
- The ‘helper’ gets their money back after 42 months “provided the buyer doesn’t default on their mortgage payments, and provided the amount of the mortgage compared to the value of the property (LTV) has dropped to 90% or less – as assessed by us...” So Lloyds have cleverly protected themselves from a house price crash of up to 25% for the next 3.5 years by effectively offering a 75% mortgage.
- Should Lloyds have only offered first home buyers the 75% mortgage it would have meant that a £5,000 deposit could have only secured a mortgage of £15,000. Instead, this scheme can leverage the first home buyer up to a mortgage of £95,000 while providing some protection to themselves.
- The mortgage is a repayment mortgage however to demonstrate quickly how much this mortgage benefits Lloyds I’m going to assume an interest only mortgage (ie no principle is repaid). Both final amounts I’ll present would be a little less if calculated as a repayment mortgage although not by much as the principle reduction per year is very small in the early years of a mortgage. Let’s look at what happens in the first year. So the buyer who takes a standard 75% mortgage provides Lloyds with charges of approximately £15,000 x 5.69% = £853.50. Now the buyer who takes a ‘Lend a Hand’ provides Lloyds with charges of approximately £75,000 x 5.69% + £20,000 x (5.69%-4.15%) = £4,575.50.

To me it looks like a continuation of the past:
- The first home buyer ends up over leveraged and indebted for life which is what put us into the credit crunch in the first place.
- Lloyds ends up squeezing more than 5 times the revenue out of the same customer.
The only difference is that this time Lloyds are a bit cleverer and give themselves some more protection than previous times.

I’m not convinced the product is designed to give “more people...a chance to own their first home” more likely a chance for Lloyds to maximise its revenues. I’m remaining out of the house market for now and the more I read about these types of products the more I think current prices are unsustainable.

As always DYOR.

Thursday 18 February 2010

Gold Within My Retirement Investing Strategy – February 2010 Update

Within my Retirement Investing Strategy I currently hold 3.2% (up from 3.1% at the last gold update due to a buy decision made this month) of my portfolio in gold with a targeted holding of 5%. Gold is the only portion of my portfolio that does not provide a yield (dividends, interest etc).

The first chart shows the updated real price of gold since 1968, with the wild ride that comes with gold obvious. This month the real (after inflation) price of gold has risen by about 0.3% to $1,119.40 per ounce. The trend line however suggests a price today of $631.00 which is the same as the last update. The historical average real gold price from 1968 also remains at $600.52. So by both of these measures gold still appears overpriced.

The correlation between the real S&P 500 (also displayed on the first chart) and real gold also holds from the last update at -0.33. The second chart provides the ratio of the S&P 500 to gold demonstrating just how far apart the two can vary. Today this ratio has lowered slightly from 1.01 to 0.96. The trend line however suggests a ratio today of 2.63 and the historical average ratio from 1968 to today is 1.63. So this measure would suggest that if you were looking to choose to buy the S&P 500 or gold then the S&P 500 might be the better option.
The final point to make however is that while both the first and second charts suggest gold is overpriced on historic measures I cannot forget that in 1980 gold reached an average real monthly price of $1,728 which is a long way above where we are today.

My investment methods are largely mechanical and given that I am underweight gold against my desired low charge portfolio I should be buying more. Unfortunately all my earnings are made in GBP and in this currency gold is starting to feel expensive. Of course I would never make a decision based on feel so I’m going to do some historic real gold price analysis priced in GBP before making the decision to buy more. Of course I’ll share this analysis with you over the next few days.

As always DYOR.

Assumptions include:
- Last Gold price actual taken on the 16 February 2010
- Last S&P 500 price actual taken on the 12 February 2010.
- All other prices are month averages.
- Inflation data from the Bureau of Labor Statistics. January and February ‘10 inflation is extrapolated.

Wednesday 17 February 2010

UK Inflation – February 2010 Update

Yesterday the Office of National Statistics reported the January 2010 UK Consumer Price Index (CPI) as 3.5% up from 2.9% and the UK Retail Price Index (RPI) as 3.7% up from 2.4%. It seems the records just keep being broken. Last month we had “the increase in the CPI annual rate of 1.0 per cent between November and December 2009 is the largest ever increase in the annual rate between two months” and this month we have an ”increase in VAT rate leads to record CPI monthly movement for a December to January period.”

The first chart is tracking the CHAW Index which is the RPI including All Items. I focus on the RPI as my National Savings and Investments Index Linked Savings Certificates use the RPI to index from. The current level of the Index remains above the trend line however what is interesting is that the index is actually starting to fall. In December ’09 it stood at 218 and it is now at 217.9, a fall of 0.1. At first glance this might suggest that the Bank of England has it all under control and inflation is going to start falling towards their 2% CPI target. I’m not convinced as let’s look at what’s happened for the same period over the previous 10 years:
- December ’08 to January ’09, -1.8
- December ’07 to January ’08, -1.1
- December ’06 to January ’07, -1.1
- December ’05 to January ’06, -0.7
- December ’04 to January ’05, -1.0
- Then in order of the previous 5 years -0.4, -0.1, -0.1, -1.1 and -0.7

The second chart is again based on the CHAW Index. This chart shows annual figures based on the previous 3, 6 and 12 month’s worth of data. As of December the 12 month figure is 3.7% (as published by the ONS), the 6 month figure is 4.2% and the 3 month figure is 3.5% annualised. It will be interesting to see what happens next month as I still think the Bank of England are looking for all the excuses to sweet talk the market but are chasing a “little inflation”. This will ease the pain on those who are in debt. That is the government and the public who on average have over extended themselves. Those prudent savers (like myself) will of course be punished as the value of their assets is reduced.

The fact that CPI is so far above the 2% target prompted the Bank of England to write a letter to the Chancellor. What a read. Firstly the excuses:
- “the restoration of the standard rate of VAT to 17.5% is raising prices relative to a year ago.” I think it’s a little hypocritical to use this excuse. When the rate went from 17.5% to 15% a little over a year ago I don’t remember anyone using this effect to help explain why we were seeing deflation. Instead it was quick, panic, drop the Official Bank Rate to record lows and Quantitative Ease (QE). Now the boots on the other foot and we just ignore it.
- “oil prices have risen by around 70%.” Why no mention of the fact that they and the government managed to engineer a currency devaluation knowing that import prices will rise, causing the average punter to pay more for fuel, which feeds into CPI.
- “the effects of the sharp depreciation of sterling in 2007 and 2008 are continuing to feed through to consumer prices.” As mentioned above all engineered by the Bank and government and now it’s all oh well too bad at least we have an excuse.
Secondly, it is clear we should not worry as the Bank of England knows what it is doing [sic]. Inflation is well above target but the “low level of Bank Rate, will continue to provide a substantial boost to nominal spending for some time to come.” In case that wasn’t inflationary enough “it will continue to monitor the appropriate scale of the asset purchase programme and further purchases would be made should the outlook warrant them.”
Finally, “equally, if at some point in the future, the medium term outlook for inflation threatened to rise above the 2% target, the Committee would tighten monetary policy.” To me it looks like we are well above the 2% target and that’s why the Bank of England are writing the letter in the first place. The Bank of England next meets on the 04 March however this letter makes it clear. Interest rates won’t be raised and we still have the chance of yet more Quantitative Easing to come. How much more do they want to distort markets and force up asset prices through low interest rates. I hope the bond market soon stops all this nonsense and takes the decisions away from them.

It’s interesting to parallel this with another developed economy central bank. The Reserve Bank of Australia seems to have CPI in control at 2.1% after raising rates a number of times. They are clearly committed to their inflation target as the latest minutes show that the decision to hold rates last month was a close call and that rates would continue to rise in 2010 if the economy continued to grow.

One only has to look at the exchange rate between the countries today to see the attitudes of both banks demonstrated by the markets.

As I stated last month, all I can say is that I’m glad I own Index Linked Savings Certificates and Index Linked Gilts.

As always DYOR.