02/08/2013 - 15:50

Price of money driving residential rebound

02/08/2013 - 15:50

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Record low interest rates are contributing to the surprising increase in Perth’s property prices.

If the mining boom is over, which it probably is, why are Perth property prices rising faster than those in any other Australian capital city?

The answer, and it also applies to another asset class  (gold) is that everything in the world of investing today is being driven by a single factor – the price of money. Or to put it another way, interest rates charged by banks.

Look at gold first because it is the bad news in this ‘good versus bad’ examination of two case studies.

Since early January, the gold price has dropped by 21 per cent, from $US1,681 an ounce to a recent price of $1,326. The biggest fall came after hints from the head of the US Federal Reserve, Ben Bernanke, he would soon start to stem the tide of easy money that is helping the US economy to recover.

The effect of those comments was electric, with key interest rates such as the US 10-year treasury bond rising sharply, knocking the stock market down and trashing the gold price, which plunged to a multi-year low of $US1,080/oz in late June.

The issue with gold is that, in its pure physical form it does not yield a dividend or pay interest. It is effectively an insurance policy against bad government and the capacity for governments to generate asset-value destroying inflation.

When Mr Bernanke stops printing money by buying bonds issued by commercial banks it will be a signal that the US economy is nearing normal and that it’s time for interest rates to move up from their current emergency setting – with the 10-year bond likely to rise from its current 2.58 per cent to 3.5 per cent and more.

The higher US interest rates go the higher goes the US dollar, and the lower goes gold.

The price of money can also be seen at work in the Perth property market because the end of the capital investment phase of the mining boom, coupled with widespread job losses and project deferrals, should have caused a fall in property values rather than the rise reported last week.

It is possible that there will be a delayed reaction in the property market to the end of the boom, but the report by Australian Property Monitors that Perth’s median home price rose by 7.5 per cent in the year to June 30 was a surprise.

Even more surprising than the annual rise, however, was the 3.2 per cent rise in Perth’s median price during the June quarter, an increase beaten only by Melbourne’s 5 per cent lift.

The next six months will be the real test of Perth prices as the full effect of mining redundancies are felt; but what really seems to have stoked a fire under the property market is the lure of super-low interest rates, with most borrowers able to secure a loan priced at less than 5 per cent.

As well as encouraging first-time homebuyers and existing owners to trade up, cheap loans are also luring renters into home ownership, because when the numbers are crunched it can often be cheaper to buy than to rent.

There is, as ever, a flipside to the property market and it can also be traced back to the critical issue of the cost of money and the question of what happens when the emergency sub-5 per cent setting ends.

For the answer look no further than the price of gold and what happened when there was a whiff of higher US interest rates – the gold price tanked.

Property prices do not move in the same mercurial fashion as the price of gold or stock market indices, but they do move when interest rates move.

From an investment perspective there has probably never been a better time to be in the property market, and a worse time to be in the gold market.

For borrowers, now is probably an ideal time to lock in whatever debt they have.

There might be one more downward leg in Australian mortgage rates after the Reserve Bank meets on August 6, though trying to pick the exact bottom (or top) of a cycle is never easy and snatching a slice of sub-5 per cent debt makes a lot of sense.

Metal market

IF central bank interest rate policies are determining gold and property prices, there are two other interesting examples of market interference worth thinking about.

The first is the curious game of the ‘warehouse war’ being played by big investment banks and commodity trading companies, which looks like it could have a spectacular end that will damage metal prices.

Over the past few years, thanks largely to rich investors seeking a higher rate of return than the low rates available on bank deposits (much like Albany’s rare coin victims), investment banks such as Goldman Sachs and JP Morgan have bought metal-storing warehouses licensed by the London Metal Exchange.

Rather than using the warehouses as a temporary storehouse, the bankers ‘parked’ the metal they had bought for clients, generating rent on the material stockpiled and only releasing small amounts to companies that use metal, such as carmakers.

No-one is happy with the situation. Carmakers are complaining about being forced to pay a physical premium to get access to stockpiled metal. The LME is planning to change its rules to force a faster release of material, and agencies of the US government are considering fresh rules to ban banks from playing in the commodity market.

The worry for mining companies is that a sudden release of the estimated 7.7 million tonnes of stockpiled metal could flood the market, further depressing prices.

Highland zing

THE electricity market is the final example of government interference in pricing, particularly with regard to the crisis brewing in Scotland.

ScottishPower, that country’s biggest electricity provider, has warned customers of a fresh round of price rises because of new energy efficiency regulations, wind-farm subsidies and the new British carbon tax.

In a strange way it’s comforting to know that other countries are suffering from the same sort of legislative madness that’s driving power prices higher and killing any hope of a revival in the Australian manufacturing sector – no matter what ‘President Rudd’ might decree.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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