The big issue in the news is clearly Russia’s intervention in the Crimean region of Ukraine. On Tuesday, my colleague Ed Bowsher took a look at what you should do. “Is it time to sit tight and do nothing? Or to switch money into safe havens? Or should you be bold and go bargain hunting?”
While events are still developing, Ed thinks that “the most likely outcome is something similar to what happened in Georgia six years ago, after the Russians marched into that particular country”. Currently, “Russian troops remain in South Ossetia. Georgia has no control over the territory”.
However, “some form of sanctions looks very likely”. The only problem is that “Russia and Western Europe are both very dependent on each other”. Indeed, he points out that, a third of the EU’s oil and gas supply comes from Russia. Despite this, “even sanctions imposed by the US could hurt Russia”.
Indeed, the Russian central bank has been forced to spend billions of its dollar reserve, and hike rates, in attempt to protect the Russian ruble.
Ed also thinks that “panic selling in a crisis isn’t a good idea”. Instead, “I’m investing on a 20-year horizon, which means I can afford to stay invested for the long-term and ride out the storm”. Of course, “if you’re older, or you think you might need cash from your stock portfolio in the next two or three years, you could consider selling some of your shares”.
In that case, “further modest investments in gold look sensible to me, although we’d still suggest that 10% is about the right level to have in your portfolio”.
Energy stocks that aren’t exposed to Russia may also benefit from higher oil prices. One example is Tullow Oil (LSE: TLW), which is “a substantial production and exploration business with interests in many areas of the world, but absolutely nothing in Russia or Ukraine”.
However, since things could “get worse before they get better”, the best idea is “to hold back and wait until the crisis reaches some form of climax, and then invest”.
Indeed, “in the 1991 Gulf War, share prices only started to rise once the bombing of Baghdad had begun and victory for the US looked certain”.
We have covered this issue in more detail in this week’s MoneyWeek magazine.
Madness of London’s property bubble
On Monday, I had a look at the London property market. My flat hunting has already brought home to me just how mad it is out there. A look at the figures suggests that there are three key points that prove that this is a massive bubble.
The first warning sign is that the gap between the asking price and the agreed price has all but vanished. Normally, estate agents like to deliberately overvalue properties, which means that the final deal ends up being at a discount to the recommended price.
However, the gap between the two has shrunk to 2%, suggesting that, “prices are rising so fast that even estate agents are unable to keep up”. Indeed, “the last time sellers were getting offers this close to their asking price was in the summer of 2007, a few months before the market turned”.
Next, London properties are being snapped up almost as soon as they go on the market. While there’s usually a lag between property going on the market and an offer being accepted, the gap is now “as little as 2.7 weeks”.
As with the previous indicator, “we haven’t seen this sort of enthusiasm in the market since the first part of 2007”. This suggests that buyers “are jumping at the first thing available in a desire not to be left behind”. Of course, this is typical of what happens when bubbles reach their peak.
Finally, “prices are now well above the peaks set before the last crisis”. The Nationwide and Land Registry put prices 13.5% and 15.2% higher. Of course, “you would expect prices to reach their peaks eventually”.
However, “given that wages have barely shifted since the financial crisis, the sort of rebound we’ve seen in London is about far more than just keeping up with inflation”.
Indeed, “ the ratio of first-time buyer house prices to mean gross earnings in London is the highest it has been since the survey started in 1983”.
All three indicators “are classic signs of a bubble about to burst”. They are also “a wake-up call for me”. Of course, you can argue that “if you’d bought at the end of 2005, two years before the peak, and sold at the trough in late 2008, you would still have made money”.
However, in reality, “if you had bought in 1987, and held through the 1989-92 crash, you would have had to wait until 1996 to see your purchase regain its original value”.
UK House Prices will fall – but not just yet
Our editor-in-chief, Merryn Somerset Webb, agrees that, even taking the wider UK market, “the average house-price-to-earnings ratio – at well over six times – is still ridiculously high relative to historical norms”.
Since she doesn’t believe that “the historical relationship has entirely and permanently broken down”, she thinks that we’re in for a “nasty adjustment”. However, the big question is “when might this happen?”
After speaking to economist Roger Bootle, who also agrees that they are too high, she thinks that, “the answer is not yet”.
The reason is that “with interest rates at their current all time lows, mortgage payments as a percentage of take-home pay are just below their long-term average”. In short, this means that, “at this level of interest rates, houses are affordable”.
Furthermore, the government is throwing “everything but the kitchen sink” in a “desperate attempt” to keep house prices high. Bootle, therefore, believes that “if you own houses or are buying houses, you have nothing to worry about for the “next few years”.
The bad news is that “all good things must come to an end”. Indeed, while interest rates are at 300-year lows, “mortgage payments as a percentage of take-home pay are only just below their long-term average”. As a result, “the minute rates begin to rise” property could be hit.
Perhaps the most optimistic scenario is that they rise slowly, which means “high inflation and a falling pound”. In this case, you “unlikely to lose money in nominal terms”, but will still be hit when inflation is taken into account.
Reader ‘Shinsei1967’ thinks that Merryn has overlooked the possibility that “earnings could start rising”, which would “reduce the house price/earnings ratio back to “normal” levels”.
However, ‘Realist’ points out that “for earnings to start rising, there has to be a proper recovery, not the false dawn we are seeing at the moment”.
Why it makes sense to be risk-averse
This week, Tim Price, who writes our newsletter The Price Report, took a look at the 17th century mathematician Daniel Bernoulli. Tim notes that Bernoulli, who was “the world’s first behavioural economist”, believed that “the more money you have in your investment pot, the less aggressively you need to grow it”. Indeed, recent studies suggest that all investors are risk averse, feeling any loss ”between two and three times more acutely than the gain”.
As a result, since 1999, Tim has focused on “trying to generate absolute returns rather than market-relative ones”. Of course, trying to beat the FTSE 100 “works well during bull markets”. However, “it can be disastrous during bear markets”.
He prefers “to follow an “absolute return” objective that incorporates deep value stocks certainly, but also high quality bonds, “absolute return” funds, and real assets, notably the monetary metals, gold and silver”.
Indeed, “each component of the Price Report portfolio acts in a different way, and offers scope for protection against different market outcomes”. The aim is “to obtain a stream of separate returns that are not correlated to each other”.
For example, “deflation, for example, is typically disastrous for stocks, but tends to be hugely advantageous for high quality bonds”. Similarly, “inflation, if moderate, is relatively benign for stocks, but high inflation would ordinarily be very supportive for the prices of gold and silver”.
Why gold miners could rocket
Bengt Saelesminde, who publishes The Right Side, is “not what you’d call a technical trader”. However, he thinks that, “there’s a simple, technical sign that we really can‘t ignore when making our trades”.
This is “volume – ie, how many investors are piling in, or piling out, at any given time”. Indeed, “this high volume of trades makes me feel pretty good about gold’s prospects”.
Bengt thinks that the best way to measure volume “is simply the number of shares traded on a given day”. After all, “volume indicates market conviction”. Of course, volume and price changes don’t always coincide “since the five-year bull market has been characterised by low volume”.
It’s also important to realise that it can also work in the opposite direction. The classic example of this is the dotcom crash, which took place at a time of record trading volumes.
Nonetheless, “during a bull run, the volume figures gradually tick up”. This is because, “as momentum in the share price builds, so it attracts more investors”. This is important since trading volumes have remained high during the rebound in the price of gold mining stocks that has taken place since Christmas.
Bengt sees this continued interest as the start of another bull market. While, “you’ll have to make your own mind up on how you read this particular market”, it’s hard to dispute that, “there’s massive activity in gold miners right now”.
You can sign up to The Right Side here.
If you want to learn more about the sector, you might be interested in our Metals and Miners newsletter, written by Simon Popple. Read Simon’s views on why gold could go back to $1,800.
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Have a great weekend!