This Will Make the Property Lobby’s Head Explode

The craziness in the oil market continued overnight. Brent crude was up around 6.5%. No one can really explain why of course, although the Financial Times had a crack:

Iran on Wednesday cautiously welcomed an initiative to freeze oil output by the world’s largest producers — even though Tehran itself is rushing to increase its own exports.

The Iranian response to a plan backed by Saudi Arabia and Russia helped oil prices to a 7 per cent gain on the day as traders discarded some of their scepticism about the first big effort to reverse the 18-month oil price slide.

I see. So the fact that Iran ‘welcomed’ a production freeze led to a huge rally, did it? Even though Iran itself wants to increase production and you can’t really rely on any other nation to curb output, despite what they promise in public.

As the saying goes, markets make opinions…

But opinions don’t matter, price action does. The fact that oil rose sharply overnight motivated global stock markets too.

US stocks jumped more than 1.5% while European stocks soared more than 2.5%.

The European banking sector, the source of much of the world’s recent problems, jumped 3.3%. But the rally is nothing more than a bounce back from oversold conditions.

The chart below, which shows the STOXX Europe 600 Banks Index, still looks very bearish. It could continue to rally for some time and still look bearish. So don’t be lured into thinking that the worst is over.

It is for now, but the bear is by no means back in hibernation.

Source: BigCharts

One reason for the positive market sentiment recently has been China. Since coming back from the lunar New Year holiday, Chinese markets have behaved well.

But don’t let the lack of news fool you. The Middle Kingdom still has some very big issues to deal with. Like its out of control debt situation.

A few days ago, China announced that total credit growth jumped by a record $525 billion in January. So much for deleveraging…

However, analysts say some of the jump in new loans is a result of refinancing from US dollar debt into yuan-denominated debt.

This is all well and good for short term growth, as it takes the pressure of firms servicing debt in a strengthening US dollar. But it stores problems for down the track. It creates even more yuan in the financial system that will potentially want to get out of the Chinese economy when things turn south again, as it undoubtedly will.

That means the issue of capital flight hasn’t gone away, it’s just resting for a while. China expert and adviser to UBS, George Magnus, has it about right. In an interview with Bloomberg, he said:

“I’m not anticipating an imminent meltdown, but we’ve got a lot of warnings going on that should make us cautious about how we see the situation developing for the course of this year.”

If Australia’s economy is already struggling, then imagine how it’s going to be when China cannot keep pumping record amounts of debt into its economy?

China’s huge credit surge over January goes a long way towards explaining the rebound in the iron ore price. It’s gone from around US$37 per tonne in mid-December to about US$46 per tonne now.

Still, it’s not much of a bounce given the half-a-trillion debt expansion in January. It suggests a lot of the new debt is going towards paying down old debt, rather than going into new construction.

Which means the iron ore bear market isn’t over. Which means Aussie governments still have to come to terms with structural budget problems.

This week, Labor had a stab at addressing the budget issues by promising to shake up the negative gearing tax perk if it wins the next election. This policy brought about a hysterical response from the property lobby, as they know that negative gearing and capital gains tax concessions fuell and price gains and speculative behaviour.

This lobby group, which includes real estate and building associations, as well as listed property companies with big land banks, has the power to bring down the reforms even if Labor wins the election and carries out its promise.

Here’s the issue: if Labor restricts negative gearing to new builds only, which is a sensible policy and a better use tax incentives, the property lobby will counter by restricting supply.

Companies sitting on massive land banks will simply not release enough land to satisfy the demand. This will push up prices and allow them to play the ‘high prices for new home owners’ card. They will say ‘I told you so’ and try to get the new rules repealed.

So the message for Labor, if they want this policy to work, is to look at the supply issue. Work with the states to release enough land to absorb the shift in demand to new homes. If they don’t, the property lobby will win and Australia will be forever locked into a high land price regime.

The other option is to bring in a land banking tax. Put a tax on companies excess land holdings to increase the cost of land banking. This would immediately encourage greater supply.

But who am I kidding? The property lobby’s head would explode if Labor (or any political party) tried that on. Making easy gains from land price rents is a rite of passage in Australia.

If you want to know how land rents work and affect you and the economy, start here.

Greg Canavan,

For Markets and Money

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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