The Dismal Future of the Australian Economy

gold price vs asx200 27 august 2015
GOLD vs the ASX200 (Commsec)

The recent volatility in stock markets has gotten me worried. Everyone keeps telling me to relax because “economic fundamentals are sound,” but when I ask them to explain how this is true, it’s revealed that they don’t really know what they’re talking about. It seems that most people just hope for the best and rationalize away bad news.

The Chinese stock market is certainly wobbly. Some say the Chinese economy is very healthy. After all, they have low debt and a massive foreign exchange reserve. They are the biggest lender nation in the world with the USA the biggest creditor nation. However, we don’t really know much about the true size of China’s debt because there is significant activity in the underground economy that is not transparent, and I’m not too confident in official figures provided by the Chinese government. Of course, China has been manufacturing products from t-shirts to smartphones, but the government has in recent years been intervening in the economy to prop up the stock and property markets. It’s uncertain whether these distortions can be held together by the government or whether the market will eventually strike back.

America has resorted to printing money, which has resulted in surges in the stock and bond markets. However, unemployment is still high and wage growth is low. Printing money doesn’t seem to have done anything other than make the holders of stocks and bonds wealthy (these are mostly wealthy people anyway).

In Australia, our economy used to be dominated by two sectors: the banks and the miners. The miners dug resources from the ground and shipped them to China. China makes goods and ships them to US consumer who buys these goods.

But the American consumer (or consumers from any other developed country) is not buying as much as they did before the GFC. This means China is slowing down, the price of resources is dropping, and the mining sector in Australia is getting crushed. We only have the banks left, and how do they make money? The balance sheets of Australian banks is mostly in loans to consumers who buy real estate. Real estate prices have been going up thanks to profits from mining. In other words, banks do well because house prices have been sustained by profits from the resources sector. Now that mining is dead, what will sustain us? Where are our strong fundamentals? House prices only go up with people buy houses, but to buy houses you need to make money in the first place. You can’t make money from houses without putting money into it in the first place.

Many who have bought stocks have made great wealth from quantitative easing, but now that tears are emerging in a bubbling world economy held together by printed money, it’s time to look at investing in gold.

Gold tends to shoot up significantly when stocks tumble, and when stocks go down, gold tends to go sideways or go up anyway, so there doesn’t seem to be any downside to investing in gold.

Personally, I will be buying this shiny metal from now on.

Protecting Yourself From GFC 2

I’ve been very lucky in that I started working full-time in 2009, which is right when the GFC hit. When I started working full-time, I started saving up about $50k per year. I was able to do this because I lived with my parents and didn’t have too much to spend on other than internet and food, so I plowed the money into shares, ETFs, and mutual funds. Luckily for me, the stock market recovered heavily after GFC when central banks around the world decided to print money to prop up stock markets.

Recently, I have become concerned about a potential GFC 2, so lately I’ve been reading books about technical analysis in an attempt to try to figure out when to sell before a crash.

Below is a graph of the ASX200 for the past year with bollinger bands overlaid. Notice how if you sold when the index hits the bottom band and bought when the index hits the top band, you’d capture all the gains and avoid all the losses.

Bollinger bands on the ASX200 August 2015 (source: Yahoo7 Finance)
Bollinger bands on the ASX200 August 2015 (source: Yahoo7 Finance)

A problem I have is that a lot of the assets I have are illiquid. Shares are diversified and selling each one would be time consuming. Real estate is incredibly illiquid, and I don’t have to explain why. Taking money out from mutual funds requires you to fill in various forms and wait many weeks. Furthermore, selling assets may have unwanted tax implications. I’ve been a believer in buy and hold for a long time, but I am starting to have my doubts.

Rather than bother with selling assets, a better idea is to use leveraged inverse ETFs. One that has been recently issued on the ASX is the Betashares Australian Equity Strong Bear Hedge Fund (ASX: BBOZ). (Note that this is supposedly not technically an ETF.) How does this fund work? As the website says, “A 1% fall in the Australian share market on a given day can be expected to deliver a 2.0% to 2.75% increase in the value of the Fund (and vice versa).”

If GFC 2 hits again, rather than watch half my wealth disappear, I can protect a portion of it by buying a large amount of BBOZ. The gains in this BBOZ will compensate for any losses. Obviously the more cash I can save up, the more BBOZ I can buy and the more protected I will be. Furthermore, buying at the right time is essential. The bollinger band patterns on the ASX200 are interesting, but I hope to study the markets further to see if I can find any clues as to when GFC2 will hit.