Let’s be honest, if you were a buy and hold investor from mid 2000 onwards you’d be pretty disappointed with your return.

Sure, you could have got some pretty good dividends, plus a capital gain. But considering the risks the return isn’t that great. Not that I’m saying you need to be looking for 50% gains every year.

Only Bernie Madoff could manage that. And turns out he was a crook.

No, what I’m saying is that as an investor you’ve got to realise that the buy and hold approach doesn’t work anymore.

The stock market is a risky place. And when things are risky you can’t afford to sit still and let everyone ride roughshod over you.

That means you’re really left with two choices. And both involve being an active investor.

You can either be an active fundamental investor, or an active technical investor…. or I don’t suppose there’s anything to stop you from being both.

Let me give you the rundown on being an active fundamental investor first. That’s what I am. It’s the method I use for picking stocks in Australian Small-Cap Investigator, and it’s also the method Alex Cowie uses in Diggers & Drillers.

The reason I’m an active fundamental investor is simple – I’m a touchy-feely kind of guy…

[Needle scratches off record]

Don’t worry, I’m not gonna freak you out here. What I mean is that I like to invest in stocks where the company has either got a big plan, they own or are looking for something tangible – such as gold or copper, or they’re actually making money right now.

[Replaces needle on record]

In other words, I’m looking at what the company does, how it does it, and what it’s getting out of it. Plus most importantly, what will the shareholders get out of it.

Based on all that information I then make the choice whether to tip the stock or not.

But tipping a stock as a buy recommendation is only half the story. The other half is what to do with it once you own it. That’s where you’ve got to be an active investor. As I say, in these fast moving, computer driven markets you can’t afford to just watch from the sidelines.

You’ve got to muck in and get your hands dirty, or at least get someone else to get their hands dirty for you.

Because when you own a stock as a fundamental investor it’s essential to make sure that the fundamentals haven’t changed from when you bought the stock.

Think about it, you’ve done all the hard work before buying the stock, it doesn’t make sense to lose interest and become indifferent when you own it. If anything you should be even more interested in it now that you’re an owner.

Yet the buy and hold investment approach teaches you the opposite. Ever heard of the expression, “Set and forget it.”? Why on earth would you do that?

It just doesn’t make sense. You wouldn’t buy a car and then forget you own it. That doesn’t do you any good. It’d be a waste of money. You wouldn’t even choose to buy a ham sandwich and then not eat it. That’d be a waste too.

Yet the buy and hold approach is still the most widely followed investment strategy. Despite it being the worst.

Instead of that, once you hold a stock, if something changes, then you’ve got to act. If it’s a positive change then you can do nothing or buy some more. But if it’s a negative change then you’ve either got to pull the pin and get out, or use the method I choose, and that’s to implement a trailing stop strategy.

Look, most mainstream fundamental investors will tell you that trailing stops are for technical traders only. Personally I don’t think they could be any more wrong if they tried.

Sure, technical traders such as Slipstream Trader Murray Dawes, uses them all the time – I’ll have more on technical trading in a moment – but there’s no rule that says fundamental investors can’t use them either.

Let me give you a perfect example of how the trailing stop strategy has worked for Australian Small-Cap Investigator subscribers over the last eight months.

In August 2009 I tipped Virgin Blue Holdings [ASX: VBA] when the stock was trading for just 35 cents. It was a crazy tip. Who in their right mind would invest in an airline stock?

But anyway, we recommended high risk investors buy in as I believed the stock was primed to soar.

Turns out I was right. Over the next seven months the stock price doubled. As the share price increased I moved the trailing stop higher, until the stock traded above 75 cents and the trailing stop was set at 70 cents.

Well, what do you know, shortly after, the stock traded lower, hit our trailing stop and I told subscribers to Australian Small-Cap Investigator to sell their shares for a 100% gain.

Where’s the share price now? Take a look at the chart below:

On Friday it was trading just above 30 cents. That’s less than half the price subscribers sold it for. Now, at 30 cents it’s worth looking at as a potential buy… But only if the fundamentals stack up.

Look, we don’t get every stock tip right. But that’s why a trailing stop strategy is so important. It takes your emotions out of the trade and forces you to act when previously you may have either hung on in there, or even worse bought more, thinking the stock was going back up again.

In the past couple of weeks, the mainstream broking firms have all cut their price targets on Virgin Blue: Macquarie, Morgan Stanley, UBS, Deutsche Bank, Credit Suisse, and RBS.

For instance, RBS has cut its price target from 81 cents to just 37 cents. Three months after we told subscribers to sell at 70 cents.

But I mentioned there was another kind of investor – the technical trader. This is where guys such as Slipstream Trader Murray Dawes relies almost purely on the share price action.

To some degree it doesn’t matter what the stock is or what it does, the important thing to a technical trader is which way the share price is going to move next and what the potential upside reward and downside risk will be.

But to be fair, working next to Murray, I’ve got to say that he approaches technical analysis like no one I’ve ever met.

Most technical traders I speak to are quick to tell me about which indicator they use, why it’s the best there is, why all the others are rubbish, and why they’re still ‘back-testing’ their strategy after ten years hoping to put their first trade on “when the market is in the right condition.”

Here’s some late breaking news, if you wait for the market to be “in the right condition” you’re gonna have a long wait. A very long wait.

That’s one of the things that has impressed me the most about Murray’s technical approach. But more on that in a moment. First, Murray’s money and risk management approach deserve a mention.

The most important thing for a trader is not to lose your capital. In that way a trader is no different from any other businessman or women. It’s important that McDonald’s doesn’t lose all of its stores otherwise it can’t sell burgers, and it’s important that a trader doesn’t lose all of his or her trading capital.

Because without money in the bank there’s nothing to use to enter a trade.

It’s this money and risk management approach that’s at the heart of Murray’s ‘1-2-3′ technical trading approach. I can’t go through all the details here, because I don’t want to give away his trading secrets, especially as it’s a proprietary trading style.

But for Slipstream Trader members, Murray isn’t so secretive. He goes through his reasoning behind each trade every time he sends out a trading alert and in his weekly video updates.

However, if you’re interested, Murray has lifted the lid a little on what goes into the Slipstream Trader service, just click here to find out more…

You see, the idea is to give traders a risk-free trade. I know that sounds mad and unbelievable, but I’ve seen him do it enough times to know it’s true.

Of course, nothing comes completely without risk. But using Murray’s technical approach there is a way that you can trade the market, so that your risk exposure gradually diminishes. It’s a trading strategy that Murray has used to optimum effect.

And never more so than during the last few weeks. As the mainstream advisers sat on their hands watching their clients portfolios get smaller and smaller, or just selling out in panic, Murray was making cash – real cash – for Slipstream Trader members hand over fist.

The point is, you’ve got to be active. And when markets are this volatile, as a technical trader you’ve got to get involved.

I’ve spoken to several traders over the last few weeks, and do you know what, most have done the opposite. The market has them spooked and they’ve chosen to sit on the sidelines, watching the market as it’s made big moves.

The kind of big moves traders should relish. The kind of big moves that traders should be making big money from.

But many haven’t. They’ve missed one chance and my bet is they’ll miss the next chance as well.

But there’s something else I’m prepared to bet on, and that is that Murray’s Slipstream Trader members won’t miss the next market move, regardless of which way it goes.

Cheers,
Kris.

I thought about tackling property (again), but I’ve only just emptied the Money Morning mailbag from yesterday and so didn’t want to create more work for myself by opening that can of worms.

Then I remembered I went out to dinner recently for my birthday [Ed note: That's the seventh time you've mentioned it today and it's not even lunchtime!]. During the course of the evening, work became a brief discussion.

“So Shae, what’s happening in the world of finance?” one of our dinner companions asked.

“It’s pretty interesting at the moment, I mean, the world’s financial system could fall apart if this Greece bailout gets any more out of hand. It’s pretty exciting times.” I said munching on my pad Thai.

“If Australia survived the Asian Financial Crisis, then we’ll survive this. After all, the Asian crisis happened in our back yard. Greece is on the other side of the world,” was the reply.

Er, what? So geography is what will prevent Australia’s financial system from falling apart?

Let’s just say we changed topic. It fell into the ‘too hard to explain’ category of conversation. And besides, it was my birthday. [Ed note: That's the 8th time].

But, I thought I’d use that idea. Now there’s the reader that lived through it, and then there’s the reader that most likely only knows about the Asian Financial Crisis through Wikipedia. You know, as something that happened in the ‘old days’.

What exactly is so different this time?

Firstly, let’s not underestimate it, the Asian Financial Crisis was a huge threat to the Australian economy. Aside from the initial currency devaluation, market confidence was shaken with fear that investors would be stuck holding bad debt.

You see, the high interest rates in countries like Thailand and Indonesia attracted investors from overseas and naturally a large amount of those funds went into the highly speculative property sector. Not long after the financial market collapsed the over inflated property sector blew up too.

As the crisis grew, the IMF decided to step in and offer a USD $40 billion bailout to keep the economies moving along. But the funds came with extremely strict measures. The Asian banking system was torn apart and the new system had to meet the IMF rules in order to obtain the cash hand out.

At the time there was a strong fear of financial contagion, which is much like there is now. However compared to now, you could really only describe the Asian crisis as just upsetting the Australian market. Because right now the market is having an extreme reaction to anything that happens overseas.

So what makes this crisis so much worse for Australia? I mean, after all, didn’t we survive the Lehman brother collapse, the subprime crisis and the worst of the GFC.

Look, Australia did get past all those crises but we did so using borrowed tax payer money. The politicians dragged the country into more debt hoping China and their mineral hungry economy would bring us out the other side. All in the name of ’surviving’ the crisis.

But yet again the over-spending and over-lending have caught up with us again, and we’re facing another financial crisis. And again, the only solution offered is more debt.

Instead of the IMF stepping in to hand out cash to a failing economy, this time it’s the IMF and the European Central Bank.

It’s obvious why the Euro Zone members have stepped in to save their currency. The bailout has nothing to do with saving Greece from government financial mismanagement.

So why when Australia’s and the world’s debt levels are higher than ever before is more money being handed over? More debt surely won’t fix the problem.

While there were many critics of how the IMF ‘fixed’ the Asian Financial Crisis, the IMF congratulated themselves on a job well done. As far as they were concerned, they ’saved’ Asia from its own financial crisis, when really they left a massive whole in Asian economies.

Because of the restrictions that went with the hand out, hundreds of thousands of white collar workers in countries like Thailand literally had to go back to the villages they came from. Massive unemployment swept through the country and many private businesses went under as access to capital became near impossible under the new lending regulations.

But now, unlike then, the entire world is being rattled and at the heart of it is the banking system.

Maybe we’ll finally realise we can’t continue to build a financial system on debt as a way to make money.

As I said last night at dinner, it’s an exciting time to be in finance. The world’s financial system is being shaken at the roots. We’re learning some pretty hard lessons that had to be learned. You can’t keep pumping air in to a balloon without expecting it to pop.

It’s the same thing with a global economy. You can’t keep flooding it with debt and expecting that will save it.

Things look pretty bad now, but the worst could be yet to come.

That’s it for me here, now for a look at yesterday’s market action…

60 Second Market Wrap

It was a pretty flat trading day for the market yesterday. The S&P/ASX 200 closed up 3 points to 4,470.70. The move from Germany to ban naked short selling caught the Aussie market by surprise and has opened in the red this morning.

The Dow Jones Industrial Average dropped 114 points overnight to close at 10,510.95. The US market was shaken when the Euro reached a four year low against the US dollar.

Germany’s temporary ban on naked short and naked credit default swap includes the short selling of 10 banks shares. It was this move that led Michael O’Rourke, a strategist at BTIG LLC, to say, “It makes it look as if the Germans are worried about something behind the scenes that the market’s not aware of. It almost looked panicked, which further undermines confidence in the markets.”

The FTSE was up 44 points to close at 5,307.34. The Consumer Price Index (CPI) came in at 3.7%, which was much higher than anticipated. The high CPI number is treated as a general indicators for inflation, however the Bank of England (BoE) governor Mervyn King said that he expects the inflation to be temporary and return to normal next year.

The Nikkei dropped again overnight, losing 146 points, ending the session at 10,096.25.

The price of spot gold in Australian dollars is trading at $1,433.06 while in US Dollars it is trading at $1,222.33. The price of silver in Aussie dollars is $22.07 and in US Dollars it is $18.80.

The Aussie dollar versus the US dollar is USD$0.8519 and against the Japanese Yen JPY79.04.

Crude Oil closed at USD$68.37.

For the biggest movers on the market yesterday click here…

That’s all I have for you today, see you tomorrow.

Shae.

“Oh stop grumbling and just hand over the money.” That’s in effect what the German government is being told to do with its taxpayer euros.

According to the Associated Press (AP):

“A 45 billion euros ($A64.45 billion) bailout package from other eurozone countries and the International Monetary Fund (IMF) should see Greece through its borrowing needs for this year. But the bailout is complicated by German grumbling, which continued on Monday, about the burden of the bailout on its own finances.”

Do you know what, if your editor was German we think we’d grumble a bit too. In fact if we were German we’d tell the Greeks to stick a Banane^ up their Kokospalme.*

We’ve long thought the Euro currency was doomed to failure. Whether the debts piled up by Greece and other Eurozone countries is enough to cause its collapse is another matter.

But one day – probably sooner rather than later – it will fail. Just like all fiat currencies are destined to collapse.

For an indication of how bad things have gotten in Greece you need look no further than current Greek interest rates and compare them to German interest rates.

First take a look at this chart from Bloomberg:

Click to enlarge

The worst thing is, that yield is only as of close of business on Friday. In overnight trade the interest rate on the 2-year bond increased to over 13%. A full three percentage point increase on Friday’s rate.

Make no mistake, that’s an absolutely massive move.

And as you can also see from the chart above, the yield has more than doubled during the past month alone.

But what this shows is that if you mess around with debt and interest rates it’ll eventually bit you on the bum.

It shows you that the attempts to manipulate interest rates by central bankers are doomed to fail. Because while the Greek government should hang its head in shame for criminally burdening its citizens with debt, the central bankers are equally culpable for drugging them up on cheap money.

Let me show you an example. Below is a chart for the same 2-year Greek bonds, except it’s showing the rolling yield going back five years:

Click to enlarge

And remember, this chart only goes up to last Friday. Based on the prices from overnight, the current yield would be where I’ve placed the big red blob on the chart.

Now, we won’t claim to be an expert on Greek government debt. But the reaction of the bond market tells you what the problem is.

It’s telling you that the government has over-exposed itself to debt over a long period and that investors are no longer willing to accept a yield of between 2% and 5% that they were prepared to accept for the previous four years and eight months.

Importantly, the problems in Greece aren’t something that developed overnight. The Greek government didn’t change from an Ebenezer Scrooge type miser at the beginning of this year to a Paris Hilton style spendaholic yesterday.

The markets have obviously known about the Greek debt for some time. It’s only now that the realisation has dawned on investors that there are perhaps better places to stick their money…

Hence why the Germans are “grumbling” over sending some of their hard-earned southbound to the Mediterranean.

This is the sort of event the saps in the mainstream insist could never happen in Australia or the US. They’re mistaken.

You see, as our Slipstream Trader editor Murray Dawes wrote in Money Morning yesterday:

“I really believe that you can never succeed in the markets long term if you’re not constantly aware of the effect your psychology has on your results.”

A large part of the reason why investors are fleeing Greek bonds is psychology. Sure there are some mug punters that are prepared to buy Greek debt on a 13% yield, but that yield shows you just how risky the punters believe it is.

The main role of interest rates is to provide a visible price of money, another role is to indicate the supply and demand for money, and finally it provides an indicator on the relative risk of money and other investments.

To use an example. While the Greek 2-year bond is trading at a yield of over 13%, the German 2-year bund has a yield of just 0.88%. That’s a spread of over twelve percentage points!

The interest rate is now telling investors that German debt is low risk and Greek debt is super high risk.

Of course it’s all relative. And you shouldn’t forget that the German rate has been manipulated much lower than it otherwise would be by the European Central Bank. But you get the point.

Keeping interest rates low gives the false impression that no one needs to save. Low interest rates over the previous four years gave the market and investors the false signal that there is already enough saving and therefore there’s no need save.

The low interest rates also made the incentive to save a lot less too, even if they were inclined to.

So, what do governments and individuals do? They heed the signals from the interest rates and spend. Only it turns out that the signals were false. The signals were like faulty traffic lights stuck on green in all directions.

Investors were happy to drive through them and luckily they missed the carnage. But eventually their luck ran out and they’ve run head on into a semi-trailer.

Which is what makes headlines such as this sent in by Money Morning reader Karl all the more worrying: “Lifting rates will not stem rising market.”

The article opens with, “SOMEWHERE amid the fuzzy logic that drives the Reserve Bank’s interest rate policy is the notion we have a housing price bubble and that raising interest rates will deflate it.”

Sadly, in the short term the writer Terry Ryder is probably right. For a time investors and people will ignore higher interest rates because they assume it to be a sign of a positive economy. But taking that attitude is no different to what’s happened to the Greeks.

Whichever way you look at it, it’s a manipulation of interest rates. And despite the fact that interest rates are rising you shouldn’t forget that they are being kept much lower than the free market would otherwise have set them.

Rising interest rates should mean that it’s time to stop spending and it’s time to save. However, because of the entrenched idea that rising interest rates means a positive economy, individuals have been brainwashed by the mainstream commentators into believing that higher interest rates is also a good time to borrow and spend.

But don’t forget, despite Australian interest rates being higher than the official cash rate in other economies, they are still being kept artificially low.

And because the Reserve Bank of Australia (RBA) is keeping rates low, it’s masking asset bubbles and convincing investors and individuals that more can be borrowed – especially as rates are below ‘normal.’

Just as the Greeks were convinced to borrow more when their interest rates were kept artificially low.

The five-year chart above provides a perfect example of how a bubble can only be suppressed for so long before it eventually bursts.

It may not look like a bubble bursting because the chart shows the yield going up. But just remember, the higher the yield the higher the risk. And also remember that bond prices react inversely to bond yields.

So if you were to see the price of bonds as opposed to the yield it would look something like what we’ve magically created using the expensive software package known as – hehem – Microsoft Paint:

Click to enlarge

You can see the bubble being artificially expanded by low interest rates, reaching a crescendo in late 2009.

But then the market reached a tipping point if you like. Investor psychology took over. It begins where one by one investors start to dislike the risk profile of a particular asset class.

Eventually one by one becomes ten by ten, then one hundred by one hundred, until the flood of investors exiting an asset is unstoppable.

You’ve seen that for yourself in the stock market.

And now you’re seeing it with Greek government bonds.

There’s no reason why this can’t and won’t happen in the UK, the US, or more troublingly in China.

And there’s absolutely no reason why it won’t happen to Australia’s asset bubbles either.

Cheers,
Kris.

^ Banana
* Coconut tree

We’re not that fussy over what the alternative energy is, as long as it’s what I like to call a game-changer.

In other words, something like the development of unleaded petrol wouldn’t be considered a game-changer. It’s just taken an existing energy source and modified it slightly.

Funnily enough, we don’t necessarily see solar energy – based on the current technology – as a game-changer either. But more on that later.

No, when I refer to game-changing technology I’m talking about the kind of technology that gives the companies in control of incumbent energy methods cause for concern.

Actually, scratch that, I’d go further. It’s more like the kind of technology that causes incumbent firms to go bust.

And sadly, in a free market, solar energy would be one of the first technologies to fall under a bus. The fact is, if it wasn’t for crazy government subsidies and an irrational obsession by green groups, solar energy would have died at birth.

The fact that the solar industry is kept alive by government subsidies tells you it’s a dog. And it’s also evidence of the massive waste of resources being ploughed into an energy source that may never be commercially viable unless it’s propped up by government handouts.

I know the green lobby won’t like that, but them’s the facts. Even the poweredbysolarpanels.com website admits:

“When it comes to converting that energy to light, the efficiency actually ends up being dramatically lower. Let’s look at what happens if the solar panel efficiency starts at 20%. That energy starts as direct current which must be converted over to alternating current to be used in the home. This conversion process loses another 20% of the resulting energy. This alternating current now goes on to an incandescent lightbulb which is typically only 5% efficient. From all the original solar energy captured, you end up with only a fraction of usable energy.”

Compare that to a real game-changing technology such as the stock we tipped in the February issue of Australian Small-Cap Investigator which has up to 60% energy efficiency, that’s almost twice the efficiency that’s available through the regular electricity grid.

Not only that, but this technology, while it may not be quite as green as solar power, it’s a heck of a lot greener than existing coal-fired power stations and a heck of a lot cheaper than nuclear energy (by the way, we’re keen to tip nuclear related stocks in Australian Small-Cap Investigator too).

The point is, out of the three technologies: solar power, coal-fired power stations, and the technology we’ve backed in Australian Small-Cap Investigator, which gets the government handouts?

Yep, that’s right, solar and coal-fired generation gets a big dollop of government largesse, yet a genuinely game-changing, environmentally friendly technology has to go begging for funds from overseas investors.

It’s madness.

Look, don’t get me wrong, I’m not trying to lobby the government on behalf of this firm. I’m not asking for taxpayer dollars to be thrown at this technology, and I’m not trying to spruik for the stock we’ve tipped.

But what I am saying is that you’ve got perfect proof of why governments will never do anything meaningful to prevent the perceived threat of climate change.

The problems with government interference are many. But the most obvious is that you’ve got government bureaucrats deciding how your money should best be spent. And how do those bureaucrats come to their decision?

Er, lobbyists by any chance? Yep, depending on which industry hires the right lobby group, and which lobby group happens to have the best relationship with either the minister or the top bureaucrat, that’s where the money goes.

If government money was handed out based purely on the viability of a technology and the dollar for dollar positive impact on the environment, solar energy would have been thrown in the rubbish bin years ago.

But because solar energy has the right image, and because it has no greenhouse gas emissions, green groups and dopey coercive (public) sector bureaucrats see solar energy as the perfect way to show-off the government’s green credentials.

Now, you could argue that “at least it’s better than nothing.” But again, that’s only the case if you observe what is seen. If you observe what isn’t seen then the picture isn’t quite so rosy.

But if you’re someone who wants to use alternative energy, but you’ve done your homework and realised solar energy is useless what do you do? There’s no point wasting money on solar power that is only effective for a few hours each day – providing it’s sunny!

What if you instead come across another technology that is at least three-times as efficient but which costs five times the cost of solar energy because there’s no government subsidy?

Chances are you’ll give it a miss.

The fact is the government can’t possibly do anything to help the environment. I mean, think about it this way, the Australian federal government controls about 35% of all money spent in the Australian economy.

Add in State governments and local governments and the number rises to well over 40% of all money spent in the Australian economy.

Now replicate that across Western nations.

Ask yourself this, with all the cash at their disposal – about 50% of all money in an economy – why has it taken fifteen meetings of the UN conference on climate change to achieve… absolutely nothing?

The reason is that it’s not possible for governments to act in the best interests of individuals. Simply because their main focus is on re-election and pandering to lobby groups who fund their re-election.

You’ve seen the opinion polls. The majority of people do believe that something should be done about climate change. Whether climate change is real or not is irrelevant to this argument.

Incidentally, as we’ve mentioned before, we’ve got no idea whether climate change is real. But what we do know is that governments won’t fix it, only the free market can do that.

But what the opinion polls tell you is that individuals would like the opportunity to do something. The only trouble is they can’t afford to. Especially not when the government is taking 30% in taxes and they’re spending half of what remains on housing costs.

Like with everything we rail against, the ultimate culprit is always the government and the central bank. It’s inarguable. And the environment is no different.

You see, here’s the problem. While government is trying to pick winners in the alternative energy sector, it’s also picking losers. For example, companies such as the stock we’ve recently tipped have had to go overseas in order to get funding for the manufacture of their energy efficient product.

A product that is at least three-times more energy efficient that solar energy, yet currently receives no government subsidy. Again, we’re not arguing that the government should throw money at it, what we’d prefer is for the government to get the heck out of the way and stop taxing people so much.

That way, all those individuals that do want to install energy efficient technology can do so. Individuals can pick winners and losers. If it turns out this particular company has inferior technology to another firm then they’ll lose out.

But if the government is swiping 30% of your wages in tax each year, leaving an average household with only about $50,000, spending $12,000 on an energy unit is a big slice.

But in a free market, as you see with all other technology, soon the price comes down. Competition ensures that. Imagine if that same unit through competition was only $1,000 or $2,000, I bet you’d buy one wouldn’t you?

Especially if it provides more than enough electricity to power the entire home, compared to solar energy which can only provide a fraction of the power to a home.

Yet that’s not happening. Instead, government panders to special interest groups about either protecting jobs in the coal sector or pandering to green groups by subsidising inefficient solar energy.

So let’s get back to what isn’t seen, because that’s where the real damage is done.

What isn’t seen are the thousands of jobs that could be created in Australia if viable alternative energy sources were able to develop here rather than being shipped overseas. Thousands of jobs lost in the stinking coal sector would be replaced by thousands of jobs created in the technology sector.

Plus, rather than only a piddly X% of energy being sourced from green fuels, we could have X% times 20 or X% times 50 being sourced from green fuels if other industries didn’t receive favours from politicians and bureaucrats.

But it’s not only that. As I mentioned above, everything can be drawn back to central banking and banks too. The creation of money from thin air by the central bank and retail banks leads to what the Austrian economists call malinvestments.

It’s the truest definition of inflation. More money and credit ultimately leads to higher prices. That means the central bank and banks have to get that money out into the economy as quickly as possible before it becomes too devalued.

What better a way to do that than pouring it into the housing market.

And right now, the biggest malinvestment is housing. Yep, believe it or not, the obsession with investing in housing and government subsidies to the housing industry is another reason why the development of alternative energy is hampered.

Consider how hard it must be for any small company to attract capital when they’re up against competition from the massive housing ponzi scheme. What bank is going to lend money to a company developing alternative energy when it can instead lend money to someone to buy a house?

So you’ve got billions of dollars being spent on a totally unproductive, non-income bearing product (housing), at the expense of capital being made available to other sectors of the economy – including but not exclusively alternative energy.

But as with all ponzi schemes, it’s too late for the banks to change direction. Because the very nature of a ponzi scheme means it requires an ever greater amount of new money to keep the scheme from collapsing. As soon as the amount of new money falls below that required to pay out existing investors and home-owners then the whole thing collapses.

Look, I’m sorry to bring housing into what started off as a non-housing subject. But the fact remains this is a perfect example of how distortion in one part of an economy has both a direct and an indirect impact on other areas of the economy.

Go ahead, feel free to say that your editor is living in the clouds with this theory. But the evidence is there.

It’s irrefutable.

If governments truly were able to do something about climate change and emissions and all the other mumbo jumbo, why has it taken so long for them to do nothing considering they have access to around 50% of all money spent globally?

In contrast, there are tiny companies that have access to probably 0.0000000001% of the money that governments have access to, that are battling against the odds to make headway in the alternative energy market.

Just remember, we’re using the environment and alternative energy companies as just one example. But you can apply the same to any other industry in the Australian market. With over 50% of bank assets being exposed to the residential housing market it’s a massive unsustainable distortion of the Australian economy.

But put that aside, back to the environmental aspect…

The paradox is that if you believe in climate change – or even if you don’t, but you don’t like pollution – the only way to achieve anything is through the entrepreneurial free market.

All those green groups that rail against capitalism and free markets, and beg for more government involvement are actually doing more harm to the environment than they can possibly imagine.

Alternatively, if you don’t believe in climate change and you hate green lobby groups then your best bet of scuppering their plans and making sure nothing is done about it is to actually encourage further intervention by governments!

Ah, it’s a funny old world isn’t it?

32 Bubbles Burst, 2 Remain

We’ll look at this in more detail, but I thought I’d pass on the link that we’ve just received in to the Money Morning mailbag this morning:

“Jeremy Grantham, founder and chief strategist at GMO (the money management firm in Boston) has undertaken extensive research into asset bubbles, defined as an overvaluation so large that it would occur statistically only once in 40 years.

“Only two remain outstanding: the Australian and UK housing markets. Grantham is confident that Australian and UK house prices will eventually fall back to their long-term trend, and this process is likely to be painful. Check out Jeremy Grantham’s interview with the Financial Times.”

You can see the interview with the FT here. The interviewer is a bit hopeless, but try to ignore that and focus on Grantham.

Preposterous Property Spruiking

As you may imagine, we’ve received more emails than we can eat. By close of play yesterday we realised we should have waited until assistant editor Shae had returned from stimulating the American economy before we sent you a request for info.

Ah well, we’ve made our bed, now we’ve got to lie in it. We’ll dig through the mailbag and republish some of the choicest examples over the next few days. If you come across any others feel free to send them in to moneymorning@moneymorning.com.au

In the meantime, Money Morning reader Jim made good on his promise to email us the headline we mentioned yesterday from The Northern Star:

And finally, it’s not necessarily spruiking, but we notice our old pal, Rory Robertson from Macquarie Group has been putting the boot into property bear, prof Steve Keen:

“Reportedly, he’s [Steve Keen] still forecasting economic doomsdays to anyone who has time to waste. Often wrong, never unsure – and good luck to him.”

Then he goes on with the usual Keynesian rubbish. Of course, while Robertson is dishing out the stick, it shouldn’t be forgotten that Robertson is the same “economist” with an unfailing belief in the Output Gap theory.

To put it simply, the Output Gap is the hopelessly illogical and discredited idea that if an economy’s current GDP is operating below the potential GDP then inflation is impossible.

As we’ve pointed out several times, take a look at even what the mainstream considers to be inflation – consumer prices – and you’ll see that consumer prices have risen. And if you consider the real definition of inflation – and increase in the money supply – then it’s gone up even further.

I’m afraid to say that only economic slowcoaches and Keynesians believe in the hopelessly illogical, flawed, discredited, and just plain wrong Output Gap.

Feel free to send more property spruiking newspaper articles to moneymorning@moneymorning.com.au

Cheers,
Kris.

We’re not sure that being down here in Frankston will add any different perspective to when we normally write from St Kilda, but you never know.

Anyway, we were gobsmacked by this quote we read yesterday afternoon…

“Prices would only suffer a small fall, they wouldn’t crash.”

That’s if mortgage interest rates hit 10% apparently – according to Martin North, director of Fujitsu Australia.

We’ll be honest, we don’t get what Fujitsu Australia is supposed to be about.

On the one hand their Mortgage Stress-ometer – or whatever it’s called – gains national headlines each time it’s updated. “Squillions in mortgage stress” is the typical headline.

But when push comes to shove, Fujitsu tells everyone not to worry because, “Prices would only suffer a small fall, they wouldn’t crash.” Well that’s alright then.

Which is a bit bizarre in our opinion. Thousands of first home buyers suckered into the idea that property prices always rise, and that now is the best time they’ll ever have to buy.

And that interest rates aren’t going above “normal” anytime soon. Then suddenly, the same economists tell us that the booming resources industry could see mortgage increase by 50% in the next two years.

Which is startling considering in February Fujitsu had a target of 4.5% for the Reserve Bank of Australia (RBA) cash rate by December 2010.

The last we looked it was already at 4.25% and there are still eight meetings of the RBA board to be held before the end of the year.

And even if the RBA does only give the cash rate a minor touch-up by the end of the year, our wonderful friends in the mainstream economist community have the RBA hitting the interest rate bottle hard leading into 2012.

“Interest rates heading for 10 per cent, experts warn,” says The Sunday Telegraph.

Ah, of course. If you think back over the last year or so, almost every mainstream economist told you that rates had to be low now, and that we can all worry about the negative impact of low interest rates some other time.

The important thing they argued, was to save the economy by spending as much borrowed money as possible.

Well, it seems they’ve now decided it’s time to break the bad news on what the future response will have to be.

As we’ve warned over the last two years – while mainstream economists were telling you to get drunk on debt and spending – payback day will come, and it’ll come sooner than you think.

Granted, some in the mainstream have warned about piling up debts for our children to pay off, but they’ve rather missed the point. That implies the payback won’t be for another 10, 20 or 30 years.

The bad news is, the payback has already started. Remember that $900 the Fairy Ruddfather handed out? Well, thanks to the interest rate rises – after many had been sucked in by mainstream propaganda – your $900 boost will have been wiped out by about now if you have an average mortgage of $300,000.

So, don’t worry about the kiddies being lumped with the debt. If they’re lucky everything will have gone bust long before they’re given the responsibility of paying bills.

See, thanks to the mainstream economic chumps, the boom and bust cycle continues. Not content with having built up the last boom, and then causing the last bust, interventionists are determined to lead you into another boom, predictably followed by another bust.

So, far their ingenious plan is “working.” Only a Grinch would claim the last twelve months hasn’t been a boom for both the stockmarket and the property market.

But don’t you dare pause for breath. Because James Kirby at The Age says, “Bullish brokers getting ready for a stampede.”

Kirby says that big name broker UBS has “lifted its ASX200 target for the end of the year from 5450 to 5550.”

Granted, it’s not much of a lift, but it means the broker reckons the Aussie market has another 10% up its sleeve before the year ends.

Is that reasonable? Who knows, but our advice is to make the most of any sharemarket gains while you can. And incidentally, to also lock in some of your gains from the last twelve months if you can.

That’s the advice I’m giving to Australian Small-Cap Investigator and Australian Wealth Gameplan members.

Let me make one thing clear. These mainstream economists who are spinning the party line about the Australian economy being robust and insulated from the rest of the world are just talking through their hat.

Remember, these are the same guys who not only utterly failed to see the global economic meltdown coming, but when it did they managed to convince most of the country that they had a solution to get out of it – borrow and spend.

And now these “geniuses” figure their wonderful plan has worked. It must have because the stock market is up and the property market is up, ergo, success! Trouble is, that little problem of inflation, higher interest rates and killer debt levels is less than two years from hitting the fan big time.

Right now it’s just simmering away, gnawing away at your wealth without you really noticing. And you wouldn’t notice because based on the stock market and property market your wealth is increasing – don’t believe a word of it.

But here’s their chance to show you how the next phase of the plan works. Surely it must be time to start fixing things after the so-called “emergency” measures.

Here’s the thing though. Isn’t it funny how there isn’t a single mainstream economist who is capable of outlining how everything will pan out. You’d think that with the amount of certainty they’ve had about the borrow and spend plan that it would be simple to give a logical breakdown of two things.

First, how this current period of depression will end.

And secondly, how their ingenious plan will ensure boom and bust economic meltdowns never happen again.

The only reason we bring it up is that on our side of the fence – the side that’s opposed the bailouts, the borrowing, the spending and the devaluation of money – there are plenty of economists who have not only explained how this depression will evolve, but also how it could be ended and prevented from happening again.

We had a discussion about this very thing in Editorial office last week. And tomorrow, in case you’ve missed us outline it before, I’ll go through again just how simple it is.

The problem of course, is that the only real solution involves the out-of-their-depth politicians and central bankers getting out of the way and not spending your taxpayer dollars.

For them, that’s not an option. Because if the general public find out that it’s the pollies and the bureaucrats that have caused the mess then suddenly the pollies and the bureaucrats will find themselves being kicked into touch.

That’s why they’ve had to blame the entire episode on capitalism and free markets.

And even as we write this morning, we see news that the Greeks are taking the cowardly route of accepting bailout money. It’s cowardly because it keeps the Greek taxpayer on the hook for billions.

When the much better and heroic course of action would be to default and start with a clean sheet.

Not only that, but the rest of the European Union is also being told to stump up the cash for someone else’s debt. And as far as we can tell, no one has thought to ask the German, French or Dutch taxpayers if it’s OK with them.

We wrote this analogy some time ago… It’s like finding out that your next door neighbour has got himself into a hole for $1 million, and then finding out that all the other neighbours in the street have arranged for you to pay out his debt.

What would your response be to that? Thought so.

Then why is it any different if the decision is made by a government rather than your neighbours. In both cases it’s expropriation of your property to pay off someone else’s debts.

Yet governments can get away with it.

Make no mistake, Greece is likely to be the beginning of the next debt meltdown rather than the end of the last one.

Cheers,
Kris.

But make no mistake, when we mention the word ‘bet’ we mean it. We’re not talking about rigorous fundamental analysis that we do for Australian Small-Cap Investigator or Australian Wealth Gameplan. And neither are we talking about the type of technical analysis our Slipstream Trader Murray Dawes uses.

We’re talking the kind of bet that you’d make at the TAB. The kind of bet where you take a quick glance at the form guide and then shove a few bucks on it.

Of course, there’s a big difference with this kind of bet when compared to throwing a few bucks at the nags or the dish-lickers.

That’s because typically you’ll find it hard to just place a $10 bet against the banks. And even if you could you’d find your reward pretty thin.

Back in mid-January we suggested it might be an idea to think about short-selling Commonwealth Bank of Australia [ASX: CBA] shares. We didn’t quite have the kahoonas to actually tell you to do it, which was a shame because after a brief rally it sank to around $51 a share from a peak of $57.

Today CBA is back above $57:

And still we can’t think of any reason why investors would want to own bank shares. Look, we won’t go into all the reasons again – overleveraged to the housing market, $2.20 of reserves for every $100 deposited, etc…

We’ve covered all that before.

But to our way of thinking, if you like a punt and you’re not afraid of taking on a bit of risk, why wouldn’t you bet on CBA moving to the downside from here?

As I’ve mentioned, it’s a punt, and betting against the banks means betting against the entire investing mainstream establishment. But quite frankly I think it’s something worth considering. Just make sure you’re fully on top of the risks should the bank shares continue to rise – which is entirely possible.

In a moment I’ll give you some pointers of two ways to play it if you do fancy taking a punt against the banks. But before I do that, let me get some disclosure stuff out of the way first…

For starters, your editor doesn’t own any bank shares.

Second, your editor is not front running this trade. In other words we haven’t taken a position to short sell the banks prior to writing this article. And furthermore, neither have we instructed any of our associates, friends, relations, friends of relations, relations of friends, friends of associates… [Reader's voice: Enough already, we get the picture!] to enter into this trade either.

And nor will we ‘back run’ the trade by jumping on the bandwagon afterwards, riding on the coattails of potential profits.

Hopefully that makes it clear for you. As an aside, we take exactly the same approach with our tips in Australian Small-Cap Investigator and Australian Wealth Gameplan. We don’t make any personal investments in those tips either.

Our personal view – and that of Port Phillip Publishing – is that even the appearance of a conflict of interest is bad for business.

Our business is doing the research, offering advice, providing ideas you won’t read anywhere else and leaving you to potentially make profits on the tips. Simply put, we enjoy writing about stocks, the market and the economy.

We leave it up to you to put your investing dollars on the line. If you profit you’ll probably subscribe again. If you don’t, then maybe you won’t subscribe again. It’s as simple as that.

Anyway, back to our bet against the banks.

When it comes to taking a punt on falling stocks I prefer to use low-risk methods which I’ll go through in a moment. You could of course just go to your broker and ask them to short sell physical stock.

The only problem with that is the broker will typically require a minimum trade of $50,000. For most people, that’s too big of a punt. Secondly, your risk management choices are fairly limited. Not all brokers offer stop loss facilities, and even if they do, it isn’t always a foolproof way of cutting losses.

That’s why I prefer to highlight the following two methods.

The first is to use something called Contracts for Difference (CFDs). I’ll be straight up, these are highly leveraged financial products. How leveraged? Put it this way, with some CFD providers you can put down $100 and get exposure of up to $10,000!

That’s 100-to-1 leverage, and it could be the quickest way to the poorhouse if you mess it up. You’d have to be mental to use that kind of leverage without considering the risks.

And if you think we’re being hypocritical talking about massive leverage in the stock market while lambasting excessive leverage in the housing market, then we’ll cop that.

But we will make one point to argue the case. We’ve never argued that the stock market is all blue sky and no downside risk. In contrast, our property spruiking pals only ever talk about the upside and never address the downside.

As an example, have you ever read a property spruiker saying you could head to the poorhouse if you mess up the investment?

Anyway, we’ll leave that one with you to make up your own mind.

Besides, with CFDs, just because the leverage is available it doesn’t mean you have to use it. For instance, if you normally trade $5,000 lots and you have $5,000 available, you can deposit the cash in your CFD account and enter a short sell for 87 CBA shares.

That gives you around a $5,000 exposure. If the price of CBA falls then you’ll move into profit. If the price of CBA rises then you’ll make a loss.

But here’s where you can limit your losses. It’s called a Guaranteed Stop Loss. I won’t go into all the details here, get in touch with the guys at City Index or CMC Markets and they’ll give you the full rundown.

In a nutshell, for a small fee the CFD provider will allow you to set a level at which you’re guaranteed not to lose any more money than a preset amount. So, as an example you could set your guaranteed stop loss at a CBA share price of $60. If CBA trades higher than that then you’ll lose no more than around $3 per share – about $260 if you short sell 87 shares.

Short selling can be pretty risky. That’s why I’d recommend you prepare to arm yourself with the proper risk management tools such as guaranteed stop losses.

Of course the flipside is, if CBA did drop to around $51 as it did recently then you’d lock in over $500 of gains. Not a bad return by anyone’s standards.

But look, remember this isn’t personal advice. If you like the sound of what I’ve mentioned just make sure you check out all the risks with the CFD provider. And also remember that by short selling the banks you’re betting against the entire mainstream investing establishment. Talk about swimming against the tide!

The other way to potentially gain from falling share prices is to look at exchange traded options. Or just ‘options’ as they’re more commonly called.

Again, there’s a whole bunch of risks involved, so make sure you check out all the details before going ahead with anything. In fact, your broker will make you complete a risk profile document to make sure you fully understand what you’re getting involved with before they’ll accept your money.

In this instance, a handy little punt is to look at May 2010 expiry put options on CBA. Right now you can take out a put option with a strike price of $55 for just 53 cents per share.

With a contract size of 1,000 shares, you’d be looking at a total cost of $530 for just one contract. Generally speaking – we won’t go into the complex stuff here – you’d need the CBA share price to fall below $54.47 in order to return a profit.

Anything below that and you’re in the money. The important point to remember with options is that they expire. So if the CBA share price didn’t move between now and the end of May then you’d lose your entire $530.

But as I say, get in touch with your broker to find out more info.

Look, we only ever look at basic options strategies in Australian Wealth Gameplan. And for the most part we’re only interested in low risk strategies. For instance just last month we recommended subscribers consider taking out covered call options against three of the stocks in the portfolio.

In that strategy we still like the stocks, but with the market near a short term high we figured it was a good time to earn some extra income in the event that stock prices didn’t move higher.

Anyway, I thought I’d give you something a little different in today’s Money Morning. Take it with a pinch of salt if you like. You know how much we dislike the banks, and we figure this is the best way to potentially profit if they do take another turn for the worse.

We’ll keep an eye on the CBA share price and let you know whether this would have been a winning or losing trade!

Cheers,
Kris.

Yesterday we crossed the t’s on the March issue of Australian Small-Cap Investigator, today we just need to dot the i’s so we can send the March issue out while it’s still March.

If you’re a subscriber – if all goes according to plan – you should see the issue drop into your inbox after 4.30pm this afternoon. If you’re not a subscriber click here to sign up without delay.

So, while our compliance boffin is making sure our latest issue of Australian Small-Cap Investigator is publishable, here’s what we’ve been thinking about this morning…

ARMageddon.

I know, more gloom. That’s just the way it is I’m afraid. We tell it like it is. Of course if you prefer sugar-coated stuff telling you everything is rosy then you’ll be sorely disappointed if you keep reading here.

But don’t go away, if nothing else it can’t be that bad to get an alternative view compared to the pap you get in the mainstream press.

But just to clarify, our reference to ARMageddon isn’t a prediction about the end of the world, but rather a reference to another article in the Weekend Australian Financial Review titled: “ARMageddon hangs over home owners.”

The ARM in ARMageddon refers to the ingenious mortgage product in the US called an adjustable rate mortgage. Broadly speaking it’s similar to our variable rate mortgages here, with one exception.

Many buyers signed up to an ARM’s with what they called a ‘teaser rate’. Again, similar to the introductory rates you’ll get with Australian mortgage products. But again, not entirely the same.

The main difference is that the ‘teaser rate’ set the repayment level lower than the interest charged on the loan, with the balance being added to the mortgage debt. So for instance, if monthly mortgage repayments were supposed to be $1,000 the teaser rate would see the repayment drop to say, $500 with the remaining $500 added to the mortgage.

As you can imagine, that’s gonna work out fine when property prices are heading to the moon. But as soon as prices stabilize and then drop, mortgage owners are in trouble. As the AFR article points out, “There is concern in the US for home buyers who hold reset loans that may leave them negatively geared.”

The reset part is important, because as I mentioned these ARMs came with a teaser rate which resets to the normal higher rate after a given period, say 3 or 5 years.

So not only do you have mortgage payments being added each month to the outstanding mortgage debt, but you’ve also got a mortgage repayment that could double or triple in one move as soon as the teaser rate period ends.

You can see the potential impact in the chart below:

The light yellow bars I’ve circled above gives you an idea of just how big the problem is. Although, take a look at the Alt-A mortgages as well. Alt-A are those mortgages deemed to be lower quality than Prime mortgages but higher quality than Subprime mortgages.

If this next leg of the US housing crisis is even half as bad as the last one, then world markets are in for another bumpy ride.

I mean, at the time buyers were taking out these loans everything seemed fine. What could possibly go wrong? So what if the monthly repayment increases, the price of houses always goes up. If the repayments are too high, home owners can just sell at a profit and move on.

And yep, they had the same mantra in the US as we’ve got here – house prices always
go up. Which brings us on to this point. Money Morning reader James sent us this article from The Acorn Online, “Northern LA and Ventura County’s Best Community and Weekly
Newspapers”.

The Acorn Online had this to say in February 2006, just before the US housing market started to implode:

“The Californian Building Industry Association (CBIA) continues to express alarm over what it calls an ongoing housing crisis in Southern California. Alan Nevin, the association’s chief economist, projected in a 2006 CBIA Housing Forecast that only 185,000 to 205,000 building permits will be granted this year, far short of the 240,000 new homes needed each year.”

Sound familiar? The article continues:

“Southern California has been experiencing a massive population boom in recent years and it’s believed that 6 million new residents will be living in the region by 2020. The population increase, coupled with the housing shortage, has the CBIA worried that it will be increasingly difficult for first-time homebuyers to find a moderately priced unit.”

Need we say any more? Of course. We’re not going to pass up an opportunity like this. Now read this press release from the Housing Industry Association (HIA):

“The report finds that if current building trends persist, then Australia’s cumulated housing shortage would reach 466,000 dwellings by 2020… Housing to 2020, which focuses on future housing demand and the number of dwellings required in meeting this demand, highlights a current housing shortage that already numbers over 109,000 dwellings.”

The impact of the so-called shortage? The press release states:

“If we don’t get a comprehensive supply response to the accumulating housing shortage then the lack of affordable and appropriately located rental properties will only worsen…”

It’s funny isn’t it. All those economists that failed to predict the financial meltdown are the same economists who now say, “Ah, but of course the US had a massive overbuild of housing leading up the financial crisis, that’s why their property market slumped.”

Maybe they did, but no one seemed keen to point it out at the time. They were too busy claiming there was a housing shortage. In fact, the CBIA claims there was a housing shortage as recent as 2006.

It was only after prices slumped that the so-called massive overbuild became apparent.

Make no mistake, the much claimed Australian housing shortage will also be seen as a myth after our housing market crashes. The Australian market is making the same mistakes as the US.

But take a look at those numbers from the HIA again. If today’s housing shortage is 109,000, and the figure in 2020 will be 466,000, that works out as an annual growth rate of about 15.6%.

That got us thinking. As luck would have it, Money Morning reader Pete sent us this video of Dr. Albert A. Bartlett, a physics lecturer at the University of Colorado. It’s well worth watching if you’ve got a spare hour or so.

What’s the relevance of the video? It’s the theme of his presentation, “The Greatest Shortcoming of the Human Race is our Inability to Understand the Exponential Function.”

Sounds riveting eh! Actually it is. And the reason it’s riveting is that it gave your editor the inspiration for the chart below we ‘cleverly’ created in Microsoft Excel.

I won’t try and repeat exactly what the prof explains, but the idea is fairly simple. If you take a seemingly small growth rate over a short period and apply it over many years the exponential growth becomes unsustainable.

For example, he makes the point:

“Every time the growing quantity doubles it takes more than you used in all the preceding growth.”

If we apply that to housing, every time the spruikers tell you property prices double every ten years it means that the price growth during that time has exceeded the price growth of every other period in history… ever!

We’re not a mathematician, so we’ll take the prof’s word for it. Take this example he gives on population growth:

“If this modest 1.3% per year [of population growth] could continue, the world population would reach a density of one person per square metre on the dry-land surface of the earth in 780 years. And the mass of people would equal the mass of the earth in 2,400 years. Zero population growth is going to happen. We can debate whether we like zero population growth or don’t like it, it’s gonna happen whether we debate it or not, whether we like it or not.”

That’s the thing isn’t it. You read all the time about growth rates of population and house prices and everything else. You hear – as we have from the HIA – that “if this rate of growth continues” then the housing shortage will be X amount, or the population will be Y, and house prices will be Z.

But the reality is, at some point the growth rate has to stop. It’s impossible for it to continue forever at the same rate of growth.

And that’s exactly what we’ve argued time and again about house prices. But it wasn’t until we saw Dr. Bartlett’s video that the penny dropped. And when we saw those house shortage numbers from the HIA everything clicked into place.

You see, if we take the HIA’s 15.6% annual growth rate – remember, we’re using their numbers – and extrapolate the number further, then by 2025 there will be a housing shortage of 958,946.

But why stop there. If we go out to 2030, the housing shortage rises to 1,979,626. And best of all, if we follow their growth rate all the way out to 2050 we find out the housing shortage will reach 35,953,391…

Coincidentally, according to the most recent Intergenerational Report, the government number bods predict the Australian population to be 35.9 million by 2050.

In other words, the housing shortage will equal the population!

Here’s the chart we’ve reproduced using the HIA housing shortage numbers and extrapolating that growth out to 2050:

The even funnier thing is, if we take the HIA growth rate out to 2055, the housing shortage will reach 74,221,381, or double the predicted Australian population.

Now do you see how dumb these housing shortage and house price growth numbers are? Sure, maybe we’re taking it to the ridiculous extreme. But it’s no more ridiculous than the arguments about the housing shortage and house prices.

The point we’re making is that at some point the exponential growth will breakdown. The unknown is at what point it will occur. We know for a fact there isn’t going to be a shortage of 35 million homes in 2050 (unless every house in Australia is demolished) when the population is only 35 million. The breakdown will have to happen at some point before that.

The fact is, just as a so-called California housing shortage turned out to be a housing glut, the same fate is destined to happen to the Australian market. House price growth can’t continue indefinitely either. If we use the same method and the doubling every ten years approach, then a $100,000 house today will be worth $1.5 million in 2050:

Again, it’s not sustainable and the growth will breakdown at some point.

The danger is that right now spruikers are using a twenty year period of extraordinary growth in house prices and extrapolating those numbers forward. And even worse is the same spruikers are taking an unproven housing shortage and making up their own future growth rate to arrive at a similarly impossible number.

Oh, and just one more thing to put this in perspective, the February 2006 article from The Acorn Online stated:

“Next year, the average home price in California is predicted to hit $573,000.”

Last week Housing Predictor website claimed:

“A lack of more affordable homes, particularly in California, where prices are still more than 50% below the markets peak on average sent the median price 9.8% lower for the one year period at $207,900.”

Good luck if you’re out house hunting over the weekend. Because this time next year you could need all the luck you can get!

On the other hand there could be a 35 million housing shortage in 2050, and you’ll be laughing all the way to the bank. I’ll let you work out whether that’s likely.

Cheers,
Kris.

Yesterday, as we took a break from cobbling together the March issue of Australian Small-Cap Investigator, we glanced over a speech given by Donald Kohn, vice chairman of the US Federal Reserve.

Look, read the whole thing for youself by clicking here. To be honest, it’s a joke from start to finish, but it’s worth reading so you’ve got some idea about the brain power of the clowns running the show.

Take this as an example:

“We are also uncertain about how, exactly, the purchases put downward pressure on interest rates. My presumption has been that the effect comes mainly from the total amount we purchase relative to the total stock of debt outstanding. However, others have argued that the market effect derives importantly from the flow of our purchases relative to the amount of new issuance in the market.”

Oh Lordy!

Well, here’s a primer for Mr. Kohn. Bond prices and interest rates move inversely. A rise in the bond price means a decrease in the interest rate. A fall in the bond price means an increase in the interest rate.

It’s not hard. In fact we’ll guess it’s probably on the syllabus of any high school economics class.

So here’s the revelation for Mr. Kohn, when the Federal Reserve announces it’s going to buy securities, market participants know that the banker to the government has unlimited funds and will therefore pay top dollar.

Therefore sellers are encouraged to demand a much higher price than they normally would – remember, a higher bond price equals a lower interest rate.

That the vice chairman of the Federal Reserve is perplexed about this is astounding. In fact it’s comical.

But if you think that’s worrying, just wait until you read what else he had to say about interest rates at the Cornelson Distinguished Lecture at Davidson College, North Carolina…

“Some observers have attributed the bubbles observed in some asset prices in recent years to a decades-long downward trend in real interest rates. In this view, the decline in interest rates has caused investors to reach for yield by purchasing riskier assets with higher returns, driving the prices on riskier assets above fundamental values. Many critics of central banks ascribe the drop in real rates to monetary policy decisions that kept rates unusually low, on average over the business cycle.”

Well, we’re one of them. In our view it’s unarguable, because that’s what happened. But don’t be silly, according to Mr. Kohn, that wasn’t the problem at all:

“From my perspective, the decisions the central banks were making about their policy rates were shaped by the underlying determinants of the balance of saving and investment…”

Stop! I’ll give you some latitude with this vice chairman, but get to your point quickly…

“… The balance of saving and investment, including, in the past decade or so, the high saving propensities of the newly emerging Asian economies and the sluggish rebound in investment globally after the recession early last decade.”

That’s right, blame it on the Asian economies. So it wasn’t that Western economies spent trillions of dollars on the never-never, it was that Asian economies tucked a few yuan, ringgit and yen away for a rainy day.

And naturally enough, if you fail to acknowledge the mistakes of the past, then you’re destined to repeat the same mistakes. Which explains Mr. Kohn’s ideas for how to avoid the credit meltdown next time:

“We simply do not have good theories…”

Correct. Oh, sorry, I interrupted you. Please go on…

“We simply do not have good theories or empirical evidence to guide policymakers in using short-term interest rates to limit financial speculation. Given our current state of knowledge, my preference at this time would be to use regulation and supervision to strengthen the financial system and lean against developing problems.”

In other words, more regulations are what’s needed, not sound money policies. The idea that regulation can fix things is a joke. It’s the equivalent of someone bombing a crowded market each day and then wondering why so many people keep dying.

So as a solution they suggest giving people armoured clothing. No, that’s not the solution, stop setting off bombs, that’s the solution!

But quite frankly it’s hard to take his argument seriously when Mr. Kohn concludes with the comment:

“Central bankers, along with other policymakers, professional economists and the private sector failed to foresee or prevent a financial crisis that resulted in very serious unemployment and loss of wealth around the world. We must learn from our experience.”

So what he’s suggesting is that the people without “good theories” and what is clearly a poor “current state of knowledge”, and who “failed to foresee or prevent” the meltdown, should be given more power and responsibilities to not see the next meltdown.

But as is the done-thing with those in the mainstream, because they failed to understand that manipulating interest rates would lead to disaster they continually refuse to accept that anyone else could have spotted it.

Clearly, Mr. Kohn and his central banking cronies aren’t avid readers of The Daily Reckoning. Our sibling newsletter has been banging on about it since 1999. And they’ve obviously never heard of the likes of Peter Schiff, Congressman Ron Paul, or the Austrian School of Economics which warned of this very problem years ago.

In fact, the Austrian School rang the alarm bells before the Great Depression of the 1930s. So for Mr. Kohn to claim that “professional economists and the private sector failed to foresee” the meltdown is disingenuous to say the least.

However, it’s not just the vice chairman of the Federal Reserve who’s been thinking out loud. Fellow Fed member, Janet Yellen, President and CEO of the Federal Reserve Bank of San Francisco has done pretty much the same thing.

In this case, a presentation to the Town Hall Los Angeles. You can read the transcript here.

A couple of things amaze us with Ms. Yellen’s speech. First is the recognition that “Growth in the past decade – especially in the overheated housing market – was fueled by easy access to credit”, but then stating “And, in order to provide further stimulus, we put in place an array of unconventional programs to speed the flow of credit to households and businesses.”

It’s what we’ve stated all along, it’s just not logical to try and ’solve’ a credit problem by encouraging the further expansion of credit. That the people at the Fed are either incapable of recognizing this, or they intentionally misinform is amazing.

But that’s not all, Ms. Yellen uses one of our favourite economic terms, the Output Gap. We’ve railed against this bit of mainstream economic nonsense before, but here’s another go, just in case you missed it…

Yellen states:

“Economists use the term ‘output gap’ to refer to an economy that is operating below its potential. We define potential as the level where GDP would be if the economy were operating at full employment, meaning the highest level of employment we could sustain without triggering a rise in inflation. Obviously, with the unemployment rate so high, we are very far from that full employment level. In fact, the output gap was around negative 6 percent in the fourth quarter of 2009…”

Got it? In a nutshell, apparently, the whole Output Gap theory claims that inflation isn’t possible while there is an Output Gap. Where the actual level of GDP is below the level of its full potential. Of course, that’s absolute nonsense.

Any person even with a pea-sized brain – such as your editor – can see that’s not true. Unfortunately it’s a theory that’s taken hold amongst mainstream economists, those in Australia included, such as Macquarie Group’s Rory Robertson.

We can see it’s not true in two ways. First, if we use the increase in the money supply as the measure of inflation then the money supply has increased enormously in the last two years, by a rate even greater than in previous years.

And secondly, even if we measure inflation as rising prices then Yellen’s own speech nullifies the reliability of the Output Gap. As she explains:

“One simple gauge of these trends [in price inflation] comes from looking at the US Commerce Department’s price index for core personal consumption expenditures, which excludes the prices of volatile food and energy products. These prices have risen a modest 1.4 percent over the past 12 months…”

So much for the idea that the Output Gap prevents inflation! But Yellen doesn’t even acknowledge the fact that even though the US is experiencing the worst depression since the 1930s, prices are still going up.

I mean, she points out that unemployment is still at 9.7%, a decrease in the workforce of around 6% in just a couple of years, yet prices have still risen. Surely that’s not the kind of thing you want to have happen when you’ve just lost your job.

Do you see how beneficial price deflation is? Prices go down to make the cost of living lower when the economy hits the skids.

But the duplicity doesn’t end there. Take this self contradiction. In one part of the speech Yellen explains:

“An independent Fed would allow interest rates to rise if needed to address inflationary pressures and resist calls to monetize the debt. By contrast, a central bank that wasn’t independent might succumb to demands to keep rates low, even if the economy were in danger of overheating.”

Just to be clear, Yellen is arguing that the US Federal Reserve is independent. Therefore an independent Fed wouldn’t monetize debt and it wouldn’t keep rates low in the face of an overheating economy.

Well, that obviously isn’t true. We’ve seen that in recent and not so recent history – including right now. But we don’t even need to rely on history to counter her claims. We can just read the speech further:

“In broad terms, the main way we expanded our balance sheet was by buying assets such as mortgage-backed securities, paying for them by crediting the sellers, and ultimately the banking system, with reserves – that is, with deposits at the Federal Reserve. Those reserves are the electronic counterpart to cash.”

In other words, the Fed ‘monetized’ the debt.

Look, the reason I’ve pointed this out is simple. Almost every day you’ll read commentary in the mainstream press that lauds central bankers as the biggest brain boxes known to mankind.

The printed and television media fawns over every word, assuming that anything said or claimed by a central banker – including Glenn Stevens – must be true. After all, they should know, right?

The fact is very different. The fact is as you can see from Kohn’s and Yellen’s speeches, these folks have less of an idea than the average man in the street. In fact, they’ve less of an idea than a below average man in the street.

That they are unable to admit or recognize the effect that manipulating interest rates has on an economy is astounding. And that they base their policies on clearly inaccurate and dangerous theories as the Output Gap is equally astounding.

As you know, I always encourage you to not take things at face value – including what we write – but instead to question everything. By now I reckon you’ve caught on to the idea, it’s just a shame the chumps in the mainstream press are yet to grasp it.

Be prepared for more information by the mainstream press as the global economy supposedly heads for recovery.

Cheers,
Kris.

Looking at the Aussie market we’re wondering, will it break out higher this time?

If you look at the chart below you can see the market has put in another rapid gain:

It’s added about 5% over the last six weeks, taking the index close to the recent peak in January.

But as I’ve told subscribers to Australian Small-Cap Investigator and Australian Wealth Gameplan the market is just as risky today as it was one year ago. The only difference is that stocks were much cheaper back then.

That’s why, in both newsletters I’m pretty comfortable with only having a few positions open. Sure, there’s a chance this market could take off. But there’s an equal chance it could crumble. So, after a 50% move in the index in the space of a year there’s nothing wrong with taking some of your exposure off the table.

And that goes for whether you’re a small-cap, large-cap or income investor.

And we’ll also guess it’s the same for traders as well – although we haven’t been able to ask Slipstream Trader editor Murray Dawes, as we’re quarantined at home.

I’ll be honest, it worries me when I read stories such as the one in the Sydney Morning Herald recently: “Plenty of force left in the bull”.

According to the subhead, “The sharemarket has charged 54 per cent higher in a year, and it’s still not too late to join the party.”

It’s got something of the “buy property before it’s too late” ring about it.

Take the quote from Lucinda Chan at Macquarie:

“We’ve had a positive earnings season with very few letdowns and there are some profit upgrades on the way through for quality companies… We’ve had some wonderfully uplifting data from China, the job news and business confidence is strong. I think the overall market is turning upwards again.”

Maybe she’s right, who knows?

The main problem I have with the ’stronger for longer’ approach of the mainstream analysts is that it ignores investor psychology.

Look, we can barely spell psychology let alone understand it. But when we look at the longer term chart for the index we start thinking about the risk/reward payoff.

Take a look at the ten-year chart for the S&P/ASX200 index below:

Obviously you can see the massive bull run between 2003 and 2007 which took the index from under 3,000 points to nearly 7,000 points in just under five years.

Already, since March last year the same index has moved from around 3,000 points to nearly 5,000 points. During the previous bull run it took the index about three years to cover the same ground.

In other words, using that previous move as an example, investors have locked up three year’s worth of gains in the space of twelve months.

That’s not a bad effort by anyone’s standards.

But that’s only half of what concerns us. Now take a look at the one-year chart below:

In actual fact, it only took around seven months for the index to cover the same ground. Five months later and the market is still at the same point.

And it’s that which concerns us. Let me explain what I mean.

Last October the index had locked away about a 50% gain. Annualised, you’re looking at around a 90% gain – give or take a few points.

Today that annualized gain is, well, it’s roughly the same as the seven-month gain from last October, about 50%. If the index is trading at the same level in six months time – which is entirely possible – then your annualized gain drops to around 33%.

And if the index is still at this level this time next year then the annualized gain drops even further to 25%.

Look, don’t get me wrong, that’s still a pretty good return. But don’t forget, you’ve only locked in that annualized gain of 25% if you had picked up the start of the run from March 2009.

If you take the Sydney Morning Herald’s advice and tuck in today, then your annual return is zero – assuming the market moves nowhere between now and March 2011.

Anyway, what I’m getting at is how likely is it that big institutional investors are going to risk leaving up to 50% gains on the market? I don’t think it’s very likely at all.

Especially not when many of them will have seen their bonuses slashed in 2008. And that will be fresh in their memories. The last thing they’ll want to do is give back a whole bunch of profits by staying overexposed to a market that’s already risen by 50% in such a short timeframe.

Let’s make no bones about it. We want the stock market and share prices to go up. We’d love it if shares only ever moved in one direction – UP!

After all, we write two newsletters every month offering stock tips. But we’re not so one-eyed that we can’t see the risks that this market holds.

Are there still opportunities? In our opinion, yes. But the idea that the whole market is undervalued, or as AMPs Shane Oliver puts it, “a long way from being described as overvalued” is far from accurate in our opinion.

We won’t say that top-of-the-market complacency has completely taken over, but some of the signs are there. Headlines in the mainstream press are a pretty good indicator of that.

That’s why, right now, it would be a mistake to completely exit the stock market.

But cutting back on your positions and using risk management tools such as trailing stop orders makes a lot of sense. In other words, give yourself some exposure to further upside gains, but don’t fall for the mainstream propaganda that it’s blue-sky all the way to a 7,000 point index.

Cheers,
Kris.

As you may have noticed, we’re not very formulaic with Money Morning. We don’t have a system where we write about one thing one day and then switch to something else the next.

Sometimes we may harp on about something for days on end. Hopefully that won’t try your patience too much, but we do like to wring as much as we can from a subject before moving on to something else.

And right now we think we’ve wrung that one pretty dry… For now!

So today we’ll take you back in time by a couple of months. You may recall that in January our colleague, Chris Mayer editor of the US investment advisory Capital & Crisis was in Australia on an investor’s tour.

He asked us to turn up as a guest speaker, which we did, where we blabbed on for 45 minutes or so about the Australian market. Seeing as what we spoke about was a concise version of what we write in Money Morning, I won’t bore you with the details.

Instead, I’ll take you through what some of the other guest speakers had to say.

In summary, there was a US based technology company, a New Zealand agricultural investment trust, and two Aussie small-caps.

Actually, the small caps were more like micro-caps. Too small and illiquid for us to consider as a tip in Australian Small-Cap Investigator, but interesting nonetheless. I won’t reveal them today as there isn’t the space, but you’ll read about them in Money Morning next week.

Today let’s take a look at the US based technology company. And unfortunately it isn’t yet listed. It’s in what they call the pre-IPO stage. In other words you can’t buy shares in the company on the stock market, all you can do – if you’ve got a big enough wallet – is buy a stake in the firm while it’s still private.

Obviously, there’s a lot of risk in that as you may either find it hard to sell your investment, or you may have to take a pretty big ‘haircut’ on the price if you need to sell your holding before it goes public.

But the hope pre-IPO investors have is that the company will turn into the next Microsoft or Google. That they can turn a USD$100,000 investment into $1 million, $2 million or $10 million when the company does eventually list its shares.

The downside of course, is that it never goes public and you’re left licking your wounds thinking about what could have been.

But the plus side for this company is that it’s already built up a pretty good list of paying clients such as AT&T, British Telecom, The Los Angeles County Bar Association, and lots more – including Australia’s own Macquarie Group.

And the firm’s representatives were out here for scheduled talks with Australia Post as well.

So, who is this company, and what does it do? Well, its name is RPost. In a nutshell – I won’t go into all the details – it provides a registered post service and electronic signature service for email.

Now, you may think, “Hang on, I can use the ’send receipt’ facility in Microsoft Outlook, and scan my signature into the PC already.”

While that’s true, based on what the guys at RPost say the Outlook system is neither foolproof and nor is it good enough, particularly when it comes to legal documents.

Take the Registered Email service. This provides an automatic record of when an email has been opened without the receiver of the email having to do anything. It means there is an instant ‘paper trail’ for anyone who sends important emails.

Because not only will you have proof that you’ve sent the email, you’ll also have proof that the email has been delivered and opened.

Look, for most people this level of ‘paper trail’ isn’t important. But you can certainly see how it could be applied for certain corporate or legal email use. The good thing about it is that it’s an opt-in choice for the sender. They can choose to just send a normal unregistered email if it’s not important to have a paper trail, or click the RPost button if a paper trail is required.

And as for the electronic signature, it allows legal documents to be sent across the country in an instant, signed with a legal enforceable electronic signature and then sent straight back. It can turn a 2 or 3 day turnaround time into a matter of minutes.

However, there was one aspect of the presentation that didn’t sit well with your editor. Don’t get me wrong, I like the product and I can see a pretty big market for it. But, it was when they explained how RPost had worldwide patents that prevented competitors from providing the same or similar service.

As we recall from the presentation – we didn’t take a note on this bit – RPost has taken out legal action against around half a dozen companies for possible patent infringements.

Again, as we recall, most of those have been settled out of court, with the remainder still being negotiated.

As you know, we like competition. But we can also appreciate that if you have the law on your side, you’ll do all you can to prevent competition from entering the market. In this case – as with many others, particularly in pharmaceuticals – patent protection provides many favours to those that hold the patent.

That means it can use its privileged government sanctioned position to lock in a monopoly on this line of business. If anyone else tries to offer a similar service they can be sure they’ll get a visit from RPost’s lawyers.

As we say, if that’s the law regarding patents, any company would be mad not to use it for their advantage.

But the way we look at it, patent protection is terrible for consumers.

The argument is always put forward that without patent protection companies wouldn’t bother to innovate because they would know another firm could just copy their product and potentially release it to the market first.

Therefore patent protection is necessary so that it gives the ‘inventor’ enough time to work on and develop their product. And as a reward for all the effort it’s only fair they should have the first crack at the market, unhindered by competition.

On the surface that seems reasonable. Why would you think of great new ideas if you knew someone else could instantly copy your idea?

The reality is that when you consider it properly, the argument doesn’t make sense.

There’s little difference between being the first to market and being fourth to market in terms of the risk you’re taking as a business. Does that make sense? Let me try and explain…

When you’re first to market with a new product you’ve either invented something that’s completely new that no-one else has previously thought of, or you’ve taken an existing method and improved it.

There could be others, but we’d think that covers the two main ones.

But when you’re second, third or fourth to market then you are either providing something similar to what’s already available, or maybe you’ve made some improvements to an existing product.

The point is, as the fourth company that enters the market, you’re still taking a huge risk. In fact you could argue that the late mover in the market is taking an even bigger risk than the first mover.

The first mover had the benefit of patent protection and a head start. The first mover was able to build up market share while the fourth mover had to wait on the sidelines.

Granted, the fourth mover could gain some of the benefits by having a ready made market to enter, but it still runs the risk of business failure just like any other business. Perhaps even more so as it doesn’t have the same ‘leg-up’ that the patent holder had.

So, how would it work if there weren’t patents? As we’ve mentioned, the argument is that people or firms wouldn’t innovate unless they were given protection over their invention.

Without patents, inventions could be lost forever as inventors would maintain complete secrecy for fear of their idea being exposed and exploited by someone else.

Those are pretty strong arguments to try and counter. But we’ll try.

The alternative way of looking at it is that without patent protection, there would be greater urgency by firms and individuals to bring their idea to market.

Rather than spending a considerable amount of time and resources on launching legal action to prevent another firm from offering the same product to a waiting public, firms would scramble to be the first to market.

For the consumer that would have to be good news. More firms competing to provide a brand new product from day one would likely lead to lower prices much sooner. Rather than waiting five or ten years for the cost of a product to decline as more competition emerges, perhaps costs will not be high to begin with. Or maybe prices would drop after just months rather than years.

The pharmaceutical industry is probably the biggest abuser of patents. Years and years, millions and millions of dollars in development costs and legal fees to prevent competing drugs from being released to the market.

But would pharmaceutical companies still look to develop new drugs without protection? After all, the costs to develop a drug that may never make it to the market is huge.

Well, we’re sure much smarter people than your editor have already done a bunch of research on this. But we’d be prepared to say that investors would still invest, and companies would still innovate.

It’s human nature, not patent protection that makes us all want to work less, or do things easier, or have medicinal drugs that will make us better. The demand from consumers will still be there even without patents.

And just as importantly, the desire by entrepreneurs and business men and women to seek out new ways to make profits will also still exist. Whether they end up actually making a profit or not is irrelevant. Some businesses will and some won’t.

Drug companies would still look for a cure for cancer or AIDS. They would do so because of the massive potential reward if they unlock the secret. Sure, under a patent they could potentially end up with bigger profits in the short term, but even without a patent, if they produce the same result, they’ll still make handsome profits.

And those profits would arrive sooner due to the urgency to be first to market under a non-patent system. Their urgency to act now would increase five or ten-fold.

In the case of RPost, governments have granted it the right to provide a registered email service to the exclusion of all other potential competitors. Competitors that may have invested an equal amount of capital and risk into their inventions.

Yet because RPost – and other patent holders – secure a government favour, consumers are prevented from enjoying and utilising the services of others that may not only be better but could also be provided for a lower cost.

In our view patent protection should be kicked into touch. Market forces and innovation by entrepreneurs would ultimately ensure consumers gained access to the best new products in a more timely fashion.

Cheers.
Kris.