Month: January 2012

Here is previous part 2 of trilogy.

The decline of the Bretton Woods began in 1971 when US President Richard Nixon took the US off decline the Golden Standard to stop the loss of gold. Finally, the USA abandoned the fixed value of dollar making it inconvertible to gold directly and let it “float” – to fluctuate against other currencies. What is significant is that Nixon made this decision not having consulted with the members of the international monetary system, that’s why it was called “Nixon Shock”.

The dollar fell. However, the same year world leaders made an attempt to save the Bretton Woods system with the Smithsonian Agreement. According to the Smithsonian Agreement, the dollar was devalued to the rate of 38$ per ounce of gold in an attempt to balance the world financial system. Nevertheless, the problem with all this was the fact that dollar was no longer suitable for the role of the sole international currency. Thus, the efforts to develop a new system of international monetary management failed. By 1973, The USA and other nations decided to let exchange rates float. Bretton Woods system was abandoned altogether. Though, it didn’t generate a chaos as did the collapse of the international gold standard in the 1930s.

That was the rise of floating exchange rate – the monetary system where the rate of exchange is determined by market forces – the supply and demand for the currency in the market. For example, the higher the demand for a certain currency, let’s say, US dollar, the higher its value will be. If the demand for the currency decreases, its price decreases, too. The floating exchange rate is changing continuously… A floating rate is often called “self-correcting”, as any variations in supply and demand will automatically be adjusted in the market.

In real-world conditions, no currency is absolutely fixed or floating. In a fixed exchange rate regime, market pressures can also affect changes in the exchange rate. Sometimes when a local currency does not reveal its true value against its pegged currency, a “black market”, which is more revealing of actual supply and demand, may appear. Then a central bank often will have to revalue or devalue the official rate for the rate to comply with the unofficial one, stopping the black market activity. In a floating regime, the central bank can also make interventions in the market when it is necessary to guarantee stability and to escape inflation; however, it is less often that the central bank of a floating regime will step in. Such notions as Dirty Float and Clean float are often associated with the floating exchange rate regime. Clean Float currency means a minimum of official intervention, except for the purpose of maintaining market stability, and its exchange rate is mostly determined by market demand. On the contrary, Dirty Float implies a changeable amount of official intervention to keep a nation’s currency in the line of a desired range of currency prices concerning other currencies.

Though a floating exchange rate regime is not absolutely flawless, it has appeared to be a more efficient means of shaping the long-term value of a currency and generating balance and stability in the international market. For the most part, floating exchange rates are preferable to fixed exchange rates. As floating exchange rates are corrected automatically, they allow a country to reduce the impact of shocks and foreign business cycles, and to prevent the risk of having a balance of payments crisis.

What was after the Bretton Woods System?

Another consequence of Bretton Woods collapse was that it accelerated European Community preparation for monetary union. European Monetary System (EMS) was established in 1979. This system was designed to bring exchange rate stability to Europe by introduction exchange rates regime in which the currencies of participating European states would be regulated against one another within a fixed range rather than simply floating. EMS included 15 countries of Europe and offered the fixation of exchange rates of one currency compared to another one; the rates for the pairs of currencies varied which was more flexible than simply fixing exchange rates. This system also allowed the change of the exchange rate in certain situations; for weaker countries the fluctuation limit has been made wider than for dominating countries As a development of this system, euro has been created; in 1999 all currencies have been fixed against euro and finally in 2002 all currencies were replaced by euro.

The countries of Asian region in their majority chose the stability of their exchange rate and introduced the policies that connected the national currency to the dollar value and let it fluctuate only in small range around the dollar value.

So, there have been many changes in the world monetary systems since 1970s till present. The most significant is the introduction of Euro as the single European currency and the creation of a single monetary authority for Europe (the European Central Bank) in 1999. Since then Euro has become one of the most popular and most traded currencies. But now when Eurozone in crisis, you may be interested in article about: How to make money with the EUR/USD during the EU crisis.

It is impossible to overestimate the importance of the Bretton Woods system for the Forex market. Bretton Woods is a very significant event since it has marked the true founding of Forex trading.

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Make sure you don’t miss first part of Bretton Woods System article.

By the end of World War II the old global financial order was over once and for all. Global financial reforms have to be made. So, the representatives of 45 leading nations of the world met at Bretton Woods, the USA, in 1944, to create a new international monetary system.

Thus, for the international economy, all economists at Bretton Woods supported a regulated system, which would depend on a regulated market with strict controls on the value of currencies. All 45 countries-participants of the Bretton Woods conference agreed on the need for strict controls, in particular of currency exchange rates. Following the rules is always the best option. For example, in money management the same situation, you should follow 10 Forex money management rules.

Several crucial conditions were conducive for establishing the Bretton Woods System: the shared experiences of the Great Depression and the concentration of power in a small number of states (remember that the number of participants of Bretton Woods conference was 45). They drew up the agreements which created an international basis for exchanging one currency for another. The exchange rate stability was a prime goal. One of the main goals was also the economic stability for the major economic powers in the world. The purpose of the conference in Bretton Woods was to avoid worldwide economic disasters such as those which the world had in the 1930s, to free the international trade and fund postwar reconstruction. 

The results of the Bretton Woods conference were the following:

• Setting up a system of fixed exchange rate – the world currencies were tied up to dollar, which, in turn, became convertible into gold at $35 per ounce. Thus, the role of the world leading currency shifted from pound sterling to dollar, and the international economy became dollar-centered (which remains to be truth till the present day, actually). The golden age of the US dollar began. Most international transactions began to be denominated in USD.
• Central banks of other countries had to keep up fixed exchange rates between their currencies and dollar. They did this by means of interventions in foreign exchange markets. If a country’s currency appeared to be too expensive in relation to dollar, its central bank sold this currency in exchange for dollars, which decreased this currency’s value. And vice versa, if the country’s money were losing its value against the dollar, central banks bought their own currency, increasing its price this way.
• Beginning of Foreign exchange as we know today. It became possible due to fact that world currencies started to be pegged against one another.
• Establishing the International Monetary Fund (IMF), the main regulating monetary institution in the world. IMF was designed to monitor exchange rates and lend reserve currencies to nations with trade deficits. Now its role is also to be an advisor on monetary policies for the countries of the world and to finance trade deficits.
• Creating the International Bank for Reconstruction and Development (IBRD), now known as the World Bank, the most important agency of the World Bank Group. IBRD focused on promotion of world trade and financing the post war reconstruction of Europe. Now it is charged with making loans for economic development purposes.

The Bretton Woods system established the US dollar as the reserve currency of the reserve currency of the world. However, by the beginning of 1970s, inflation in the USA and the growing US trade deficit were weakening dollar’s value. The USA tried to press on Japan and Germany – the countries, whose payment balances were positive, to buy their own currencies in order to increase their value. But these countries didn’t want to take this measure, because increasing their currencies’ value would result in raising prices for their goods and harm its exports. This stage can be described as the return to convertibility of Western European and Japanese currencies. A high level of monetary interdependence was developed. Convertibility made possible and promoted the vast expansion of international financial transactions, which deepened monetary interdependence. These changes resulted in breakdown of international monetary management, since exchange rates could no longer be centrally regulated, or controlled by some external forces, like central banks or governments.

One more factor that damaged monetary management was the decay of U.S. hegemony. The U.S. was no longer the domineering economic power it had used to be for more than twenty years. By the mid-1960s, the European Economic Community and Japan had become international economic powers. With total reserves much greater than those that the U.S. had, with higher levels of growth and trade, and with income approaching that of the U.S., Europe and Japan were narrowing the gap between themselves and the United States.

The move toward a more pluralistic distribution of economic power led to increasing dissatisfaction with the privileged role of the U.S. dollar as the international currency.

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The Bretton Woods System and Its Role for Forex Market

If at least some of the following words: “fixed exchange rate”, “fluctuations of the foreign exchange rate”, “pegged currencies”, “IMF” and “Smithsonian Agreement” do not sound like abracadabra to you, but, on the contrary, seem quite familiar, perhaps you must have heard about the Bretton Woods system then. And even you see the above-mentioned terms first in a lifetime, and out of the collocation “the Bretton Woods system” you know only the word “system”, still the information below will be useful for you. We all live in a world where Foreign exchange is a very important and frequent thing, and each of us tackles the necessity to deal with foreign currencies – most often for our private purposes, like travelling abroad or paying for foreign goods. However, only some of us connect Forex not with the physical exchange of money only, but rather with making profit on the Forex market.

Trading currencies in the Forex market and existence of the Forex Market itself became possible thanks to some global financial reforms that took place in the XX century. These reforms resulted in establishing the floating currency exchange rate regime, which made trading currencies against one another possible. However, there were three major landmarks in the history of Forex, and the Bretton Woods system is one of them. So, in order to get a deep understanding of what Forex is, let’s have a closer look at these landmarks.

On the whole, the history of Foreign exchange can be subdivided into three large periods:

1. Before the Bretton Woods system;
2. The Bretton Woods system itself;
3. After the Bretton Woods system.

So, let’s start the ball rolling. After we have answered the following questions, we will have a full picture of Bretton Woods system, its role and significance for the Foreign exchange.

The Foreign exchange before the Bretton Woods system

In fact, the notion of Foreign exchange was not very developed in the times before theBretton Woods system (XIX – early XX centuries). The matter is that the world economy was not very mobile at those times, especially in comparison to today. The reason of this was the level of science and technology development. Development of transport was quite poor, that didn’t allow quick cross-border capital movements. At that time, the value of the national paper currency was defined depending on the gold reserves of a certain country. That is, the more gold a country had in its reserves, the more powerful and valuable its currency was considered. This system was called The Gold Standard. The pound sterling was the leading currency at that time, because it was the most backed up with gold. As a result, England became very influential and authoritative country in the currency market at that time.

That was a period of a certain economic stability. The Gold Standard became the domineering economic system in the world. However, it wasn’t absolutely flawless, and over time its faults began to show themselves.

By the end of the XIX century the world economy started developing rapidly – that was for a large part thanks to the technological and scientific progress. The world has never faced such tempos of development before. Certainly, currency exchange rates were affected, too – national currencies could devaluate and revaluate in a boom-bust regime. Inflation could replace economic growth on the instant, because it often turned out that the supply of paper money in a certain local country did not always to correspond to the gold cover of this country, and nobody could be made responsible for that. Moreover, gold production was not sufficient to meet the demands of international trade and investment. By the time of World War I governments began to control imports and exports in order to compensate blockades of the war period. This led to the manipulation of currencies for the purpose of shaping foreign trade.

What is more, most countries governments in the 1930s were keen on such practice as currency devaluations to increase the competitiveness of a national’s export products to reduce balance of payments deficits — which resulted in falling country’s incomes, shrinking demand, mass unemployment, and an overall downturn in world trade. Trade in the 1930s became largely limited to currency blocs. Currency blocks were the groups of nations that used an equivalent currency, for example the “Sterling Area” of the British Empire. In particular, the British Empire created their own economic block to shut out the US goods, since they were realizing that they could no longer compete with the US industry. These blocs held back the international flow of capital and investment opportunities from foreign country. This strategy dramatically worsened the international economic situation.

This ongoing volatility of the Golden Standard system and the lack of universal rules regulating currency relations were highly inconvenient for the most governments.

Then the Great Depression came. Though the Great Depression of the 1930s is notion referring to the USA economy for the most part, its experience was very painful for the entire world. In fact, it led to led to a breakdown of the international financial system and a worldwide economic depression. The Gold Standard collapsed entirely during the Great Depression that generated a chaos.

Source: http://www.forexreview.org/bretton-woods-system/

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Gold Up – Dollar Down – Japan Intervention Talk

Article from Forex FX 4X

Gold moved higher on Tuesday and bullion prices are set for a major monthly rise following from the the Federal Reserve pledge to maintain interest rates at close to zero levels until late 2014. This has likewise put downside pressure on the dollar as the loose monetary policy by the US Federal Reserve has market speculators positioning themselves accordingly.

The precious metal is heading towards a near 11 percent gain in January, this is the highest since a 12 percent gain in August 2011

• The 61.8% Fib retrace of the previous major swing lower is situated just above the 1762 high from 2nd December and is an area of potential resistance on the move higher.

• Further to this the 1800 area previously gave major resistance and a subsequent drop down to the 1530 level.

With regards to the USDX.  There is a technical area of confluence between  78.20 – 78.30 which has 38.2 Fibonacci and 50% retrace levels of the respective swings highlighted below.

Price structure historical support levels are seen at 77.89 and 76.50 which could be hit should the current USDX down trend continue.  Previous resistance is noted at 79.67 with the 80.00 psych level just above.

One topic that is one the mind of many traders right now is whether the japanese will intervene on the currency markets.  The chart below shows how price is moving closer to the all time lows. Jun Azumi, the Finance Minister of Japan advised yesterday that they will adopt firm steps in opposition to excessive volatility.  See the USDJPY chart below.

Any information or views found in this post are provided for educational reasons and do not in any way represent investment advice. The article author doesn’t guarantee the accuracy or completeness of this or any other information provided. Forex-FX-4X or the post authors will not accept liability for any losses arising directly, indirectly or because of reliance on any of the trading setups or associated analysis in any way.

Video courtesy of ForexCT – A leading Australian forex broker, liscensed by the Australian Securities & Investments Commission, offers the MetaTrader4 and PROfit Platform to retail traders. Other services include Segregated Accounts, Trading workshops, Tutorials, and Commodities trading.

Source: ForexYard

After reaching a six-week high against the US dollar in early trading yesterday, the euro staged a downward correction after Greece once again failed to come to an agreement with its creditors regarding its debt. Today, traders will want to continue monitoring announcements out of the euro-zone, with any further negative news likely to bring the common currency further down. Additionally, economic indicators out of both Germany and France are likely to influence euro pairs today.

Economic News

USD – Dollar Stages Upward Correction Following Poor Euro-Zone News

The USD came off a six-week low against the euro in trading yesterday, after news that Greece had once again failed to come to reach a debt swap deal with its creditors. Earlier in the day, the EUR/USD reached as high as 1.3231 before investors began selling off the pair. The AUD/USD also saw a substantial drop, falling well over 100 pips during the European trading session. The greenback failed to move up against the yen, as investors chose to keep their funds with the safe-haven Japanese currency.

Turning to today, dollar pairs are likely to be influenced by any announcements out of the euro-zone which may lead to further risk aversion. Traders will want to pay particular attention to any news out of Greece. While a Greek debt swap deal is likely to be finalized by the end of the week, safe-haven currencies may continue to go up until a final agreement is announced.

With regards to the rest of the week, traders will want to keep in mind that a batch of US data is forecasted to have a significant impact on the markets. Wednesday’s ADP Non-Farm Employment Change figure, as well as the ISM Manufacturing PMI are both considered valid indicators of the current state of the US economy. Furthermore, a speech from the Fed Chairman on Thursday, followed by the Non-Farm Employment Change figure on Friday, are both likely to generate substantial market activity.

EUR – EUR Hits 4-Month Low against CHF

The euro dropped to a four-month low against the Swiss franc on Monday, as investors once again fled riskier assets after Greece failed to reach a debt swap deal with its creditors. Hopes that Greece would come to an agreement to avoid defaulting on its debt were dashed after the Greek finance minister rejected suggestions that the country give up control of its budget policy. Additionally, the EUR/USD dropped well over 100 pips after hitting a six-week earlier in the day.

Today, in addition to monitoring the situation in Greece, traders will also want to keep track of the overall situation in the euro-zone. There are still plenty of scenarios that could cause the euro to tumble against its main currency rivals, including a deteriorating situation in Portugal, which is widely considered the closest to default after Greece. Additionally, news out of the US scheduled for later in the week is likely to generate a lot of volatility for euro pairs.

AUD – Risk Aversion Causes AUD to Slip against Currency Rivals

The Australian dollar had a particularly bearish day yesterday, after poor euro-zone news sent investors to safe-haven currencies like the US dollar and Swiss franc. The AUD/USD slipped over 100 pips throughout the European trading session, while the AUD/CHF dropped some 50 pips before staging a mild correction.

Turning to today, traders will want to note any news out of the euro-zone which could cause the aussie to slip even further. Should Greece once again fail to reach a debt swap deal with its creditors, riskier currencies like the AUD could see further bearish momentum. At the same time, any positive international data is likely to boost confidence in the global economic recovery, which could result in a boost for the AUD.

Crude Oil – Oil Falls Further to Start off Week

Negative euro-zone news sent the price of crude oil tumbling throughout the day yesterday, as investors fled riskier assets in favor of safe-havens. Crude fell as low as $98.49 a barrel during European trading, before staging a slight correction.

Today, crude may continue to fall as long as a Greek debt-swap deal is not reached. It appears that without positive euro-zone data, investors are unlikely to shift their assets to commodities like oil. At the same time, with significant economic data out of the US set to be released later in the week, crude will likely have several opportunities to recoup its losses in the coming days.

Technical News

EUR/USD

According to technical indicators on the daily chart, this pair is in overbought territory and may see a downward correction in the near future. A bearish cross has formed on the Stochastic Slow, while the Williams Percent Range is currently at the -10 level. Traders may want to go short in their positions ahead of the downward breach.

GBP/USD

Technical indicators are showing that this pair may have hit a significant resistance point and could see a correction in the near future. The daily chart’s Relative Strength Index is in well into the overbought zone, while a bearish cross has formed on the Stochastic Slow. Going short may prove to be the wise choice.

USD/JPY

Technical indicators on both the daily and weekly charts are showing that this pair is oversold and may see an upward correction in the near future. The daily chart’s MACD/OsMA has formed a bullish cross, while the weekly chart’s Relative Strength Index is hovering close to the oversold zone. Traders may want to go long in their positions.

USD/CHF

Most technical indicators show this pair trading in the oversold zone, meaning that an upward correction could take place in the near future. The Williams Percent Range on the daily chart is at the -90 level, while the Relative Strength Index on the same chart has dropped to the 15 level. Going long may be the preferred strategy today.

The Wild Card

Platinum

After steadily climbing in recent days, it now appears that platinum may see a downward correction in the near future. Technical indicators on the daily chart, including the Relative Strength Index and Williams Percent Range, are in overbought territory. Forex traders may want to take advantage of the impending downward correction and go short in their positions.

Forex Market Analysis provided by ForexYard.

© 2006 by FxYard Ltd

Disclaimer: Trading Foreign Exchange carries a high level of risk and may not be suitable for all investors. There is a possibility that you could sustain a loss of all of your investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with Foreign Exchange trading.

The Central Bank of Colombia raised its monetary policy interest rate 25 basis points to 5.00% from 4.75%.  The Bank said [translated]: “The increased risk of central forecasts growth remains a disorderly adjustment in Europe. The risk materializes, the world economy would grow significantly less than expected, international prices of basic goods could fall and exacerbated global risk aversion, all of which adversely affect the Colombian economy. For its part, the main risk to inflation coming from excessive expansion in demand or increases in cost overruns, with strong and lasting effects on expectations and credibility of monetary policy. In a longer time horizon, excessive credit growth and the persistence of low real interest rates could be a source of financial imbalances have negative consequences on the sustainability of economic growth.”

The Central Bank of Colombia last hiked the rate 25 basis points at its November meeting, while its previous change was an increase of the interest rate by 25 basis points to 4.50% at its July monetary policy meeting, following a 25bp increase in June last year.  Colombia reported annual inflation of 3.6% in December, 3.96% in November, 3.73% in September, 3.27% in August, 3.42% in July, 3.23% in June, 3.02% in May, and 2.84% in April; which compares to the Bank’s inflation target of 3% (+/- 1%).

By MoneyMorning.com.au

The outlook for China matters enormously to markets and the world economy.

So it’s a shame that the argument over whether or not it will have a ‘soft landing’ is framed so poorly.

What most pundits seem to mean by a soft landing is nothing of the kind. It doesn’t even qualify as a landing.

And they seem to be ignoring the risks for what is probably the most important sector in the world right now – Chinese real estate…

Chinese Real Estate Investment is Slowing Very Fast

When analysts talk about a soft landing in China, they mean a scenario in which growth gently slows to around 8%. This is widely assumed to be the minimum growth figure the country needs to maintain a solid job market and generally keep its citizens happy.

This scenario seems unlikely to me, to say the least. Especially when you look at what’s going on in the Chinese property market.

Real estate investment grew around 28% year-on-year in 2011. But it has been decelerating sharply. The year-on-year pace was 25% in October, 20% in November and 12% in December.

Chinse property accounts for around 13% of China’s economy directly and impacts on as much as 25% of GDP through related sectors. So a major slowdown here would inevitably be a serious drag on the economy.

In fact, it’s not much of an exaggeration to view Chinese real estate as the single most important sector in the world right now.

Chinese export manufacturing is facing slower demand from Europe and the rest of the world. The government seems unlikely – for now – to embark on the kind of aggressive stimulus it followed in 2008-2009. And consumer spending is obviously not going to fill the gap.

So why does this matter? Because most people seem to expect Chinese real estate investment growth of around 12-14% in 2012. That’s about half the 2011 pace, and would give you 8% overall GDP growth.

However, real estate is very cyclical. When it stops growing fast, it tends not to plateau, but to contract. And if real estate investment shrinks even a little bit, GDP growth is likely to be closer to 6%.

That might still seem pretty good. It’s certainly not a hard landing by any reasonable definition. But in an economy that has been growing as fast as China, that sort of shift in pace would be very noticeable.

Any drop may not show up fully in the headline GDP figures, which are measured year-on-year. But these tend not to capture the full extent of a slowdown, so long as growth picks up again relatively quickly.

Quarter-on-quarter growth was an annualised 8.2% in Q4 2011 from 9.5% in Q3, according to the official figures. I wouldn’t be surprised to see that rate drop much further. The ingredients are there for a much more abrupt change in the economy than most analysts want to admit.

This isn’t necessarily a bad thing. If growth falls because the government is deliberately trying to restrain property investment, it shouldn’t be seen as a sign of weakness. Rather, it reflects policies that should be beneficial in the long run.

I don’t believe the Chinese property bubble is anything like as big as some argue. But there’s absolutely no doubt that property developers in China are exactly the same as everywhere else: fond of piling on the leverage and overbuilding when times are good, then going bust when the cycle turns.

Western economies let real estate get out of hand and are now paying the price. Chinese policymakers are being more proactive: they’ve been clamping down on the industry for over a year.

For most of 2011, analysts constantly expected them to loosen curbs in the near future. That hasn’t happened. There have been some minor moves towards loosening Chinese monetary policy more broadly, but little relief for real estate.

Hopefully they’ll stick to this; an economy where real estate plays a smaller part will be a healthier one. But any move towards better quality growth will clearly reduce the growth rate – and not just for the next few months.

China’s trend growth rate has probably peaked. In hindsight, the mid-2000s will probably seem exceptional. With exports to the West now unable to grow so fast, the demographic dividend of cheap labour from the countryside getting smaller, and less scope for high levels of investment in real estate, the pace is likely to slow.

Indeed, the government’s target is now for 7% annual growth in 2011-2015, below the fabled 8% that analysts continue to use as a lower bound. A target has little value in itself: growth regularly beat official goals by a large margin in the past decade.

But the change suggests a shift in policy, where runaway sectors such as real estate will not be tolerated solely in the name of higher GDP.

So if China’s growth comes in lower than expected over the next year, it shouldn’t be seen as too alarming. In fact, if the brakes come off and real estate investment is allowed to accelerate again, that would be more worrying for the long-run health of the economy.

But whether the market will see it that way round is another question.

Cris Sholto Heaton
Contributing Editor, MoneyWeek (UK)

Publisher’s Note: This article originally appeared in MoneyWeek (UK)

From the Archives…

Is There a Reason You’re Not Using the 90/10 Strategy?
2012-01-27 – Kris Sayce

In the Market or Under the Mattress?
2012-01-26 – Keith Fitz-Gerald

What if the Australian Dollar Was a Stock?
2012-01-25 – Kris Sayce

Why Tungsten and Other Strategic Metals Could Prove Good Investments
2012-01-24 – Dr. Alex Cowie

Will These Commodities Help You Claim The Best Investment Gains Of 2012?
2012-01-23 – Dr. Alex Cowie

Why Chinese Real Estate is the Most Important Sector in the World Right Now

By MoneyMorning.com.au

On 12 January Britain’s largest supermarket chain, Tesco, reported weaker than expected Christmas sales. It threw in a profit downgrade for good measure. As a result, the share price fell 16 per cent. It was Tesco’s largest share price decline in over 20 years.

Amongst the panic, Warren Buffett’s investment vehicle Berkshire Hathaway increased its stake in the food retailer to more than 5 per cent. Buffett first invested in Tesco in 2006. In the five years since, the stock price is down from where Buffett first bought in.

Yet he just purchased more.

This approach is what sets Warren Buffett apart from 99.9 per cent of investors. After investing in a company for 5 years, with the stock price going nowhere, most investors would ‘throw in the towel’ and sell after a profit downgrade and 16 per cent price plunge.

It’s the emotion of it all. We’re fixated on price. If the price is not doing what we want (moving steadily higher) we get restless. Sharp price movements invite an emotional response.

This is Warren Buffett’s strength. He avoids the emotional response because he focuses on the business not the stock price. Business value (and therefore share price value) is hard to grasp. It’s subjective. And you have to believe that in the long run value will always rise to the top. You just don’t know how long the long run really is.

Investing is a marathon. Slow and steady wins the race. Trying to catch every rally and moving from one sector to the next ‘hot’ area of the market is a mug’s game. It makes you feel like you’re doing something but you’re really just chasing your tail.

Over the long term, the market will deliver returns commensurate with the business performance of the companies listed on the exchange. If you invest in companies that offer the prospect of above average long-term returns, you will beat the market – over the long term.

Warren Buffett’s performance over the decades validates this approach. He is the ultimate tortoise. But keep in mind he beats the market, first, by buying companies at a good price. And second – and perhaps more important – by overcoming the emotional constraints to successful investing.

Greg Canavan
Editor, Sound Money. Sound Investments.

Ed Note: You can learn first-hand in Sydney what Greg thinks are the biggest opportunities – and risks – facing Australian investors, retirement savers and homeowners in 2012 by attending our “After America” conference. Find out more by clicking here…

From the Archives…

Is There a Reason You’re Not Using the 90/10 Strategy?
2012-01-27 – Kris Sayce

In the Market or Under the Mattress?
2012-01-26 – Keith Fitz-Gerald

What if the Australian Dollar Was a Stock?
2012-01-25 – Kris Sayce

Why Tungsten and Other Strategic Metals Could Prove Good Investments
2012-01-24 – Dr. Alex Cowie

Will These Commodities Help You Claim The Best Investment Gains Of 2012?
2012-01-23 – Dr. Alex Cowie

How Warren Buffett Plays the Tortoise and Not the Hare

By MoneyMorning.com.au

Many years ago as a backpacker, the timing chain went on my knackered old Falcon XF. That was the end for ‘old Falco’.

As I stood in despair with the bonnet up, an irate local ran over to me. He was yelling ‘Put the bonnet down! You don’t want those Holden-driving buggers gloating, DO YA!?’

As a fresh-to-the-Lucky-Country pom, I thought this passion was great. These days, it seems this passionate division of opinion has migrated from Ford vs. Holden over to the Australian property debate.

With good reason. Property makes up a cornerstone of many Australian’s wealth. And Aussie property has had a bull market like no other. It started in the 1970s, decades before things got going in the United States. Over 40 years, Aussie property has gained an average of about 3% a year. Doesn’t sound like much, but it adds up quickly.

From the 1990s onwards, Australian house prices went up a few gears, and never looked back. Prices rose at an average rate of 6% a year at that time.

Australian property prices pulled back from gravity-defying heights by at least 3.7% last year. Melbourne houses are down 9%.

Many home owners are nervous. Is this pullback the start of something bigger? Nearly every property market elsewhere in the world has spent the last few years imploding. US property prices are down by 40% in six years. Compare US prices in blue on the chart below against Australian house prices (in red)

When looked at like this, if property prices were to fall, you get a sense of just how far they could go. The 40% pullback in US prices that started in 2005 would be a picnic.

But WILL they fall?

There are wildly diverse opinions on where house prices are heading. That’s what makes a market.

Part of the reason for differing opinions is that there is more than one property market in Australia.

The resource-rich states, such as Western Australia, can be rising. While an economy with slow growth, such as Victoria, can be falling. Top tier suburbs can outperform the boondocks. Boiling the country down to just one market oversimplifies it, but it is the right place to start before scratching deeper.

Another reason for differing opinions is that some commentators have a vested interest in maintaining high prices. It’s impossible for them to be objective. It’s human nature.

For example, residential property loans makes up the vast majority of banks’ balance sheets. It’s not in their interest to put out negative research that could reduce the value of their portfolio.

Yesterday’s ANZ report suggests ‘…housing market fundamentals remain supportive’. And it pins any falls during 2012 purely on sentiment.

Australia dodged a crash last time because the government juiced the market with cheap loans in the form of First Home Buyers Grants. Now this sugar-hit has faded and prices are falling again, sentiment has really turned. Buyers are just waiting, knowing that house prices are likely to fall further. As they fall, their view is vindicated so they wait some more. It becomes self-fulfilling. Sentiment can quickly send a fragile market south.

Australian property has many home-grown critics.

There is now a long and growing list of international experts expecting prices to fall.

Last month, rating agency, Moody’s, reckoned current prices were ‘not sustainable’ based on simple metrics. Metrics such as the average-price-to-average-salary ratio being close to 7, when the average in the developed world is 3.

Moody’s also pointed out that city house prices have quadrupled since 1990, and household debt has tripled. The point is that this puts home owners in a very delicate position in the event of an economic shock.

The Economist Magazine calculates that, based on the ratio of rent to price, Australian property is overvalued by 53%. A leading US real estate analyst, Jordan Wirsz, is calling for the Aussie housing market to fall by as much as 60%. He said ‘I’m bearish about world real estate but I couldn’t be more bearish about the Australian market’.

This is just part of a growing chorus of voices from overseas ‘experts’. But what do ratings agencies, magazines and analysts really know? They don’t have their money on the line.

What I put more weight on is when people start putting their money where their mouth and start making bets against property.

The world’s biggest hedge fund, Bridgewater Associates, with about $120 billion in management, expects Australian property to fall and is betting heavily against the Australian dollar this year.

Bridgewater was one of the few hedge funds to make money last year, and notched up one of the best returns in the hedge fund sector at 23%. This is on the back of consistently outperforming the market over 20 years.

No one knows for sure. But taking a calculated approach, my view is the risk of a crash outweighs the chance of making a meagre gain. I voted with my feet and sold out of property a year ago, buying gold with the proceeds. My mates thought I was nuts. But so far it has been a good trade. I’ll swap back when the time is right.

Most Australian ‘experts’ reckon Australia property won’t crash, and deny it is even in a bubble.

Alan Greenspan and Ben Bernanke said the same thing to Congress in 2005.

Right before the US housing market started a 40% fall that continues today.

Dr. Alex Cowie
Editor, Diggers & Drillers

Publisher’s note: If you enjoy reading Alex’s essays in Money Morning, we bet you’d love to meet him in person. It just so happens that he’s appearing live at the first ever Port Phillip Publishing Investment Symposium in March. It’s in Sydney. You should come. To meet Alex and hear his views on China, America and Australia – go here

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