Gold crash: How to spot (and dodge) investment bubbles + Rate rise outlook

Hi everyone,

Happy Friday. An interesting week when it comes to your finances, dominated by the Reserve Bank increasing interest rates (they’d cut them only last August). More on that shortly.

In this week’s newsletter:

• Interest rates up - but is there more come?

• Property values continue to increase, but how will the rate rise hit future values?

• What are the main factors which drive the decision to sell a property?

• How to spot an investment bubble - and how to avoid getting caught when it bursts.

• What our mineral resources are worth to each of us.

Interest rates up - but is there more to come?

It came as no surprise when the Reserve Bank lifted official interest rates this week, raising the cash rate by 0.25 per cent to 3.85 per cent. As I said last week, the December quarter CPI was a shocker, and the RBA had to act.

How quickly the economy has changed. The last interest rate cut was just last August and there were lots of predictions of another cut for December and another one or two in 2026. Apart from Japan, Australia is the only western country in the world putting up interest rates.

My thanks to IFM investors for the charts below, which show just how quickly the economic environment has changed. They track the Reserve Bank’s key forecasts for the main drivers of the Australian economy. The green lines show the forecasts made in November - just three months ago - while the orange lines are the updated RBA forecasts released this week.

Have a look. In some areas, the differences are striking:

• Inflation: Both headline and trimmed mean inflation are now expected to remain above the RBA’s target range for all of this year. Just three months ago, inflation was forecast to return to the target range by mid-year.

• Dwelling investment: A major reversal, with dwelling investment shifting from positive into negative - unsurprising given interest rate rises.

• Wages and jobs: Wage growth staying higher, but unemployment rising.

• Households: Consumers are cutting back on spending as the cost-of-living crisis intensifies, with higher loan repayments and many moving into higher tax brackets.

It’s not a pretty economic picture:

So yes, the rate increase decision was expected, but it’s the RBA statement attached to it which is important to understand. I often talk about this statement as giving some insight into what the board is thinking - it's sort of reading the RBA economic tea leaves and is fascinating for a finance nerd like me.

This is this week’s RBA statement compared with the previous board meeting’s statement.

At the last board meeting, inflation had picked up. At this meeting, inflation picked up materially in the second half of last year.

Have a read:

See what I mean? It’s interesting to see how the board evolves its thinking and is an insight into what they could do in the future.

In terms of our everyday finances, the rate rise will push monthly repayments up by about $94 for someone with a $600,000 mortgage. That’s an extra $1,128 a year - money which many households simply don’t have to spare when they’re also being hit with higher grocery costs, insurance premiums and energy bills.

Mortgage holders should keep a close eye on communication from their lender, who will advise when rates will increase and what their new repayments will be. But it may still be possible to create your own rate cut.

Never assume you’re getting a good deal – even while rates are on the rise, there may be discounts for people willing to do the leg work. If your bank hikes your interest rate but they’re advertising lower rates for new customers, see if they can move you to a better deal or be prepared to walk.

If there’s a big difference between your rate and the ones that are advertised, there may be room to pay less.

Recent data from Compare the Market, shows that a quarter of Aussies (25.17 per cent) surveyed in January listed mortgage or rental costs as their biggest budget pressure over the past 12 months.

The research found homeowners would try to ease financial pressure by:

• Making extra repayments: 14.15 per cent.

• Switching and refinancing to a more competitive variable-rate home loan: 12.19 per cent.

• Doing nothing and staying with their current home loan lender: 11.99 per cent.

• Opening an offset account: 10.52 per cent.

Property values continue to rise, but how will they react to rates?

The latest data from property research group Cotality shows continued strong growth in values across all capital cities and in the regions over January.

Nationally, values are up 0.8 per cent for the month, 2.4 per cent for the quarter, and 9.4 per cent for the year.

Once again, Brisbane, Perth, and Adelaide outperformed the larger Sydney and Melbourne markets, which are being held back by affordability issues - issues that will only intensify as mortgage repayments rise.

A rise in interest rates usually dampens the property market as buyers can’t afford the extra repayments on a loan. But because there is such a shortage of properties being built and available for sale, the rate increase is more likely to dampen the market than crash it.

What are the factors that drive property sales?

According to property giant Ray White, over the past 25 years, property sales levels have moved through repeated boom and bust cycles, ranging from fewer than 380,000 sales a year to more than 580,000.

Ray White chief economist, Nerida Conisbee, says volumes spike when financial conditions and confidence improve and collapse when they tighten, regardless of whether prices are rising or falling at the time.

The challenge is that selling a home is rarely a single decision. It is usually one part of a chain. One household sells in order to buy another property, which allows another seller to move, and so on. If something breaks that chain, whether it be interest rates, lending restrictions or confidence, sales volumes can fall quickly even if prices remain high.

Prices and expectations
Over the long term, price growth does matter. Rising prices encourage owners to list because they can see capital gains and feel confident that they can achieve a good result.

Falling prices have the opposite effect as many owners choose to wait rather than crystallise a loss. But price is only one of many forces at play, and often not the most important one.

Interest rates
Interest rates are a major influence on volumes because they determine whether people can actually move.

When rates fall, borrowing capacity rises and upgrading, downsizing and investing all become easier.

When rates rise, households become stuck. Even people who would like to move often find they no longer qualify for the loan required to buy their next home. This quickly leads to fewer listings and fewer sales. Extremely low interest rates was a key driver during the pandemic when we saw not only very high price growth but also high transaction volumes.

Access to finance
Closely related to this is access to finance.

Lending standards, serviceability buffers and competition between banks all shape how easy it is to transact.

Periods of tight credit have repeatedly caused transaction volumes to fall sharply, even when interest rates were low. Conversely, when credit is readily available, volumes can surge as more buyers are able to participate in the market.

This was a major reason transaction volume fell so sharply through the late 2010s, as APRA’s tighter lending standards significantly reduced borrowing capacity even though interest rates were low.

Investor participation
Investor activity is another critical driver. Investors tend to trade more frequently than owner occupiers, and when they enter or exit the market in large numbers, total sales volumes change quickly.

Policy shifts, changes to tax settings or rental market conditions can all cause investors to pull back or rush in, amplifying cycles in turnover.

For example, when investor tax and lending rules tightened from 2017 onwards, investor purchasing fell sharply, contributing to the drop in overall transaction volumes.

Economic confidence
Economic confidence also plays an important role.

When people feel secure in their jobs and incomes, they are more willing to take on the disruption and risk of moving home. During periods of uncertainty, households often choose to stay put, which suppresses listings and transactions even if underlying housing demand remains strong.

Life stage and mobility needs
Life events drive a large share of property transactions. Marriages, divorces, new children, job changes, retirement and death all require households to buy or sell.

These moves are not optional, but they are often delayed in tougher times. When financial conditions are tight, people postpone moving if they can, which again reduces turnover.

New housing supply
The level of new housing supply also influences volumes.

When construction is strong, new dwellings are being sold and existing owners are more likely to trade into them. When building activity slows, fewer new properties enter the market and fewer chains of transactions are created, pulling down overall sales.

Rental market conditions
Rental market conditions matter as well.

Tight rental markets push renters into home ownership and make property more attractive to investors. This lifts both buying and selling activity. When rental conditions ease, the pressure to transact diminishes.

Taxation and policy
Taxation and government policy can move volumes quickly. Changes to stamp duty, land tax, capital gains tax or investor incentives all alter the financial equation for buyers and sellers.

These shifts can bring forward transactions or cause them to be delayed, leading to short term spikes and troughs in sales.

Sentiment
Finally, sentiment has a powerful effect.

When the market feels strong and headlines are positive, people become more comfortable making big decisions. When sentiment turns negative, hesitation sets in. Even if the fundamentals have not changed, behaviour does, and transaction volumes respond.

How to identify an investment bubble, and how to avoid getting caught when it bursts

They are the investment phenomenon which makes a person’s wildest financial dreams come true and then instantly shatters them. Investment “bubbles” have been inflating and bursting for hundreds of years.

The wild ride of the gold price and the value of digital currency group Bitcoin over the last few weeks is a timely reminder that while asset price bubbles can be fun on the ride up, you don’t want to be caught in the inevitable bust.

The key is identifying when your investment is becoming a bubble rather than just delivering strong asset value growth. It can be a fine line and bubble identification is often done in hindsight. But we have plenty of bubble history to draw on for guidance.

I’m old enough to remember the gold bubble of the late ’70s and early ’80s, when the precious metal dropped 57 per cent overnight on Valentine’s Day 1980.

Since then, we’ve seen the Japanese “Take Over The World” bubble in the 1980s, the Asian currency bubble of the mid‑90s, the dot‑com bubble of the late ’90s, and the global easy‑credit and housing bubble of the early 2000s, which culminated in the Global Financial Crisis.

But it seems even painful crashes haven’t stopped buyers from driving other assets into “bubble land,” where prices are well above what good old-fashioned investment fundamentals like supply and demand would dictate.

Inevitably, the investment cheerleaders in bubbles start using phrases like, “traditional investment fundamentals don’t apply in this case because …,” or “it’s different this time because…,” or “there are no limits because we’re changing the paradigm by….”

Whenever you start hearing this type of language you should start to be concerned.

Been there, done that

Investment history tells us that every asset runs in a cycle, and prices generally gravitate back to their historic averages if the pendulum swings too far in either direction.

Many experts warn we’re more exposed to bubbles than ever, and they’re inflating and deflating faster. Technology and products like Exchange Traded Funds (ETFs) make it easy for larger amounts of money to swamp an investment, driving prices up rapidly, then be pulled out just as quickly to cause a sharp burst.

The investor strategy seems pretty simple: See a bubble, walk away.

The problem is, it's all but impossible to spot a bubble before it collapses. Experts also seldom agree about whether a given investment fits the bill. One analyst's catastrophe-in-the-making is another's new traditional “opportunity”.

So, to try and help avoid being caught in an investment bubble, here are some of the tell-tale bubble scenarios I’ve come across over the years and which sound a warning:

How to spot a bubble red flag

1. A little too ‘revolutionary’
   A stock based on a process or technology that claims a revolutionary, unlimited path to growth is exactly the kind of hype that fuelled the dot-com bubble.

2. Excess cash and few opportunities
   When cash is abundant and investment options are limited, it leads to people buying or investing in anything available. This is often the basis of our housing booms.

3. Too tricky to understand
   If an idea is so complex that it can’t be fully explained to investors, that’s a warning sign. Remember Firepower and its “pill” to drop into the petrol tank for better efficiency?

4. A lemming phenomenon
   This is when the crowd blindly follows the leader — even the gardener has a tip! Think of the Nickel/Poseidon boom of the ’70s, a pattern that seems to repeat on the share market every 5–6 years.

5. “New paradigm” claims
   New fundamental levels are sanctioned by supposed experts claiming, “We are in a new paradigm!”

6. Relaxed lending practices
   Financial institutions loosen lending rules. Easy money flows like water to anything or anyone with a new idea.

7. Cult figures and media hype
   Influential personalities emerge to champion the new paradigm. The media celebrates the “greed is good” gurus and their lavish lifestyles.

8. Rationalisations, but no selling
   Everyone has a reason why it can’t continue - yet nobody sells. Profits are held, new buyers vanish, and the market stalls.

Smart investing tips

As well as learning how to spot a potential bubble, you can also protect your money with these investment fundamentals:

• Invest in quality assets.

• Understand what the investment actually does.

• Take profits on the way up and bank them.

• Maintain balance in your portfolio.

• Understand where you are in the investment cycle.

Remember too, it is better to make a little less profit by selling too soon than to take the greater risk of overstaying the market in a stock which is overpriced.

Investment bubbles happen, so be aware, cautious and agile.

How lucky are we to have mineral resources?

We really are the “lucky country” - a great nation with a sense of humour, unbeatable lifestyle ... and resources.

I know the mining companies are often criticised (sometimes for good reason), but the mineral resources we hold in the country are a major foundation for our national wealth and privileged lifestyle.

Take a look at this graph below which shows the value of each country’s mineral reserves per head of population.

I know companies mine the resources and make big profits which they distribute to shareholders. But they also pay taxes (company, payroll, GST), employ people (who pay taxes), pay extra resources and contribute to superannuation. So the nation is a big beneficiary.

It’s no surprise Saudis earn the most per capita from their resources. They're rich in oil and have a small population (35 million).

Canadians are second richest and Australians the third.

Large populations push China and the U.S. to the bottom of the top 10 despite their large total reserves.