PropertyInvesting.net: Property Investment Special Reports

284: Assets versus Savings and Inflation

08-30-2009

PropertyInvesting.net team

 

There are a few interesting dynamics happening in the UK economy at the moment that we thought you should be aware of:

 

• First of all, the Bank of England continues to print money – called “quantitative easing”
• Meanwhile inflation stays stubbornly high at 1.8% CPI – despite a massive GDP contraction of ~5% in the economy since August 2008. This implies underlying inflation over growth rate of a worrying large 6.8%
• Meanwhile oil prices have risen from their lows of $38/bbl in November 2008 to the current $70/bbl – almost 100%
• Interest rates stay at historic lows of 0.5% - with the Bank of England showing no sign or inclination of raise these yet – and giving us all the impression that rates will stay at these lows until well into 2010
• House prices continue to move higher – a total of 6% since February 2009 (that’s an annualized rate of 12%)

 

Our Expectation:  What we now expect to happen is the following:

 

• Because “Peak Oil” was July 2008 and we are now on a bumpy production plateau, as global oil demand increases as almost all economics come out of recession by end 2009, the oil price will move sharply higher (Note: despite the so called “demand destruction” caused by the economic-financial meltdown, global oil demand has dropped only 2.6% from it’s peak in July 2008)
• Inflation will then start moving well above the Bank of England’s target rate of 2%
• The Bank of England will then be forced to increase interest rates just as the UK economic group starts gathering momentum by year end (Note: they are mandated to keep inflation close to 2% and their only real lever is interest rates)
• Banks will jack-up their interest rates further – mortgages of 7%-8% or more can be expected by mid-end 2010
• The housing market will again stall out – some time in 2010 – some drops could then re-occur

 

"It's the oil stupid":  If you took out the effects of “Peak Oil” or stubbornly high oil prices, you would probably get fairly benign economic conditions that could lead to long term house price growth, but because the oil price feeds through to all other goods and services – this will be enough to add a few percentage points to inflation and hence this will lead to higher interest rates and lower house price growth.

 

But before we all run to put our money into savings – remember the worst place to have money during inflationary times is in savings. Value is destroyed over time because savings rates are lower than inflation. If you borrow money and leverage up (not a popular term these days) then if the asset prices also rise – you will beat savings by an enormous margin. This is why the smart investor will normally have most of his or her money in assets and very little in savings, particularly during low to high inflationary times.

 

But what sort of asset prices are likely to increase during inflationary times, and what type of assets are likely to decrease?  Well, predicated on our firm view that energy prices will rise sharply because of oil demand from all countries in the world, particularly China, India and Brazil – we think this fundamental principle will strongly control how different investments sectors and products will perform.

 

What Will Happen?   Based on oil shortages occurring, we believe the following will happen:

 

• Oil prices will rise, followed by gas, coal and energy
• The dollar will decline further
• Gold prices will rise (as a hedge against inflation)
• Metals-mineral prices will rise
• Wood, food, forestry and water prices will rise
• Property prices (and currency values) in countries that export oil/gas/metals will rise
• Property prices (and currency values) in major oil/gas importing nations will drop – and their currencies will come under pressure

 

Based on this synopsis, we believe the best sectors to invest in the medium term (1-5 year time frame) are:

 

Accumulate or enter:

• Oil and gas exploration, development and production companies
• Wind power companies
• Solar power companies
• Electric turbine companies
• Electric car companies
• Land and farms close to large cities in Western Europe
• Water conservation-efficiency services
• Energy conservation-efficiency services
• Energy financial funds
• Internet - online services
• Green Tech companies and funds
• International property in Norway, Canada, Australia

 

For the UK property investor wishing to invest in the UK:

 

• UK property close to high speed rail links (Ebbsfleet, Stratford, Woking, Ashford, Folkestone)
• Property in city centres close to high paid jobs (London, Aberdeen)
• West End property – affordable to the super-rich (international oil money)
• Regeneration-Olympics areas (especially East London close to City-Stratford)

 

Divest or avoid: 

• Airline businesses
• Overseas farmland that relies on air transport to ship fresh produce (e.g. Kenya)
• Out of town shopping malls and far flung commercial centres with only car transport links
• UK property in towns and villages in Midlands, Wales, North and Scotland that have poor rail, no shipping links, that require expensive car transport to get to (except oil-gas centres of Aberdeen, St Fergus and Stonehaven)
• Second home areas in the north that rely on long distance car transport for viability
• Retail businesses
• Overseas holiday homes in Europe that rely on low cost airline travel (small regional airports in remoter parts of France and Spain)
• Overseas holiday homes that rely on long-haul airline travel (e.g. Cape Town, Cape Verde, Mauritius, Seychelles)
• Car manufacturing
• Manufacturing
• Banking (unless it is an obvious turn-around)  

 

No warning:  Finally, for the UK property investor with large portfolios – there is a need to be careful with cash flow. Expect interest rates unexpectedly to start shooting up by end 2009 – with little warning. The Bank of England will not want to warn everyone many months beforehand for risk of killing off any embryonic economic recovery. But when momentum builds and inflation starts heading towards 3% - expect the Bank to act very aggressively – failure to do so will prompt a requirement for the Governor to write another letter to the Chancellor explaining the Bank’s actions.

 

Change in Government?  By June 2010, also expect another government (if you believe opinion polls-ratings) and then a slashing of public sector expenditure and jobs. The loss of public sector jobs will have a proportionately large impact on Wales, Scotland and the North. London and the South will be less badly effected. So just as the new government enters office, inflation will have taken hold – and their first crisis job will be trying to kill off an inflationary escalation and reducing public sector debit, deficits, unemployment and all the rest – all at the same time. This normally takes a few years to reign in such over-expenditure and start to get the books sorted out. Expect VAT to increase, income tax to stay the same or drop. And state benefits to reduce. As the UK produces less oil and gas in the next 5-10 years, this shortfall will also need making up.

 

More Turbulence: So expect more turbulent times in 2010 – and don’t expect the low interest rates to last much longer. The party is just coming to a close. But at least house price will rise in the short term – probably to early 2010 at least – before correcting again.

 

We hope you have found this Special Report helpful and/or insightful – we aim to give you the latest objective views from fellow investors that will help guide your investing and improve returns. If you have any comments, we can be contacted on enquiries@propertynvesting.net

 

 

 

 

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