US Bond Market Crash
Dennis began the presentation with a report from PIMCO founder, Bill Gross. Bill Gross is commonly known as the bond king as he was an expert in bond investment and he had made a lot of money from it. His view was that the US bond market would crash. He reasoned that with QE 1 and QE 2, the Fed has been buying 70% of US government bonds. What happens after the Fed stops buying? The demand for US bonds is not sustainable. He had sold all US$28.6 bn worth of US bonds in his PIMCO Total Return Fund and he is actually holding a 4% short position on US bonds. He has 37% of the portfolio in cash which is unprecedented (less than 20% in the past).
How will it lead to a financial crisis in 2012
Dennis added that the US government had only printed US$800 bn in 200 years. But QE 1 alone printed US$2 trillion in 2 years and QE 2 printed US$600 bn in 6 months. He expected that unemployment would remain higher than 8% even after QE 2 has completed. Thereafter, a QE 3 is likely to boost the economy further but it would similarly be futile to solve the problem. Looking at the biggest foreign holders of US bonds, China and Japan, the former declared that she is paring down her position on US bonds and the latter would sell bonds to raise money to rebuild the country after the earthquake. Hence, the demand for US bonds would drop. And once the Fed stops the QE projects, demand would dry up and bond price would fall.
US credibility is of question. In traditional finance, US treasury interest rate is known as the risk free rate, as the assumption is that US will never default as a credible and stable country. However, US Treasury Secretary, Timothy Geithner had just mentioned US required to raise its debt limit (borrowing limit) to avoid defaulting on loan repayments. It is akin to increasing your credit card limit to borrow more money to pay back debts. It becomes a never ending vicious cycle.
With the inverse relationship between bond price and interest rate, once bond price crashes, interest rate would rise rapidly. Housing loan interests would rise in tandem and some people would have problem repaying a higher loan installment (that’s why Dennis always use 4% as a prudent assumption). As economy slows, companies profits will decrease and unemployment will rise. Stock market will crash as well.
Dennis foresees this crisis will be worse than the last one. In 2008 crisis, the US government was able to borrow money to bail out companies, but with US government credibility in jeopardy, no one would lend them money anymore.
Supply of private condominiums in 2013-15 would be 50,000 units or 16,942 units/year in 3 years. Last year was the highest sales with 15,000 condominiums sold. We can see that the supply would outpace demand very soon. And if the financial crisis in 2012 becomes reality, demand will definitely come down significantly. Historically, an average of 6000 units were sold per year.
Supply of BTO flats was 16,000 last year and 22,000 this year. The demand in 2008 which was a financial crisis year was 9,000 units.
Resale HDB transactions were 40,000 last year compared to historical average of 26,000 per year. Home buyers would buy new flats when they are available and demand for resale would fall as well.
3 possible scenarios may happen. Firstly, if inflation went up high, property prices may drop 10%. Secondly, if inflation is contained, prices would drop 30%. Thirdly, when properties are oversupplied, rental yields would drop 30%.
Gold and Silver
Dennis compared the ratio between gold and silver price to put things into perspective. The lowest ratio was 16:1 in 1980, while the highest ratio was 89:1 in the last 200 years. The average ratio has been 30:1. Taking the lowest ratio, if gold is worth US$1,500/oz, silver should worth US$93/oz.
The demand for silver in 2010 was 878 mln oz while the supply was 735 mln oz. The shortfall was 143 mln oz. Unlike gold, silver has industrial demands and had grown with the rise in population. The concern maybe that industrial demands may drop when economic growth slows, but Dennis expects the investment demands to go up. This is because of the devalution of US dollars and potential inflation in the future.
Silver dropping 30% in 5 days is overdone according to Dennis. As long as silver maintains above US$30, the uptrend is still intact.
Dennis reckons the STI would continue to rise. The PE ratio of STI is currently at 11. It has the lowest PE ratio compared to other Asian countries. China at 17 and Nikkei at 17.7. If STI goes to PE 15, STI would be equivalent to 4,268 points.
The blue chips could go up another 20-30% but Dennis would rather invest in strong penny stocks which have greater upside of 50-100% returns.
Asset Allocation is important to minimise risk
Dennis does not put all the eggs in one basket. He diversifies his portfolio into stocks (30%), cash (30%), property + land banking + gold/silver + wine (30%) and Traded Endowment Policies (TEP) (10%). TEP would provide the downside potential with capital protection. The hard assets (property, gold/silver etc) would rise with inflation. Stocks would ride on the last phase of this bull market. Cash would provide opportunity when the market crashes. This is an all weather-proof portfolio as Dennis terms it.