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LuckyOne

Buying A House To Protect Against Inflation Is Insane ....

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A fairly consistent them that has popped up recently is that some people are thinking about buying houses now to protect against a massive devaluation of paper money.

This is a really inefficient strategy for a number of reasons :

- If inflation really takes off, interest rates are going to rise and mortgage payments for many will rise more quickly than incomes placing a severe strain on many household budgets which will increase supply and only drive real prices lower.

- The optimal LTV in an hyperinflationary enivronment might be 75%. The real value of a house might drop by 75% and the real value of debt might drop by 100%. This is a break even trade at best. It could be breathtakingly destructive if we get into an unexpected and seriously deflationary environment instead.

- Buying houses for cash if you fear hyperinflation is a poor trade. Real values of houses will drop by 75%. In a deflationary environment, nominal prices will drop by 50% at least.

A much more efficient strategy is to buy a carefully selected inflation linked ETF. The selection criteria are as follows :

- Ensure that the nominal return on the ETF cannot be below zero. This prevents any unexpected deflation from eroding nominal capital.

- Potentially look for currency diversification if you fear that the UK situation will be relatively worse that the rest of the world.

There are a few consistent themes to consider in very high risk environments like we are currently experiencing :

- What happens if your central thesis turns out to be incorrect? Betting everything on red (hyperinflation) or black (massive deflation) could be very destructive if the wrong colour comes up.

- Look at the fine print to ensure that your protection is actually valid. Negative nominal returns for some inflation linked products in a period of massive deflation is an area that deserves some consideration.

- As Keynes said, markets can remain irrational longer than we can remain liquid. It is not a good strategy to be right about what happens in the long run but not liquid enough to ensure that you benefit from being correct. I have seen this happen to too many people too often to ignore the fact that staying in the game is as important as being correct.

After thinking it through, I do not see how buying a house in either an inflationary or a deflationary environment is a good strategy at the moment (irrespective of the leverage taken) compared to other alternatives.

As a slight dig, the strategy of buying gold is not really that brilliant compared to inflation linked products with a coupon of max(zero,inflation) as gold will get crushed if we enter into a deflationary environment. Even if gold bugs are correct, They often only holfd tcertificates which represent claims against physical gold and are really just another form of paper money in a hyperinflationary environment.

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gold-bars-2.jpg

Of course there is.

Gold is a really dangerous commodity to hold if we experience (unexpected admittedly) deflation. It will get crushed relative to some linkers which include a zero percent floor on the inflation rate.

If we are 100% certain that inflation will be massive, gold is great as it's market price and payoff is completely independent of any government statistics.

If we accept that there is even a 5% chance of significant deflation, suddenly the 0% floor on some linkers is excpetionally valuable relative to gold.

One way of looking at the world is that some issuers gave away the 0% floor on inflation at about zero when it seemed improbable that we would ever experience deflation. These options are probably still massively undervalued at the moment which makes some linkers a much better bet than products without options (gold in a deflationary environment or "nominal" bonds in an inflationary environment).

My view is that investors in gold are very certain of their predictions for the future. They might well be right but my experience is that markets punish those who take on strongly held views with binary outcomes.

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Come on folks. Peoples propensity to attach value to arbitrary physical things is a given. It all comes down to which ones wear the best over time.

Sugar is fine, but watch out for rain.

I am not a gold bug, but I cannot discount the appreciation of it, nor can I ignore the historical relevance and power which it has wielded through the millenniums.

Personally, I would be quite happy to own all the bars in that photo....although I would be paranoid and not get much sleep if I did.

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Come on folks. Peoples propensity to attach value to arbitrary physical things is a given. It all comes down to which ones wear the best over time.

Sugar is fine, but watch out for rain.

I am not a gold bug, but I cannot discount the appreciation of it, nor can I ignore the historical relevance and power which it has wielded through the millenniums.

Personally, I would be quite happy to own all the bars in that photo....although I would be paranoid and not get much sleep if I did.

If those are 1 kilo bars and there are 12 of them, their market value is only about 240k so still less than the average house.

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Gold is a really dangerous commodity to hold if we experience (unexpected admittedly) deflation. It will get crushed relative to some linkers which include a zero percent floor on the inflation rate.

If we are 100% certain that inflation will be massive, gold is great as it's market price and payoff is completely independent of any government statistics.

If we accept that there is even a 5% chance of significant deflation, suddenly the 0% floor on some linkers is excpetionally valuable relative to gold.

One way of looking at the world is that some issuers gave away the 0% floor on inflation at about zero when it seemed improbable that we would ever experience deflation. These options are probably still massively undervalued at the moment which makes some linkers a much better bet than products without options (gold in a deflationary environment or "nominal" bonds in an inflationary environment).

My view is that investors in gold are very certain of their predictions for the future. They might well be right but my experience is that markets punish those who take on strongly held views with binary outcomes.

Interesting points raised here.

Can I ask why you think deflation is unlikely?

I see it being the most likely hypothesis. This government is persuing reckless monitary policy, and although its doing much "printy, printy", the state of the country's finances and the unemployment increase/destruction of much of the private sector suggests a deep deflationary spiral.

Now I can see the value of our currency is being devalued quite a bit (is this unintended consequences? or part of the plan?) which will cause prices to fluctuate widely, but short of them releasing a torrent of QE cash (which I suppose is possible, but i'm talking maybe 10x the amount they currently are printing), I think deflation will win out.

All this green-shoots-recovery-ramping is irresponsible, but with confidence low, taxes rising, national debt levels ascending v. rapidly, and an eye-watering budget deficit, coupled with rising unemployment and falling productivity, add to this the possibility of many skilled employees leaving the UK in the next 24-36 months, its hard to see any other mid-long term outcome but a deflationary spiral from here.

That said, i'm paying down all my remaining debt as a priority in case i'm wrong and hyperinflation does occur.

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Gold is a really dangerous commodity to hold if we experience (unexpected admittedly) deflation. It will get crushed relative to some linkers which include a zero percent floor on the inflation rate.

If we are 100% certain that inflation will be massive, gold is great as it's market price and payoff is completely independent of any government statistics.

If we accept that there is even a 5% chance of significant deflation, suddenly the 0% floor on some linkers is excpetionally valuable relative to gold.

One way of looking at the world is that some issuers gave away the 0% floor on inflation at about zero when it seemed improbable that we would ever experience deflation. These options are probably still massively undervalued at the moment which makes some linkers a much better bet than products without options (gold in a deflationary environment or "nominal" bonds in an inflationary environment).

My view is that investors in gold are very certain of their predictions for the future. They might well be right but my experience is that markets punish those who take on strongly held views with binary outcomes.

'investors' in gold do not understand it, get burnt and are nothing more than gamblers.

holders of gold are in for the longterm, will always end up and understand gold properly.

Gold is a long term insurance, a store of wealtyh - to preserve ones spending power not enhance it, a currency in itself.

If you investigate then you will see that gold performs its duties just as well in a deflationary environment as it does in an inflationary one.

bugs that understand it only hold physical metals and will laugh in your face at the idea of paper gold which as you point out really is worth no more than a paper note.

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What happens if your central thesis turns out to be incorrect? Betting everything on red (hyperinflation) or black (massive deflation) could be very destructive if the wrong colour comes up.

This is my problem at the moment applied to all aspects of the credit crunch/crash/recession/depression/collapse or whatever you'd call it.

To me it seems there are huge uncertainties. Some posters act as if the have it all worked out - but their answers all differ.

Some people will come out of this whole mess alive and well and maybe even rich. Others may emerge as paupers or not even live to see the end of it. How you can fall in with the correct camp other than by luck, I really have no idea.

Some posters leave me feeling like their attitude in 1940 would have been to advise me to learn German and/or head for Switzerland. It could be the right choice but it's very hard to be sure.

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This is my problem at the moment applied to all aspects of the credit crunch/crash/recession/depression/collapse or whatever you'd call it.

To me it seems there are huge uncertainties. Some posters act as if the have it all worked out - but their answers all differ.

Some people will come out of this whole mess alive and well and maybe even rich. Others may emerge as paupers or not even live to see the end of it. How you can fall in with the correct camp other than by luck, I really have no idea.

Some posters leave me feeling like their attitude in 1940 would have been to advise me to learn German and/or head for Switzerland. It could be the right choice but it's very hard to be sure.

then hedge your bets, don't try to come out of this rich just aim not to be poor.

clear your debts, keep some cash, buy some gold. If inflation raises the price of gold then you are even against the lost value in cash. If deflation causes a fall in the price of assets then your cash is worth more so even again.

it is worth buying and storing a few things though just in case the situation goes way beyond expectation, consider it like taking out insurance.

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If those are 1 kilo bars and there are 12 of them, their market value is only about 240k so still less than the average house.

I make those £219k at spot and would rather have those than a house right now.

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I was one of those people earlier this year that started a post on buying a house as a protection against inflation. Moneyweek have also gone down this way of thinking.

Personally, my doubts about this strategy have increased since I posted that, mainly due to the reasons the OP suggests...what if the UK does go Japan? Also, any inflation that is coming is likely to be commodity based, not asset based. However, if you are just looking to buy a home, and you see a property at 2001 prices, and are able to get a long fix (and I'm thinking 5 years minimum), then it makes to sense to buy. But as investment strategy, unless you have a very diverse portfolio and are able to lose your initial stake (deposit) and risk the exposure through gearing, then why not? The thing about ETFs or Gold is that you don't get the boost from leveraging if you do get a period of hyperinflation, whereas with property you could take a 25% deposit and make much bigger returns.

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Even if gold bugs are correct, They often only holfd tcertificates which represent claims against physical gold and are really just another form of paper money in a hyperinflationary environment.

Oh dear. :(

Sorry mate, I can't help you now. They'll be along soon and I'm hiding in a cupboard 'till it's all over.

I have heard very good rumours that a World shortage of sugar is fast approaching.

What!!! :o

Only a rumour I stress, but if anyone needs it I have 200 tonnes stored safely to be sold at a reasonable price. ;)

Hmmmm.... that *might* just be sufficient for my needs.

Charlie, have I told you lately how I've always admired you?

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I was one of those people earlier this year that started a post on buying a house as a protection against inflation...The thing about ETFs or Gold is that you don't get the boost from leveraging if you do get a period of hyperinflation, whereas with property you could take a 25% deposit and make much bigger returns.

You don't really get "periods" of hyperinflation, you get a short period of it then the country collapses.

Therefore, this strategy seems to (1) cost you a f-load of mortgage interest then (2) land you with a house in a broken country.

Would a house in Zimbabwe now, following the "period of hyperinflation" be a wise investment?

As a hedge against inflation, maybe. Hyperinflation - no.

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When does Summer end in the northern hemisphere? September 22nd-ish rings a distant bell.

Aside from 20% in cash that I can put my hands on immediately, the rest of my wealth has been converted into physical gold and silver bullion, 60% and 20%, respectively.

Yes, I took a 12% hit paying premiums on the bullion but I've slept a lot easier since because all my senses tell me there's a huge currency devaluation coming by Summer's end - minimum 30%, more likely 60%-70%, and it'll probably be a synchronised theft of people's savings worldwide.

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A much more efficient strategy is to buy a carefully selected inflation linked ETF. The selection criteria are as follows :

- Ensure that the nominal return on the ETF cannot be below zero. This prevents any unexpected deflation from eroding nominal capital.

- Potentially look for currency diversification if you fear that the UK situation will be relatively worse that the rest of the world.

Please explain how this ETF solves the problem.

I really have no idea what it is but it seems to be a privately backed fund of some type. So ISTM that the inflation guarantee is only as good as the person making the guarantee. Anyone who invested in a Lehman's fund before the crash lost all of their money. How do I know that this wont happen to my ETF?

Sorry I don't care how low the risk of complete failure is, it is one that I am not prepared to take.

tim

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You can't protect yourself against the manipulations of powers infinitely stronger than yourself, what you can do though is reduce your dependency upon them.

Self-reliance rules and I don't mean you and your family alone against everyone, I mean try to build up community relationships wherever you live, a closely knit, mostly self reliant, community will survive any inflation or deflation as long as within the community there is production of food and other basic necessities (so you are better off in a small town in the country side rather than a big city).

Try to help others with your skills and most will help you should the need arise.

After all money should be just a means of exchange, in a closely knit community you can (almost) do without it.

Those who will suffer most are people who's livelyhood depends on one job with a long commute and who don't even know their neighbours.

Edited by wise_eagle

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For the average person the best way to hedge against inflation is indeed to buy a house with a fixed mortgage.

The reason is simply because

No capital gains tax on your 1st home, almost everything else involves capital gains tax of 18% and perhaps more in the future if tax increases.

No margin calls: this is important because you need to leverage up. In most investments if your equity approaches 0% then you get a margin call. This is not the case for houses.

Plus then there are the benefits of owning your own home instead of renting (but also pitfalls)

Overall for most people houses are indeed the only real inflation hedge.

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I have heard very good rumours that a World shortage of sugar is fast approaching.

Only a rumour I stress, but if anyone needs it I have 200 tonnes stored safely to be sold at a reasonable price. ;)

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post-12677-1246302608_thumb.jpg

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CURRENTLY No capital gains tax on your 1st home, almost everything else involves capital gains tax of 18% and perhaps more in the future if tax increases.

Slight correction above. In fact with the need to repay all this massive debt I wouldn't be at all surprised if the government introduces cgt on your 1st home, many other countries have it.

When you own a house you are a sitting duck for the tax-man.

No margin calls: this is important because you need to leverage up. In most investments if your equity approaches 0% then you get a margin call. This is not the case for houses.

Oh yes, when you have to remortgage, you can quite well get a 'margin call'!

Edited by wise_eagle

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Slight correction above. In fact with the need to repay all this massive debt I wouldn't be at all surprised if the government introduces cgt on your 1st home, many other countries have it.

When you own a house you are a sitting duck for the tax-man.

Well there is none at the moment and imo highly unlikely that one will be introduced. Too much political fallout from it plus it would totally ****** up the economy because no one would every move thus your tied to your home and not mobile.

Oh yes, when you have to remortgage, you can quite well get a 'margin call'!

But you don’t ever need to re-mortgage.

Especially if your doing it for a hedge you would be on a 10 year plus fix. Even if your not, you don’t have to get off SVR and if your in neg equity the bank will try to keep it sweet as they don’t want to take the hit on your house.

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Well there is none at the moment and imo highly unlikely that one will be introduced. Too much political fallout from it plus it would totally ****** up the economy because no one would every move thus your tied to your home and not mobile.

Again, the amount of public debt that has accumulated recently will not leave the government any chice in the matter, they will have to come up with LOADS of new taxes in the next few years.

But you don’t ever need to re-mortgage.

Especially if your doing it for a hedge you would be on a 10 year plus fix. Even if your not, you don’t have to get off SVR and if your in neg equity the bank will try to keep it sweet as they don’t want to take the hit on your house.

People who are on a 10 year plus (and likely in neg. eq. if they buy now) won't be able to move either, so that would be bad for the economy too, as you say.

Plus it makes you inflexible for finding a new job should you lose your current one, as you can't easily move so you risk losing the house (and therefore your savings which you used as deposit) very easily.

Especially in a recession it's best to be mobile so you can move quickly for a new job or a better opprtunity, which means renting.

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A much more efficient strategy is to buy a carefully selected inflation linked ETF. The selection criteria are as follows :

- Ensure that the nominal return on the ETF cannot be below zero. This prevents any unexpected deflation from eroding nominal capital.

- Potentially look for currency diversification if you fear that the UK situation will be relatively worse that the rest of the world.

That sounds more easily said than done. Do you have any suggestions you could post?

Some ETFs can be difficult to understand ( http://ftalphaville.ft.com/blog/2009/06/17...ctured-product/ ) and that is before anyone asks "so how do we measure inflation", or rather "whose measure of inflation do we trust".

I would be very happy to be convinced otherwise, however I fear you cannot come up with a cheap, reliable inflation hedge that cannot decline in nominal terms any more than you can develop a foolproof method of obtaining a free lunch (and breakafast and dinner). Even so, please do post whatever ETFs you had in mind. Thanks.

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