Is Australia's housing bubble about to burst in terms of gold? It is our view that in the not too distant future the average Australian home will cost less than a couple of kilos of gold. The question remains, however, will gold rise 700% or house prices drop by 85%?

The great Australian dream has thus far dodged a bullet when considering the massive house price deflation that has plagued the western world since the onrush of the global financial crisis. All due, say the pundits, to a combination of solid banking regulation, Rudd’s stimulus, and our appendage to China with its unquenched thirst for minerals and resources. The supporting argument is always as follows - “It’s not a bubble, we’ve got a restricted supply of housing here in Australia.”

When considering the bubble question, this theory of supply and demand for housing could well prove to be a misnomer. Upon closer analysis, it appears that the primary driver of house prices is the supply and demand for credit, not houses. The easier the credit, the higher the house prices. The seeds of easy credit were planted in Australia with banking deregulation under Treasurer Keating in the early 1980’s. Throughout the 1990’s competition increased, banks reduced deposit requirements, the RBA lowered rates and house prices began their skyward ascent. The introduction of securitisation in the mortgage market opened the flood gates to non-bank lenders, further increasing competition and encouraging lenders to take on more risk. By 2007, with no-deposit loans, the First Home Owners Grant and multi decade low interest rates – credit just couldn’t get any easier.

Today in 2010, credit is not so easy. We’ve seen most lenders withdraw their no-deposit loan products, the Federal Government has wound back additional First Home Owners Grants, interest rates are on the rise, and housing affordability is so low you could stub your toe on it. As far as supply and demand for credit is concerned, the great Australian dream could well become a nightmare.

A decade of easy credit inevitably resulted in a rapidly expanding money supply. After house prices took off, that old time relic and inflationary indicator gold, also began making huge gains. That however, is where the similarities end – Gold and house prices have recently parted ways. As indicated earlier, house prices are driven by a specific type of inflation – home lending. The gold price on the other hand, is driven by inflation in all forms. More specifically, government deficit spending, quantitative easing or currency debasement. Whilst our banks have been tightening the noose on home lending, reckless governments the world over have felt obliged to borrow, spend, bailout and monetise debt to prevent contraction of the money supply. Inflation by way of government spending is typically clumsy. Fingers point toward the home insulation debacle, or the government’s knee jerk decision to mail every citizen a $900 cheque. The intention is clear, inject money into the economy and do it fast! Rest assured, the borrowing and spending is only beginning. Say nothing of the inflation.

Western government’s approach to this crisis bares striking resemblance to US Government policy of the late 1960s. Unchecked spending on the Vietnam war and ‘Great Society’ programs resulted in Nixon dumping the gold peg in 1971 - the inflation genie was out of the bottle. Then, as now, setting the stage for a decade of high inflation, currency crisis and skyrocketing gold prices. We can look to the relationship between gold and Australian house prices in the 1970’s for an indication as to what to expect in the coming years. From the chart below we see baby boomers purchased homes for the equivalent of 700oz of gold in 1967. Twelve years later on the back of high inflation and concerns of a collapsing US dollar, the same house could have been purchased for a mere 80 oz of gold. Imagine bidding at an auction with a little over a kilo of gold in each pocket to purchase an unencumbered property. If you own gold, just sit tight and that opportunity will come knocking again in the near future. You see, this same cycle began again in 2004. Generation Y, scrambling for their place on the first rung of the property ladder, paid the equivalent of 600oz of gold for the median house. Today, that property costs about 350oz. If you’re concerned you’ve missed the boat, don’t be. The biggest gains on the gold side of this relationship are yet to come, we expect you could attend that auction with a mere 50oz of gold in your pocket in the coming years, and that may well include a tip!



Whether you’re in the inflation or deflation camp, it matters not. An extreme deflationary scenario sees house prices drop 85%, gold is flat giving a house/gold ratio of 50. An inflationary scenario would see housing remain flat, with gold climbing to $8700oz, giving the same house/gold ratio of 50. While the winner of inflation vs deflation debate will be determined largely by Government policy, we can be certain of one thing - Precious metals are significantly undervalued vs Australian real estate.