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My take on Gamestop

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Greenville – Circa April 2018: GameStop Strip Mall Location. GameStop is a Video Game and Electronics Retailer I

The Gamestop saga has been fascinating viewing. Here’s my key takeaways.

Ok, I know this is a little out of my usual range, but it is pretty much the biggest story in investing markets right now, and heaps of people have been asking me about it, so let’s go there.

Gamestop.

So let’s kick off the basics. Gamestop is a been-around-for-ages bricks-and-mortar video game retailer. Computer games began the move to streaming about 5 years ago, so a lot of people thought Gamestop didn’t have a future.

So they shorted it.

That is, they took out a bet that it shares would fall in price.

Basically, they borrow a share of Gamestop from a broker and immediately sell it at the current price. Then, if things go well and the price goes down, they buy the stock back and repay the broker the stock that they owe.

Because they’re buying at a cheaper price than they sold, they’ve made a profit.

However, if the price goes up, then they’re buying at a higher price, and they make a loss.

And if they’re buying at a price that is 1600% higher, which is what the share price of Gamestop has done over the past month or so (much of it in the last week), then they stand to lose a lot.

And because we’re talking hedge funds who always bet big, then we’re talking about them losing billions.

There’s another dynamic at play. It’s called the ‘short squeeze’. So if the price does start going up, the short sellers start to panic, and then need to buy the stock to close out their positions.

However, that just adds to demand, and if no one is selling because, you know, prices went up 400% this week, then that extra demand just throws fuel on the fire, and prices go even higher.

It becomes something of an avalanche, and this dynamic is what’s called a ‘short squeeze’.

So this is what we do know.

But let me clear a couple of things up.

First up, the media wanted to tell a story about cowboy amateurs ganging together on social media and taking an irresponsible bet that just panned out luckily for them. Like, they had no idea what they were doing.

This is sorta true, but it’s not how this story started. It started with someone taking a good look at the company and seeing that there was value there – a new management team, a deal with X-box, digital sales up 300% in the December quarter.

So sure, there’s some pretty crazy hype that’s followed, but it was on the heels of a solid investment thesis.

Wall Street and the media might want to paint it all as the digital equivalent of a ‘mob riot’ but there was more substance to it than that.

That said, people are talking about it like its some sort of revolution – sticking it to the hedge funds and ‘eating the rich’. Sure. There was at least one hedge fund that took a bath. Awesome.

But short-squeezes always end in crashes, and the question is, who’s holding the baby then? My bet is will be the mum and dad traders who were just a few hours late.

The Hedge Fund managers will lose their bonuses. The late traders will lose their house.

If you think that’s a victory against capitalism, you’re dreaming.

And this goes out to the crypto community as well. Capitalism is a speculative orgy. True enough. But you can’t overthrow that with a speculative get-rich-quick orgy of your own. That’s not how it works.

You’re not overthrowing the system. You are the system.

So that’s what I reckons going on. That’s the key takeaways for me.

It is a pretty wild story. Its fun to watch.

But let’s not lose our heads.

JG

The sector where investors are ‘settling’ for 8% yields

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Cashflow can be a killer, but it’s on tap in this segment right now.

Cashflow is always a killer.

It can bring down otherwise healthy businesses, it can derail otherwise successful portfolios.

And in the early days investors will often go for equity and capital gain. Nothing impresses people like a portfolio worth millions.

But by the time they realise they need cashflow to keep the whole show running, it can be too late.

And this is a tough cashflow environment right now. If you look at what’s happened to yields in residential property over recent years, we’ve seen a compression that’s taken them back to bare bones at best.

I mean, look at the latest data from CoreLogic:

In Melbourne Gross (and that’s gross!) yields are a smidgen over 3%. In Sydney they’re not much better at 3.2%.

I don’t know how you make it work with gross yields of 3%, and really, if that’s what buyers are accepting, then they’re probably not trying hard enough.

And yields get a little better when you move out to the smaller capitals, but not all that much.

Right now in residential property, there’s not a lot of cashflow for investors to hang their hat on. You can still get good returns, you can still get cashflow positive properties, but you’ve got to search a little harder – put a little more time in.

And that was all well and good when interest rates kept heading down and capital values kept heading north, but the APRA restrictions are seeing interest rates nudge up, with the threat of even more nudging in the offing.

Cashflow could become the make or break issue more many investors in 2019.

And in that context, I found this article in the AFR about BIS Oxford’s commercial property outlook interesting.

It noted that the past 5 years have seen a massive boom in commercial property, especially in office and industrial.

There were points there where the Internal Rate of Return (more or less equal to Gross Yields) were running at close to 20% in Sydney Offices!

BIS notes that these levels were never going to be sustainable, and over the next five years, they are going to be wound back.

But this is the thing. Even with them winding back (which is itself due to prices catching up and growing faster than rents, rather than rents falling), we’re still looking yields in Sydney and Melbourne around the 7-8% mark.

Don’t you feel sorry for those commercial property investors – having to suffer through yields of 7-8%? I might send them a Christmas card.

And this is for offices and industrial, and those commercial segments tend to be dominated by CBD offices and large industrial centres. Smaller scale commercial investments – the kinds of things easily accessible to ‘mum and dad’ type investors – those things typically come with a yield premium.

So 8 or 9%, even 10% is easily achievable – if you know what you’re looking for. (You need to know what you’re looking for.)

But how is this possible? How is commercial property still delivering this kind of cash flow to investors, while residential property is just slugging along?

The thing to remember is that residential property is being held back by a string of recent APRA restrictions – restrictions specifically designed to slow the market down.

APRA never threw the hand-brake on commercial.

I mean, compare the APRA restrictions put on the two sectors over the past 18 months or so:

Residential
• Investor lending growth capped at 10% pa.
• Interest Only lending capped at 30% of new loans
• Much tighter income and expense reporting
• Compulsory Credit Reporting across the financial sector

Commercial
• Corrected typo on p.17 of ADI Commercial Lending form.

That is, APRA hasn’t hassled commercial the same way it has hassled residential. And so commercial is still tracking in line with the economic fundamentals – where economic activity is picking up and unemployment remains low.

So even as the hectic pace of the recent five years unwinds, we’re coming back to some very solid fundamentals.

Which means the yield, and even the capital growth outlook for the right commercial properties is still very, very strong.

That means, for cashflow hungry investors, commercial property could be a strong option.

Most investors won’t touch commercial – and really, they probably shouldn’t. The cross-over from residential to commercial isn’t hard to make, but there are some important things you need to be aware of.

But personally, since I happen to like cashflow very, very much, I could see the balance of my purchases in 2019 tipping more and more towards commercial… at least until the APRA restrictions wash through.

I mean, we all like cashflow, right?

How to make and how to lose $100K in 13 months

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Flipping always looks like a great strategy in the good times. But are some investors about to come unstuck?

Sometimes you strike it lucky in property.

Like this story of a guy on the Gold Coast who flipped a parcel of land for a $130K uplift.

(The story appears in the UK’s Daily Mail, because there’s a picture of him with his girlfriend in a G-string. Pure class).

A 23-year-old man has made more than $101,000 profit after buying a plot of land and mowing it twice.

Anthony Dart, 23, bought the property on the Gold Coast for $310,000 and 13 months later he sold it for a staggering $439,000. Mr Dart told Daily Mail Australia he made a solid profit of $101,000 after expenses.

The young entrepreneur was shocked by how much the property appreciated in value in just over a year.

Hats off to him. From what I know of the Gold Coast market, at that price I expect he bought under market value, and that’s what made those kinds of gains possible.

And with property prices on a tear-away in recent years, a lot of people would have similar stories.

Trouble is though, people seem to think that these kinds of stories are the norm.

Amazing deals like this happen when you do your research and buy under-market, or when you do your research and buy in an area primed for growth.

That is, when you do your research.

If you’re not doing your research, then you’re only going to get these kinds of results if you get lucky. And if you’re relying on luck, then you’re just gambling.

And all gamblers lose at some point.

Western Menbourne might now be about to become a case in point.

There’s been a bit of a frenzy going on out there in recent times around house and land packages.

It’s pulled in a lot of speculative activity, with buyers looking to flip their purchases before settlement.

As prices stall though, there’s an air of panic brewing:

Speculators who hoped to get rich on a boom in Melbourne land prices are “panicking” as settlements loom and they can’t find developers to on-sell their sites to, according to Resi Ventures’s Khurram Saaed, who has been developing for 15 years.

Mr Saaed said he was getting one call a week from panicked speculators, including one buyer who had put down $21 million in deposits on a number of sites and risked losing all their money.

“These are people who have been successful in other business, and who have just bought land with no due diligence in the hope of making a lot of money in three to four years’ time by flipping the site prior to settlement,” he told The Australian Financial Review.

And there’s been a strong rise in people taking to gumtree to offload their properties, as real estate in general takes longer to sell:

A rising number of land owners in Victoria are selling off-the-plan housing lots on classified advertisement and community website Gumtree ahead of their expected settlements next year.

In the first three weeks of October, nearly 50 advertisements have been uploaded – more than twice the number in September – offering sales of lots in communities like Dahua Group’s Orchard project in Tarneit, Satterley Property Group’s Botanical in Mickleham, MAB’s Merrifield in Mickleham and Stockland’s Edgebrook Community in Clyde and Cloverton in Kalkallo.

Other land sites for sale are in places such as Greenvale, Melton, Lyndhurst and new suburb Weir Views, all of which are about 20 to 35 kilometres from the Melbourne CBD.

I’d be keeping a wary eye on this space.

I don’t think the growth corridors of Western Melbourne were bad places to invest, if you were genuinely investing. I think they’ll be decent going forward.

And I wouldn’t say no to buying there now… but I would be driving a very hard bargain with eyes wide open.

But if the flipping spree was as widespread as they say it was (possibly isn’t, who knows), then some extra diligence really is in order.

Don’t say I didn’t warn you.

Is the credit crunch already over?

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The data says that APRA’s restrictions have done their job. Time to let the market run free again.

It’s looking to me like the credit crunch might be about to ease up.

Let’s remember how we got here. Right now, the national property market is in the midst of an orderly and mild consolidation.

And consolidations are expected. The property market moves in cycles, up and down.

Most times that’s driven by dynamics in the cycle itself. Left to it’s own devices, the property market, just like the broader economy, will run hot, then cool and then run hot again.

But that’s the thing. The property market wasn’t left to its own devices. Since 2016, APRA has been getting involved, creating limits, particularly on investor lending. It started with making sure lending to investors wasn’t growing too quickly, and then became about cutting back the pace of Interest Only (IO) lending.

This clamp down on IO lending was across the market, but was particularly focused on investors.

Predictably, as the credit taps were squeezed, price growth began to stall, and over the past year or so, prices actually started to come-off, little by little.

And that’s where we are today.

So obviously if we’re interested in finding out when the market is going to start growing again, then the first question is really, ‘when will APRA back off?’

This is a little hard to predict. One of the things that came out of the Royal Commission was that APRA – who is responsible for regulating the banks – seems to have been a bit asleep at the wheel.

Given the huge list of crimes, misdemeanours and affronts to human decency that emerged from the Royal Commission, you do really have to wonder what APRA were doing.

APRA has been made to look a little silly. But what worries me now is that they might over-compensate – try to play the tough wild west sheriff. And that might mean that conditions remain tougher for longer than they need to.

And the truth of it is that right now, I’m seeing a case for letting up on the restrictions.

Take a look at this chart here from the RBA. It shows what has happened to IO lending since the restrictions came in in 2016.

The orange lines – new lending – is the one to be watching here. As you can see, IO lending pretty much fell off a cliff when the restrictions came in, particularly to investors in the bottom panel there.

But what you see here is the banks very quickly bringing themselves into line.

And after the initial adjustment, things just sort of levelled out – the share of new lending has remained fairly constant in recent months.

If it remains constant, the share of outstanding lending – the blue line – will keep trending lower, and until it re-joins the orange line.

And the structural change in the market that APRA was looking to create, will be complete.

Mission accomplished.

The thing I would note is that once this transition has been made, then the normal cyclical dynamics should start to reassert themselves.

That is, even if the share of new lending remains at around 30%, after a year, that will be the new reality we’re working with – so our annual growth rates (which compare this month with the same month 12 months ago), there won’t be any impact left in there at all.

And so that should mean that we should see price growth should realign with the cyclical trend.

It is possible that these restrictions have caused the cycle to turn. There’s a good chance of that. So I don’t think we’ll see positive growth numbers this year or in the first half of next, but after that, I’d be looking for things to start moving again.

But I’d also be saying to APRA, since you’ve caused the cycle to turn, and you have done what you set out to do with IO lending, maybe it’s time to cut investors some slack.

We certainly don’t need any more restrictions. We don’t need no sheriff out there shooting from the hip.

Here’s hoping cool heads will prevail.

Where the market is really at (My thoughts)

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Cut it up and things actually look robust.

Where is the market fundamentally at?

This is an important question in any asset class, but it’s particularly true of property. And that’s because the market can get buffeted about by all sorts of ‘extra-market’ factors. And by that I mean things like the kind of restrictions APRA’s had in place for last two years.

And you’d be forgiven right now for thinking that the market is fundamentally softening. Headline numbers are soft, prices are actually slipping in Sydney, investor lending is cooling.

But in my mind, these things are more sea-foam than sea – more noise than signal.

A few charts will help tell this story I think.

First, let’s look at what investor lending is doing – this is amount of finance going to investors.

You can see that investor lending growth slipped into negative territory in September last year. At that point, the amount lent to investors was less than it was at the same time a year earlier.

So ‘the market’ is getting softer right?

Well, maybe. But if you showed this to the staff at APRA, they’d be saying ‘job well done, boys.” This is exactly the kind of outcome they were trying to engineer. Investor lending had been growing too quickly (growing at more than 40% a year in 2014!) so it was time to rein it in a bit.

What followed was a bunch of restrictions at the individual bank level, and investor lending, predictably, started to fall.

So while it looks like a cycle, it’s has nothing to do with the normal cycle of the market, and everything to do with APRA.

To make that point clearer, come over and have a look at the same chart on housing finance, but this time, just to owner-occupiers.

The first thing to note is that these charts are on the same scale, so the smaller hills and valleys on the owner-occupier chart tells you that the cycle of owner-occupier lending is generally much smoother and gentler.

The other thing to note is that growth in owner-occupier lending peaked about the same time as investor growth turned negative. So just as investor lending was cooling, owner-occupier lending was pumping.

Partly, I think this was about a bunch of lending that would have normally been classified as ‘investor’ was instead classified as ‘O-O’ – just to get around the APRA restrictions. But that can only be a small part of the story.

Rather, it shows that as the APRA restrictions were taking effect, the fundamental demand in the market was strong.

O-O lending has since followed investors down, but even then, we haven’t dipped into negative territory. We’re still lending more to owner-occupiers than we were this time last year.

Lending is still growing.

And the other interesting thing in all that is that lending to first-home buyers is actually picking up.

And now, the percentage of O-O lending going to first time buyers is back to around ‘normal’ levels, after freaking everybody out for a bit there.

So to me, when I look at these charts together, what I see is this: Yes, investor lending is falling thanks to the APRA restrictions. But looking through that, owner-occupier lending is still growing, particularly to first time buyers. To me that suggests that fundamental demand is still strong, even though the investor segment and the market overall appears to be cooling.

It’s just not as bad as the headline data suggest.

The fear-clouds are gathering.

Soon it will be time to be greedy.

Why financial planning is seriously stuffed… ( my opinion)

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Our financial planning system was always going to fall over eventually.

Everyone’s acting all surprised that the Banking Royal Commission has unearthed a graveyard of dodginess and financial abuse.

Probably not my readers since I’ve been banging on about it for years now. And the reason that I’m not surprised in the slightest is that the concept of financial planning, as it plays out in Australia is fatally flawed.

It’s a mess of misaligned interests that was always doomed to fail.

Let me explain.

The key confusion is around whether financial planners sell a product or a service.

Imagine you engage an interior designer. They offer you a service and that service is a interior design for your home. You expect them to be working with your home’s needs first. Maybe they then help you go out and get the individual elements, maybe not. But they’ve given you a service – a design.

Now imagine you walk into Ikea. They offer you a bunch of products. They will try and tune into what your needs are, find the right product for your circumstances, but at the end of the day, they’re trying to sell you something off the showroom floor. They’re not going to recommend you go down the road to the bespoke vintage homeware store, no matter how much your open plan entertaining area is calling out for it.

But that’s ok, because you know that. You’re going to them to have a look at the products they have on offer.

Now what does a financial planner do?

Well, if you look at their marketing, they’re a service. They’re there to design a bespoke financial strategy just for you.

But if you look at how they get paid, particularly by the banks, they get paid as if they’re a product showroom. They get commission based on how many units of certain financial products they sell.

When you look at the remuneration structure, the planners interests align with the banks’, not yours.

But of course, there’s some mechanism that brings those interests into alignment right.

Well, actually no. Not really. There’s codes of conduct and blah blah, but at the end of the day, the only protection you’ve got is your planners’ own ethical sensibilities.

And you know, most of the time, let’s be honest, that’s enough. Most people do the right thing.

But the law isn’t there to protect us from most people. It’s there to protect us from the worst of us.

And as the Banking Royal Commission has shown us, right now, the law is failing miserably.

So in my mind, the only way you can bring financial planning into alignment is to stop financial planners from also selling products.

Make them do what their marketing says they’ll do – design a strategy based on your unique circumstances.

Then we can have financial product showrooms – what the banks used to do. Somewhere you can go to get the right financial products for your needs, once you’ve nutted out what your strategy is.

But there needs to be a firewall between them.

Sure, financial planners can recommend particular products off that showroom floor, but as soon as they’re being paid based on how many units they sell, then there’s a misalignment of interests.

And at some point, somewhere, that’s going to break down.

And this is why financially planning, as it currently exists, is fatally flawed. It’s set up to fail.

But don’t expect to see change come from the financial planners or the banks. The system is set up to serve them. The fight needs to come from the customers.

You up for that?

Nah, me either. That’s why I walked away.

How to buy your life back

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At the end of the day, the aim of the game is to buy your own life back

How much do you need to replace your income? Let’s crunch the numbers on it.

Ok, so say the average household income is $80K a year. That’s a decent mark to aim for. You can get by on that.

Let’s also assume that you’ve got a portfolio of properties yielding 5% a year. That’s also modest. You do hear of people settling for 2% in Sydney and Melbourne these days, but across the country, I think 5% is realistic.

So let’s back it out. How much do need at that kind of return. Well, to replace $80K you need 20 times that much: $1.6 million.

Could you ever save that much?

No way. Even if you saved 50% of your pre-tax income (a massive amount) it would still take an average household 40 years to save that much money!

But thankfully we don’t live in a universe where we have to live off savings alone. We can invest, leverage our money, and use our wealth to grow more wealth.

But even still, building a $1.6m portfolio takes time and patience. For some people it’s a life’s work. Sadly, some people are only ready to retire when they are almost ready to retire.

Such a tragedy.

But let’s think about that 5% number for a second there. Some people might look at that and think it’s ambitious in the current interest rate environment.

I look at that and think it’s piss-weak.

I can tell you that my portfolio is easily returning double-digits. Not every deal and not every property gets north of the 10% line, but some of them are well north of that mark, and on average, I’m into double digits easy.

Now, partly that is about being at a stage in my wealth journey where I’m able to access a different class of deal. I get invited to the high-roller table on a regular basis. And because I’m tipping in more capital, the returns tend to be higher.

Wealth creates more wealth.

But it’s also about being smart with the deals I do go in for. And I would say to anyone starting out in property investment, no matter where you’re coming from, that 7-10% isn’t an unrealistic target to aim for. With the right skills and the right knowledge, any one can hit that mark.

So let’s look at our numbers again.

Let’s assume that instead of getting 5%, we’re now getting 10%… does that change the game much?

You bet it does!

Now instead of needing $1.6m, we need half that much, just $800,000.

Or think about our world where savings are the only way to grow wealth. We’ve just saved ourselves 20 years!

Even in the real world, that has just saved us a tonne of time. Like what? Maybe a decade.

Who wouldn’t like a decade of free time?

The central point is, what’s going to be easier? Saving and amassing another $800,000, or investing in your skills and education, and getting better returns on the deals that you’re doing?

(yes that’s a rhetorical question)

And I’m not talking huge bucks. $10,000 would well and truly cover it.

Would you pay $10K for a decade of free time?

Seriously. A decade off. A decade without work, without deadlines, without the boss telling you what to do.

A decade to put energy into the things that matter. Your relationships, your passions, your I’ve-never-done-spear-fishing,-might-give-that-a-go’s.

A decade that is entirely yours.

Seriously think about it. Imagine, in my hand I have the ticket to the next ten years of your life. I can make them completely yours. The price tag? Just $10K.

That’s a bargain isn’t it?

This is the power of education.

It’s the power to buy back your life.

Are We (Property Investors) Evil?

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If investors are evil, explain this…

I know I’m pissing in the wind, but here’s what really happening in Australian property.

One of the interesting themes that does the rounds is that the reason that house prices have risen so much and therefore the reason why our poor children are sleeping in cardboard boxes under the railway tracks, is because of investors.

Greedy investors have destroyed the market, destroyed affordability and destroyed the Australian dream.

A lot of this goes unchallenged. I find that interesting. I think what it shows is that we still have a bit of cultural cringe around making money.

I think a lot of investors do feel a little bit guilty that they’ve made good money in recent years. That somehow, they must have done something at least a little bit naughty.

Nevermind that the CEO of any major Australian bank takes home a small African nation’s GDP worth of stock options each year, or that Paris Hilton gets paid millions of dollars to rock up to a party and do balloon animals.

No, I made 10% on a property I spent months researching. What a bad boy am I.

It is just one of those things, and as funny as it is, I’m still happy that we don’t live somewhere as money and status conscious and shameless as the US.

So it is what it is.

The thing that I find interesting about this stylised fact, is that there isn’t a whole lot of data to support it.

It is true that we saw the investor share of mortgage finance increase in recent years, especially in NSW and Victoria.

But when APRA started putting a brake on investor lending, we found out that the processes that gathered info on whether the loan was OO or investor were pretty loose.

It didn’t really matter, so the banks didn’t stress all that much about recording whether someone was an investor or a first home owner.

And there were some creative work-arounds that allowed first time buyers to stretch a little further if they said they were buying it as an investment property – by saying they expected $x rental income, and using the default bank assumptions about their own rental expenses, and squeezing out a couple of extra hundred dollars in servicing.

And so some chunk of investor borrowing might actually have been owner-occupier.

Of course, now it’s flipped the other way. Investor mortgages are attracting a premium, and so some investors are actually finding it better to declare as owner-occupier if they can.

So who knows what the truth of it is.

The best guess is probably the ABS survey of Household wealth. Corelogic did some interesting analysis on it the other day.

What they found is that yes, there has been an increasing in the number of households that are rental properties.

It’s up from around 26% of households in 1994, to about 30% in 2016.

That’s not a HUGE increase in 22 years, and note that it’s fallen in the most recent observation. So the narrative of investors ransacking our children’s future doesn’t really bear out here.

But what’s interesting is when they look at owner occupiers.

The percent of households that own outright has been on a steady downward trend – from 44% in 1996 to just over 30% in 2016.

That’s a much bigger fall than the rise we’ve seen in rental properties.

At the same time, the share of households with a mortgage has risen steadily, up from 27% in 1996 to 37% in 2016.

Again, making the rise in rentals seem small.

So the real story here is the fall in the number of properties in Australia owned outright.

Is that about evil investors buying all the properties? Hardly. It’s about more households having a mortgage, and presumably, for longer.

What’s driving that? Price rises. As prices rise, it takes longer to pay off a mortgage (since prices have risen much faster than wages).

What’s driving price gains? Record low interest rates, strong population growth, with a sprinkle of Chinese money.

So this isn’t a story about first home buyers doing it tougher. It’s about everyone doing it tougher. It’s about everybody having a mortgage and having it for longer.

“Evil” investors have nothing to do with it.

Not that I imagine that’s the last we’ll hear of it…

Why does the evil investor story have so much appeal?

Part 3: Bitcoin is Bitshoit!

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Last week I told you why Bitcoin could be awesome. This week I tell you why it could be BS.

Ok, so we’ve had a look at the Basics of Bitcoin, and I’ve given you the arguments for.

Now let’s look at the arguments against. I’m going to divide this into two sections. First I’ll look at the block-chain in general, and then I’ll have a look at crypto currencies and Bitcoin in particular.

The Block-Chain
Disruptive technologies are all the rage these days. Like the way Uber disrupted the taxi market, or the way AirBnB disrupted hotels. It’s very buzzy.

And people point to block-chain as the next big disruptive technology. The most recent example of anything like it was the birth of the internet, they tell us.

And I am loving what block-chain has to offer, but when I look into it, it looks less like a disruptive technology and more like a “foundational technology”.

So email disrupted regular mail. The internet was the foundation for email.

But even that’s not entirely right. The block chain is more like TCP/IP (transmission control protocol/internet protocol), which created the shared language that made the internet possible.

Before that, computers had to connect to each other directly (or network to network). TCP/IP enabled all participants to join together in the world wide web, without the need for a central exchange.

It was ‘distributed’, and that’s why it’s a better metaphor for block-chain I think.

But TCP/IP launched in 1972. It would then be over 20 years before the first commercially viable internet-based companies launched.

So how long do we have to wait before the commercial promise of the block-chain is realised?

What’s more, you couldn’t monetise TCP/IP itself. You couldn’t make money of it. It was a common good. It was owned by everyone, it benefited everyone. That was precisely the point.

Same story with the block-chain. It’s set to make a whole bunch of amazing things commercially viable. But it doesn’t mean that the block-chain itself, or the first generation of block-chain thingys, are going to make money.

The other thing I’d say about the block-chain is that while it contains seeds for a social revolution, that revolution will take many, many years to materialise.

So say, you have smart-contracts based in the block-chain. That contract says that I owe you $5. There indisputable proof that it’s true. We know the block hasn’t been tampered with. It clearly says that I owe you the money.

But I refuse to pay.

So what do you do?

Contracts are useless unless they can be enforced. For that, you need some wholesaler of violence – historically the government.

But then you might say, but it’s a trust system. If you diddle someone, it’s recorded. You get something like an e-bay profile score. That disincentives cheating.

But hang on. I thought anonymity was one of the great selling points for the block-chain? And what’s to stop me from setting up a string of fraudulent identities?

A huge amount of social infrastructure goes into simply proving to others that we are who we say we are, so we can enter into contracts with each other.

If you take governments out of the equation, you take all this social infrastructure with them.

Ultimately, we may find better way to do all this, and block-chain may be a start, but it’s far from the final word.

Bitcoin
The first point with crypto-currencies is that money is power. If you think that governments are just going to sit back and hand all that power over to the people, I think you’re a dreamer.

But, you might say, “It’s too late. The block belongs to everyone. They can’t control it now.”

I think it is probably true that they can’t kill it, but I don’t imagine they’d want to. They’d either side-line it or co-opt it. Currently, neither option strikes me as particularly hard.

(China recently shut down all its crypto-exchanges and went and seized all their records. So much for anonymity.)

Of course there are ways round this. But if your solution involves every person in the global economy running their own virtual private network and putting time and energy into staying a step or two ahead of the crypto-police, again I think you’re dreaming.

The other big draw-back for cryptos is that transactions are not free. People talk like they are because, there’s no central fee processor (like PayPal), but there’s still a cost that needs to be borne.

Currently the processing that drives the Bitcoin network is driven by miners. They receive rewards in the way of coins, and fees from individuals who want to see their transactions moved to the front of the cue.

And currently, that whole system is being driven by five to ten companies, according to Business Insider.

That’s not sounding that awesome.

It’s not immediately evident to me that a global financial network organised by a couple of hundred nations is inferior to a financial network powered by five to ten companies.

Especially if those five to ten companies have an ability to control fees…

But the point is, unless transactions are free, there is a cost that must be borne. There is a price that must be paid, and a fee that must be collected.

Money is concentrating somewhere, and with it, power.

This might sort itself out in time, but the current generations of cryptos all seem burdened with this flaw to me.

The final point is about Bitcoin in particular.

Have a read of this statement from Amazon’s 1997 letter to shareholders:

“We established long-term relationships with many important strategic partners, including America Online, Yahoo!, Excite, Netscape, GeoCities, AltaVista, @Home, and Prodigy.”

Of course they did. These were THE players in the internet space in 1997. Netscape was the first personal web browser. These companies dominated the internet just as it began to launch.

And how many still exist?

Maybe Yahoo, kind of, but apart from that, they’re all dead.

Now if block-chain is the next internet, as people like to claim, is Bitcoin the next Netscape?

Even ten years is a long time in business these days. If you’re betting on Bitcoin, you’re betting that no other player comes along and cuts bitcoins turf in the next.. what? 30 years?

That’s quite a gamble.

The way I see it, Bitcoin is very vulnerable to disruption. Its cost structures seem high, so there’s always the potential for undercutting.

Or, let’s say Amazon – the largest retailer in the world – launches its own coin – the Amazonian. At the time it says that you can only buy things with Amazonians but it will accept any Amazonians from anywhere.

(Remember when governments launched money in the past, they decreed that all taxes had to be paid in that money, to enforce widespread use. This would be Amazon’s equivalent play.)

People would find that they’d be happy to accept Amazonians, because there is a guaranteed use for them. If, at the same time, governments tried to block Bitcoin, but gave the green-light to Amazonians because Amazon committed to submit to the tax structures of the day (dodging tax seems to be one of Bitcoins supposed selling points) then the bulk of coin users will gravitate to Amazonians. It would just be easier.

In this game, user-numbers are king.

Bitcoin has the numbers for now, but there’s a long road of uptake ahead of it before it can claim to be the dominant player for sure.

And even then, how long do dominant players in any industry last these days? 10-20 years?

So to me, betting on Bitcoin is really a bet that no better system will evolve in the next 10-20 years. And I’m not talking about better from the perspective of an anarchist utopia, but better simply from the point of convincing more mum and dad users to get on board.

That is a HUGE bet in my mind.

So if you’re investing in Bitcoin – and really we should stop saying “invest”. If Bitcoin is actually currency, you don’t ‘invest’ in currencies. You speculate in them. You buy them on the speculation that they will increase in relative price. There’s no underlying value.

So if you’re speculating in Bitcoin, I would say that you need to be aware that the massive returns that are possible are equally balanced with the massive risks involved in any single crypto-currency.

Block-chain is a revolution. It’s amazing. But so was and is the internet. And a lot of money got poured down the toilet during the dot-com boom.

To me it feels like a case of history repeating.

???

What do you think? That’s my case against Bitcoin. Stronger than my case for?

I’ll leave it to you to be the judge. I’m just trying to shed a light on a world that has become very confusing very quickly.

And of course. I’m no expert. I’m just a smart guy with a few hours up his sleave. There could be huge parts of the story I’m missing.

Very happy to hear about it.

NEXT TUESDAY: I’ll look at wether Bitcoin is a bubble (what you need to be in a bubble) and look at ways you could still make money, even if it is. Look out for that.

What did I miss?

New opportunities everywhere.

by

Should you be getting into marijuana stocks?

There’s a big market here, but one big swing factor.

There are two new big-dogs in the world today and I’m talking about emerging (hype-driven) opportunities.

One of them is Bitcoin, I’m researching everything to do with that market and will be reporting back my finding within the next two weeks.

The other is marijuana. Let’s begin…

In Japan, the Emperor wears hemp.

He has done for centuries. The hemp plant – of which ‘marijuana’ (the plant you smoke to get you ‘high’) is just one strain – has had a long and fruitful connection with humanity.

Hemp oil was being used by the ancient Egyptians as a medicine.

NASA was using marijuana to help astronauts unwind from a tough day on the space station.

(No, I just made that last bit up.)

But then marijuana (and with it hemp) went out of favour. It became a prohibited substance. The hemp industry got shut down.

(Many people say it was Dupont and the cotton industry that got hemp shut down – mounting a massive scare campaign about the dangers of marijuana.)

Whatever the case, it’s been illegal for about a century.

But now, it seems, the tide has turned. In America, there are now more states where marijuana is legalised to some degree or another than there are where it isn’t.

It’s a radical social experiment, but one that is creating a billion dollar industry in the process.

And for people in the right place at the right time, a small fortune.

This chart here has some of the big success stories. If you put just $100 into some of these companies just three years ago, you could be banking some incredible returns.

One company turned $100 into $35,500 for you! Nice!

Of course, not everyone’s a winner. The alcohol industry for example. They’re not stoked about it. Alcohol and marijuana seem to be in competition with each other.

In states where marijuana is legal, pot sales are growing exponentially, while booze sales are flat or falling.

Take this chart from Washington state.

Quarterly marijuana sales have boomed from $23.6m just a few years ago to over $300m today.

Some people are saying that the marijuana industry is going to be bigger than the manufacturing industry in the US by 2020. It’s pretty huge.

And the stereotype is that marijuana is for teenage boys with their X-box and Dominos pizza.

But if you break it down and look at who is actually using legal weed shops in the US, it’s a surprisingly broad cross section of the community.

It’s only very slightly tilted towards males, and it’s tilted towards younger cohorts (25-34) but not massively.

To me, that looks like an industry that’s got legs.

Ultimately the American experiment is a case study in how governments can make or break a market.

Sometimes government regulation is a good thing. I personally prefer to live in a world where there isn’t an open market for personal nuclear weapons. I support government regulation in that industry.

However, and I know this will come as a surprise to many of my readers, the government isn’t always perfect.

It doesn’t always make great decisions. Often, it actually makes very bad decisions in order to protect the interests of the rich and powerful.

(I know! It was a shock to me too. I’m sorry. I really should have made sure you were sitting down first.)

So is all hell going to break loose if we legalise marijuana? It seems unlikely. Marijuana has been down the priority list for the police for a while. It has never been particularly expensive or difficult to get.

And we’ve got by.

And some argue that there’s a signalling effect here. That if we legalise marijuana we’re telling kids that it’s ok to get off your face.

That’s kind of the message we started sending when we legalised alcohol again if you’re using that logic. And if you’re taking moral guidance from the government you probably need to have a good long chat with your priest.

So personally, I see this having a very small impact on the fabric of society.

So if you’re ok with the moral dimensions, and I more or less am, then the question is, where is the money?

This is a tricky one. We’re really looking for the government to make a market here. There are a number of Australian companies getting ready to launch when Australia finally starts down the path towards legalisation.

But the government is sending mixed messages here. Some days it looks like their stance is softening. Other days, it looks like it could be years down the track.

As I’m sure you know, it’s cash-flow that kills most start-ups. For marijuana stocks in Australia that could mean a whole lot of stranded companies with state of the art infrastructure and nowhere to deploy it.

And the longer the Australian government drags it out, the more opportunity there is for foreign companies to fully gear up and get ready to expand.

I mean, let’s say Australia doesn’t open the door until well after 2020. By that stage, the American marijuana industry will be starting to consolidate. Large players will start to emerge. They’ll have developed all the tools they need – technology, business models, finance partners.

They’ll come into the market full guns blazing, just as our little Aussie battlers are trying to get off the ground.

They’ll probably get slaughtered.

And right now, it seems that the government is going the wrong way for people interested in backing Aussie companies. I know a hemp farmer up in Northern NSW. They’d been gearing up production of low-THC (the stuff that gets you high), high-CBD (the stuff that has medicinal properties) crops.

The government had been moving towards making CBDs legal.

But then the Therapeutic Goods Association surprised everyone and said, actually, no, CBDs will remain illegal. You have until October to wrap things up.

It looks like they’re stuffed.

So this is the danger here. If you’re investing strategy relies on the stroke of some bureaucrat’s pen, your strategy is built on an institution that has been corrupted time and time again.

So there’s a substantial amount of risk there.

And that’s one of the reasons why the returns are so high. Can you predict what the government’s going to do in two or three years? Sometimes it’s a coin toss.

So look, yes, there are potentially some huge returns to be made out of the marijuana industry. I’m looking at some options myself.

But be aware of the risks. The government was happy to hang a whole bunch of hemp growers out to dry. They’re not going to give a toss about your investments.

That’s not to say it’s not worth it. But marijuana stocks belong in the risky tail of your portfolio, I reckon.

Have you made money from the marijuana hype? Are you sold on it, or are you staying well clear?
Do you think it’s a bubble about to burst, similar to techwreck2000?