So, are you ready for my comments on the most mainstream of "save haven" investments: real estate? Not only are you likely to learn something very useful for predictions about real estate in the next few paragraphs, but I will use facts that you probably already know. You may say to yourself "why didn't I think of that?" Plus, I will detail what I mean by "copmpound leverage" as a way to enormous profits.
Most people are familiar with the concept of financial leverage, though some do not know the term. Leverage basically means buying something with borrowed funds. That's simple, right?
Two of the most common leveraged purchases are purchases of automobiles and real estate. The purchaser comes up with a down payment of 20% (one fifth) or 10% (one tenth), and then borrows the rest.
In certain extreme conditions, purchases can be made with "no money down" or people can even get "cash back" at the time of purchase. Generally, the trend of the last few decades has been that down payments have gone from around 20% down to 10% then 5%, then even 0% or "cash back at close."
That trend is likely to reverse. It is not likely that people will go to borrow money to buy a house in ten years and they will be offered cash back of 50% of the value of the purchase with no money down. It is even less likely that in twenty years people will be offered cash back at close of 200% of the value of the purchase with no money down.
When exagerrated like this, one sees the "likelihood" of the near future reversing of that trend of lower and lower down payments. In fact, it has already begu to reverse. This means that "infinite leverage" purchases will disappear and folks will need to put 10% down or 20% down or even 50% down.
Note that there is no guarantee that lenders will be able or willing to finance purchases at any point in the future. In that case, people will no longer regularly use the term "down payment" and people will need to cover the full purchase price of an investment like an automobile or real estate (or gold or stock or tuition).
Consider what the disappearance of abundant financing would do to those markets. Here is one example.
A few years ago, when brokerages changed their leverage (margin) policies overnight on certain commodities futures contracts (such as gold), this meant that sales were forced overnight, because the brokerages (banks) were unable and/or unwilling to carry so much debt for their customers. Gold prices fell from the upper $300s and did not stabilize until the lower $300s.
Of course, not very many investors were investing in gold futures at the time, so most people do not know about the sudden change in leverage policy and the sudden foreclosing of those gold futures contracts- driving gold prices down sharply. Note that banks have it in their contracts that they can change the leverage/margin policy and demand payment in full if the ongoing operation of their business depends on it. [Those DBA] banks have no obligation to lend money to anyone to buy gold or anything else!
Note that the prior rise in gold futures (from below $260) had been subsidized or encouraged by fiat lending practices. Note also that the later rise in dollar pricing of various markets such as gold, real estate, and automobiles was still subsidized by fiat lending practices- though, over time, the extent (leverage) of the subsidies change.
Sometimes, as down payment rates are lowered from 20% to 10%, this generally encourages greater leveraging (at least by those who are relatively
aggressive/speculative in their purchases). Sometimes, as down payment rates are raised from 0% (or negative in the case of cash back at close), this generally forces foreclosing of investments and leveraging is reduced dramatically and suddenly.
While it might be interesting to consider the implications of all of the above as it relates to a market like US real estate, which has fallen significantly since the middle of 2005, that is not the present primary purpose. Instead, let us consider that, as long as financing is available in a certain market, leveraging allows for immense gains for prudent investors (those who are not following trends that have already ended).
Consider that one might purchase $100,000 of a certain asset with only $10,000 of expense. That is 10% down or 10:1 leverage.
Then, if that asset rises in nominal price from $100,000 to $120,000, that is a gain of $20,000 or 20% for the asset itself. However, that $20,000 gain on a $10,000 investment is a tripling of the initial investment of $10,000. That means that someone has used $10,000 to earn another $20,000. If they sell at that point and pay off the $90,000 or so of outstanding debt, they have made a nominal gain of 200%, that is, they gained twice as much ($20,000) as they invested ($10,000).
That is why leverage is so attractive to investors who wish to speculate in a given market. If their gamble at 10:1 odds goes well, they profit enormously.
So, what is *compound* leverage? Compound leverage could mean borrowing money to make the down payment. I might borrow $10,000 from a credit card to use as a down payment for a real estate purchase.
In that case, if I accrue a gain of $20,000 from a real estate deal, then I can pay off the credit card debt and I ultimately have a standing gain of around $10,000 (probably a little less because of interest on the credit card). How much did I risk to make that gain of around $10,000? All I risked was credit. I invested nothing "out of pocket" and I gained around $10,000.
That is functionally the same as paying "nothing down" for the real estate investment. It is perhaps not as extreme as "cash back at close," but it is pretty close.
However, that is not really what I mean by "compound leverage." Again, that is functionally the same as the "infinite leverage" of recent real estate speculation.
Instead, by compound leverage, I simply mean using leverage repeatedly- time and time again. That's compounding with leverage.
That would be like using the $20,000 gain from one real estate deal as a down payment on the next. Then, if one pockets, for instance, $35,000 from the second real estate deal, then one could use that on another investment at 10:1 leverage.
Of course, that pattern would eventually be a rather extreme gamble. Why? First, banks will change leverage (lending) policies- perhaps forcing a sudden foreclosure, and, second, market trends will ultimately reverse, and typically, both go together at once- just like in the case of gold futures a few years ago. (By the way, the recent decline in gold, so far by 16%, was not sparked by a change in leverage/margin policy.)
So, instead of compounding leverage in just one market, such as real estate or gold, one might compound leverage much more prudently. One might select specific markets that are most likely to produce significant gains in short periods of time, and then execute relatively short "trades," then re-invest most of the gains with each new investment.
Note that when I say "relatively short," I mean this in contrast to most real estate investments which are held at least a few years. One may find a better range of opportunities than gambling on only one market with the extreme leverage of real estate currently, which leaves one vulnerable to further declines in real estate like that of Japan in the 1990s or that of the last year or so in the US.
Instead of investing in a single market exclusively, especially one that involves the transaction delays of real estate (typically several weeks to close a deal once a buyer is found), why not diversify? In addition to trading the recent decline in precious metals, I have traded other major markets like stocks, bonds, and currencies (forex). If I need to close a position, there are several markets with hundreds or thousands of bids available on the average trading day. This is potentially far more stable than the infinite leverage of the recent real estate market.
Using leverage in investments is optional, of course, but moderate leverage of 3:1 to even 10:1 (like 10% down) is generally best as long as one is trading high volume markets and using reliable forecasts. "Forecasters" of real estate who say "real estate will always rise" are not really forecasters, but, at best, gamblers who are placing their bets while declining to look at the cards (the relevant data).
Because of trend-followers like those, casinos (and banks) make pretty reliable profits. Indeed, such folks who really don't even deserve the description "gambler," (for failure to even look at "the cards"). Further, precisely because of so many folks like those, I make large reliable profits with compound leverage.
Finally, attached is some of the relevant data for the US Housing market. This chart is from
http://www.jasmts.com/promonews/ which is authored by one of my favorite economy forecasters. (That guy has been 100% accurate for more than two decades by taking only a few extremely easy trades every year or two.)
