Wednesday’s Markets and Money promised you a guide to Australia’s coming deflation. But the mainstream media stole our thunder. Here’s how Peter Martin and Tim Colebatch from The Age covered the report that’s got everyone in a frenzy:
‘Australia faces a run on its currency, a deeper collapse in housing prices and a bank funding crisis to rival Europe’s as it tries to come to grips with life after the mining boom, according to a report from a boutique US advisory firm.
‘Entitled Australia: The Unlucky Country, the report from Variant Perception argues that Australia faces a classic case of Dutch Disease, the erosion of capability that flows from a resources boom and an overvalued exchange rate.’
Yes, Australia is about to catch a Dutch cold – a koud.
A fall in the Australian dollar, a bust in the mining boom, a bursting housing bubble and a banking crisis are all on the cards. The real worry is whether we’ll manage to get all of them at once.
All of those risks will sound more than familiar to Markets and Money readers. Now that everyone else is cottoning on, it’s time to figure out how to make money from the shemozzle we face.
But first, here’s our favourite chart from the Variant Perception report. It shows the Net International Investment Position. The NIIP is the difference between what Australians own abroad and what foreigners own here.
The so-called PIIGS surround Australia and New Zealand on the far right of the chart. Foreigners own far more in Australia than vice versa. The worry is that Australian asset prices could plunge if foreign investors pull out of Australia.
There are plenty of other scary charts like this one in the report. It’s a very good read for anyone, even if the economics isn’t simple. Anyway, let’s get to profitable investment ideas.
First up, it’s good old gold. It protects you from all four risks, especially the falling Aussie dollar. We wrote about how the currency exchange rate and the gold price work together a long time ago.
It’s worth going back to the ‘Australian Gold Matrix’ if you’re not familiar with the effect the Australian dollar can have on Australian gold prices. The short version is that, even if the gold price falls, if the Aussie dollar falls more, then Australian investors profit.
If gold rises and the Aussie dollar falls, you’re in for a double whammy of a gain. That’s while the rest of Australia is struggling.
But does owning gold during a crisis really work? Consider what is happening to Italian gold owners:
‘Since I was a child I remember that gold was given as a gift on various occasions and people used to say: ‘Put it aside’. We used to laugh at it, but they turned out to be right. Many families are surviving thanks to this gold.’
It’s one of those cases where wisdom passed down through the ages seems silly, until it isn’t. Newsletter editor John Mauldin, who sent his subscribers the Variant Perception report above before it hit the headlines in Australia, is on the right side of this wisdom.
He buys a given dollar amount of gold coins every month. And he cops some friendly mockery from his rather large batch of children for it. Maybe that’s the point of owning some gold. It excommunicates you from the mainstream and status quo of the investment world. Suddenly, you have to think instead of conform when you decide how to invest.
Anyway, profitable investment idea number two is a basket of European and American assets. It might include the euro, certain American shares and Irish property. The idea here is to buy beaten down assets.
Fellow Markets and Money editors Greg Canavan and Dan Denning are already onto this trend in their newsletters. We’re throwing in one specific suggestion for you in a moment. But first, there are two obvious objections to the idea of going bargain hunting overseas.
Aren’t the US and Europe economic basket cases? Yes, and that’s why there are bargains to be had. Apart from that, both the US and Europe have a lot of economic distress behind them already. Australia hasn’t.
The US and Europe may be in the eye of the storm, set for another round of disaster. But that doesn’t mean Australia won’t fare worse. Again, a drop in the Australian dollar is likely to offset another round of falling asset prices overseas.
Then there is the potential for gains. According to a German study, things are already turning around in many of Europe’s crisis ridden countries. Labour costs have fallen dramatically, so those countries are beginning their industrial recovery.
For now at least, they have a stable currency system within which to operate. That significantly boosts their chances of success. If the crisis countries were using their own currency, they would have been on a high inflation path by now, creating more problems.
But is the euro safe? This is the second objection. And it’s also a valid one. But in the medium term, the inevitable money printing will be perceived as a rescue of the euro, not a devaluation.
That means a euro rally might occur just as the Australian dollar begins its plunge. Once again, there’s the potential for a double whammy of a gain: Currency gains from the euro and price gains from beaten down assets. It’s very difficult to know how the European sovereign debt crisis story plays out in the long run. But for now, Australia may fare worse in terms of investment returns.
So what’s our specific suggestion to profit from this opportunity in foreign assets? It’s the American stock General Motors. And it’s purely a value play. The idea comes from an interview with James Grant, who writes ‘Grant’s Interest Rate Observer’:
‘The thing for investors to know about GM is that it is an extraordinarily cheap equity. A great deal of upside. It’s very well financed out of bankruptcy. Chances of permanent capital impairment are probably very low. The chances of gain are pretty good.’
To be clear, this isn’t an endorsement of the US in terms of its economy. Far from it. But, as Grant put it in the interview, ‘I believe in GM at five times the [earnings] estimate.’ The same sort of analysis applies to any European equities you might want to buy. Look for value, not growth or risk.
Combining the opportunity of cheap industrial stocks and currency gains are Australia’s export manufacturing companies. They are profitable idea number three. The Variant Perception report explains the potential for an industrial renaissance in Australia.
The economy will rebalance after the mining boom. Call it a Dutch recovery, if you like. A low currency and low interest rates will be favourable to exporters and producers generally.
Greg Canavan is onto this story too. He has just placed onto his watch list a company set to benefit from an industrial recovery. It produces something our office consumes every day. It’s not strictly industrial, but the same factors are at play.
Best of all, it’s a seasonal good, which means exports to the northern hemisphere. 70% of Australia’s crop is exported. And the stock is badly beaten down from an unfortunate but temporary development. In other words, it’s cheap, it exports and it produces real stuff. There are plenty of similar companies on the ASX.
You could implement all three of the investment ideas above in the next 24 hours. Not that you shouldn’t carefully evaluate whether they are a good idea for you first. Along with seeking personal financial advice on the matter.
But here is the real point to today’s Markets and Money. We are entering a time where Australian investors can be proactive again. It may be far too early to declare that. And it definitely doesn’t mean things will be improving in asset markets soon.
It might still be time to mix some rum and lemon juice and wait out the Dutch koud. But there are valid investment propositions forming behind the geopolitical nightmare of bubbles, bailouts, and monetary shenanigans. Unfortunately, Australia is on the wrong side of those three problems. We have yet to face them. That means the opportunities are overseas and in assets with overseas exposure.
Until next week,
Markets and Money Weekend Edition
About the author: having recently escaped from academia, Nick decided to drop his tights (the required attire of a trapeze artist) and joined Port Phillip Publishing. Instead of telling everyone about the Markets and Money, he now spends his time writing for the weekend edition.
ALSO THIS WEEK in Markets and Money…
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