The Best and Worst of the Australian Economy

Is ‘confidence’ the missing ingredient in getting Australia’s economy back on the road to recovery? That’s the question I’ll attempt to answer in today’s Daily Reckoning. Plus, I’ll look at two stocks that show you the divergent paths the Aussie economy is on right now.

But first…is the oil price on the way back down?

Overnight, West Texas Crude fell more than 3% and is back under US$50 a barrel. As you can see from the chart below, over the past month oil rallied nearly US$10 a barrel. It took prices back up to the 50-day moving average (blue line).

But this looks like an area of resistance. There’s a good chance that oil will now retest its late January low of around US$45. After such a big decline from mid-2014, at the very least, oil has a lot of work to do before it can start moving higher in a sustainable manner.

That’s why trying to pick the bottom after such large sell-offs is always fraught with danger. The rallies tend to be short and sharp…and most of the gains are lost when the downtrend reasserts itself.

So if you’re a buyer of oil and energy stocks here, understand this is a long term bet. Hindsight will probably prove you correct. But in the meantime, you’ll look like a fool while oil goes nowhere and the rest of the market moves higher.

At least that is the lesson from gold’s sell-off in mid-2013. While the very sharp falls brought gold close to its lows, here we are nearly two years later and the gold price, at least in US dollar terms, is still struggling.

But in Aussie dollar terms, it’s a different story. As an Aussie investor, it’s a difference you need to take notice of. Most of the analysis about gold centres on gold priced in US dollars.

If you’re investing in Aussie gold companies though, you need to focus on gold priced in Aussie dollars, because that’s how these companies earn and derive their profits.

So while US dollar gold continues to languish around $1,200 an ounce, Aussie dollar gold is a healthy $1,540 an ounce. At this price, local producers should start to generate strong profit growth.

That’s why I think it’s an important time to start looking at the sector again. If I’m right, you’re going to see big gains in the years ahead. The biggest gains will be reserved for those getting onto the trend early.

Last week, I recorded a brief presentation outlining the case for gold and some favoured stocks in the sector. You can check it out here.

But the market isn’t really interested in gold companies. They are flying under the radar right now. Which is why now is such an exciting time to take a look.

Two companies reported profit results yesterday that tell a tale of two economies. For engineering contractor, UGL, it is the worst of times.

UGL reported a writedown of around $280 million for a half year loss of over $120 million. This related to cost blow-outs at an LNG plant it is building in Darwin as well as other provisions based on the general slowdown in the commodities sector.

Underlying profit fell 40% to $29.3 million. It’s tough times for companies exposed to the resource sector.

UGL’s share price has declined more than 50% over the past few months, and that’s after taking into account the sale of its property management business, which netted shareholders around $500 million.

But after disbursing the sales proceeds, now the company can’t afford to pay a dividend. It could be a while before its reinstated. In this market, failure to pay a dividend due to cash constraints is like having corporate leprosy.

UGL’s share price is in a solid downtrend so I’d be steering clear of it for a while.

Meanwhile, over in property land, it’s the best of times. Yesterday, global property developer Lend Lease announced a 25% increase in first half profit to $315.6 million.

The solid result was largely due to the strong performance of the Aussie division, which saw a 33% increase in operating profits. And that was due to the strength in the residential property market. From the press release:

Strong residential trading conditions saw the Property Development business deliver profit of $132.6 million. Residential settlements increased 18 per cent from the prior corresponding period, apartment pre sales increased 195 per cent including sales for The Yards at Brisbane Showgrounds, 888 and 889 Collins Street in Melbourne and at Darling Square in Sydney.’

Lend Lease is one of the largest land bankers in the country. That is, it owns a huge amount of vacant land zoned for residential development. It can choose to hold back from developing this land when times aren’t so good, or it can make hay with it…like now.

The problem with this approach to land management is that it exacerbates the supply issues that Australia faces. A common refrain is that Australia has limited supply of land for residential property.

That’s not exactly true. We have a limited supply of land because land banking companies restrict it. They only release it in numbers when the profit margins are fat.

When people aren’t willing to pay big prices, the land sits idle, accruing gains while the land banker’s wait. Heads they win, tails you lose.

Lend Lease is in a strong uptrend, but it’s not exactly cheap. I’d be holding if I owned it but wouldn’t be buying at these levels.

The moral of the story? Resource related work is tough going right now…property related business is good. Very good.

Yet property transactions, construction and the associated money shuffling that facilitates all of this is not enough to give our economy the boost it needs to get over the resource downturn.

Some say it’s just a matter of confidence. Get the confidence and animal spirits back and we’ll be economic world-beaters again. I say that is utter bollocks.

I’ve run out of time to make the case for why that is, but I’ll revisit it in Thursday’s Daily Reckoning. Until then…

Greg Canavan,
for Markets and Money

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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