The objective of today’s Markets and Money is to tackle the question of whether today’s market is more volatile than past markets. If it is, how you invest, trade, or allocate your assets would be affected, and probably have to change. But in order to make that determination, we first have to define volatility and then have a look at the market data itself.
Before we get to all that, though, let’s deal with some mainstream reporting, some production figures from the resource sector, a disturbing report from Harvey Norman, and an even more disturbing report from the Australian National Audit Office (an agency you may be hearing a lot from in the coming years.)
“Consensus is beginning to emerge among economists and market analysts that the recovery in the Australian share market will be sustained, and some brokers are encouraging their clients to start buying now,” reports an article in today’s Age. As the Mogambo says, “HAHAHAHAHAHAHAHA!”
Wouldn’t it have been better to buy on the March lows instead of now, when the market is almost 30% higher?.
Maybe that’s unfair. We didn’t predict the March rally any better than anyone else, although we did persist with recommending at least one stock per month in Diggers and Drillers. But our main point is that you should be very cautious when the brokerage industry starts shouting for you to get back in the market with both feet and all your cash.
Anytime it’s safe to express an opinion on the front page of the paper without being contradicted or laughed out of the room, you ought to give that opinion a wide berth, or at least a huge dose of skepticism.
Besides, opinions about the markets are like left ear lobes; everybody has one. What you want are investment ideas, not opinions. And right now, we reckon the best ideas are coming from a review of first-half production figures and cash-flow statements. If you can find a business that’s managed to keep costs down and the cash flowing, despite lower commodity prices, well then you may be on to a winner.
What about retail? Harvey Norman shares fell 6% yesterday-and that was after the company reported that sales were up 3.8% over the last twelve months to $6.03 billion. The devil was in the details. Same-store sales growth was up 1.4% in the fiscal year, compared to 4.4% growth the year before. And the overall sales growth rate was down over 50% from the 8.7% rate the year before.
Is that nit picking? Growth is growth isn’t it? Shouldn’t any increase in sales be a tribute to what Access Economics calls “the remarkable resilience of Australia’s mums?” Isn’t confidence the most important thing in a consumer economy?
The Access analysis has to be one of the stupidest pieces of economic analysis we’ve ever read. As if Australian mums will manage to defy the necessities of reduced consumption in a balance sheet recession to return the nation’s economy to a pre-bust glow. Absurd. Confidence matters. But whether you have money to pay your bills or buy a new DVD player matters more.
Our guess is that retail figures are going to suffer as households shift their mindset from spending to saving. We’re talking about a sea change in consumer behaviour, not a cyclical rebound from an ordinary recession. You may disagree. But if this is a balance sheet recession and not just a garden-variety recession, households will gradually reduce debt, use fewer credit cards, and begin to live beneath their means again.
As we mentioned yesterday, we think the LNG industry may be Australia’s next big export winner. And today, we’ll give you some proof, or at least an argument. The Australian Bureau of Statistics released data last Friday that show Australia’s export prices plummeted in the June quarter-but not for all commodities.
The Export Price Index is important for a lot of reasons. But it’s probably most important because it’s a measure of Australia’s national income and the terms of trade. If the country is making more because it’s selling more, and what it’s selling is going up in price, this means it has more money to do other things (like service the interest on a growing public debt).
But if there are major changes to the structure of the nation’s income, well that’s the sort of thing you’d want to pay attention to. For the record, the Export Price Index decreased by 20.6% in the June quarter. It was the largest quarterly decrease since the current series began in September quarter 1974.
According to the ABS, “The decrease was driven mainly by falls in prices received for coal, coke and briquettes (-36.8%) and metalliferous ores and metal scrap (-23.5%), as well as the appreciation of the Australian dollar against all major trading currencies. These falls were partly offset by rises in prices received for petroleum, petroleum products and related materials (+12.9%).”
One quarter does not a long-term trend make. But we’d argue that the June quarter indicates a shift in the balance of earning power for Aussie exports. Steel-making bulk commodities (iron ore and coking coal) may suffer from increased production or excess capacity in steel-making countries like China, Korea and Japan.
Energy, on the other hand is probably a more durable investment bet. Of course there are people that predict energy prices-especially for an oil substitute like LNG-are only rising because of the actions of speculators and that high inventories and tepid global growth mean oil prices are headed much lower this year, not higher.
That difference of opinion (different analysis of the same facts) is what makes it a market, though, isn’t it? There is a strong historic correlation between GDP growth and electricity production. The thing we like about LNG is that it’s not coal. It’s a cleaner-burning fuel to produce electricity. And at some point, steel-intensive growth in China is going to give way to a more balanced consumer economy (perhaps with a lot of hybrid electric cars). This, to us anyway, argues for a big shift to energy (and LNG) as Australia’s most valuable energy export.
The transition to that status will be volatile though. In Monday’s Wall Street Journal, Robert Matthews reports that, “The world’s biggest miners and steelmakers are on the brink of forging a new system for setting iron-ore prices that is expected to increase the volatility of steel prices, but perhaps make the process more transparent.”
What’s at stake here is control of iron ore pricing power. At last year’s Agora Wealth Symposium we argued that control of pricing power was switching away from the steel-producers in Asia and to the iron ore producers in Australia. But that was before the credit crunch led to a sharp drop in global industrial production and Asian exports and a big fall in spot prices for ore.
Now, it’s a bit of a draw to see which party will control the ore price. And no one really expected the Chinese to complicate the issue by arresting Rio Tinto executives. That’s a dangerous kind of leverage that may not work out exactly as intended (a more compliant Australian ore duopoly that is less threatening to Chinese interests).
But just to show that the Rio showdown with China is good theatre but not the start of a bitter, confidence-destroying feud between Shanghai and New South Shanghai, Bloomberg is reporting that China Shenhua Energy Company-China’s largest coal producer-has been given permission to buy land in New South Wales by the Australian Federal government.
Shenhua is 68% owned by the Chinese government. The story says the Foreign Investment Review Board approved Shenhua’s purchase of six farms “of about 2,000 hectares.” Last year, the company paid the New South Wales government A$300 million for an exploration lease near Gunnedah, where it reckons there may be 500 million tonnes of coal just waiting to be dug up and mined, beginning as soon as 2013.
Selling pieces of land with valuable resources to foreign governments in order to paper over large structural budget deficits is not exactly what we’d call great statecraft or prudent management. But it does show you that Australia’s national income is directly influenced by how it chooses to handle “the resource question.” Sell the assets outright for a few hundred million now? Or try, in some cases, to benefit from more value-added commodities without surrendering ownership of the assets?
One sure result of the all this is that if ore prices are set quarterly and not annually, they are going to be a lot more responsive to monthly changes in steel supply and demand. That makes for more efficient, market-based pricing. But it also makes for more volatility in the price, and probably in the share prices of the major and junior miners.
One last point on national income and accumulating debt. The trouble with being a debtor is that you gradually surrender a larger share of national income or assets to your creditors. This is probably something we’ll talk about at next week’s debt summit.
Today’s let’s just put in a California-kind of perspective. As you may know, California is facing a huge debt crisis. It’s spending exceeds its revenues. Its legislature can’t come to an agreement on the right combination of revenue-producing measures (taxes) and spending cuts (government services).
That assumes there IS a right combination. No one is really wondering whether the whole structure of the modern welfare state has simply hit the wall, with California-as usual-at the leading edge of the storm.
But Australia is drifting toward its own Federal budget Catch-22. The two charts below-taken from a presentation by the Australian National Audit Office-show that the second-largest contributor to Federal government revenues are “company and petroleum resource rent taxation.”
One issue to watch in the changing nature of export prices is a reduction in government revenues from resource rent taxation. By the way, we’re not entirely sure what the Audit Office means by that. We’ve called and left a message.
But the numbers are what they are. Revenues fell by 4% to $291 billion in the last fiscal year. That was a combination of individual, corporate, and excise taxes. Meanwhile, as they tend to do, expenses rose to $338.2 billion. You can see that from the chart below.
The difference between revenues and expenses, if the latter is greater than the former, is what we call a deficit. The way you eliminate it is to increase revenues or reduce expenses, or some combination of both. The trouble is, increasing revenues through taxes means removing potential business and household spending from the economy-not exactly a good idea at the moment.
But if you reduce government spending, doesn’t that reduce stimulus too? We’d argue it doesn’t. We’d argue that the government could probably be 30% smaller and Australians would get by just fine. They’d keep more of their money and expect less in the way of services delivered inefficiently by the government.
(or money its borrowed for you to repay later)
In any event, the numbers show a gap is forming between what Australia’s government takes it revenues and what it spends. You can’t bridge that gap by selling off the national silver ware. That leaves reduced spending – something the government has committed to. But it’s awfully hard to win elections when you can’t give other people’s money away to your voters. It should be an interesting eighteen months.
Of course, if the economy booms ahead and confidence is restored and tax revenues bounce back faster than expected, well then we’ll just close up shop here at the Old Hat Factory and go open a coal mine somewhere. But somehow, we think the budget gap will get a lot worse before it gets better. More on that tomorrow.
for Markets and Money