More on Aussie Dominators

July has not produced much in the way of excitement for shares. We have found out a few interesting things this month. One, as long as sovereign debt woes in Europe persist, U.S. Treasury bond yields can go lower. Investors seeking a haven from Europe don’t seem to have any problem buying U.S. bonds at near record-low yields. This is bizarre.

Of course at a superficial level, if you were concerned that the European bank stress tests were a sham and that interest rates in Europe could go much higher unexpectedly, you might view U.S. Treasury notes and bonds as “safe.” This is only possible in a world of utter relativity.

After all, the U.S. government ran a deficit of 9.9% of GDP in 2009. The Congressional Budget Office in Washington reckons next year’s deficit will be $1.47 trillion. That forces the U.S. government to borrow 41 cents of every dollar it spends. Imagine if you ran your finances this way.

But it’s a strange old world we live in. Europe’s problems have been America’s blessing. Demand for U.S. Treasury bonds and notes is the highest on record, according to the Wall Street Journal. On July 23rd, the yield on two-year notes – a kind of near cash fight-to-safety proxy for big money – feel to 0.5516%. Ten-year notes briefly yielded less than 3% earlier this month and for the entire month of July, the U.S. Treasury managed to flog off $173 billion in bonds to investors.

This is an important development. As long as global savers – for whatever reason – are frantically bidding for U.S. debt at auctions, U.S. borrowing costs should stay relatively low. It should also allow the Federal government to run its absurdly large and reckless deficits. And most importantly, if investors are buying U.S. debt it means the Fed doesn’t have to, at least not yet.

This last point is the most important, we reckon, because it averts the dreaded hyperinflationary scenario in which Fed money printing leads to an inflationary shock. So far, investors (who may have gone wobbly on stocks) have decided there is safety in numbers in the U.S. bonds market. We’ll see how that works out for them.

All this has taken some starch out of the gold price. You will have known about this if you read the latest salvo in Michael Pascoe’s increasingly strange vendetta against gold in today’s Age. He points out that spot gold prices are at three-month lows in New York and down 8% from the June highs.

It’s pretty obvious by now that Pascoe either doesn’t understand gold’s role as money or simply believes gold is an anachronism in which “money” can be created by central banks. Frankly it’s a pretty unserious and mildly embarrassing argument to make given the last few years of economic events. But each to his own.

The bigger issue is what will happen with the gold price from here. Yesterday we spent an hour on the phone chatting about this and other things with Greg Canavan, the editor of Sound Money. Sound Investments. Greg pointed out that the gold price doesn’t normally perform so well during the North American summer.

Our view? We’d be pleased to buy more gold on dips, even if for the year gold doesn’t make a new high. Gold is insurance against financial disaster. And if you think there aren’t any more financial disasters lurking, you’re not thinking hard enough. And yes, this is a fear-based trade. We are worried that bad fiscal and monetary policies worldwide can wipe out savings, depress share markets, and destroy purchasing power. Totally wacky of course. But there you go.

What about Aussie dominators though? Are there businesses in Australia that are so well positioned they can’t help but make money? Greg sent us a note on that later in the day.

“I’d have to say that there are very few Aussie ‘world dominator’ stocks, which is not all that surprising given the relatively small size of our economy. There are many things that go into making a business ‘good’. It’s not just all about growth, it’s about profitable growth. High return on equity, smart capital management and sensible debt levels are just a few of the things to look for. But what most people don’t realise is that a company can be all these things, but if it’s not good value you will not make any money.

“Think Woolworths and QBE a few years ago when their share prices were much higher. They were great businesses (and still are) but the price you were being asked to pay virtually guaranteed a low long term return. Here are a few candidates for the world dominators:

  • BHP – Very high quality asset base and one of the best management teams in the industry. However, disproportionately reliant on China.
  • Westfield – One of the most successful businesses in the world. But has still delivered a poor total shareholder return due to reliance on property values and ongoing capital raisings to strengthen the balance sheet.
  • QBE – Quality global insurer that consistently generates strong profitability. Always subject to the global insurance cycle, which has been in a downturn. Price now represents good long term value.

“And here are some that are not in the world class category, but definitely Aussie dominators:

  • Woolworths – Probably the best run company in Australia. Its profitability is so consistent it’s like a bond. (Generates an ROE in the 30%’s). Good value at the moment as well
  • Telstra – Much maligned but it’s a highly profitable, dominant business. Generates massive free cash flow which makes for a good income investment.
  • The banks – HAVE BEEN completely dominant but post credit bubble bust the question of dominance must be questioned.

Greg wraps up, “The aim of Sound Money. Sound Investments is to build a portfolio exposure of around 50-60% in these companies (buying at the right price of course) to provide stability and income. We are looking to have around 20% invested in precious metals with the remainder in promising/good value small cap stocks.”

To see what Greg’s up to or sign up for a free trial to his newsletter, go to Sound Money.Sound Investments.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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“That forces the U.S. government to borrow 41 cents of every dollar it spends. Imagine if you ran your finances this way. ”
but that’s how we all ‘run’ our environment… a kilo of food, a kilo of soil lost etc incl. irreplaceable phosphate

woolies and coles might gain value when the government (including Liberls now) force social security recipients to buy half their stuff using a special card, probably only redeemable at large supermarkets. Id be interested in if Aldi would be included in that scheme. – its the only competition.

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