Sino Gold (ASX: SGX), Babcock and Brown Wind Partners (ASX: BBW), Energy Resources of Australia (ASX: ERA), and Beach Petroleum (ASX: BPT) where the top four performing stocks the last time the ASX/200 was open for business last week. We think we see evidence of the evolutionary progression we outlined yesterday for energy and resource stocks in 2007, namely MESI.
It’s not the best name. In fact, if you think you have a better one, we’re all ears. But it describes the energy markets (as well as life.) For now, it gets the point across…More exploration and production…Efficiency and enhanced recovery…Substitution…and Innovation. That’s how we expect things to play out in 2007, leading, most probably to higher resource prices for Australian shares, as well as alternative energy companies.
We say “most probably” because there is an intriguing twist to the commodities story. Chinese production of base and precious metals is now large enough to exert downward pressure on prices. Up until now, the China story has been all good news for Australian resource producers, especially iron ore, coal, zinc, nickel, copper and alumina. But what’s this? Alumina production in China surged by 60% in the first ten months of 2006 while iron ore production expanded 38%? This according to Stephen Wyatt in today’s Financial Review.
A few years ago when we were working out of Sea Container’s House near Blackfriar’s Bridge on London’s Southgate we were feeling pretty smug about our place in the world and how smart we must be. We remember a new hire warning us that China would become a force for deflation in the resource markets the way it had become a force for deflation on retail goods and consumer electronics.
“Idiot,” we recall saying cautiously.
“That could never happen. Or at least not right away. Building mines and smelters takes a ton of real capital. And you have to have the resource base to begin with, which means you have to find it out in the wilderness, and then find the people who can turn it into a functioning mine, and get ore from the mine mouth to a railhead, and from there to a foundry or smelter, and from there…well…you see…that sort of thing just doesn’t happen overnight. And why bother when you can buy most of what you need from the good people of Australia?”
“I don’t know mate. I’m just saying…”
“Quit saying. Keep reading.”
Maybe our fresh-faced associate knew something we didn’t. Or maybe we were just an arrogant ass. Or both! But at the time, China was a net importer of steel. Three years later, it’s a net exporter, and both the world’s largest producer and consumer of steel. “Refined copper production rose more than 19 per cent, aluminum 18 per cent. Zinc concentrates 20 per cent, refined zinc 16 per cent, stainless steel 46 per cent, and crude steel more than 18 per cent,” Wyatt ads.
Here’s the thing: we don’t know the total volumes of production. Off a sufficiently small base, even a 46 per cent gain is nothing to write BHP about. But though we don’t know the names of the next great Chinese commodity producers, is there any reason China can’t develop its own BHPs, Xstratas, or Rio Tinto’s?
Well, the best reasons China has for developing its own metals and mining industry are high prices and capacity constraints in Australia. We suspect the high prices are the prime mover. They tend to attract competition from new producers. This is true in any industry. And that’s what’s happening here. But don’t discount China’s strategic reluctance to have all its resource needs met by a few markets. It’s not good strategy. And it shouldn’t surprise is that a prudent business or strategic-thinking government would seek a more favourable, stable, long-term position. Already representatives of Korean Steel maker Posco are obliquely warning the global iron-ore oligopoly to keep up with demand, or else!
Or else what? “Australian people must look quite seriously at the adequate expansion of infrastructure. It is good for Australia, because if Australia fails to do this we will have to find an alternative,” says Kwon Young-Tae in today’s AFR. Kwon is the top purchasing executive of Korean steel giant Posco and used to run Posco’s shop here in Australia. When the man with the purse strings speaks, we’d pay attention.
We see two investment consequences here. First, in the run-up to the Federal elections in May you might see something of a spending bonanza on infrastructure. This should bode well for infrastructure stocks, many of which already have full order back-logs. Second, Chinese resource production does in fact represent a long-term threat to Australia’s resource boom. We don’t expect China to become the next Australia. There can be only one “lucky country” at a time. And we can’t see the Chinese cricketers thumping the English the way Ricky Ponting’s boys are. But China has access to the same cheap borrowing Australia does, and China has famously cheap labour. Stranger things have happened.
The immediate alternative may be increased Chinese, Korean, Russian, and Indian pursuit of Australian mining assets. In other words, if these countries can’t produce what they need from their home soil, they may expand their efforts to do it right here on Australian soil. Short of forming new companies and pursuing the permits for new projects, the quickest way to do that is to acquire locally.
Speaking of which, now that Shell has been kicked out of Russia’s Sakhalin II gas project by Gazprom, how long will it be before the company reignites its pursuit of Woodside Petroleum (ASX: WPL)? Shell’s initial courtship of WPL was shot down by the Treasurer on the grounds that Shell’s interest in the Sakhalin project made it less likely to develop Woodside’s gas assets in the NorthWest Shelf.
Today, we imagine Shell is quite keen to develop anything it can get its hands on, if only to replace current production from its rapidly dwindling reserves. Shell may be forced to cut its proven oil and gas reserves by four percent as a result of losing out on the Russian venture. The company needs new gas assets the way a hobo with delirium tremens needs a drink-which is to say it’s a matter of survival. Woodside has them. Hmmm. How do you think this will end?
While Shell goes-a-shopping for new oil and gas reserves, BHP is going the old-fashioned route to increasing its exposure to 2007’s energy bull market. BHP would like to proceed developing its Caroona project, near Gunnedah in northwest New South Wales. The company estimates the land contains nearly 500 million tones of coal, which is a lot of coal.
The only problem is that the very same land where the coal waits the light of day is also some of the country’s most productive agricultural land. According to today’s Daily Telegraph, local farmers worry that drilling to explore the coal deposits could disturb the aquifers which feed the fertile farm land. Welcome to a resource dilemma.
It comes down to energy either way. On the one hand, there are the British thermal units (BTUs) that come from a lump of coal. On the global market, that’s a valuable resource. On the other hand, arable farmland produces food, and the calories in food provide the energy for people like your editor to flail away on his keyboard each day. In summary: Food provides calories. Coal provides jobs which pay salaries which make it possible for people to buy food. Which jobs are more important, farmers or miners?
So far profiting from Australia’s resource abundance has been an easy thing. Australia has the resources, produces them more efficiently than anyone else, and the production has not displaced any other industries. On the contrary it’s created new jobs and whole new economies. Now you have new producers in China, rising costs at home, and tougher choices about how to best use scarce resources. The boom ain’t over. But it’s getting more complicated.
On another note entirely, we are watching with keen interest the development of what we believe is an emerging, always-on, 24/7/365 global exchange. Not quite yet, though. The Nasdaq and the New York Stock Exchange are closed today in honour of the late Gerald Ford. We will use the occasion to take a closer look at the exchanges themselves.
Last week we mentioned that someday in the next five or ten years, you’ll be able to trade anything in the world at any time from your home office. You may not want to do that right now. It may not even be a good idea. But we’re pretty certain it’ll happen. Why? It has to. That is the surest path ahead for the money shufflers to keep making money. They need more product to shuffle and more ways to shuffle it.
Australian superannuation funds are adding about $65 per year to professional money management funds. That money is automatic because it’s compulsory, and the tax regime is encouraging even more asset-based saving. By 2015, that could mean a total of over $2 trillion in super funds. Already, Australia ranks fourth in the world of countries with funds under management, ahead of even the U.K. That money has to go somewhere, doesn’t it?
With oceans of money available to willing borrowers, the only way the investment industry can lose money in the coming years is by running out of investment products to sell the public. So the drinks-in the form of new actively managed investment products for retail investors-are flowing. They have to, or stock prices will simply go to high.
The problem is basic economics. The supply of publicly listed stocks is growing, but not as fast as the money chasing stocks. That leads to what S&P warned about yesterday, a collapse in price/earnings ratios. This can come about in two ways, either you get an unanticipated fall in earnings (which drives the ratio up even higher for a bit), or you get a much anticipated fall in prices, as investors begin to get gun shy paying too much now for tomorrow’s earnings. But in order to prevent investors from considering factors like reality, the money management industry has a better answer….
Give people more things to buy!! And by things we mean stocks, structured products, and hedge funds. Stocks are especially easy. Find a company, or just an idea, slap a plan together, and flog it to the public in an initial public offering. The London Stock Exchange sold nearly $70 billion in new equity to the public last year. It was a 71% increase over what the exchange floated in 2005.
It was enough, in fact, to push London past New York as the world-leader in new IPOs. The New York Stock Exchange managed to float around $45 billion in new offerings to the public. But with the convoluted Sarbanes-Oxley law scaring global companies away from a U.S. listing, London and Hong Kong surged ahead.
No wonder shares of the London Stock Exchange (LON: LSE) doubled last year. Like the Chicago Mercantile Exchange (NYSE: CME) and the New York Mercantile Exchange (NYSE: NMX), and even the New York Stock Exchange itself (NYSE: NYX) it is a very good time to host the selling of stocks.
None of these stocks are cheap, even as earnings are booming. Nymex trades at 76 times last year’s earnings. CME trades at a whopping 222 times trailing earnings, although just a petite 34 times next year’s projected earnings. NYSE? It trades at 86 times last year’s earnings. In mid-June of last year, NYX swooned to dip just under US$50 at the close. And then it doubled from there. By November 22nd, it closed at $108.
Since then, NYSE shareholders have approved of a plan to buy Paris-based Euronext for US$14.3 billion. The deal would create the first trans-Atlantic securities market. And it probably paves the way for New York-based global domination of share markets.
Maybe. The merger needs the nod from regulators. And then Asia awaits. NYSE’s 51-year old CEO John Thain wants to integrate the two companies, and then set up a joint-venture to do business in Asia. “We’ll be the largest exchange in the world, and in some ways the most powerful exchange in the world,” Thain said in a recent Businessweek interview. “We’re in an era of big global exchanges, and a lot of little ones as well. Japan, China, and India are a logical place for another transaction.”
What about Australia? Too few new listings? Not enough local capital? Hmmn. Also, we note that just a day after the NYSE merger with Euronext looked set to go ahead, Gerald Putnam, the president of NYSE Group, Inc. filed a form with the SEC signifying his intention to sell 3,015 of his shares in the company for between $98.73 and $100.83. Assuming Mr. Putnam sells everything at a low-bid, he’s looking at a pre-tax gross profit of $297,670, which is not a bad day’s work, if you can get it.
We don’t mean to imply that there is anything suspicious or illicit about a company insider selling his own shares for a profit. That’s how you get rich these days. According to the results of a recent study done by Merrill Lynch, 37% of all wealth generation results from the “sale and ownership of businesses…an additional 33% is derived from income and options. All the evidence suggests wealthy entrepreneurs have carved a growing slice of the corporate pie.”
You can type that again. We now know that 2% of the world’s population owns more than half its wealth, or around $158 trillion, if you’re counting at home. Mr. Putnam’s modest profit on the sale of his NYX share is a teardrop in a rainstorm by comparison. But the point is well-taken…these days you make the most money on Wall Street being a seller, not a buyer.
All of which is our way of saying that the exchange stocks are your canaries in the global equity coal mine. They are the casino. If they keep going up, the good times will keep rolling. But if they start coughing and rasping, watch out below.
It’s not just stocks that are rising. Houses are chugging along too! “International house prices have defied rising interest rates this year, growing at more than ten per cent in some European countries, and many analysts expect residential property to remain resilient in 2007,” writes Scheherazade Daneshkhu (we’re not kidding) in today’s Financial Times. Just who are these analysts and who cares what they think about global house prices anyway?
Most real estate buyers don’t go to sleep at night worrying about house prices in Iceland or Italy…unless they live in Iceland or Italy. And even then, you’re not worried about the national market, you’re worried about the market in your village or on your block. What are house prices doing in your neck of the woods?
Last night a would-be house-buying friend of ours told us about an auction he went to in Williamstown. On offer was a Baby Boomer dream home, left unfinished as the couple ran out of money and the bank ran out of patience (admittedly a rare thing these days.)
The house was a dream too far. It was certainly audacious. It had a massive 8- man spa connected to the interior of the home by a sort of canal that wound its way around the place. An enormous plate-glass window looked out onto the affair from the second-story, where a library with empty shelves stared forlornly on the whole scene.
We toured the place ourselves a few months back, thinking it would be a nice place…if you were Hugh Hefner living the Playboy lifestyle with fabulous house guests, great food, and lots of poorly lit but comfortable corners. You may not be able to put a price tag on a dream. But a mortgage payment or a home loan is all about affordability. And this was clearly an unaffordable dream (if not bad taste), at least for one couple.
Someone did buy the property. It was listed at $400k and ended up going for around $850k. The buyer must reckon he’ll be able to spend a few hundred thousand dollars finishing the place up and then flip it for around $950k or $1 million. That seems like a lot of work-and risk-for a 10% profit.
“There are six billion people on this planet and only one of them is worried about your problems,” we mused out loud to our friend last night. He agreed. He said he had told his friends, hard-drinking mates in their late-20s, that in three generations no one would remember who they were.
“This really bothered them. I don’t know why. They didn’t believe it at first. And then I asked them if they could name their grandfather. They didn’t say anything. Grandmother? No response. Then they started drinking heavily.”
We don’t mind the thought of not being remembered. Lives are only memorable to the people who remember them. Our informal call-to-arms in life is that it isn’t the result of your actions that matter, it’s the quality of your effort. Chance accounts for half your successes anyway (and all of your failures, we prefer to think.) And even though reputation can be just as capricious-getting credit for things you don’t deserve and blame for things which aren’t your fault-we can see how it would be disappointing to die, believing your life is unappreciated by others, or that you will go unmissed.
We were thinking more morbid thoughts this morning after we got a note from an older brother in Colorado. Our father is slowly dying from prostate cancer. He asked, indirectly, if we’d be interested in writing an obituary for him. And for the first time in while, we didn’t know what to say.