Today marks the day Australian house prices begin to climb again. Manufacturing will rebound and layoffs will cease. The stock market will soar. Maybe the oceans will cease their rising and our hot little planet will be saved as well. And all of it will be thanks to the Reserve Bank of Australia (RBA) cutting interest rates by at least 25 basis points.
That’s the build-up today’s announcement from the RBA has received from the press. When the expectation is so emotional and non-rational it’s bound to be disappointing. We hope Glenn Stevens raises rates just to throw everyone off. But either way, people should know by now that you can’t really make the world a better place or the economy a more efficient machine by hitting the accelerator (cutting rates).
But if you don’t know that by now, you’re doomed. So good luck!.
There is real growth and there is fraudulent growth, according to Markets and Money founder Bill Bonner. Real growth comes from taking inputs — labour, capital, energy, raw materials — and turning them into something people want, preferably something that’s useful or maybe beautiful. This growth comes from enterprise, but requires all those inputs, not least energy.
Fraudulent growth comes from debasing the currency, increasing the money supply, and expanding credit. You generate the appearance of economic activity by hosing down the economy with money, much the same way you’d pour gasoline on a fire. It’s bright, hot, and loud for awhile. But the only way to keep it going is to pour more on the fire. And even then, all you’re doing is creating an incredibly warm sideshow. It’s not real growth.
The real growth stories in Australia are energy stories. The real money in the share market was made telling these stories last year. And we’re not shy about saying we published our story on the shale gas firms of the Copper, Canning, and Perth basins in the June issue of Australian Wealth Gameplan last year (2011).
Matt Chambers is on to the story in today’s Australian. He reports that,
‘Improved drilling technology and higher prices have made previously unobtainable and uneconomical shale-gas reserves accessible, and the US has gone from having a gas shortage in the middle of the previous decade to now having a glut. Australia is seen as having similar potential, although the quality of the shale is yet to be fully tested and a lack of infrastructure and drilling equipment mean big gas flows are a long way off and will be more expensive.’
All of that sounds right. And after we updated the drilling results for our shale recommendations in our Friday report to AWG readers, one of those readers admonished us that, ‘Not all gas is equal.’ You can say that again. A year ago, it was enough to know this could be ‘the next big thing’. If you’re investing (or speculating) today, you need to know more about the petroleum geology of the key permits areas owned by the key companies.
In crude terms, it comes down to ‘wet gas’ versus ‘dry gas’. Wet gas is another way of describing natural gas liquids. Ethane, propane and butane can be liquefied when compressed. Once liquefied, you can transport them along pipeline networks. Ethane is the feedstock for the plastics industry (it becomes polyethylene).
Wet gas is more valuable than dry gas. Dry gas is 80-95% methane. Mind you, dry gas is perfectly suitable for say, combusting in a power plant to drive a turbine that generates electricity. Our hunch is that Australia’s vast, mostly untapped unconventional natural gas resources will eventually be used for this purpose. But they have to be located, explored, drilled, defined, and produced first. That’s the state we’re at now.
Incidentally, of the shale stocks we’ve tipped in AWG, half are up and half are down today. By the time these stories make it to the inside of the paper, they aren’t new anymore. That means newspaper stories don’t drive share price gains. Drilling and production results do.
The moral of the story: if you want to capture the early gains in exploration stocks, you have to take risk. Equity investors are rewarded for this risk, historically, through the equity risk premium. That’s the return you get in stocks over and above the so-called ‘risk-free’ rate of return you’d get in a government bond. You’re compensated for your adventurousness with an extra reward — but only if you’re right.
The diabolical aspect of a low interest rates and credit bubbles is that they flatten out this equity risk premium. In other words, you’re not really taking any risk as a share market investor when you’re counting on easy money to lift all shares higher. You’re just trend following.
Still, doing the hard work of securities analysis (like Greg does) or the risky work of trying to find stocks that have real assets (like Alex does), or the even riskier work of finding companies that have disruptive business models or technologies (like Kris does), is worth it. It’s worth it because if you’re right, you’ll capture a lot of the early value as these stocks are re-rated.
You can take the safe path and sit out the risk taking. But don’t expect to get compensated for it. The years of easy double digit returns in the share market from a commodity and China boom are over. Investors who want bigger returns will have to take more risk and work harder.
But you can count on the government and the financial services industry to counsel you otherwise, we reckon. The risk to them is that if you work harder you’ll begin to think for yourself.
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From the Archives…
How to Use Preference Shares to Become an Absolutist Investor
2012-04-27 – Nick Hubble
Why Politicians Can’t Solve Economic Problems
2012-04-26 – Bill Bonner
2012-04-25 – Greg Canavan
Investor Choices – Do You Have a Lifeboat or a Bottle of Brandy?
2012-04-24 – Tim Price
A Bankrupt Idea Whose Time Has Gone
2012-04-23 – Dan Denning