Tuesday, November 25

Australian market wrap

Against a backdrop of modest declining business profits, combined with a marked slowdown in global production and falling sales, economic forecasters are becoming more and more bearish and dire as each day passes. However as individuals and corporate save more, the slack in investment can be ameliorated to some degree by increased spending from reserves by the government sector on any number of very worthwhile investment projects which will have beneficial multiplier impact on their local communities. Hence it is in an excellent position to ensure large scale initiatives start to make some impact in countering the daily swag of negative thinking. The purpose of this posting is to examine the current state of play in the Australian economy and its effect on sentiment in our markets.

Risk of a housing price collapse

One identified risk relates to the relatively high level of private and consumer debt (linked to existing high house prices) and the adverse effects of a severe diminution or collapse in house prices on the solvency of our lending institutions. Lending by our instructions has for the most part been responsible and our defaulting provisions allow mortgagors in bankruptcy (unlike the USA where mortgagees are only linked to the property which was the subject of the mortgage) to pursue all defaulter assets in any recovery action. Hence mortgagees are much more likely to try and keep their homes during periods of economic hardship. Mortgages are also predominantly written on the basis of variable type interest rates which are currently declining rapidly. The risk of higher unemployment will cause concerns of course but there is also a severe shortage of housing stock supply which ensures any increase in stocks can comfortably remain below underlying sustainable demand.

It’s much more likely there is a softening in house prices in the order of say an annual decline of 5%. If that was to continue over the next 5-10 years it would be ideal (although unlikely) to ensure housing affordability was restored to more sensible sustainable levels.

Risk of a Business Lending collapse

The danger on the business front would be if banks shut off existing lending for investment projects to the extent such action might turn a recession into a depression. At the moment considerable press coverage is devoted to concerns about whether companies or individuals will continue to be financed. This is despite the fact our banks remain in good shape and are rated amongst the top in the world. The fear about lending being terminated or cut back is not borne out by any data or reported by any viable companies, but rather it is all about why it might happen.

Central bank governor Glenn Stevens summed it up well in a speech last Wednesday night in his relatively upbeat assessment of Australia's economic prospects ………….."Given that we have that scope, and given the underlying strengths of the economy, about the biggest mistake we could make would be to talk ourselves into unnecessary economic weakness,"

What’s causing our market downturn to mirror the USA?

Share markets in Australia continue to plunge. Australian shares have fallen nearly 50% from its peak last year without corresponding falls in profits. Many large Fund Managers see the nexus between reduced demand from the USA (confirmed to be in the middle of a very deep recession expected to last at least until the 3rd quarter of 2009) and the flow on effect to the Asian region including very adverse effects for Australia.

There seems little appreciation of the fact that in many of our service, manufacturing and exporting industries price contracts with customers are negotiated either on a yearly basis or even over several years and hence the dire predictions are simply not possible within the short periods anticipated. Asian economies such as Japan and Honk Kong are currently in recession whilst others are in decline which has not helped sentiment about the Australian economy.

Nevertheless I think it’s been just one factor amongst many that has caused Fund mangers outside Australian to dump Australian stock indiscriminately across the board. We represent only a small proportion of the total world market and hence it’s relatively easy for it to be oversold within a simplistic regional response to risk.

Listed below are other factors weighing against the Australia market.

Effect of an Aussie weakening dollar-The situation is also not helped by the weaker Aussie dollar, (historically it has always been linked to commodity prices and hence rises and falls with commodity price movements ) acting as a temporary catalyst to defer overseas investors investing in stocks here, until such time as the currency confidently stabilizes. Although we have seen commodity prices collapse the lower Aussie dollar also translates into much larger export receipts which offset what otherwise would translate into reduced export earnings.

Further reductions in interest rates- Australia will be further reducing our interest rates which puts a floor under any currency movement to the upside. This reduces buyer interest in our stock, fuelled by unsubstantiated fears of offsetting currency deterioration. If the currency was to temporarily reduce to below the rate of 60cents US than the Reserve Bank has already indicated its intention to become buyer until such time as it regains its value.

Inflation and the danger of stagflation -Our annual inflation was five per cent in the September quarter and will remain high because of our falling dollar which has reduced from a high of 98.49 US cents in mid-July to a 5 year low to around 62 to 64 US cents. Consequently this means lower fuel prices arising from the reduced cost of oil will not be fully passed on at the bowser price. Also that reduction will be offset by increased food and imported price rises as consequence of the exchange rate. Hence the danger for stagflation is zero.

In a nutshell the fall in the USA mirrors adverse economic developments whilst those same falls (in terms of magnitude) on the Australian market are largely anticipatory. The danger is what is anticipated may turn out to be a self fulfilling prophesies.

Margin selling –The market is also being held down by a surge in margin calls (Margin lending refers to loans to buy stock where the loan is not to exceed certain percentage of the current value of the stock – usually the loan is to be a maximum of 60/70%) in good quality stocks when there is insufficient confidence for the bargain hunters to enter the market and buy up those stocks at bargain basement prices. Paradoxically it is the better quality companies who have sustainable responsible operations which were subject to the initial margin lending proposals which perversely, by virtue if that strength now bear the brunt of indiscriminate forced selling.

So in conclusion I return to the statement by our Reserve bank governor, which I fully endorse ‘"Given that we have that scope, and given the underlying strengths of the economy, about the biggest mistake we could make would be to talk ourselves into unnecessary economic weakness,"

Notwithstanding I think (as a consequence of the recent considerable financial wealth destruction, combined with falls in commodity prices flowing from recessionary impacts in the USA, Europe and Asia ) it maybe difficult to avoid a very short recession in Australia but it need not be anywhere near as bad as is feared. In the meantime we could still see further weakness in our share market driven largely by anticipatory fears until there is a return of confidence and a return to uncommon common sense.

There is also an irrational view that successful businesses and sustainability depends upon continual growth for any prosperity, similar to that other equally perverse idea that you have to populate or you will perish. Nothing could be further from the truth.

If I have only learnt one thing in business it is this; success is not dependant upon size or growth or coups or cleverness but has more to do with being in the right place at the right time. When your not there your success is contingent on being able to hard peddle and adapt to both changing circumstances and the environment whilst understanding what your core competences are and how they are attractive to customers. In fact that has always been the case and in essence it is not that much different to nature which we attempt to mimic in many different subtle ways.

We are going through a deleveraging period to return us eventually to a more sustainable economic position which means we will be less reliant on credit and more on investing from a savings pool, not a borrowed one.

Within that context companies and individuals can prosper just as markets will finally mirror that prospect.

Tuesday, November 18


Joseph had the blessing of his father’s hands
Always at his loving side
Brothers jealously could not stay inside
Emotions were a rising tide

It was that fateful day, Joseph at play,
Lured him away and sold him on to slavery
To be at Pharaohs feet
Dipped his coat in wild animal blood
And lay at his weeping father’s feet

But with Pharaohs dream he did foretell
Released from his binding chains
To rule over all his lands and his stock
While shepherds tend their grazing flocks

It was that fateful day, Joseph at play,
Lured him away and sold him on to slavery
To be at Pharaohs feet
Dipped his coat in wild animal blood
And lay at his weeping father’s feet

Joseph’s graineries all overflowed
For the days were coming he foretold
When a mighty famine would grip the land
Nations will come, to beg at his feet

It was that fateful day, Joseph at play,
Lured him away and sold him on to slavery
To be at Pharaohs feet
Dipped his coat in wild animal blood
And lay at his weeping father’s feet

When his brothers came in mortal shame
To beg at their younger brother’s feet
He forgave them all and rejoiced
As they flourished in pharaohs promised land

It was that fateful day, Joseph at play,
Lured him away and sold him on to slavery
To be at Pharaohs feet
Dipped his coat in wild animal blood
And lay at his weeping father’s feet

His fathers joyful tears, like raindrops
Washed away all their fears
And to renew the human race

It was that fateful day, Joseph at play,
Lured him away and sold him on to slavery
To be at Pharaohs feet
Dipped his coat in wild animal blood
And lay at his weeping father’s feet

Thursday, November 13

oil pricing

At the present price of around $57 per barrel the oil price has fallen quicker than I would have anticipated which is due maybe to futures traders activities, or perhaps more likely to be a combination of weaker demand and speculative trading in oils non transparent traders market. A trader need only put down a very small amount and borrow the rest to create the highly leveraged position which can help either drive prices up or down.

I don’t believe speculators serve any useful purpose other than to profit by manipulating a market at the expense of normal supply and demand principles. In turn this makes sensible investment decisions virtually impossible which is much more damaging than most folk realize. I think we need to clamp down on these jokers instead of just blaming oil producer nations for high prices that may have nothing to do with them. Bear in mind also the current oil price is 60% below its long term inflation adjusted price.

In so far as the speculation is concerned I think even the hardest headed economists can no longer be in denial, they must now all freely admit to the huge price distortions that have permeated markets for some considerable time. The speculators had the added advantage that many were lulled into a false sense of certainty about the inevitability or rising oil prices. Many advocating the ‘peak oil theory’ confirmed authoritatively we had reached the so called tipping point (falling supply could no longer satisfy existing demand) so it was virtually impossible for prices to diminish. Well so much for the immeadiacey of that theory; it looks like the price has fallen by 67%. The speculators also knew that we don’t have the information about the worlds known reserves as most producer countries refuse to divulge them. We don’t even know what the stockpiles of oil are applicable except in the USA. Even so, personally, I think oil will increase in a few years.

But before investors are asked to fork out their hard earned money into alternative energy enterprises by way of direct investment in shares or governments concede substantial subsidies for consumer to pay higher utility costs for government funded alternatives they also need to make sensible estimates about the long term price of oil. Make a wrong guess and it will bankrupt many investments whose prospectuses are reliant on false assumptions or severely disadvantage consumers in some countries should oil be so much cheaper than what was estimated. Anyone betting on $35 a barrel?

A long time ago Allan Greenspan argued very strongly to congress against any form of regulation of derivatives trading for the relatively newly formed but growing insurance derivatives called credit default swaps. Hence the market for these insurance based derivitives were never transparent nor was it regulated.

If there is one golden rule that has since been learnt about markets during the current unprecedented turmoil it is the critical need for transparency and regulation in all markets, including oil.

Simply put the need to know what’s going on so as you give yourself the opportunity to intervene, (as undoubtedly you will need to do) and have needed to do in all of the so called free markets from time in memorial.

Sunday, November 9

What’s the long term price of oil?

In a matter of a few short few months as oil prices skyrocketed to peak at $150 a barrel, there was no shortage of expert analysis suggesting the world was on the cusp of the end of the oil age.

What was envisaged by many pundits was the world was to suffer from dwindling supplies and continue to be buffeted by price increases of the order of $200 to $250 barrel and beyond. At that time when I last revisited the ‘peak oil Theory” in my post in August this year I concluded there wasn’t enough empirical data available to reach any reliable conclusions, but if anything prices were likely to reduce to somewhere below the $100 per barrel in the shorter term although the overall peak oil theory remained creditable enough longer term.

But since then oil has tumbled to currently test $60 barrel, and may even fall as low as $50. Recessionary fears have had an effect but are insufficient in themselves to justify a 67% decline. Rather it has been the speculative investment in commodities, including oil,(seen as a hedge against inflation and a weak dollar) that caused both its rapid increase and subsequent collapse as commodities sunk. Hence the collapse of commodities precipitated an unwinding of these positions which accounted for most of the initial recent rapid price decrease just as its reverse impacted similarly on oils previous upward price spiral.

Oil is also not subject to the usual price mechanism, e.g. as prices rise supply will increase to meet the demand and as prices fall supply will decrease. That’s because many of the larger producer countries economies are so dependant upon oil incomes that they will continue to pump oil regardless of falling prices and may even accelerate production( with the exception of OPEC) during periods of declining prices to make up for the shortfall in income by increasing volume. Hence it can fall more than the fundmentals would suggest.

So it would seem we are now somewhere near its long term price (which is well below the long term rate of inflation) but it will decline in the short term as recessionary impacts further curtail demand

However when there is a sufficiently large enough rise in its price previously uneconomic fields become feasible and this is true for much of the heavy shale mining which is now prevalent in Canada.

Cart who has a particular inertest in Canada , having resided there recently, sent me this article - Ironically, As Price Per Barrel Drops, American Oil Supply From Canada Imperiled
which further highlights the intricate web of supply that make price predictions under the 'peak oil' theory problematic.