Monthly Archives: October 2014

Straya T’day 14/10/2014

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Iron ore is back!

I noted in a post on Friday that signs were suggesting the worst may have past for the iron ore miners this year.

Well, spot really turned it on yesterday with the biggest one-day gain of the year.

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Here’s the latest from Reuters. There was undoubtedly a little short-covering happening in yesterday’s move. Dalian futures rose again today but the most-traded (Jan) rebar contract was flat.

The larger debate now is whether this move heralds a pronounced rebound as in 2012, when prices almost doubled between early September and late December. I have previously detailed why I think the restocking rally will not be anywhere near as aggressive this year, and that this view can only be undermined by a ‘big bang’ stimulus in China.

The recent bullishness has been stoked by an apparent loosening of credit conditions in China. This should support mortgage lending and support property prices, however I remain highly sceptical that the government will allow credit to flow freely enough that it reboots the boom. I therefore see current measures as aimed towards arresting the slide in property, which has been turning increasingly nasty of late, rather than reigniting the excesses of previous years.

NAB business confidence slips again

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Straya T’day 10/10/2014

Arise, Sir Vol!

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Chart from John Kicklighter

We’ve finally been treated to some decent volatility in the past couple of months. Although it was initially concentrated in foreign exchange markets as the USD rediscovered its mojo, we’re now seeing sizeable moves across the asset spectrum.

We’ll start with FX.

It’s no secret that the USD has been on a rampage these last couple of months (I’m preparing a post on the history of the USD post-Bretton Woods in which I’ll try to contextualise the current outlook for the dollar and its ramifications).

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Here’s how it’s looking on a long-term basis:

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The proximate cause behind the timing of the rally was somewhat unclear, but the overarching case for a stronger USD has been sound for some time. The US is in the midst of the longest period of uninterrupted jobs growth in its history, at 55 weeks and counting, and the unemployment rate is down to 5.9% (here’s the latest jobs report). However, countering this is the fact that the decline in the unemployment rate has been largely accounted for by the decline in the participation rate, suggesting considerable slack remains in the labour market.

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Some of this is certainly a consequence of retiring baby-boomers, although the timing and pace of the fall, coinciding as it did with the onset of recession, makes me a bit suspicious of this as the dominant explanation. Nevertheless, the market excitedly seized on a paper from the Fed last month arguing that the fall in labour force participation was largely structural; the implication being that labour markets would tighten without a big rise in the employment-to-population ratio, and the Fed would be compelled to adjust monetary policy accordingly.

If this is the case, it’s not yet showing up in wage pressures. Inflation measures have been creeping up lately, but not in any concerning fashion. In any case, the strong dollar will knock these pressures on the head, should it continue to run as I expect it to.

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So although the US is improving, it’s hardly charging. The case for a stronger dollar has therefore centred on the miserable state of its peers. Germany is sinking into recession, adding to the persistent weakness plaguing the Eurozone, Japan is looking sickly after hiking the sales tax earlier this year, and China is doing its best to rebalance without detonating its debt time-bomb. Combined with the end of QE this month, the USD is looking the least ugly out of a pretty ordinary bunch.

Black gold

Many commodities have struggled under the weight of a resurgent USD, chief among them being the anti-dollar: gold.

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Gold managed to bounce off its double bottom at $1180, forming a triple bottom now. This is garden variety technical pattern which often would be interpreted as a bullish signal, but that’s certainly not how I’m looking at this market.

As you can see on the short-term USD index chart, the greenback gave up some of its gains this week as the Fed minutes showed some members were concerned about the negative impacts of weak external demand and the high dollar on the US economy. In truth the dollar really just needed a bit of breather after the run it’d had. This consolidation gave gold another kick up. It may be that gold finds a little further to rally, especially if equities continue to sell off, but in time expect critical support at $1180 to give way and gold to go much lower.

The entire ‘buy gold because the Fed is printing money, stoking inflation and trashing the dollar’ theme has been unraveling since early last year, as it became clear that QE would end with no inflation in sight and the dollar outperforming, rather than collapsing. Depending on the severity of the equities downturn and the followthrough on the dollar, I’d be looking for gold to break $1180 by the end of the year, heading below $1000 in fairly short order.

Oil has also been suffering under the weight of the strong dollar, although more importantly its fundamentals have been growing increasingly bearish. The US is awash with oil in a way it hasn’t been for decades.

US oil

This is the result of the shale and tight oil boom, which allowed previously inaccessible gas and then oil resources to be exploited. There are plenty of reasons to believe that this will be a relatively short lived spike in US production, but for now all you can do is recline and admire America’s capacity to revitalise itself at the most critical of moments.

Adding to the supply mix has been the return of Libyan crude to world markets, the stability of Iraqi output despite its dire geopolitical environment, and the disinclination among OPEC producers to cut output, as many assumed they would. This could well be a reflection of political tensions in the Middle East. The Gulf Arab states are embroiled in a vicious proxy war at present against the Shi’ite bloc led by Iran. Iran is seriously suffering with oil at current prices, giving the Arab states an incentive to maintain supplies and turn the screws on Iran. That’s just speculation of course; we’ll need to wait until the November meeting for a better gauge on OPEC’s response to the price slide.

Against the supply backdrop we have anaemic ‘growth’ in Japan and Europe, and signs of a meaningful slowdown in China, giving us a perfect storm battering oil prices.

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Energy stocks are being crushed accordingly, with the S&P energy sector index yesterday posting its biggest one-day fall since April last year.

The recent surge in US oil production has depended on high oil prices and continuous investment due to the rapid depletion rate of shale wells. This ought to provide a floor of sorts for prices. However, as we saw with natural gas a few year back, producers kept the gas flowing long after they were doing so unprofitably, simply because the cash flow was preferable to shutting down production altogether. This leaves scope for an overshoot on the downside. There’s also the aforementioned situation with OPEC to consider. On the demand side, I see little prospect of a substantial pick-up outside the US. Together with the stronger dollar, this adds up to a high likelihood of more pain ahead for oil.

Equities on edge

After flirting with the lower bound of its long-term channel earlier this year, the Salt&Peppa has decisively broken through support.

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It’s now around 5% off the September high, and looking like it has room for a proper correction (>10% fall).

If we take a closer look at recent price action, we get a better impression of how poorly the market has traveled this week.

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That’s three breaks of the trend line. The second rally back above support was provoked by the Fed minutes I mentioned before. It was a desperate rally and the swiftness with which it was rejected will be a shot in the arm to the bears.

The IMF meeting this weekend, at which a number of Fed members will be speaking, heightens risk of holding positions into the close tonight. It’s looking as though the various speakers, Vice Chairman Stanley Fischer in particular, will need to pull something generously dovish out of the bag to rescue equities in the short-term.

In some ways you’ve got to marvel at the manner in which this (potential!) correction in equities is unfolding. You’d be hard pressed to find anybody with even a passing curiosity in markets who isn’t aware that QE has supported stock prices. Likewise, every man and his broker has known that the end of QE at least risked a serious dislocation in asset markets. As the great Stanley Druckenmiller put it just over 12 months ago, “How in the world does anyone think when the actual exit (from QE) happens that prices are not going to respond?”

How indeed. Prices are responding just as so many expected them to, but not really in anticipation of the end of QE, but rather right as its happening. It’s a poignant reminder of the level of complacency that accompanies low-volatility, financially repressed asset markets, where the hunt for yield dominates over all other concerns.

Whatever happens with equities in the immediate future, it’s looking as though the days of leveraging up and exploiting yield wherever you can find it, with scarcely a care for the risk involved, is on the way out. With the global growth phantasm fading (again), and the end of QE to boot, markets are set to get much more belligerent and unforgiving.

Volatility is back.

Home sweet home

One consequence of all this excitement for us Aussies has been a sharp and most welcome drop in the AUDUSD.

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Similar to gold, AUDUSD bounced off the previous low set earlier this year. It then staged a heroic but short-lived rebound, which was smacked down ruthlessly. Hard to see support holding for long.

AUD-exposed firms with a strong export profile therefore remain the best prospect among Australian shares. However, I wouldn’t be in any great hurry to rush in, as the downside risks to equities at the moment are palpable. (Note that the chart below reflects after-market futures trading, the close was 5188.)

AUS200

With equities well down for the calendar year now, it’s worth taking a look at the sectoral breakdown within the market.

Unsurprisingly, the materials index (XMJ) has been getting pummelled this year. Financials (XFJ) are up slightly but they’ve had a rough ride of late as well, particularly as foreign money hastily bails out of all AUD exposure (which of course has hastened the AUD slide).

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Charts built using Yahoo Finance

Both consumer staples (XSJ) and discretionary (XDJ) are down year-to-date, and this is reflective of lacklustre consumer sentiment and subdued retail sales post-budget. Health stocks (XHJ) are looking healthy, although that’s almost entirely because of CSL’s rally in August after its profit beat and buyback plan announcement (CSL is roughly half the index).

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Industrials (XNJ) have mostly sold-off in sympathy with the market since early September. Energy stocks (XEJ) briefly joined utilities (XUJ) as the star performers of 2014, until the collapse in oil prices spoiled the party. This leaves the humble XUJ as the stand-out sector so far in 2014. The driver of the strength in the utilities space this year has been natural gas pipelines operator, APA. As Australia prepares to ramp up its LNG exports, APA has been in the box seat to exploit bottlenecks in gas transportation networks. Even after the recent broad market selloff, APA is still up around 20% for 2014.

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Steel-ore complex

Better price action for steel and iron ore today in China, with the most-traded rebar contract up 1.6% and Dalian iron ore up 2.3%. More in the usual place.

Here’s what spot is looking like at:

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Still fishing for a bottom.

There has been a noticeable thawing in the policy stance towards property in China recently, and if this helps property prices stabilise then it could provide the impetus for a bit of restocking by steel mills, bestowing upon us the fabled Q4 rebound. The trouble is, along with steel and iron ore, property is oversupplied to a degree it hasn’t been in the past; it’s going to take a truly massive credit splurge to reboot the bubble now. And all signs indicate the government isn’t stupid enough to do that.

Still, the worst may well be past for the iron ore miners in 2014. But they’d better pray the AUDUSD has fallen hard by the time the pain resumes in 2015.

The sorry state of Strayan stats

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Last month’s seasonally-adjusted jobs figure was wonderful, except for the fact that it didn’t pass the laugh test. As I said at the time, I more or less ignore the seasonally-adjusted roulette wheel and focus instead on the trend data, which seem to provide the most reliable reading on the health of the labour market. But the volatile seasonally-adjusted figure still presents a troubling breakdown of respectability at the ABS.

Yesterday they acknowledged as much. The 120k jobs supposedly created in August was an adjusted figure based on seasonal patterns which the ABS believed were present this time of year. Yesterday that figure was revised down to a more-believeable 32.1k, as the ABS has decided that seasonal influences of past years aren’t exerting themselves in 2014.

Here’s the latest reading on the labour market. The revised jobs gain last month has been largely wiped out, with a seasonally-unadjusted 29.7k jobs lost. The unemployment rate ticked up to 6.1%. 5.6k jobs were created on a trend basis and the unemployment rate held steady at 6%.

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The ABS isn’t exactly sure why previously observed seasonality is not showing up this year, however the following possibilities were offered:

It could have resulted from one or more factors including changes in ‘real world’ labour market behaviour, changes in the timing and content of the supplementary survey program (run in conjunction with the Labour Force Survey), the introduction of web-forms, the introduction of the new labour force questionnaire, or refinements to collection procedures.

Given the sudden shift away from the usual seasonal patterns, the ABS has determined that the usual seasonal adjustment process, based on patterns in previous years, is not appropriate for application for the most recent months’ estimates.

As such, they’ve set the adjustment factors to one for July, August and September, meaning no change has been made to the original data to reflect seasonality. If this sounds as though the ABS is groping about in the dark, then you’re on the same page as me. Only about .32% of the labour force is captured in each survey, which is fine, that’s how statistics works, but it bears remembering that any deficiencies in the collection and organization of the sample, either through incompetence or inadequate resources, can easily screw around with the output.

It certainly appears as though the problems at the ABS stem partly from a lack of resources. Both the current and the previous government have sought to reduce funding and squeeze greater efficiency out of the ABS. Whether this is the chief cause of the labour force survey woes, I cannot say. However I can say with no uncertainty that one of the proposed solutions to this problem would be bad news for Strayanomics. According to Hockey, a user-pay system for ABS data is “one of the things we’ve been actively looking at and I’ll be taking initiatives to cabinet in the next few weeks.”

The ABS has a budget of a little under $400m. This is less than .1% of the Federal government expenditures. I am quite aware of the pressures on the Federal budget, indeed I have been pointing out for some time that they are in considerably worse shape than many commentators recognize. There are many bones of contention when it comes to the current government’s strategy for reducing the deficit, and these are mostly political questions around which segments of society should be targeted for tax hikes and spending cuts.

Perhaps some would disagree, but I do not consider adequate funding of the ABS to be a debatable political issue. Access to sound economic statistics is paramount to the government’s entire macroeconomic policy mandate. The ability to craft and implement effective macroeconomic management is all the more difficult if you don’t have the clearest picture possible of conditions in the economy and the outcomes of policy choices. So while it’s hard to see the government allowing further funding pressures to hinder the ABS, adopting a user-pay model to access the bureau’s data would be a regrettable solution.

Firms are afforded free access to ABS data and may use it for research purposes to generate revenue. They would be inclined to pay for that data, assuming it is integral to their business. For a blog like Strayanomics, with no suggestion of it generating revenue except in moments of pure jest, I can tell you it is a pain in the ass trying to get data at the best of times. Publicly available statistics are therefore the life-blood of amateur analysis. They offer any interested citizen the means to check for themselves whether the pronouncements of the media or politicians bear any resemblance to reality.

Discouraging such inquiry by charging for basic information about the state of our nation would be a sadly regressive step; a blow to the Open Society.

RBA Statement

No change in the cash rate today, as expected.

Here’s the full statement.

Some takeaways:

  • Chinese property a drag (albeit it with strong indication of a changing policy stance, whether it is effectual remains to be seen)
  • Volatility up globally, though still not elevated by any means
  • Mining investment is declining offset by a pick up by ‘other areas’ of private investment (other areas mostly being residential property construction)
  • Labour market data have been all over the place lately, conditions aren’t dire but softness remains (a great share of recent job creation has been centred on property construction)
  • Monetary policy is loose. Overall credit growth is moderate but being driven by housing investors
  • Exchange rate is down, but not far enough given the drop in commodity prices, and has further to fall to lift the moribund tradable sectors
  • Wage growth is more or less nonexistent, and inflation not concerning (appears RBA is happy to ‘look through’ a rise in import prices as the currency falls in value, rightly so in my view)
  • On present indications, the most prudent course is likely to be a period of stability in interest rates.

Nothing to get too excited about either way at this stage.

As I said when I launched this blog and soon thereafter began a series on Australian interest rates:

In a country like Australia, changes to interest rates tend to be quite effective in influencing economic conditions. Lower rates stoke borrowing, asset prices and consumption, giving way to higher rates, and vice versa. Why then are we drifting across a calm blue ocean of low interest rates?

Primarily due to the uneasy schism that has emerged in our economy. On the one hand we have the descent from what has almost certainly been the biggest terms of trade/investment boom in our nation’s history. On the other we have a raging house bubble boom. Which force prevails in this struggle will determine the short- to medium-term direction of interest rates.

For now, the RBA is happy to sit and wait for further indication of which force is gaining the upper hand.

Straya T’day 7/10/2014

RBA day

Well, what a day to return to the world of econ after a long weekend of agreeable company and responsible drinking.

The Treasurer has acknowledged that the terms of trade bust is likely to weigh heavily on the budget in the years ahead, which seems to have spooked bank stocks (Australian banks funding costs are dependent on the health of the public balance sheet). Although I am in agreement on the outlook for commodity prices, it’s worth bearing in mind that the budget in May expected the Australian dollar to remain at .9300 against the USD. The large falls in the AUDUSD during the past couple of months will therefore help to cushion the impact of the prices for key exports (by supporting company tax revenues).

The RBA will chime in shortly with its view on the state of the economy. There’s effectively zero chance of the RBA changing the cash rate today, meaning my dovish forecast will survive another month.

Perhaps the most impactful development in the last couple of weeks has been the RBA’s Damascene conversion to Church of Macroprudential (see here also). Bloomberg picked up the story on the weekend, with RBA Makes Hawks Cry With Turn From Rate Tools: Australia Credit

The article quotes forecasters who’ve pushed out their expectations for rate hikes due to the change in policy from the RBA.

TD Securities and AMP Capital Investors Ltd. joined traders in drawing back from forecasts for early rate increases in response to policy makers’ hardening rhetoric on curbing mortgage lending to housing investors. RBA Governor Glenn Stevens is forecast to keep the benchmark unchanged at a record low tomorrow.

It is indeed true that the RBA’s adoption of macpru tools, if they prove successful in cooling the investor housing feeding frenzy, will reduce the need for higher rates. To recap my well-worn view on Strayan rates: the unfolding terms of trade shock and the decline in mining investment are currently jostling with a robust housing sector, concentrated especially in Sydney and Melbourne, for primary influence on the short-term direction of interest rates. So if the RBA can find ways to take the froth out of the housing market without raising rates, this favours interest rate doves.

We know what the situation looks like for iron ore and mining investment.

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Turning to the bullish influences, activity centred on the property sector is clearly very strong at the moment, as we can see this in the latest reading on construction activity from the Australian Industry Group.

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Unlike the manufacturing and services sectors, construction is charging (above 50 indicates expansion):

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It is good to see a supply-side response in the property sector, since structural supply constraints have hampered the market for years. But it must be remembered that this cannot sustain the economy indefinitely. Once a house or apartment is built the positive impact on the economy has mostly passed. Of course, it provides a place to live, but living in an apartment doesn’t support jobs; building it does. Therefore other sectors, especially the non-mining tradable sectors, need to be revitalised to fill the void left by the declining terms of trade and support jobs in a sustainable manner. To achieve this means substantially lowering the real exchange rate. Raising interest rates now would severely diminish the prospects for a continuation in the currency’s fall, and make the goal of a lower real exchange rate all the more challenging.

It would be nice to suppose some excitement will be injected in monetary policy after soporific missives from the RBA, but I suspect they will be content to stand pat for the rest of the year for some time yet.

Straya T’day 1/10/2014

National Day brings peace and quiet…

…unless you happen to be occupying Central, in which case you’re embroiled in the thick chaos of rebellion.

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For Aussies at least, China’s National Day holiday week offers a welcome respite from the daily torment inflicted on us by the Chinese commodities exchanges.

So no iron ore or steel news today; for once this Straya T’day post will be all-Strayan.

Retail sales miss

Retail sales for August came in lower than expected, printing a 0.1% seasonally-adjusted gain over July, on expectations of +0.4%. Retail turnover was 5.1% higher than August last year. The respective trend figures were +0.2% and +5%.

The yearly gain in sales still looks fairly healthy. (Both charts use trend data.)

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However much of this strength reflects the surge in the latter half of last year, which is still ‘passing through the snake’.

Monthly figures have been subdued for most of this year.

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The budget didn’t do much for consumer sentiment, and this has no doubt been a key factor in households’ reluctance to loosen the purse strings. It may also be a function of the deteriorating outlook for iron ore, which has been reported more widely and with an increasing acceptance that the situation is not likely to improve materially in the foreseeable future, other than perhaps a tepid restock in Q4.

Manufacturing PMI surprises

In fairness, Australia’s manufacturing PMI surprises me with every release, since its very existence implies that manufacturing has survived another month.

It’s pretty bleak reading, although that’s nothing out of the ordinary. Until Australia’s real exchange rate significantly devalues, there’s little hope of a broad-based revival in business expenditure in the manufacturing sector.

Mining capex unwind is upon us

Along with retail sales, the ABS released quarterly data today on engineering construction work, which is an important measure of mining investment activity. Combined with the flagging terms of trade, the downturn in mining investment is the chief headwind facing the Australian economy over the next couple of years.

Overall, the value of work completed declined 2.2% in the June quarter from March. The value of work completed by the private sector declined 1.9% to $23,130m.

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So far the descent has been fairly smooth, however this is set to steepen rapidly over the next 6 to 12 months.

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Of course, all this investment is going towards substantial increases in Australia’s export capacity, primarily in LNG. So will the decline in investment give way to a boom in exports, such that the net impact on the economy is benign?

Not quite.

It’s important to remember that Australia’s mining boom over the last decade has been enriching beyond precedent because it was a boom in profits. So despite the vast majority of Australia’s mineral resources being owned by foreign interests, the profits generated by these firms greatly increased company tax receipts and royalties revenue, much of which was then passed on to households in the form of tax cuts and transfers. Booming profits also saw wages in these industries skyrocket, providing another conduit for the windfall to flow into the Australian economy.

The ‘boom’ in LNG exports after the investment phase passes and supply ramps up will be quite different. These mega-projects in Queensland, WA and the NT are going to be about the most expensive sources of LNG on the planet, placing them at the other end of the ‘cost curve’ to Australia’s iron ore majors (see below). This means that current LNG prices aren’t going to deliver the massive profit margins that characterised the mining boom. So although Australia’s export volumes will surge, supporting GDP growth by improving the trade balance, the income effect on Australia will be negligible when compared to the iron ore and coal booms of the last decade.

The gas has mostly been sold on long-term contracts. However, what happens to spot prices once the gas starts flowing remains to be seen. There was already a mini-crash in spot prices this year during the northern summer…

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…and yet the ramp-up in Australia’s LNG exports has barely begun.

LNG exports

If spot prices do fall significantly below contract prices, there will be immense pressure on suppliers to renegotiate those agreements.

Here’s where Australia’s LNG projects sit on the cost curve (in orange).

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Clearly, if spot prices drop much below the levels they did during the northern summer, and stay there for any length of time, a lot of these projects are going to face serious trouble as buyers attempt to wriggle free of contractual obligations.

Yet another reason why we’re fervently cheering the Australian dollar lower!