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The Close – 30 Nov 2016
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Video Transcript below
Video Transcript: Sky Business – The Close – 30 Nov 2016
Carson Scott: It is the 30th of November, very nice to have your company as we look at what’s going on in markets to the minute.
Those comments doing nothing to see the banks themselves suffer today, indeed just like yesterday, they stood their ground. Let’s have a look see just what looks like a weaker finish though on the market, down some four tenths of a percent. And to guide you through every move that it’s been making today in China and of course for what’s ahead, Tim Rocks, principal of Rock-on-mics and David Novac from Wealthwise Education.
Gentleman, great to have you with us. Lots and lots and lots of moving parts. Tim, welcome to the show for the first time this afternoon as well, alongside. Here we have OPEC in frame, energy is a big talking point. You go around the region at the moment and headlines in Singapore I can tell you, every single paper is crowing about it. Are we getting too ahead of ourselves, or have we, on energy, and what OPEC can do?
Tim Rocks: I think there’s just too much focus on OPEC. OPEC, I think is over. OPEC has lost its credibility, it’s lost its power, really, over the last year or two. Particularly late last year really, when Saudi-Arabia really signalled the end of it, I think, by increasing production at that point. By talking about the floating of those assets in London.
I think there’s too much hype about this. I don’t think, really, what’s been talked about this OPEC, meeting tonight is really going to make much of a difference in the longer term.
Carson Scott: Which is ironic, because the member states themselves, and you’d call out the Saudis and Aramco, that future listing is when not if, and also Russia. You know, not a formal member, but sits there and, it’s been pumping like crazy. And its economy is really on the mat.
Why are people not blinking? And seeing the sense, and actually some cessation in production?
David Novac: Well, everybody’s got a self-interest here. I think in the ore market, that’s the thing. There’s a lot of self-interested parties.
Carson Scott: But is there not one common thing, that less is best? I mean just to paraphrase, less is best for all who produce.
Tim Rocks: But of course, OPEC has significantly changed. Their power has so dramatically changed over the past few years. Look the big change in US, in production over the last five years has been US production. That massive, massive increase in US production.
Carson Scott: Now net exporters.
Tim Rocks: Yes, exactly. So, you can only operate a cartel, if you have control of the market. You know, very small number of players that you can actually talk to, look in the eyes, and negotiate with.
Carson Scott: So the only real beneficiaries of this are, frankly speaking, hotels in Vienna, which is great, for that economy.
Tim Rocks: And the whole other issue here is that US inventories are absolutely enormous at the moment. And can potentially, sort of swamp everything. So, I don’t know, the idea that you are going to get a big increase in prices here, I think is kind of wrong.
But even if you did, is that a good idea anyway? Because we know there’s a whole bunch of marginal production. Of shoal. Of those tar sands kind of stuff in Canada. Just waiting to come in at about $60, so what can you actually achieve in all of this.
Carson Scott: Clearly nothing, it’s rhetorical of course. Back on the producers themselves here then today, David. Beaten down, back to back, from where they had been, if you want to make a comparative play on it. Are there any screaming buys, given that backdrop story from Tim? Or still you’d say, just keep calm and carry on, somewhere else?
David Novac: Well, I have been bullish on this sector for the last three to six months. But taking profits after this big run-up we’ve seen particularly in Santos and Woodside. So, look, some of the juniors I really like. I think there’s opportunities in that junior-mid category sector. Like Sundance Energy, would be one that I particularly like.
You know, so there’s, well it all depends on the hedging policy as well. As Santos came out and said they’ve hedged so many percent of their oil, I think at $52 or thereabout, for the next 12 months. Which I think is great, but they probably left it a little bit too late compared to where the oil price was. Especially given what their debt scenario was.
Carson Scott: Because that seems quite heroic. Given what you’ve been saying about a 60 range and then marginal producers are back in play. At 70, again, that’s implying that that doesn’t necessarily happen, or imagines that it doesn’t happen does it not? There’s a gap between where we’re at and 70, clearly.
David Novac: Yeah, but see again, you know, Santos, you know, if they can, to me that gives us a level of comfort for investors. Like I said, what company takes on five, six billion dollars in debt in a commodity that’s highly volatile and doesn’t lock in the price to at least repay the debt. And that was their big mistake.
So, they’ve come in now realising they don’t want to play with the oil market, they want certainty, and that’s what they’ve done with the next 12 months. That’s why Santos shares have been holding up quite well.
Carson Scott: Let’s go outside that space, let’s talk banks for a moment. Because today ANZ was front and centre, that’s to say Shayne Elliot out talking, and indeed, as they looked to have finished, ANZ out in front with a one percent rally, so clearly, the market taking some comfort from what was said. Let’s just listen to maybe a fraction of those remarks at a Reuters conference today.
[00:05:51 News excerpt starts]
Shayne Elliot: Banking margins have actually continued to come down, it’s almost a straight line. And the only, there’s a small blip in there called the GFC. But they’ve continued to come down, and customers in Australia, every, have essentially gotten a better and better deal over that time.
And what’s interesting about that, is that’s true if you look at total revenue in our sector over our balance sheet, our average interest earning assets, so fees, the whole thing, not just the classic definition of margin. That’s halved as well. So, what the Australian banks have done a really good job, what has their response been to that? Well, shareholders have taken some pain. Over that time return on equity in our sector has gone from 20ish percent (as an industry), down to the low teens.
So, shareholders have taken pain. And actually, the other thing we’ve had to do is take out a lot of costs. We’ve got a lot more productive.
[00:06:43 News excerpt ends]
Carson Scott: Yeah, what he didn’t mention was as well, they cancelled the employee share bonus for 2016, so, that’s not a nice sector thematic remarks from Shayne Elliot, Happy Christmas, but no nice, or handshake on it. If you’re in house at ANZ.
What do we make of it? Let’s face it, the ROE was running at levels that internationally were way out of kilter already. So, is that just part of a rerate that was needed?
Tim Rocks: Look I think the real challenge with the banks, is that the only real business that is firing is their traditional mortgage business. Everything else is under really significant pressure. The business lending is dead.
Carson Scott: Even for NAB?
Tim Rocks: Yeah, for NAB. There’s no business lending. There was credit data out today, businesses are not lending any money. The financial planning, wealth businesses are under significant pressure. The margin pressure coming through regulatory change, through some of these disruptors like Hub24, really attacking that sort of platform business.
So, you’ve been narrowed back to the mortgage business. Which for the last two or three years, fantastic. And it’s really sort of supported them. But the big question mark is you go for one year or two, if you get into a period where we’re raising rates, the margins are under further pressure and the volumes fade away. What have you got left then?
Carson Scott: And, in that space of time that you’ve just reference, David, we’ve had the sell down by NAB of Clydesdale, we’ve had the retreat now of ANZ largely from Asia. So, they’re all going, you know, like vultures, for one, ever decreasing slice of the pie.
And if immigration doesn’t hold up, because we’ve got a new dynamic in the Senate, we’ve got new nationalism, if you’d like to paraphrase, the one nation story. What does that do to demand, to Tim’s point. On home lending?
David Novac: Well, especially depending on what happens on interest rates. It’s, at the moment you’re seeing how bond yields have moved up globally. So, what does that do for our market going forward, and cost of funding for the banks as well. And the Aussie dollar. But what the RBA does, at its next meeting, inflation expectations, that’s going to be a big factor to mix in with all of it. I think is where the higher interest rates are coming, or whether there’s going to be any cut for the cuts.
Carson Scott: We were discussing this yesterday. Here we have ANZ, the lowest earnings since 2011 announced recently. And they responded with a cut to the dividend. The rest of the sector though, is almost blinkedly pressing on, and not prepared to think the unthinkable on the divvy. Is that kind of an extend and pretend scenario upon the sector right now, right here, right now on the dividend?
Tim Rocks: Look I think it absolutely has to be. There’s no doubt, again, the other big question on that three to four-year view is capital and dividends. Now at the moment, all of the banks in different forms are trying to extend the capital problem by trying to sell assets. ANZ, most obviously with all its wealth assets, but of course it’s, as you mentioned Clydesdale for NAB.
So, that’s the big question. They can sort of fudge it by continuing to sell assets for two or three years, but sooner or later, they have to recognize the fact that the big fall in ROE that you referenced, must mean a lower sustainable dividend.
Carson Scott: By which level you mean what? In terms of percentage of the pay-out. Are we talking 60, are we talking something with a six in front of it?
Tim Rocks: I think 60 to 70 is reasonable, but actually, probably off of a lower earnings base, or certainly not a higher earnings base. I think probably a lower earnings base in a few years’ time.
David Novac: But also, let’s face it. The banks have had a period of nirvana here for 25 years. You know, we’ve had declining interest rates and a property sector taking off. And, the lowest provision for bad and doubtful debts. At some point you’ve got to think; does that cycle turn? You know, if there are higher interest rates, a slowdown in the property market.
Carson Scott: Well, is the cycle turning with the rise in the ten year? Frankly, if you look at that from an Australian mortgage level position, that’s kind of the level to be most appraising.
David Novac: Well I think people out there could now be expecting higher interest rates next year. I think that’s at the back of the minds of property investors and borrowers.
Carson Scott: Even if GDP stands still in the quarter? I mean it’s possible that we even did nothing. When we get those reads. Is that, to your mind a recipe for an RBA that does nothing?
Tim Rocks: I mean obviously, the RBA’s going to look forward and not backwards. And I think they will have been encouraged by some of the recent data, and some of the indications for growth next year, and certainly the big swing factor is going to be this business investment side. Some hope that mining and energy investment, which of course has been on a, you know, trajectory to zero, might actually start to pick up. Given what’s gone on with commodity prices.
We know that there’s some state level infrastructure spending. We hope there might be some tourism related spending. We need to build a hell of a lot more hotels given all the Chinese coming here. So, I think the RBA, but also bear in mind on housing as well, even though the data was weak today, we’ve still got a two-year pipeline of apartments that are going to be built.
Carson Scott: This is, what you say that almost as if it is a fait accompli. The pipeline’s not necessarily the same as proceeding with those plans. There can be, in the interim there can be cancellations.
Tim Rocks: I mean, there can be, but I think the market would have to look a hell of a lot different to what it is today for there to be cancellations. You know, we can raise the issue that higher rates might lead to weakness. But realistically that’s not on the short-term horizon.
And it’s certainly something that, you know, the RBA would address if they saw that coming. Because that would be pretty catastrophic I think.
Carson Scott: True, well the China connection to all of this. Because there’s no guarantees there that China doesn’t sort of send out, a bring it all home missive, to its expats. Do we see any sense of that likely occurring? The idea of, as there are outflows from the Chinese economy, potentially on a fare tightening policy into next year, that, in order to sure up their own defences, China looks to bring back money from, a lot its citizens that have made investments abroad. Up sticks come home.
Tim Rocks: I mean, they’ve obviously been trying to do that for three or four years through the anti-corruption measures and the most recent attack on the big whales for –
Carson Scott: Well we haven’t had a Trump for the last three to four years, have we? I mean that’s just a recent phenomenon the idea of Trump in the White House. A policy on tariffs for instance, on Chinese goods, that’s now a live option, not just a theoretical construct.
Tim Rocks: Yeah, but I think that might affect big spending, but I mean, I think a lot of the Chinese money coming in now is individuals relatively on a low level, that are sort of making sensible decisions. So, I don’t think that that money is really at risk.
Carson Scott: So, you don’t think it’s hot, it’s more settled?
Tim Rocks: Yeah, I mean, I think so. That’s a trend and you know, there’s been many attacks on that over the years, but they continue to find ways to, actually sort of, get that money out, so I think they will probably –
David Novac: And I think that the dark horse is Trump, again it’s what his policies outline, pre- his presidential election.
Carson Scott: Well in terms of the view, that that’s not going to, I mean, from what you just said there, that that’s not going to result in any tit for tat call out on what Chinese abroad should be doing with their assets.
David Novac: Yeah, well it’s just about his trade, I’m talking about his trade policy there, because he’s talking about imposing trade tariffs.
Carson Scott: Why would you do that though if it’s going to make life that much more expensive for your own citizens? I mean, the corollary of not having exports into the economy, and you’re not producing is to jack up prices.
David Novac: Oh, I totally agree.
Tim Rocks: Look, I mean, I think this trade stuff, to a larger degree, is going to be exactly like everything that Donald Trump has said before he got elected, which is, say what the punters want. Once you’re in we’ll sort it out.
The idea, and I think this is the greatest opportunity in markets at the moment, the idea that global trade is going to somehow decline, and contract and we’re all going to become domestic markets again, I think is just wrong. And selling off emerging markets on the back of that, being taken away, is just absolutely wrong.
If you look at what China is doing, this whole new silk road, one belt, one road initiative, what that means for China’s potential to massively, massively grow its trade, particularly into Europe over the next decade. There’s just absolutely no way that trade is going down. It’s going up, and it’s going up in a big way.
Carson Scott: Except that the road does run through ISIS territory, but that’s just kind of a, that’s just a geographical hiccup in the road, literally.
Tim Rocks: Well it massively runs through Pakistan. Pakistan is the enormous buyer on the one belt, one road. Because the quickest way to get to Europe is to go west and through Pakistan and around through the see. So the amount of money that they’re throwing to Pakistan is just incredible.
Carson Scott: We were talking about that, no it’s on topic, because we were talking about that in the current of Bloomberg in Hong-Kong shortly. He’s got some fresh insights into it for you. But when we come back, still on the China piece. The consumer story there, what’s been going on in November, we’ll be joined live by Matt Hassan, senior columnist at Westpac, for some fresh analysis on the data out there. Stay with us.
Carson Scott: Very nice to have your company. Second half of the show, it’s live at five, and our top stories, ending the market today in a weaker position, the commodity story is still one that warrants discussion. It was a key contributor to the weakness, as was falls in the energy space.
There we have Monadelphous linked symbiotically to every move that materials make. And it stood out for being the worst performer. Off over six percent. On the other side though, Infigen Energy rose on no material news though for the company today.
But also making news this hour, Medibank Private’s CEO has unveiled a three year turnaround plan for the insurance giant, and it’s his first main strategy update since he took the top job.
Top of the tree at ANZ, Shayne Elliot is saying it is reasonable to expect out of cycle mortgage rate hikes. The big four banks of course facing increased lending and regulatory costs.
So, the market was on the back foot, yet again today, not in a significantly weaker way, but still of note. We did swim against the tide again of our regional peers in the round, so that was just a theme we are keeping a watching brief on, so to speak.
Let’s have a look see what the panel though makes of it all and then in for the second hour, Tim Rocks, the principal of Rock-on-omics. And David Novac from Wealthwise Education. Panel, having looked at health we kind of moving into a broader discussion now of what is just a sensible strategy for investors at this point in time.
We have swing factors from offshore that will come into play, but for now, even on today’s session, it’s funny, because things like consumer discretionaries were bid for. You would have thought that those sorts of things would have been seen as icing on the cake at times of volatility, not necessarily mainstays that you will revert to. What does that tell us about investors and their thinking? Was, is this sort of today trade pattern that is emerging, to dominate? What’s the tussle between?
David Novac: Well look, it’s a tough question. You’ve just got to look at the sectors that there’s been a rotation, obviously today, out of resources, and more into banks. And that’s had the market held up pretty well when you consider the sharp falls in the resource sector.
Carson Scott: It’s the second day that it’s happened, isn’t it? I mean, they were like that yesterday as well? Banks stood out. For what fundamental reason? When you hear from ANZ saying rates are going to go up, I guess it’s good for your margins, but doesn’t necessarily mean that the end customer can weather that. So, that’s the unknown versus, in theory, a margin uplift.
Tim Rocks: Yeah, I mean, I think the banks have been pretty weak for a whole year now. So, a lot of this, sort of bad news, and the fact that we were talking about the banks the last hour, is sort of reasonably well-known now.
And the fact that they’re all accelerating these asset sales, perhaps puts that capital-raising issue a bit further into the background. So, that’s a moderate positive for the banks that is going on.
I mean, stepping back from it, I mean, my own view is that, again, the Trump presidency, and in particular, the significant change in view in China, the real policy change that occurred towards the start of this year. Is a really significant one that will probably drive the resources higher for longer.
Carson Scott: And to sum that up. That significant change is best paraphrased as what?
Tim Rocks: Spending money. The old China is back. The new China equals the old China basically. Yeah, I think you, the anti-corruption campaigns have dominated the first three, four years of Xi Jinping’s rule, around October last year he made a change. And they decided to start spending again. And those credit numbers that you saw through December, January and February were the start of allowing local governments to spend again.
And when local governments spend, again, it’s a two- to three-year story. And it really surprised me that there was initially scepticism about that. But it’s really those projects that really started, are still now in the embryonic stage, and will drive Chinese growth going forward for the next one or two years.
So, I think that was a really significant change that they are still going through. I think Trump just kind of adds to that kind of story. And thank God, it means a significant change in market dynamics, because we’re not talking about central banks, and QE and yield chasing any more. We’re actually talking about how much growth, and where is it going to be.
Carson Scott: Well to that end, let’s look at this chart, let’s bring this one up and bring Kerry Crag into play, the global market strategist from JPMorgan in Melbourne. Kerry, welcome to you.
I want to animate into the chart first off, because every point that Tim just made, there we have the ten-year, interesting that you’ve gone for the ten-year and not the thirty-year US, but still. Talk to us about this correlation, because this is a Fed connection here.
Kerry Craig: Yeah, exactly what has just been talked about, the fiscal stimulus that is expected out of the US. And you can see that being factored into the surge in the US Dollar and as well as that, the movement in yields as we expect more inflation to come through.
And this is simply what this chart shows. On the left-hand axis, you have what the ten-year yield is offering now, and it’s pickup after the Trump election in November. And similarly on the right-hand axis, you’re looking at the US Dollar on a trade weighted basis.
You can see that these two things usually move along the line in tandem, but that correlation has become so much tighter just recently. And I think more importantly about this chart is that last week or so, where you’re actually seeing, after quite a dramatic surge, things start to level off a little bit. Markets really are digesting what all this fiscal stimulus might actually add up to. How much of it will materialize, and what the inflationary impact will actually be.
So, while we are seeing more fiscal stimulus around the world and a definite shift away from lenders of last resort, from central banks, to spenders of last resort and government, and there’s no clear indication of what that will materialize as in terms of growth, especially in the US.
Carson Scott: Well that end axis, so the US Dollar there, you’ve got fed-fund futures only price in 30% chance of another hike by May. So, beyond what happens in December, there’s a view that there’s going to be quite a long gap. And if that is the case, Kerry, it’s going to cap that rise in the USD, is it not? Because, how do you get upward momentum if fed-fund futures are saying there’s only a 30% chance the fed goes again in May?
Kerry Craig: Well I think there is a chance that the fed will be caught behind the curve on this one. We will look in a couple of weeks at the latest December Fed announcement and what they do with that dot plot and their outlook, and I think that they will keep that rate path quite gradual, but it doesn’t really line up with what the market expects, and I grant you that.
However, we do know that simply looking at the base effects from energy prices, that we will get a jump in inflation next year, around the world. And that those inflationary themes have been building for some time. Whether it’s the slowly creeping hire and wage cost in the US, the fact that you’re seeing inflationary pressures build and PPI numbers in China.
All this should add to getting more rates come through in the US than the market currently expects. We’re looking for perhaps two to three rate hikes next year, and certainly we will see the Federal Reserve become more hawkish as we see some of the committee members change, under Donald Trump administration.
Tim Rocks: And I think that’s a very important point, right? That Janet Yellen is not going to be reappointed under a Trump presidency.
Carson Scott: But she’s there until 2018 with Stanley Fischer, they both go out the door in unison mid-2018. So, we’ve got a whole year plus still of the dubs.
Tim Rocks: And as Kerry said, some of the members will start slowly to change –
Carson Scott: Enough to influence the two top dogs? Stanley rules the Fed, let’s face it.
Tim Rocks: Yeah, well, unlike Australia, it’s a vote. In Australia it’s just what, well now Phil Lowe says. But, there it’s a genuine vote, so you do have to pay, you have to listen to the people around the table. But it matters for markets though. Because markets, if you’re pricing in a five-year note, you’re thinking about what, where rates are going to be in two years’ time, not just where they’re going to be for next year.
So, we could have much more of an influence on the Dollar and on those three-, five-year bond rates. Well that could happen sooner than an axis of change in a –
Carson Scott: So as Kerry says, that dot plot reanalysis in December will be key.
Tim Rocks: Yeah, yeah, the other thing I’d actually like to ask Kerry. So interestingly on the US Dollar, cause normally US Dollar can actually go down when you have stronger growth right? Because you get that reversal of those flight quality flows, so flight to quality can be kind of a big driver.
When things are looking a bit shaky, you go to US Dollar. So, do you think that the US Dollar, at the moment, is being driven by interest rates rather than, kind of those flight to quality and concerns around growth?
Kerry Craig: Well I think the growth stories, I think the currency stories are driven more by the growth differential rather than the interest differential. You know, the fed rate hike is basically priced in by the market. And that is being reflected in yields in the currency. But I think if we look at the world as a whole and we say, it’s slowly picking up, and the development markets are showing that the US, obviously, is leading the way.
You know, you had a great revision to the GDP print last quarter, and we expect that to continue through as you see this boost to growth. And Donald Trump was inheriting an economy that was already in pretty good shape. You know we have low unemployment rate, we had good housing numbers come out recently. We see consumer confidence rise again.
I think that growth in the US is just always going to be better than the rest of the world right now. There’s still concerns about the Eurozone. You know we look at the UK and what’s happening. So, I think that’s what’s really going to drive the currency. It’s not that safe haven flows, it’s that people are genuinely seeing investment opportunities in the US economy, compared to the rest of the world.
And we would mirror that. We do think that the US equity market is going to be a good performer for next year.
Carson Scott: That last points interesting though. Because, you know, 45% of S&P 500 companies, generate revenues ex- North America. Now earnings in the coming year, Kerry, based on what you say, you’re calling out more USD appreciation. That’s only a hand brake, not an acceleration on earnings position, is it not?
Kerry Craig: You’re right, we saw that happen this year. We saw the Dollar and oil drag on markets largely, especially across the first couple of quarters and earnings. That did reverse in the third quarter.
Finally we had year on year change in earnings, and it will drag on the earnings outlook and drag in a little bit. But we feel that their Dollar appreciation will be capped to a certain extent. The Dollar is already very high, compared to where it has been in the past. We’re very elevated and we think appreciation will be limited from here.
And so, based on that, the impact on revenues that are generated off shore will be limited as well. And the thing, if you think about the sectors in the market that we like, and you think about the fiscal sectors, sorry the financial sectors, the banks, you know that’s a lot more of the domestic orientated market, and that’s where we think the positioning should be, not just in the big multi-nationals.
David Novac: Yeah, hi Kerry, David Novac here, look, just based on what Carson was saying about equity valuations in the USD. You know, I was, one statistic that I just looked at recently was the market capitalisation of equities, US equities to GDP. Which is back to historical highs, where it was in the dot com mania, and pre-GFC, which I find interesting.
But, you know, it seems like there’s a lot of justification, I keep hearing, for equity valuations being up even in the US. Personally, I think there’s got to be some kind of correction here, because it’s just, it seems to be running on Trump optimism, or Trumpism if you like to call it. You know, so –
Kerry Craig: So, I think the reaction that you’ve seen in the market and equities has actually been pretty calm when compared to what you’ve seen within the fixed income, or the bond market where we’ve seen that huge shift in yields, the equity market has seen that shift in rotation towards the financial sector, and that had been building already.
And I think yeah, they’re looking at earnings, they’re looking at the sort of stability in the fed outlook, and they’re looking at the fact that they see more growth in the US economy. That’s not what’s worrying bond markets. Bond markets are worried about the inflation that comes through when the fed does get behind the curves.
So, I think, relative to what was in the bond market, equity market has been relatively calm. I do agree that the evaluations are elevated. They came down little bit. But it was about that relative evaluation compared to the fixed income market. Because those yields were so low, and as they creep up, that story unwinds a bit, and that will cap what we do expect the equity market to return a little in the coming year, because that P-multiple, perhaps won’t go as high as it has in the past.
And that chance for multiple expansion will definitely limit that. And we do need to see that earnings growth to drive that market. So I think, our expectations for the US market are tempered somewhat by that.
David Novac: Yeah Kerry, one last thing, what do you think about Trump’s spending plans. Obviously, there’s going to need to be approval to lift the debt ceiling limit once again, that must be coming up shortly.
I think Trump quoted four and a half trillion over the next four years, and reducing taxes to 15%. How do you see that playing out? That’s a hurdle I think he’ll have to get through the Senate there.
Kerry Craig: Yeah, it’s definitely the case that all the things that were talked about during the campaign trail, it’s about the sequencing of how they come through. Is it healthcare first, is it corporate tax rates first, is it the spending first, all that will determine how the market reacts.
I think it was a trillion dollars over ten years is what he planned to say. His attitude to spending is very different to the rest of the Republican Party who are perhaps a little more fiscally conservative. And so I think that, combined with the slim majority that they have, in one of the houses of government, means that there is a definite chance that not all that spending will be approved.
We do think some of it will go through, and that will add to that inflation and growth, but perhaps not all of it. And I think that’s one of the big unknowns the market, the market’s reacting to the promise of all this good stuff that’s gonna come through, but we know not all fiscal expansions are created equal, and they will definitely have a different multiplier effect on the economy.
The debt ceiling debate is, I think, not so much of an issue. I think that will be approved largely. We actually saw when that happened back in 2012, the market did largely shrug it off, and in the end it became a bit more automated.
So, I think there’s less of an issue. I do think the market will need clarity on what exactly this fiscal stimulus will look like, in size and scope, to actually see the inflation that comes through and growth that will come through on the back of it.
And on the back of that as well, you’ve got to figure out who’s going to actually do the work, when that unemployment rate is so low and the labour market is quite tight. There’s going to be a limit to how many workers they can actually hire to do these infrastructure plans.
Tim Rocks: And the timing is very important as well, and we know from that, Australian experience, that it takes two to three years to actually ramp up investment, you know, infrastructure spending. So, even if things worked very, very fast, he managed to get those congressional approvals in his first six months of office, you’re actually not going to see a meaningful impact on the economy for most of his first term.
So, I think that sort of goes to an equity market reaction as well, that at some point equity markets are going to realise that they probably have got ahead of themselves on the –
Carson Scott: On that basis, that is very, very true. So that point, time for, maybe some corrective price action that does stick.
Thank you so much Kerry, as always, we value it. JPM’s Kerry Craig there live in Melbourne. Coast to coast we go, and that’s proven after the short break we’ll go live to Perth, Peter Strachan in the chair there, from Strachan Corporate, talking about the commodity frenzy, serving the rally not over in his patch. More in just a few moments.
Carson Scott: So we have in the event, we’re going to talk, when we talk commodities seen quite a reappraisal in the last 48 hours, but does that necessarily change the trend of again, what’s been a pretty giddy rise and rise. The likes of copper running at 20 year highs at the moment and showing no real signs of pause and reflect.
Peter Strachan from Stock Analysis has been pausing and reflecting on these issues. Live in Perth. Peter, welcome to the program. Looking at some views coming direct from Asia now about the frenzy, about the open interest from retail, speccies, if we want to style them as that. I mean, what does it tell you, what does it talk to about the need, I guess, even from an Asian perspective, of locking in some hard, USD assets, at a time when currencies there are looking under pressure.
Peter Strachan: Yeah, well the Chinese are certainly looking to get their Yuan out of the country. It’s very difficult if you’re a wealthy Chinese person to actually take money out. I think there’s a limit of 50 thousand Dollars, so you have to have some sort of approval from the central bank to take money out.
And buying an asset, or some sort of productive asset overseas is usually good enough for the central banks to get approval to do that. So, that’s how we’re seeing that money coming out. And I think the other way of doing it is converting it to gold, so the Chinese are now the largest producers of gold, and probably the largest hoarders of gold globally, they’re turning their Yuan into gold as fast as they can.
And I think turning it into other currencies as fast as they can, and you know, even buying copper, as you suggest, although copper is not at a 20-year high-
Carson Scott: 20 month is it not? My apologies, my months and years tend to flow into each other these days.
Peter Strachan: Months yeah. It’s come up, but it’s not, it’s got a long way to go to $4.50.
Carson Scott: Understood, yeah, rightly called out. Let’s talk iron ore though. With the chart that you’ve mocked up, because this one warrants, again you’re keeping a rolling update for us week to week. Now, across these allied industrial commodities.
So, just talk to this, what you’re observing.
Peter Strachan: So, what we’ve seen is that the iron ore price has rocketed back up to over $80 a ton, from, when it was in the mid-40s, and briefly below 30. And so just overnight, it fell about three Dollars fifty, I think it was quite a big fall, along with the price of coking coal, and the price of thermal coal.
So again, is this noise, or is it signal? You know, we’ve had a big rise, the price of iron ore has doubled, and then it falls three Dollars, it’s not the end of the world. But I do think there has been a lot of speculative interest, and as you were saying, speculative interest out of China in iron ore. And I think, as I said last week, really the way for iron ore over the next three or four months is down.
We’ve had this seasonal influence, running into their winter, and I would have thought that the market is very well supplied, and also the Chinese steel production this year is about the same as it was in 2013. And it’s really no more, certainly no more than it was last year. So, you know, with steel production fairly flat, you know, the swing producers in iron ore is in fact the Chinese mines, and at the current price of $80 a ton, you could add another 40, or 60 million tons a year just from high cost Chinese producers.
David Novac: Yeah, Peter, David Novac here, question about, just in that sector, the iron ore sector. I mean, Goldman Sachs probably, you may recall, came out with a call a few months back saying, I think it was halfway through the year, saying that their forecast was that iron ore was going to average around 35 a ton, US.
Now they’ve just changed that forecast, and upped it to 62. You know, how do you view, I mean, no one’s got a crystal ball, you know, but-
Peter Strachan: It depends where you start, doesn’t it? It depends where you start.
Carson Scott: So you’re kind of treating that with a bit of, what? It’s not worth the paper it’s written on?
Peter Strachan: No, well I mean, they’re followers rather than, you know, if they had good reason to say it was going to be $35 a ton previously, I’d like to see what’s changed, you know in that time, to say it’s going to be $62. So, you know, the market is still very over supplied.
What we’ve had is this unknown. Everyone’s scratching their heads saying, why is the price of iron ore so high? Why is the price of coking coal so high? I mean, at least with coking coal, we can see that it’s because, yeah, the Chinese have shut down a lot of their mines.
And also, what a lot of people are forgetting, and I’ve said it here a number of times, is that the Chinese are now really focused on reducing their air-pollution, so reducing their pollution. And they do that by using the best quality coal, and the best quality iron ore that they can.
And that’s why they’re prepared to pay a premium for the 62% iron ore and the, you know, the guys producing 57% and 58% iron ore are not getting so much of this benefit.
Tim Rocks: So Peter, what do you think is the critical price for iron ore, above which you see a really significant supplier response. Be that from China, or from India, or from Brazil, or in fact for another increase in investment in Australia?
So, what do you think is that natural, kind of, limit on the iron ore price?
Peter Strachan: Yeah, well that is a very good question, and I would say we’re at it. If you could sit down, and lock in $80 a ton for the next five years, and just guarantee that, just write that into your offtake agreement, there would be a lot of iron ore coming back into the market at this point.
But I think, that’s not going to happen, because people don’t believe the current price. And they wouldn’t want to be committing hundreds of millions, or billions of Dollars to new production, and then six months down the track find that we’ve got $45 a ton.
Tim Rocks: And so, do any of the Australian companies, you think, have a next set of projects that they thinking about, that might be reasonably quick to come back into production? Or, sorry, to start production, if the iron ore price stays this high, say, for another six months, or a year, or something like that?
Peter Strachan: Yeah, well certainly Atlas has got replacement production that they’re looking to bring on as their existing resources are consumed. And also, some small expansion there. But BHP and Rio Tinto, it’s more of a brownfields. I don’t see them being major expansion projects, but where we’d have to look for major expansion, would have to be in some of these magnetite projects in say, South Australia, or even in the central west, of Western Australia.
But I mean, they would really need to be able to put their hands on their heart, and guarantee that the 62% rate was going to be $80 a ton, and I don’t think anyone’s prepared to, certainly the bankers and financiers wouldn’t be bold enough to come up with the cash at this point.
Tim Rocks: Yeah, and because they’re printing money now right? But what have they reduced their marginal costs to, I mean, there’s this episode of cost reduction over the last two or three years, are they down into the 20s generally, for their cost of production?
Peter Strachan: Yeah, well the cash cost of production is certainly well below 20, I mean, I think Fortescue for instance, is looking to get it down to 13 US Dollars per wet metric ton, and remember that’s for the lower grade product. But then on top of that then you have to add the royalties cost, and the shipping charges.
So to get it, the FOB charge is more than that 15, 13 Dollar level. Because you’ve got to get it the port, you’ve got to get it onto a ship and then you’ve got to pay royalties. And then there’s extra, even the shipping costs can vary dramatically, depending on the demand.
I mean, it can be anywhere from sort of $6 to even $15 a ton, depending on the cost of shipping. At the moment shipping costs are very low, so that’s playing into the hands of, especially the Australian iron ore producers, who are actually closer to the market than are the Brazilians.
Carson Scott: Peter, got to leave it there, thank you so much. Appreciate it.
Peter Strachan: You’re welcome.
Carson Scott: Taking a break, same time zone, different city, coming up for you, almost the same time zone I do declare, that’s to Hong Kong we go next. And Enda Curran, on life after a TPP trade. Winners, and some. After the break, stay with us.
Carson Scott: Welcome back into the show, not many more minutes to run on it. Some breaking news as well. OPEC has changed the start time of its formal meeting, slated for 10AM GMT Wednesday. That’s, you know, that has now changed, according to two OPEC sources, to 0900, so panel, Tim Rocks and David Novac, they have brought the time forward by an hour, breaking news. Are we minded to think that this is a good positive signal, or how does it fit in even with the statement? Because you have noticed what, that there will be a statement served at what time?
David Novac: 4AM, yeah our time.
Carson Scott: 4AM Sydney time.
David Novac: Sydney time.
Carson Scott: Alright, so that’s roughly 11 hours.
David Novac: I certainly won’t be watching this.
Tim Rocks: Well at least it suggests that they think there is things to talk about. So, they will talk. They will come out with a statement.
Carson Scott: But realistically, the statement will be, what? As weighty as to say we will all freeze? Which, at this particular point in time it means, we freeze at a record level, because we have all scurried to lock in record production ahead of this meeting.
Tim Rocks: Well you’ve got to remember, I mean, what they say, and then what they ultimately do are two very, very different things. And there’s a reasonable chance that they will say something.
Carson Scott: Like Trump?
Tim Rocks: And there’s a reasonable chance that they will do something completely different.
Carson Scott: Alright, so it is like Trump, isn’t it?
Tim Rocks: Yeah that’s right.
Carson Scott: David, have you got any hope at all, that we won’t see anything other than a wild lurch down, or in this case up? Or even if it is a lurch up, that it will be just as quickly reassessed and brought right back down?
David Novac: Look, I don’t think anybody can make that call Carson, in the end it’s how cooperative the OPEC members are, and what agreement they come to, and consensus. If they all come to a consensus that they cut back obviously, that will be very bullish. But if you’ve got a few dissenting members, then that, you know, say we’re not going to do anything, or you know, we’re worse off, we could be increasing production at some point. Well, then, who knows, I mean, nobody can predict.
Carson Scott: The thing is, the stocks on our market like Qantas, today they were at roughly a three-week high. Sorry a weekly high for Qantas, it rallied about two and three-quarters of a percent. Now, that is on a weakening off crude story, not a strengthening one. So, I mean it matters as far as the inputs, I mean it’s the biggest input cost there for Qantas.
Tim Rocks: Yeah, and I think that’s true of the energy companies too. I think that our market for the transport stocks, for the energy stocks is priced for oil to be about where it is now. So, I think if there’s any, if there’s a 5% move up or down, you’re going to get the stocks that are going respond to that.
But on all accounts about these negotiations, they are actually pretty close. Like the way the negotiations have been presented. We’re really only talking about sort of detail here. So, it seems more likely that they’ll come out with a statement that-
Carson Scott: So, you think Iran will blink.
Tim Rocks: No, they’ll say something. But whether they actually do it or not. It would be very, very unlikely, I think, that Iran would actually, ultimately cut production. Remember, they haven’t been able to sell for what, 20 odd years before this year.
So, they’ve still got a lot of ground to make up. And I think it’s pretty unlikely that they’re going to, will want to negotiate too much.
Carson Scott: Not only that, but is there a sense, back on Trump, that we get sanctions slapped back onto Iran in a quest for Trump to sure up US domestic production? At this point in time, I mean can we rule that one out?
Tim Rocks: Yeah, I mean, I hadn’t really thought about that.
Carson Scott: I mean that’s the point isn’t it, we don’t know who the secretary of state choice is. If it’s Giuliani for instance, there will be no qualms in being bluster and crash through on past forms.
Tim Rocks: Yeah, that’s definitely the next factor.
David Novac: Yip, it is. That’s for sure.
Carson Scott: Right, beyond on that. Companies’ AGMs tomorrow. Does anything jump out, I mean just running through the list of what might be things to watch.
Tim Rocks: Oh, I mean the capex data tomorrow is definitely, definitely important.
Carson Scott: The estimates as well?
Tim Rocks: So, yes, that non-mining investment recovery is absolutely critical for the next 12 months, two years for the Australian economy. We’ve been waiting for Godot, I guess, on that recovery coming through.
If it does come through, it will be a big mover.
Carson Scott: There’s a well pointed out there as well, Nufarm has its AGM tomorrow. Is it a stock that you like? Spark Infrastructure as well, just, you know, data digested and that’s banked. Do you look at either of those stocks and say there’s upside?
David Novac: I haven’t really studied Nufarm very well, but just looking at the numbers very quickly. Look here, there’s, look it’s in a growth sector that’s for sure, and I’ll just have a quick look, I haven’t looked at the chart.
Carson Scott: They’ve been restructuring their Brazilian ops, you know, they’ve already talked about they’ve had to cock a loss, just on account of doing that. But I suppose that’s the price you pay for integrating one business, beyond the main ops.
David Novac: Yeah, look the chart doesn’t sort of scream at me to say, rush out and buy Nufarm right now. Just kind of, going in a sideways consolidation. Could break up or down from here. And between $9 and $8.
Carson Scott: Alright, and as you say, for its part, Spark, doesn’t hold much appeal?
David Novac: No, I don’t mind Spark, in fact I like Telstra as well. But, you got to start looking at TPG I think as well.
Carson Scott: Even in spite of the others?
David Novac: Well it’s just had such a big fall. You’ve got to think. I mean, these companies were priced for perfection, let’s admit, 33 times earnings, come on. I’ve got, that’s why Vocus and TPG have fallen so sharply.
But I think they will be soon biased down here, I think accumulating some TPG shares, I’d particularly.
Carson Scott: Alright. There is that call to finish the show. And I want to thank you David Novac from Wealthwise, very much. Tim Rocks from Rock-on-omics; great to have you with us as well. And one of my panel returning for the final count with Peter Switzer, find out which one after this very short break, in just a minute.