23 Quotes & Shorts: RBA Repeats Inflation Worries, And More...
24 Can Chen Zhi Save The World ?
25 Quotes & Shorts: ECB To Start Cutting Interest Rates, And More...
26 Quotes & Shorts: Rio Tinto Shares Towards $139.50?, And More...
27 Rudi On Thursday
28 Quotes & Shorts: It's Getting Tougher For AMP, And More...
Sell&Buy-ology 29 Old King Coal
Weekly Analysis 30 It's The RBA Against The Australian Consumer
Is Japan Hiding Billions In Subprime Losses? By Greg Peel
It is estimated that across the globe some US$400-500bn has been wiped off the value of subprimesecurities, such as collateralised debt obligations, which were held by all and sundry. However, to date thebanking fraternities of the US and Europe have only written down US$130bn. Admittedly banks everywherewere initially reluctant to make "kitchen sink" write-downs (implying that all losses were now on the table)as they tried to kid themselves values would bounce back, or as they tried to cover their mistakes, but nowsupposedly the end is nigh. New accounting regulations now in force in the US, for example, rather preventbanks and brokers from fooling anyone anymore.
So the question is: Where is the other US$300bn?
Fingers have begun to point to the Land of the Rising Sun. It is all rather speculative at this point, andother commentators dismiss the notion, but it could be that Japanese banks have been holding back. Todate, subprime losses declared by Japan total only US$4.7bn. Back in the nineties, when the Japanesebanking system all but collapsed, Japanese banks spent years trying not to reveal the extent of theirdifficulties, lest they should "lose face". This just made the situation all the more dire when finally thetruth came out.
The London Daily Telegraph's Ambrose Evans-Pritchard notes that while all around the world stock marketshave been falling, Japan's has fallen by a significant 17%. Leading the Nikkei index down has been heavyselling in the bank sector. Banks such as Mizuho Financial, Mitsubishi and Sumitomo Mitsui have seen theirshare prices trashed just as much as their American counterparts, yet from subprime declarations to dateone would assume Japanese banks have remained relatively unscathed.
As the credit crisis has gained momentum in recent months, analysts have been constantly on the look outfor what might be "the next shoe to drop". It might well be that Japan is it. Evans-Pritchard notes that adefault risk index of 50 Japanese companies saw its biggest ever one day jump (perceived risk increase)last Thursday. This is a big warning signal. Japan remains, after all, the world's second largest economy bya big margin. And that economy has been hurting badly since October. Goldman Sachs' chief Japaneconomist, Tetsufumi Yamakawa, has suggested "Recession is a clear and present danger in Japan" and hiscolleague at Morgan Stanley has suggested likewise.
That's not good news for Japan, as it has spent over a decade trying to drag itself out of a deflationaryenvironment. Prior to the subprime implosion, the Bank of Japan had finally raised its cash rate to 0.5%from zero, and signs were that another rise could be around the corner. Now it looks like zero will be backagain. This would only provide more fuel for the carry trade fire.
It is the existence of the carry trade that would tend to make one believe Japan must be deeply stuck inthe subprime mire. Most of the carry trade is conducted by mum & dad Japanese who are assiduous saversbut need to invest outside of Japan to avoid their retirement funds being eroded by negative real rates.Japan holds US$3 trillion of foreign reserves, or about the equivalent of the US foreign debt. About US$1trillion has gone out as carry trades, with investments being made in sovereign bonds from New Zealand toIceland. Subprime CDOs were high-yielding instruments with AAA ratings. They must have looked ratherattractive to Japanese banks as offshore investments offerings.
What is missing are data indicating just where some US$250 billion earned each year from offshoreinvestments has gone. Indications are that Japan has not increased its holdings of US Treasuries.
Stories To Read From FN Arena www.fnarena.com
1 Asia
Not Everyone Is Negative About ResMed By Chris Shaw
Last week FNArena cautioned some in the market were anticipating sleep disorder group ResMed ((RMD))would deliver a disappointing quarterly profit result (see ResMed Expected To Deliver Subdued Quarterly,7/2/08) and the company did exactly that, its profit of US$26.9 million being below market consensus.
As a consequence there have been earnings downgrades in the market, reflecting what GSJB Were notes isa risk the company’s market in the US has shifted to a lower sales growth platform of 10-15% from 15-20% previously.
To reflect the quarterly result the broker has cut its estimates in FY08 by 7.4% and in FY09 by 6.8%, whileMacquarie has dropped its forecasts by around 13% in each year and UBS has made more modest cuts ofaround 3% in both years.
Of more significance than the earnings changes are the changes in ratings, as following the quarterly anumber of former supports have lost some of their confidence in the group.
Both Credit Suisse and Macquarie have downgraded the stock to Neutral from Outperform/Buy previously,both to reflect the likely lower earnings flowing through given the slower US sales.
ABN Amro agrees the outlook is more difficult and expects the tougher market conditions will remain inplace through FY08 at least, leading the broker to reiterate its Hold rating.
Citi has been more drastic in reducing its rating to Sell from Hold, arguing the stock is overvalued atcurrent levels given the sales outlook. While some upside remains from a potential bid from a playerlooking to further rationalise the sector and from a positive ruling next month on home diagnosis, thebroker points out neither of these are certain and are offset by the poor earnings prognosis.
Others continue to rate the stock as a Buy though, UBS suggesting comparables sales figures are nowentering a period of easier comparables and this should translate into better quarterly performance, whileJP Morgan expects some upside as the company releases new products onto the market.
GSJB Were also remains positive, seeing the second quarter as the bottom of the cycle for sales growth andsuggesting there is now value in the stock at current levels as the downside risks appear fully priced in atcurrent levels.
Overall the FNArena database shows the stock as rated as Buy three times, Hold six times and Sell once,compared to five Buys and five Holds prior to the 2Q result. Price targets have also been revised lower, thedatabase showing an average target price now of $5.46, down from $6.05 last week.
Shares in ResMed today are higher despite last week’s disappointing result and as at 11.05am weretrading up 17c at $4.82.
Stories To Read From FN Arena www.fnarena.com
2 Australia
Upgrade To Buy For Conquest Mining By Rudi Filapek-Vandyck
It has been a while since FNArena has written a story on precious metals hopeful Conquest Mining ((CQT)).The company thought investors, shareholders and all other enthusiasts would likely be happy to read thatstockbroker Tollhurst Noal has upgraded its rating to Buy/LT Buy following a meeting with management.We thought we'd spread the word with a news story on top.
The meeting in itself generated not much news, analyst Cathy Moises reports, but given the recent shareprice fall and the fact that she has lifted long term gold and silver price forecasts to US$600/oz andUS$11/oz respectively, a recommendation upgrade seemed appropriate.
That is probably even more the case as Conquest Mining shares post the recent sell-down are now tradingat around half the $1.09 value Moises has put on the shares. This valuation theoretically would become$1.39 if today's spot prices are used instead of the long term price assumptions.
The table of forecasts included in Moises' research report suggests the company should become profitablein FY10 with a projected earnings per share of $0.29 for the year, suggesting Conquest is currently tradingat a price-earnings ratio of about 2x for FY10. Shareholders should receive a dividend of 3c per share thatsame year too.
Conquest Mining shares were trading slightly higher at $0.525 amidst an overall depressed market onMonday around 1pm.
Stories To Read From FN Arena www.fnarena.com
3 Australia
Exploration Risk Hits Home By Greg Peel
It would have been easy to believe that this stock market caper was money for old rope if you'd jumpedinto the Australian market in 2003 and held on into 2007. The truth is, however, that the period in questionoffered stand-out returns on a historical basis. And now that some form of correction has been in progresssince about July (or November if you count the misconceived share market rally), the risks inherent in stockmarket investment are only too clear.
In major corrections it is often the small caps which suffer badly, given small caps tend to offer higherrisk/return scenarios than large caps. Investors look to ditch anything on the fringes and circle the wagonsaround only the trusted names. This is a bit tough if you're a small cap, given often your upside potentialmay have little to do with what's happening in the wider market. This does mean, of course, that somebargains could well present themselves if you are happy to take a plunge.
Cabcharge ((CAB)) is one company that may fit that bill, given its shares have followed the broad marketdown and turned $14.25 into less than $10.00. One could perhaps put forward an argument that Cabchargeis not defensive, because in times of financial difficulty one can always catch a bus. But the reality is we'dhave to be in the deepest of recessions before you could find a cab within minutes in Sydney on a Fridaynight and besides, Cabcharge also runs a fleet of buses.
The other reality is that Cabcharge operates a unique cashless charge service used by cabs, not the cabsthemselves, and that service is currently being ramped up in Britain. Cabcharge's system is used in 96% ofAustralian cabs, and now that Macquarie ((MQG)) has withdrawn from rival Lime, the monopoly is onceagain cemented. Credit Suisse analysts note Cabcharge's EBIT growth has averaged 26% in the past threeyears, it is implementing cost reductions when all about are suffering cost blow-outs, and it has all sorts ofpotential deals in the offing. CS has just added Cabcharge to its Top 20 preferred small cap picks, hot onthe heels of similar positive comments about Cabcharge elsewhere.
So what's this got to do with AED Oil ((AED))?
It came to FNArena's attention that still sitting on the CS Top 20 list was one AED Oil, a stock that hasfallen from $11.40 to $1.30 since October. It would be easy to jump in here and say the moral is neverlisten to Credit Suisse, but the truth is the whole world has been caught out by AED, and not for anysinister reason. UBS, for example, upgraded AED to Buy in October with a target of $11.48. Only on Mondaymorning did the analysts reverse their recommendation, turning the Buy into a Sell and offering a newtarget of a mere $1.16.
It is not the analysts' fault. It's not never the analysts' fault, as sometimes they come out with somescreamers, but in AED's case the early enthusiasm had much justification. AED is an owner of the Puffinwells off the coast of far north Western Australia, an area already proven to be teeming with black gold.Surely one had only to send down a drill bit and another gusher would appear? And so it was, as the oilprice climbed rapidly to US$100/bbl, that analysts placed great faith in AED's exploration potential. Such aplay had come off for so many small cap resources companies since 2003. Just think of Paladin ((PDN)) inuranium or Fortescue ((FMG)) in iron ore, for example. And analysts are always careful to apply risk ratiosto their valuations anyway.
There's little point in buying an oil exploration company after the gusher has appeared, if you're looking forextraordinary returns. It's like going to the bookie's window and trying to back a horse after it's alreadywon. And so it is that Australia is a hotbed of "speccy" mining and drilling companies, with share priceshaving risen to the moon during the commodities boom despite not having reached production. Fortescuehas still not sold one rock, but at least the company is safe in the knowledge it does have a lot of iron ore.
Conversely, AED found dust.
Stories To Read From FN Arena www.fnarena.com
4 Australia
Or, more specifically, water. The Puffin wells are not totally devoid of oil, but Jed Clampett might haveelected to go after the food instead. AED is keeping a brave face, and is sure there are commercialamounts to be found and exploited. In the meantime, what oil there is at Puffin can still be brought to thesurface, but for one small problem - AED has run out of money.
It is never surprising if a small cap explorer joins up with an equity partner to take its reserves to aproduction level. Nor is it surprising if it were to seek a capital injection to expand its operations. AED islooking for capital, but what caught analysts by surprise is that AED has an outstanding bill from aNorwegian offshore drill-rig company for $41.5m. And it can't pay. AED is seeking capital to pay out itscreditors, before anything else. $41.5m? That's a good night out for Twiggy Forest.
AED needs to spend money to get its production levels higher, which would then allow it to pay its bills, orvice versa. UBS has called it a Catch-22, for at the same time AED's reserve estimates are being continuallydowngraded. UBS has thrown in the towel, dropping its target from its most recent $3.68 down to $1.16,and suggesting investors get out.
Deutsche Bank dropped its rating to Hold last week and its target from $9.25 to $3.75. Deutsche has yet toupdate following the Norwegian invoice announcement. And so has Macquarie, who has been at Neutral andsilent since November, when it dropped its target from $9.09 to $5.42.
Credit Suisse's resource analysts have also been silent since early this year, and are thus still registeredwith an Outperform rating and a $7.50 target. It's no wonder AED is still on CS's Top 20 list. But to be fair tothose compilers, the list would have been finished before news of the outstanding $41.5m came to light.
AED had a shot, and so far it looks like it may have missed. That's life in the big city. For analysts, well theycan only work on the information they have. For investors, it has to be realised that not every speccycommodity explorer is going to come up trumps.
Apart from Cabcharge and AED Oil, the other small cap favourites of Credit Suisse include Tower NZ((TWR)), Tower Australia ((TAL)), Henderson Group ((HGI)) and Australian Wealth Management ((AUW))among financial stocks; and Oakton ((OKN)) and SMS Management & Technology ((SMX)) in the informationtechnology sector. In the media sector the broker prefers Photon ((PGA)), Prime ((PRT)) and Austar((AUN)), while Bradken ((BKN)) and Gunns ((GNS)) are selected under the label "Basic Materials / Miningservices". This still leaves Pharmaxis ((PXS)) in the healthcare sector, McPherson's ((MCP)), Fantastic((FAN)) and Specialty Fashion ((SFH)) among retailers, plus Cardno ((CDD)) and Equinox ((EQN)) to completethe list.
Ansell; Standout Defensive With Strong Growth Potential By Chris Shaw
As the Commonwealth Bank result this morning has demonstrated investors are more than happy to reducemarket exposure via selling down any company that disappoints in terms of earnings results.
This means stock selection is becoming increasingly important and finding a stock with limited downside isa sensible strategy given the current market uncertainty.
According to Southern Cross Equities one such company is Ansell ((ANN)), the broker rating the gloves andcondom maker as a Buy after the company solidified its position this week as a “bullet-proof†play inthe broker’s view by lifting earnings guidance for the full year when it reported its half-yearly profitresult.
Guidance now stands at US58-62c for the year, up from US56-60c previously, reflecting strong sales as thecompany continues to release well received new products as it in the broker’s words “shapes themarket to its advantage".
Analyst Stuart Roberts anticipates solid earnings growth in coming years, forecasting US 64c this year andan increase to US73.7c in 2009 and US90.1c in 2010. This puts the stock on a P/E (price to earnings ratio) ofjust 11x in 2010, which is cheap even allowing for the recent market weakness.
Along with stronger earnings comes stronger cash flows and the broker sees this as a recipe for additionalcapital management initiatives, estimating there is scope for a further buyback of eight million shares oraround 6% of issues capital at the same time as it funds its growth projects.
Southern Cross has a target price of $15.00 on the shares, which compares to an average price target in theFNArena database of $13.18, up from $12.59 prior to the result. Merrill Lynch is the high marker at $14.20.Merrills too sees the stock as a defensive play in the current market, while UBS is dragging the chain at$12.23 given it has some concerns with respect to latex prices in the second half of the year.
Overall the database shows three Holds and three Buys, Macquarie upgrading to an Outperformrecommendation on the back of the profit result. Shares in Ansell today are higher and as at 3.45pm wereup 6c at $12.31.
Stories To Read From FN Arena www.fnarena.com
5 Australia
Transurban's Capital Beltway Project Is A Winner By Chris Shaw
Since the start of the credit crunch around the middle of last year infrastructure companies have found thegoing more difficult given the significant borrowings they have in place, with toll road player Transurban((TCL)) a prime example as the stock has fallen from more than $8.00 per share last June to less than $6.50now.
But according to Austock Securities there are reasons the company should be considered a Buy at currentlevels as the group has long life assets, is developing scale in its US operations and the yield on offer is veryattractive.
The broker has recently completed its analysis of the group’s Capital Beltway project in the US and thissupports its positive view on the stock as it suggests guidance from management as to the asset’s returnswill prove to be very conservative.
The project will see additional High-Occupancy Toll or “HOT†lanes added to the existing Beltway,which should ease bottlenecks on one of the more crowded sections of road in the US.
On the broker's numbers the project should generate an internal rate of return of a little over 16% butmanagement has guided for a return of 13%, the broker suggesting given the lack of any toll price caps andthe area's high income demographic there are likely to be real toll price rises in the future.
This leads the broker to predict the indicated real revenue growth rate of 1.3-1.5% will prove to be toolow, as historical traffic volumes on the road show annual increases of around 5% over the past 20 yearsand independent forecasts suggest volume growth of 2.5% annually for the next decade is likely.
As well, management’s guidance is for relatively constant margins but the broker takes the view with afairly fixed cost base any toll increases should mean margins move higher over time.
Overall the broker’s estimates for revenue growth from the asset are around twice the guidance ofmanagement, but it suggests the risk remains to the upside as it may take higher toll increases to preventtraffic congestion.
The major negative with the project is it won’t open until 2013, meaning while the outlook appearsgood the market has little reason to pay up for it now, particularly in light of the continued volatility infinancial markets.
There is also an impact on cash flows and earnings per share in the medium-term given the capexrequirements of the project, though taking a longer-term view Austock points out the project will result inincreases in both measures.
On the broker’s calculations the Beltway project adds 61c to its net present valuation, though allowingfor the impact of higher interest rates in Australia and lower rates in the US the overall valuation impact isonly an increase of 9c per share to $8.09.
Given the group’s financial structure earnings in EPS (earnings per share) terms will remain negative incoming years, so EBITDA (earnings before interest, tax, depreciation and amortisation) is a more instructivemeasure. On this basis the broker is forecasting an increase from the $395 million recorded in FY07 to $502million this year, $599 million in FY09 and $625 million in FY10.
Distributions are also expected to increase, the broker forecasting payouts of 57c this year, 59c in FY09 and61c in FY10, putting the stock on a FY10 yield approaching 10%.
Stories To Read From FN Arena www.fnarena.com
6 Australia
The broker’s target price on the stock is $8.10, which compares to the average price target according tothe FNArena database of $7.48, with Deutsche Bank the highest at $8.50 and GSJB Were the laggard at$6.44.
The database shows the stock as rated Buy four times, Accumulate once and Hold five times. Shares inTransurban today are slightly higher and as at 11.35am were up 3c at $6.37.
"Not So Defensive After All" By Greg Peel
The credit crunch has proven a double-edged sword for the big Australian banks. Depositors and borrowershave flocked back to the traditional pillars, having either been burnt by, or in order to avoid being burntby, smaller banks and non-bank financials who have proven vulnerable since the collapse of securitisedintermediation...
The big banks have been forced to wear cost of funds increases for a while to help precipitate this prodigaltransition, and although having raised lending rates recently they will continue to suffer from lowerearnings margins for a while yet.
But that's okay if the result is stronger business growth in a new credit market regime. This is the mainreason many banking analysts have been positive on the big banks - at least as defensive plays in anotherwise weak market. The theme has been short term pain for long term gain.
Another underlying theme has been the general balance sheet health of a lot of Aussie corporates, in starkcontrast to conditions prevailing in the early nineties and which led to the deep recession of the time. Assuch, analysts have generally been unconcerned about a significant jump in bad loans. Only JP Morgan hasbeen banging the bad loan drum, as part of a sector Underweight call.
But JP Morgan has also been championing Commonwealth Bank ((CBA)) as the best of a bad bunch,suggesting CBA should be less affected than the others by the credit crunch and that its capital base is themost stable. So even JPM got a shock yesterday when the CBA half-year earnings result came in 5% belowthe analysts' expectation. Ironically it was an unexpected jump in bad loans that made all the difference.
All banking analysts were caught out, to varying degrees. The result was about 4% below consensus. Theannounced interim dividend of 113c also fell 1-3c below expectations. Bad loans weren't the only culprit,with weaker retail bank revenue growth and higher overall cost growth adding to the pain. CBA has longenjoyed a valuation premium to its peers, and guidance from management is that performance shouldcontinue to either meet or exceed peers. Deutsche Bank believes this claim "no longer seems credible".
GSJB Were has never been happy with the premium CBA attracts, and yesterday's result did nothing tochange the analyst's Underperform rating. Credit Suisse actually upgraded from Underperform to Neutralbelieving yesterday's shock sell-off brought CBA back to reality, and some. Mind you, all banks were sold offso there wasn't necessarily much premium collapse. Macquarie posted the only downgrade - fromOutperform to Neutral - suggesting the market's risk appetite has greatly diminished and bad debts don'thelp. The analysts also believe CBA's premium vis-a-vis the other banks is now under threat.
That puts the Hold count in the FNArena database at seven out of ten. Analysts acknowledge that CBA's baddebt result has put the frighteners through the market. Until this half, Australian banks' bad debt ratioswere at all-time lows. Investors are nervous, and it could be a while before solid buying returns to thebanking sector.
Out of the experts who issued an update this morning, only JP Morgan retained Outperform (within thesector). While JPM acknowledged that even it managed to underestimate what it had been expecting for awhile, it still sees the other big banks as likely poorer performers. We won't know that for a while as therest of the group report in April/May. JPM notes CBA should be least affected by the credit crunch and hasa more sustainable dividend payout ratio which is also higher than its peers.
All brokers reduced their FY08 earnings expectations this morning, around 2-3%. The most noticeablechange, however, was in target prices.
The average target price in the FNArena database fell from $56.69 to $52.11. If you take out a so far silent
Stories To Read From FN Arena www.fnarena.com
7 Australia
UBS ($60.00) that average becomes $50.98. The share price had bounced 1.7% to $46.98 at midday, soanalysts are still looking for some of the positives to kick in by twelve months down the track.
So what of the other banks? GSJB Were actually believes the overall result for CBA was a positive for thebanking sector in general, with the caveat that one-off corporate defaults remain the wildcard risk. Thegood points for the sector are that underlying credit quality is still strong, loans and deposits are growingsolidly, margin declines have not been that dramatic despite the increased cost of funds, capital positionsare strong (on contrast to the US, for example) and wealth management income, although receding in aweaker market, is still supported by solid inflows.
However, Weres also believes now is not the time to be piling in, despite yesterday's sell-off. We have untilApril/May to learn more about the others and the market at present is jumping at shadows. Unless you arean aggressive investor, it might be best to sit tight.
The CBA result has been a wake-up call for some analysts stuck on the "banks are defensive" cliche. Theglobal credit crunch has not yet played out. When it has, and all casualties are known, then it should betime to be more positive. Hopefully that will be some time in the second half, and 12-month targets on CBAsupport that view. But it is with trepidation that analysts will look towards April. Stand by for some moreconservative reviews of earnings and targets on the other big banks.
Site Visit Confirms Upside In Equinox By Chris Shaw
For some time both Credit Suisse and GSJB Were have been pushing the investment case for emergingcopper producer Equinox Minerals ((EQN)), both rating the stock as a Buy on the likelihood of a re-rating asthe company moves from an explorer to a producer.
Following a site visit to the Lumwana project GSJB Were has not changed its positive view, the brokerseeing scope for the stock to deliver returns of more than 50% over the next 12 months if the re-ratingmeets its expectations.
The construction of the plant at the mine was 75% complete as at the end of December and the contractorsremain confident the plant will be completed by the end of June as specified in the contract.
The broker is not so sure but suggests while the plant may not be completed on time it should be closeenough to allow for ore to be fed and concentrate produced, but to adopt a conservative approach it hastrimmed its production forecasts for FY09 to 61,000 tonnes from 66,000 tonnes previously.
At the same time the broker notes the risk to its forecasts appears to be to the upside, but either way theearnings growth as the company ramps up output should be significant. On GSJB Were numbers thecompany should generate earnings per share (EPS) of US38.2c this year as production commences, beforejumping to US118.7c in FY09 and US126.2c in FY10.
The estimates of Credit Suisse are slightly lower, the broker forecasting EPS of US37.6c this year and US99cin FY09. It remains positive on the stock as there should be positive news flow from the company throughthe course of 2008 thanks to a feasibility study for the uranium portion of Lumwana due in March andpotential for good results through the year as the company expands its exploration budget.
GSJB Were sees potential for the company to fast track its uranium project as recent drilling has movedmore of the reserves into the indicated resource category, the broker suggesting the timetable may bebrought forward so that earthworks commence this year.
As noted in this week’s Rudi on Thursday column there are some potential supply side issues for copperin particular and metals generally in Africa given issues in delivering power to mining operations, whichshould prove supportive for prices.
Equinox is not immune as while it will have internal generating capacity the company will be tapped intothe Zambian National Grid and connected through the Democratic Republic of Congo. When the plant is upand running the Zambian power generating capacity will be fully drawn, so there is some risk of disruption.
Neither broker sees this as detracting from the value on offer though, Credit Suisse pointing out late lastmonth the stock was priced at less than 4x earnings in FY09, which it argued was significantly undervaluingthe company given the expected production increases.
The broker has a target price of $8.75 on the stock, while Weres has set its target price at $7.80. The onlyother coverage in the FNArena database comes from Aspect Huntley, which this week downgraded thestock to Accumulate from Buy.
Shares in Equinox as at 1.40pm today were up 5c at $5.20, while the stock’s trading range over the pastyear has been $1.97-$7.05.
Stories To Read From FN Arena www.fnarena.com
8 Australia
Exco Sitting On A Goldmine (Among Other Things) By Greg Peel
RBC Capital Markets this week initiated coverage of junior explorer Exco ((EXS)) with a level of excitement.The Exco story is not just one of exploration alone, but of the goings on at neighbouring operations ownedby none other than global mining giant Xstrata.
"We believe that EXS owns one of the most impressive copper exploration tenement packages in all ofAustralia," the analysts exclaimed.
Exco owns 4700 square kilometres of Queensland in the Mt Isa area. Tenements are located in and aroundthe same areas as existing well known copper mines and deposits. Exco bought the tenements from astruggling BHP Billiton ((BHP)) back in the nineties, when that company was in the doldrums and offloadingits global exploration assets. D'oh! In 2006 Exco further acquired ground in the Cloncurry region.
Given time, RBC believes there is a good chance Exco will stumble upon a large Iron Oxide Copper Golddeposit. Where you find lots of copper you also find gold, and you can throw in uranium as well. Theanalysts have extrapolated recent exploration tenement acquisitions around the region to decide Exco'splots are worth 10c per share. The current key asset is "E1", which is just 8km from Xstrata's significantEarnest Henry copper mine and which contains 200kt of copper close to the surface. Add in 10c per share incash held by the company, and an investor's floor price should be 20c. The stock is trading at 25c today.
The current traded price is about 50% of what RBC determines is Exco's net asset value of 53cps. Thisdiscount is about normal for junior explorers. RBC is working off a long term copper price of US$1.30/lbwhen the current spot price is over US$3.50/lb. Increase the LT price to US$2.00/lb and Exco's NAVincreases to $1.04 per share.
But wait, that's not all.
What RBC is really excited about is that Xstrata's Earnest Henry mine is moving from an open pit operationinto underground mining. The open pit will be closed by 2014. The underground operation will beginconstruction this year, but won't be up and running until 2011. In the interim, Xstrata will be left with alarge copper smelter running at only 80% capacity. But E1's ore is of a similar grade, and drilling in 2008should increase the current resource by 20%. Xstrata has already flagged a need to sign joint ventures withnearby mines to keep its smelter earning its keep, and although there are a few around to choose from,RBC sees Exco as a stand-out contender.
RBC suggests an off-take agreement with Xstrata could be worth $1.00 per share.
RBC has initiated with an Outperform (speculative risk) rating and a 12-month target price of 45c. But theanalysts suggest an off-take agreement would spark a "serious" re-rating. The 45c target takes into accountthe risk of this not happening.
Stories To Read From FN Arena www.fnarena.com
9 Australia
Good News From Pharmaxis By Greg Peel
Bio-tech Pharmaxis ((PXS)) has come away from a meeting with the Australian Therapeutic GoodsAdministration (TGA) with a thumbs up in regards to its Bronchitol product. Bronchitol is intended to treatthe incurable lung condition brochiectasis and the implication from the meeting is that Pharmaxis can goahead with its planned marketing submission in the September quarter with initial TGA support.
The submission will go ahead following the completion of the "open-label" component of the internationalPhase III brochiectasis trial. The timing is as the analysts at Credit Suisse expected, although ABN AmroMorgans had set an earlier date. No problem, as ABN suggests a June quarter 2009 product launch is still onthe cards.
The Australian market for the product is around 18,000 but this stretches to around 600,000 globally.
Credit Suisse is encouraged that the initial approval went through smoothly, as it implies there have beenno major issues with the drug to date. The next milestone will come up in the next few weeks as Pharmaxismeets with the European Agency for the Evaluation of Medical Products (EMEA). Credit Suisse sees thepositive TGA meeting as boding well for the EMEA meeting. This meeting will determine the timing on aEuropean launch.
ABN cautiously notes that this is a complex process, but that each quarter of potential delay would onlyknock 5cps off valuation. Europe represents 210,000 of the 600,000 global figure.
Shares in Pharmaxis are currently trading around the $3.00 mark. ABN has set a 12-month target of $4.60with a Buy rating, while a more excited Credit Suisse has set its target at $5.35 with Outperform.
Stories To Read From FN Arena www.fnarena.com
10 Australia
Goodman Group Comes Through By Greg Peel
The CEO of listed property trust Goodman Group ((GMG)) must still wake in a cold sweat at nightremembering that fateful day of December 14 - the day that Centro Property ((CNP)) came out of a tradinghalt with the announcement of potentially terminal financing problems. Oblivious analysts got the shock oftheir lives and a previously complacent market spared no haste in dumping every property trust on theexchange.
Goodman was not spared from the rout, but as analysts frantically scoured balance sheets and forecaststhey all came away believing that if there was one LPT which was probably the victim of too much guilt byassociation, it was Goodman.
Mind you, some were fairly positive on Valad Property ((VPG)) as well and that trust has since run intorefinancing issues of its own.
Goodman's shares fell from around $6.20 to about $4.10 on that day, before bouncing back to $5.00 thenext as bargain hunters heeded analyst assessments. However, ongoing global credit market issues, furtherbad news from Valad among others, and a general market malaise has seen Goodman's shares test newrecent lows. At around $4.20 today the stock has been trying to pick itself back up, but a revised marketapproach to risk means LPTs are mostly in the "stay well away" bin for at least the time being.
Nevertheless, the majority of brokers in the FNArena database have continued to recommend Goodman asthe LPT to have in a portfolio if any LPT is to be had at all. The big shift-down in share price means Buyratings have outnumbered, with several brokers having upgraded in December post the Centro rout. Thecurrent B/H/S ratio stands at 6/1/1. However, Deutsche Bank (Hold) has not reported since August nor UBS(Buy) since November. That leaves a more realistic 5/0/1, with Credit Suisse (Underperform) not yetcommenting on yesterday's result.
The Buy raters were vindicated yesterday when Goodman posted a first half result that was down 5.4%(realised) but ahead of consensus estimates. Earnings per share was, however, up 11% on the previouscorresponding period and funds under management grew 8%. Management reconfirmed guidance, of whichthe first half result represented 51.5%. Given everything the global and local markets have thrown atGoodman the past six months, this was agreed by all to be a good result.
If you took an LPT analyst aside he or she would probably admit, off the record, that they should have seenCentro coming. The trust was very highly geared, had an inferior portfolio of down-market US shoppingmalls that were staring at a possible recession, and had refinancing obligations approaching in a frozencredit market. Thus it was that Goodman stood out in contrast, with around 50% gearing, a diversified andhigh-quality portfolio of international assets and near term finance already in place.
Nevertheless, the outlook for Goodman in the short term is not all beer and skittles. Cost of funds willremain inflated and a large part of the portfolio is in the UK where property prices are under pressure. Thetrust is holding only around $600m in available liquidity which will make new acquisitions limited. However,JP Morgan points out that Goodman does have the potential to successfully recycle assets worth up to$1.25bn. This is again in contrast to Centro, which is now hoping someone - anyone - will pay at leastsomething for its shopping malls before the tumbleweeds take over.
Merrill Lynch notes three reasons why Goodman should be considered as a Buy. It's well protected fromlocal inflation, given almost all its debt lies in offshore markets; it is a play on Asia-Pacific growth, with78% of earnings derived from that region; and it has refinanced $2.3bn of debt in the past eight months,suggesting it's no "house of cards". The Group also derives a lot of fee-based income from its servicesdivision which makes it more attractive to lenders than other LPTs.
Stories To Read From FN Arena www.fnarena.com
11 Australia
At current prices analysts are forecasting an FY08 yield in the 7.00-7.50% range. Averaging the target pricesof the four brokers who reported this morning (the rest are bit old) produces $5.31 against about $4.20now. All those brokers have Buy ratings.
Macquarie sums up the feeling by suggesting Goodman will see slow growth in the short term, but that theGroup is well positioned for the longer term relative to peers. The consensus is that if you want to find abargain in the potentially over-trashed LPT sector, this is the safest bet.
Aevum Delivers, Brokers Remain Positive By Chris Shaw
With the market continuing to fluctuate a solid profit result is one way to restore or retain investorconfidence so both ABN Amro and Austock Securities were impressed by the earnings performance ofretirement village and aged care group Aevum Limited ((AVE)).
The company posted a 1H08 profit of $10.9 million, up 41% on the previous corresponding period andmatching the estimates of both brokers, Austock noting the result was helped by the contribution fromrecent acquisitions and by a 39% increase in property valuations.
ABN Amro estimates this $14.7 million increase in valuations lifts the group’s net tangible asset backing to$2.07 from $1.60 in the previous corresponding period, another positive being following a recent capitalraising the group’s gearing stands at just 14%.
Earnings guidance from management suggests an increase in EPS for the year of 5-10%, Austock forecastinga 5% increase for the year but seeing earnings risk as to the upside given an expectation of some furtherdeals before the end of the financial year.
The low gearing will help facilitate any deals, Austock adding the company is also well placed given it has$24m in cash on hand and $25m in unused credit facilities with which to fund any deals and itsdevelopment options, with 496 units currently in the development pipeline.
The broker expects any acquisitions in coming months are likely to be smaller off-market deals as theseinvolve less competition, ABN Amro noting management has indicated the pace of acquisition growth islikely to slow in the medium-term as there is currently less value on offer.
Following the profit result ABN Amro is forecasting earnings per share (EPS) of 25.3c this year and 28.5c inFY09, which would put the stock on a FY09 P/E (price to earnings ratio) of around 8.2x.
Austock’s forecasts are a little lower at 24.3c in FY08 and 27.3c in FY09, though its target price is slightlyhigher at $3.50 against ABN Amro at $3.22. ABN’s target has been reduced from $3.86 to factor in recentmarket volatility.
In Austock’s view the recent share price weakness is an opportunity and the broker has upgraded its ratingto Strong Buy from Buy, while ABN Amro continues with its Buy rating following the interim profit result.
No other brokers in the FNArena database follow the stock but as a means of comparison Thomson OneAnalytics shows a median price target on the shares of $3.50. Shares in Aevum today are slightly higher andas at 12.25pm were up 1c at $2.35, which compares to a range for the past 12 months of $2.22 to $3.98.
Stories To Read From FN Arena www.fnarena.com
12 Australia
Tough Year Ahead For Zinc By Chris Shaw
Whether or not commodities are in the midst of a supercycle, the price of individual metals will stillfluctuate based on expectations for supply and demand and these fundamentals are leading many in themarket to suggest 2008 will be a difficult year for zinc prices.
As Barclays Capital notes this is on the back of 2007 already having been a poor year for the metal, as lastyear zinc was the only one of the industrial metals to record a price fall in year-on-year terms.
The fundamentals appear to be getting worse rather than better, Barclays pointing out over the past sixmonths there was relatively heavy selling in the metal on expectations of supply increases. This turned outto be something of a prescient view as after three years of deficits the group, along with GSJB Were,estimates the market recorded a modest surplus for 2007.
Much of this can be attributed to increased supply, GSJB Were noting a number of new projects came onstream last year and some, such as the San Christobel mine in Bolivia, are now ramping up their output.
While demand growth will also increase in the broker’s view thanks primarily to increasing demand fromemerging nations the GSJBW suggests it won’t be enough to prevent the market’s surplus increasing,so it is forecasting an excess of around 420,000 tonnes in 2008.
Barclays shares this view, making the point Chinese demand growth is likely to slow this year given there iscurrently an oversupply of low end galvanised steel in the Chinese market. On the group’s numbersthere could be a global surplus of around 300,000 tonnes this year.
UBS’s estimate is for a surplus of 600,000 tonnes, the broker forecasting total refined demand toincrease from 2007’s 11.6 million tonnes to 12.1 million tonnes this year while supply increases to 12.7million tonnes from 11.2 million tonnes in 2007.
Given the widening surplus zinc prices are expected to come under further pressure, with 2008 averagesforecast to be well below the price levels experienced in 2007. The unknown is the supply side response, asBarclays points out most of the excess smelting capacity is in China and there are logistical issues intransporting increased volumes of concentrate to these smelters.
It also notes there could be changes to the current tariff system in that market and this would likely limitglobal supply, which is significant as China is expected to account for much of the increase in globaloutput.
GSJB Were sees the risk to prices in the coming year as to the downside as on its estimates a surplus of420,000 tonnes is around seven weeks worth of supply, well up from the three weeks supply whenstockpiles were at their lowest in 2006.
From an average of US147c per pound last year the broker is forecasting an average price of US115c perpound in 2008 but sees scope for prices to come in below this figure. On its numbers prices are forecast todecline further to an average of US91c per pound in 2009.
Barclays is even more bearish and is forecasting an average price of US90.7c per pound for the year, with afurther modest decline to US86.2c per pound in 2009.
UBS is closer to the GSJB Were view with its forecast of an LME price of US115c per pound for 2008, thoughit notes this estimate is around 5% above current market consensus. Where the broker differs is in itsforecast for next year, as it sees prices gaining in 2009 to an average of US140c per pound.
Stories To Read From FN Arena www.fnarena.com
13 Commodities
Spot Uranium Stabilises At US$75 Per Pound By Rudi Filapek-Vandyck
Spot uranium is no longer falling. After sector consultant Ux Consulting decided to lower to US$75/lb andpull its spot price in line with fellow-consultant TradeTech last week, the latter has kept its own weeklyspot price indicator unchanged this week. US$75/lb it is then. Long term price indicators remain atUS$95/lb for both consultants. TradeTech reports at least two sellers remain active in the spot market.However, the consultant also suggests that last month's aggressive sellers seem to have resided to thesidelines for now, signalling these sellers may have sold what they had to sell. Uranium priced at US$75/lbagain has triggered renewed interest from buyers. TradeTech reports at least two hedge funds arecurrently considering whether they should purchase some product or not. If last year's pattern repeats itselfthis year, spot prices should find a bottom at current price levels, similar to September-October last year.
Stories To Read From FN Arena www.fnarena.com
14 Commodities
Are Base Metals Prices Near A Bottom? By Chris Shaw
Ever since concerns begin to emerge over the health of the US economy industrial metal prices have foundthe going tough and in the case of nickel and zinc it means prices are now around 50% below their cyclepeaks.
According to Natixis Commodity Markets the falls can be attributed more to weaker demand than to supplyside increases as the slowdown in the US is spreading and Europe is now displaying evidence of a weakeningeconomy via measures such as declines in steel demand.
This weaker demand has dragged down zinc and nickel prices and turned sentiment towards the industrialmetals far more bearish, Natixis noting on an equal weighting measure for the base metals sector prices areon average down around 20% from levels of a few months ago.
Are the price falls excessive? According to Natixis that depends on your view of the outlook for the globaleconomy. Its own view is there will be a US-led slowdown but not a recession
The group argues the strength of the BRIC (Brazil, Russia, India and China) economies is such that even witha US slowdown these countries will continue to enjoy strong internal economic momentum, meaning theirdemand for metals will continue to grow through the coming year.
This is the de-coupling effect that has been mentioned a lot of late, though the group points out itwon’t be enough to positively impact on sentiment in the short-term given economic indicators continueto suggest further weakness.
Examples of this include recent falls in the OECD Composite Leading Indicator, which suggests weakergrowth is expected in the coming 6-9 months. At the same time the EU Manufacturing PMI fell in December,which is indicative of a weaker performance from the EU’s industrial sector.
US data don’t add anything positive to the picture, Natixis noting the ISM Manufacturing Index there fellfor the sixth month in a row in December. The good news though according to the group is much of theweaker demand environment is now priced into the sector, which means any further downside appearslimited.
This sets the scene for some stabilisation of prices generally in coming months, though the group’soutlook for each metal in the sector is influenced by specific factors.
Aluminium experienced an estimated fall in "Western World" consumption of 0.8% last year and Natixisdoesn’t see any pick up in the first half of 2008 given the weak US economy and weak constructionsectors in a number of markets.
Later this year the group expects demand to pick up, the result being a 3% rise in demand for the year as awhole. With the market predicted to remain in a modest surplus for the year the group sees a slightstrengthening in prices, with an average for 2008 of US$2,800 per tonne, up from US$2,640 per tonne in2007.
From a relatively balanced market in 2007 Natixis expects copper to record a modest market surplus thisyear of around 200,000 tonnes, but this will develop in a market where stockpiles are currently at lowlevels.
As a result the group expects copper prices this year will be relatively similar to those of last year,forecasting an average price of US$7,150 per tonne against last year’s out-turn of US$7,126 per tonne.
Stories To Read From FN Arena www.fnarena.com
15 Commodities
While tight conditions will persist for a few months the group expects the availability of lead concentratewill improve across the course of this year, while spare capacity in China suggests output will rise andgenerate a surplus of around 90,000 tonnes for the year.
On the group’s estimates the lead price should average around US$2,600 per tonne for the year but theprice should be strongest in the first half, with the end of the year to see prices closer to US$2,000 pertonne.
The demand side of the equation will be the key for nickel prices in the group’s view, with currentweaker demand expected to improve by the end of the current quarter. Following last year’s 7.7% fall indemand the group sees a turnaround this year and estimates demand will increase by almost 10%, thoughprices are expected to average around US$30,000 per tonne against last year’s US$37,181 per tonne.
With the tin market expected to record a small deficit in 2008 the outlook for the metal appears solid,especially as increased “Western World†demand will be matched by strong domestic demand in China.As a result the group sees prices averaging US$16,000 per tonne this year, a gain of about 10% from lastyear.
Zinc in contrast is expected to record a surplus of around 250,000 tonnes this year but with current pricesaround 50% below previous peaks the group doesn’t expect the larger surplus will push down pricessignificantly. Natixis is forecasting an average price for 2008 of US$2,400 per tonne.
The biggest risk to the group’s outlook is the health of the global economy, as it notes with prices inmost cases still above the marginal cost of production a downturn in demand would present some downsiderisk for prices.
On the plus side, any relatively quick recovery in the US would likely spur demand and with stockpiles stilllow and scope for supply side issues remaining, such an outcome could be expected to bring about aturnaround in investor interest in the group’s view.
Further Upside Remains For Gold By Chris Shaw
After rallying to record highs late last year gold has carried on the positive momentum into 2008 and racedthrough US$900 per ounce, Natixis Commodity Markets suggesting the rally was driven by investmentdemand as wealth preservation became an objective while global financial markets corrected.
In the group’s view this positive momentum may well continue for a few months, a view shared byMerrill Lynch as the broker notes along with investor demand there are a number of other supportivefactors including US dollar weakness, record oil prices and ongoing geopolitical tensions.
The oil price is of some significance as the broker notes higher oil prices are inflationary and this is goodfor gold, while history shows there is a better than 80% correlation between the oil and gold prices.
This has resulted in Merrill Lynch lifting its forecasts for the gold price significantly in coming years, withits estimate for 2008 raised to (a year average of) US$925 per ounce from US$750 previously, in 2009 toUS$1,000 per ounce from US$800 previously and in 2010 to US$1,100 per ounce from US$750.
The broker’s long-term price has also been increased to US$650 per ounce from US$600 previously as thelonger-term supply/demand outlook continues to look more favourable.
On the demand side the broker notes jewellery demand remains good in emerging markets in particulareven as prices have moved higher, though UBS suggests jewellery demand globally was relatively poor inthe December quarter of last year.
The supply side of the equation looks supportive as well, the broker noting production in 2008 should beflat with respect to output in 2007, while output itself may come down as grades are falling at existingoperations. UBS agrees and expects the supply side will remain under pressure, particularly as de-hedgingshould also continue to trend down.
Natixis also sees little to hurt prices from the supply side, the group pointing out there have been somedisruptions to operations and costs continue to increase, while there is also scope in its view for officialsales to trend lower over the course of 2008.
Natixis takes a slightly different view to Merrill Lynch though in seeing some risk to the price from therecent high level of investment buying, as there is always a chance the funds will reverse their longpositions and this could prompt a sharp fall in the share price and at least should keep price volatility atrelatively high levels.
Overall though the group expects gold will move through US$950 per ounce at some point this year, with atest of US$1,000 a possibility. The volatility means a smooth rise is unlikely, Natixis seeing scope for pricesto trade down to US$800 per ounce as well in the coming year with an average in the high US$800 range.
UBS is more bearish and expects an average of US$825 per ounce for the year, the broker arguing using justjewellery demand as a base for the gold price it is currently around US$200 per ounce overvalued. In thebroker’s view 2008 will prove to be the peak for prices in the current cycle.
RCR Equity Research takes the view the gold market’s fundamentals will remain strong through to 2010,so the group sees US$1,000 as very attainable this year given the metal’s position as a relatively safehaven in the current uncertain environment.
In terms of the impact on the gold producers in the Australian market the group suggests the higher price iscreating opportunities in both new and existing regions, with takeover activity in the sector also likely to
Stories To Read From FN Arena www.fnarena.com
16 Commodities
be stepped up.
The group also notes the price is encouraging exploration plays to look to new markets, as evidenced bySino Gold ((SGX)) in China, Southern Gold ((SAU)) in Cambodia and Mundo Minerals ((MUN)) in Brazil.
Emerging producers it sees as offering leverage to the gold price include Monarch Gold ((MON)), ApexMinerals ((AXM)), Dioro Exploration ((DIO)), Norton Gold Fields ((NGF)), Navigator Resources ((NAV)), SilverLake Resource ((SLR)), Regis Resources ((RRS)), Emperor Mines ((EMP)), Intrepid Mines ((IAU)) and CrescentGold ((CRE)).
Others with exploration upside that also offer gold price leverage include Andean Resources ((AND)), ExeterResources ((XRC)), Mutiny Gold ((MYG)) and YTC Resources ((YTC)).
Global Steel Output To Rise By 5.7% In 2008 By Chris Shaw
On the back of continued strong demand steel industry consultant MEPS is forecasting a 5.7% increase inglobal steel output in 2008 to 1,420 million tonnes, with blast furnace iron to make up most of the outputand to top 1,000 million tonnes for the year.
Strongest growth in production will come from China as MEPS anticipates output for the year of 533 milliontonnes, up from 489 million tonnes in 2007. While Japan will show relatively flat output of around 120million tonnes the rest of Asia is expected to generate an increase from 2007’s 144.9 million tonnes to justunder 153 million tonnes in 2008.
The Former USSR countries are also expected to record a solid boost in production, with the groupforecasting output to increase from last year’s 124.4 million tonnes to a little over 131 million tonnes thisyear.
The EU is expected to show an increase to 215 million tonnes from 210 million tonnes last year, MEPSsuggesting the modest increase will be a reflection of continued solid demand in the region. Other Europeshould also be stronger on the back of strong demand from Turkey in particular, the group forecasting totaloutput rising to 33.4 million tonnes against 30.5 million tonnes previously.
The weak US dollar is limiting imports in the North American region and this should help boost productionslightly, MEPS expecting output of 134.8 million tonnes against last year’s 132.8 million tonnes.
Slight gains are expected in Australia and the Oceania region generally, MEPS forecasting total productionof 9.0 million tonnes, up from last year’s 8.8 million tonnes.
Stories To Read From FN Arena www.fnarena.com
17 Commodities
Barclays Predicts Aluminium Price Jump By Chris Shaw
Barclays Capital, a long time bull on aluminium has reaffirmed its positive outlook for much the samereasons as others have been turning bullish recently; demand is strong and strengthening but production isbecoming more difficult given the enormous amount of power required in the metal's smelting process.
As Barclays notes more than 40% of global aluminium smelting capacity is coal fired and with spot thermalcoal prices having more than doubled to US$130 per tonne in the past six weeks the cost of producingaluminium is rapidly moving higher.
This implies prices will need to move higher in tandem, the alternative being production will fall asmarginal producers start to lose money.
Add in the fact many regions, and China and Africa are the most recent examples, are struggling togenerate enough power to meet their requirements not just for aluminium but for their populations ingeneral, and we're left with a real risk there won't be enough low cost power to meet demand fromsmelters.
Assuming the situation in South Africa remains difficult in terms of power generation, and Barclays notespower company Eskom is now considering buying back power from BHP Billiton ((BHP)), it potentially putsat risk up to 3% of expected global aluminium output.
If this were to eventuate Barclays estimates it could turn the market from a likely surplus to a deficit forthe year of as much as one million tonnes, so bringing down stockpiles.
The group suggests the price reaction would likely be significant, with US$4,000 per tonne and beyondpossible in such an environment compared to current prices of around US$2,815 per tonne.
(See also Preparing For The Aluminium Boom, Sell&Buy-ology, 07/02/2008).
Stories To Read From FN Arena www.fnarena.com
18 Commodities
Oz Consumer Confidence Dives In February By Rudi Filapek-Vandyck
The Westpac/Melbourne Institute Index of Consumer Sentiment fell by 5.5% in February from 103.1 inJanuary to 97.4 in February. Economists at Westpac explain that an Index level below 100 indicates thatpessimists now outnumber optimists. Also, the fall in the Index follows the Reserve Bank's 0.25% increase inthe cash rate to 7% on February 5. That rate hike followed the average 0.15% increase in new and existingvariable mortgage rates by the major banks in January and two previous increases in the cash rate by theRBA in August and November last year. Westpac notes consumer Sentiment has fallen sharply followingeach of the six RBA rate hikes from 2005-2007. This time is no different. The average fall in the Indexfollowing a rate hike over 2005-2007 was 9.7% and on two previous occasions in August and November 2006the Index fell below 100 to 90 and 95 respectively. The Index is now 12.6% below its level a year ago; 15.5%below the average level in 2007 and 6.5% below the average in 2006. The economists also note that afterplunging in both August and November 2006 to below 100 the Index quickly recovered through the first halfof 2007 to reach an all time peak of 123.9 in May 2007. Confidence among Australian consumerss has nowfallen fairly steadily through the second half of 2007 to now be down 21.4% from that peak. Despite the fallin Confidence through the second half of 2007 Westpac points out consumer spending has sustained strongmomentum. Retail sales volumes grew by 1.6% in the December quarter and real household disposableincome grew by 7.8% through the year. The economists believe lower confidence levels are likely to seethe consumer again opt for a higher level of savings. They predict continuous strong income growthwill support "decent growth" in consumer spending in the months ahead. The confidence of respondentswith a housing loan fell by 6% this month. However, the economists highlight that those who wholly owntheir own home registered an 11.3% fall in confidence, indicating that factors in addition to interest ratesmay have been significant contributors in the fall. The component of the Index assessing the outlook foreconomic conditions over the next 12 months fell sharply (by 14%), but the component assessing theeconomic outlook for the next five years rose by 10.3%. So did the outlook for family finances over the next12 months: up by 3.6%. Overall, Westpac reports, the expectations Index fell by only 0.1%, compared to a13.1% fall in the current conditions Index. Opinions on whether now is a good time to buy a majorhousehold item fell by 15.5% while opinions on family finances compared to a year ago were down by10.7%. Westpac economists have joined their colleagues elsewhere and believe the Reserve Bank ofAustralia will raise official interest rates again at the March meeting. Assuming the bank will raise by 25basis points, this would take the official cash rate to 7.25%.
Stories To Read From FN Arena www.fnarena.com
19 Economics
Strong Employment - Good News And Bad By Greg Peel
"Full employment" is a utopian goal of politicians who, for obvious reasons, believe a country in whicheveryone has a job is a successful one. Clearly any country's employment can never really be "full", as thiswould imply every single man and woman who wants a job, or must otherwise look for a job to qualify forwelfare, has one. In other words unemployment would be 0%. Apart from being an unrealistic concept, it isnot really a great help either. Imagine a sports team with no substitutes on the bench. What happens ifsomeone is injured?
So a loose definition of "full" employment that has prevailed for some time is actually 5% unemployment.This is seen as relatively ideal, as it allows for employers looking for new staff to still find candidates whiledisaffected employees can still make choices. If unemployment is 0% there's no room for growth and no onewould dare leave their job.
The unemployment rate in Australia, however, long ago fell below 5% and in January hit a 34-year low at4.1%. This has prompted some economists to suggest that maybe "full" employment should be reclassified as3% unemployment, given Australia's economy is powering along quite nicely and not suffering too manyramifications of being "over-employed".
The number of Australians employed increased by 26,800 in January, compared to consensus estimations ofa 15,000 increase. The participation rate remained at a historically high 65.2% of population, andunemployment fell to 4.1% from 4.3% in December. January represented the fifteenth consecutive month ofjob increases.
If just about everyone has a job it should be good for an economy, as there's money in the pocket to spend.It also goes some way to explaining why, in Australia's case, consumer spending has failed to be curtailedby higher energy and food prices. It is also beneficial in the face of higher interest rates, which have risendue to aforementioned inflation, in that home owners with jobs are better prepared to weather mortgagepayment increases. Compare Australia's situation to that in the US, where despite significant interest ratecuts unemployment has begun to rise, mortgage defaults are widespread, energy and food costs are soaringthere too, and the economy is possibly already in recession.
But if there are benefits of a 4% unemployment rate, there is also a dark side. There might still be areserves bench to make sure things don't come to a grinding halt, but there is little to stop those who are ina job recognising their greater value in a market where good substitutes are thin on the ground. If energy,food and interest payment costs are rising for the average household, there's little to stop the averageworker leveraging more pay out of an employer. And now that the Rudd government is about to begindismantling the previous government's work agreement system, unions in particular will be pushing forwage increases.
Australia's employment growth is even more significant when you consider that (a) immigration has steppedup to strong levels and (b) the Howard government took steps to ensure many more Australians - the aged,disabled and others on welfare - either remained in or returned to the workforce. Apart from someincrease in productivity, this goes some way to explaining why the wage increases the RBA has beenexpecting for at least a year had not yet eventuated. But the RBA has never diminished its expectationsthat wage inflation must soon become an issue, and its monetary policy tightening has borne that in mind.If price inflation is rising, and then wage inflation rises, the two can end up fuelling each other in anupward spiral.
Thus the January jobs figure only goes to strengthen economist expectation that for the first time in agesthe RBA may make consecutive monthly rate hikes, and perhaps another in May following the first quarterCPI result. Until the RBA can apply some form of brake to this runaway economy the labour market willremain uncomfortably tight.
Stories To Read From FN Arena www.fnarena.com
20 Economics
Stand by for at least a 7.25% cash rate soon, if not 7.50%.
St George Bank Maintains Australian Outlook Still Solid By Chris Shaw
As St George Bank notes in its Monthly Economic Outlook for February, the main economic story at presentis how strong the Australian economy is at a time of economic weakness in the US.
The bank agrees the US outlook is currently very shaky given the combination of sub-prime credit issues anda weak housing sector is flowing through into broader sections of the economy.
While some question whether the US is already in recession or not, the bank takes the view the question isirrelevant, as either way the US economy is weak and will likely take time to get better, especially givenlabour market data suggest a worsening trend in US employment.
With US recessions having in the more recent past averaged about 10 months in duration the bank expectsthe current weakness to continue for at least another six months and this leads it to suggest the run ofstrong growth in the global economy is drawing to a close.
It is a view supported by recent downgrades to global growth estimates by the IMF but while these revisionsshow growth still coming in above trend the bank questions whether this will be achievable given theweakness in the US economy.
Those anticipating growth in China and India to make up for the weaker US contribution may bedisappointed in the bank’s view, though it makes the argument a slowing in China would actually be apositive as it would lessen the risk of that economy suffering a hard landing, an outcome that would causeeven more damage to the global economic picture.
In contrast to the US issues the Australian economy continues to power along on the back of higher houseprices, solid retail sales and domestic demand and still high commodity prices, these factors leaving it wellplaced to withstand any global slowdown.
Looking forward the bank expects continued strength in the labour market but notes there are signsbusiness conditions have peaked. As a result it expects growth to decline to just below trend levels throughthe course of the year, estimating a GDP outcome of close to 3%.
Even allowing for higher interest rates the bank sees the current housing upturn as continuing and forecasts5-10% price increases in most capital cities. Perth is the exception as the bank sees lower growth in thatmarket.
While some in the market are expecting the Reserve Bank of Australia to again hike rates in March the bankis not so sure, suggesting a more likely outcome will be a wait and see approach until the next batch of CPIdata are available in April. Regardless of the timing of any move it sees no change to the RBA’s currenttightening bias for at least several months.
Assuming interest rates in Australia peak around the middle of the year the bank expects that will alsoprove to be the peak for the Australian dollar, with a first-half average exchange rate of US88c expectedbefore a fall to around US85c in the second half of the year.
While volatility can be expected to continue shorter-term in equity markets the bank takes the viewvaluations are now reasonable and profit growth should continue, so it sees the market ending 2008 ataround 6,300 as measured by the S&P/ASX200 Index. This suggests upside of around 8% from themarket’s level as at the end of January.
Stories To Read From FN Arena www.fnarena.com
21 Economics
Quotes & Shorts: AED Oil's Money Problems, And More... Not everything your team of FNArena journalists comes across can be put into a separate news story. Butthat doesn't stop us from sharing with you some of the noteworthy, outstanding or even bizarre views,opinions and news items we come across via an occasional amalgamation of non-interrelated Quotes &Shorts.
AED Oil Remains Positive Amidst Mounting Worries
FNArena has learnt that the AED Oil ((AED)) share price weakness this week can be traced back to a stockmarket announcement by Norwegian oilfield services company AGR Group. The company did some drillingat AED Oil's Puffin field in the Timor Sea and is apparently still waiting to be paid for this. We're talking$41.5m. No wonder the market is getting edgy when it comes to owning AED Oil shares.
The company acknowledged as much in its response to an ASX query on Friday, accompanied with the usual"we're confident we'll achieve a satisfacory settlement with the Norwegians". However, AGR Group'sstatement reportedly displays less confidence with the cautious Scandinavians reportedly having taken aprovision for the contract.
For what it's worth, AED Oil said it is "progressing well" in its strategic review, which effectively meansmanagement is looking for ways to raise money and indications so far are it will be able to do so. Thecompany said it remains cash flow positive in its operations of the Puffin NE field, though production hasbeen hampered this week due to a break down in the gas lift facilities on the FPSO (that's a floating drillingplatform to you and me). AED expects the FPSO to be "fully operational" the coming week.
"The risk of dual recession is mounting. Our US economics team is already calling for capex-inducednegative GDP growth in successive quarters (Jan-Mar, Apr-Jun), for a technical minor recession in the firsthalf of the year by definition. We are forecasting that Japan will cling on to a modicum of growth in theOct-Dec 2007 quarter, boosted by external demand, but there is a possibility that, like the US, that quarterwill mark the peak and the economy will retreat in Jan-Mar. Future data for industrial production will tellus if this is the case. If industrial production drops in Apr-Jun, Japan will also be in recession." (MorganStanley Japan specialist Takehiro Sato this week).
"The US and Japan appear on the brink of recession, and Europe is slowing sharply. Chinese growth is alsoslowing, as policy makers tighten into a slowing external demand environment. We see risks that worldgrowth will slow to a sub-trend pace, consistent with lower commodity prices. That said, central bankeasing may help to arrest the decline, and reinforce the (later) recovery phase. While the risks to worldgrowth appear to be to the downside, we believe the domestic economy is likely to grow quite solidly inthe year ahead." (Westpac economists).
"With all the excitement over China and the rapid growth in Australia's exports to that country, it's oftenforgotten that Japan is still Australia's largest export partner, particularly for our commodity exports. Andit's Japan, rather than China, that faces the greater risk of economic slowdown in our view." (Credit Suissestrategists)
"Even though they have been sold off a long way, we would still recommend being underweight the wealthmanagers. Reason: The risk to their earnings outlook is still unfavourably skewed (if markets go sideways orkeep falling, EPS will need to come down further; even if markets recover, but by less than 5% by June andless than 10% by December, EPS will still need to come down further)." (Equity analysts at GSJB Were).
The next wave from the subprime mortgage crisis will flow past lenders and homebuilders and strikenonfinancial US companies with forced write-downs, the chief executive of PricewaterhouseCooperswarned.
According to Chief executive Samuel DiPiazza many nonfinancial companies were exposed throughsecurities in their own investment portfolios. "It's not just in banks," DiPiazza said. "These securities sit incash equivalent accounts of industrials; they sit in investment portfolios of pensions. We are having to dealwith this with thousands of companies, not just a handful of big banks." (Quotes taken from a Reutersreport)
Following the recent RBA rate hike all major banks have now adjusted their standard variable home loanrates. Some increases exceeded the RBA rise of 25 basis points, following on from increases the banks hadpreviously instituted independent of the RBA target, reflecting increased cost of funds. The "premium overRBA" scorecard now stands at National ((NAB)) 12 points, Commonwealth ((CBA)) 15 points, Westpac((WBC)) 15 points, ANZ ((ANZ)) 20 points and St George ((SGB)) 20 points.
Quotes & Shorts: RBA Repeats Inflation Worries, And More... Not everything your team of FNArena journalists comes across can be put into a separate news story. Butthat doesn't stop us from sharing with you some of the noteworthy, outstanding or even bizarre views,opinions and news items we come across via an occasional amalgamation of non-interrelated Quotes &Shorts.
RBA Sticks To Tightening Bias
"The situation in the global economy and financial markets remains a major source of uncertainty for thisoutlook. It is possible that there will be a sharper downturn in the world economy than is currentlyforecast, and there is also a risk that tighter credit supply could constrain demand and activity in Australiato a greater extent than is assumed. Should those risks eventuate, inflation would fall more quickly than iscurrently forecast. On the other hand, domestic demand has to date shown considerable momentum, andthere are further income gains from the terms of trade and other factors ahead. There thus remains a riskunder the current monetary policy setting that demand does not moderate sufficiently to achieve theforecast reduction in inflation. A further risk is the possibility that inflation expectations could rise, whichwould make the reduction in inflation more difficult to achieve.
"On the current outlook, then, and allowing for the inevitable uncertainties in forecasting, the risk ofinflation remaining uncomfortably high for some time is considerable. Absent a further shift in economicrisks to the downside, therefore, monetary policy is likely to need to be tighter in the period ahead."
(RBA Statement on monetary policy, February 11, 2008).
The Australian Financial Review reports on Monday Societe General's infamous trader Jerome Kerviel("mister EUR5bn") had at least one copycat in Australia. Allegiance Mining's ((AGM)) business developmentmanager Benjamin Amzalak had been playing the market throughout 2007 with some of the $30m MerrillLynch had raised for the aspiring nickel producer. The positions were closed out in January and have led toa loss of $7.9m. Amzalak has been fired, the newspaper reports, but similar to Kerviel he believes he's beenmade a scapegoat claiming management was fully aware of what he was doing and all trades had beenapproved by the company's finance department.
According to the newspaper, the board has begun an internal investigation. Allegiance is currently thesubject of a takeover bid by Zinifex ((ZFX)).
So much for those ever-recurring market rumours about Dutch-Anglo Royal Dutch/Shell's ambition toreinvigorate its previous intentions to fully acquire Woodside Petroleum ((WPL)) with the latter announcingon Monday morning it is buying out the North West Shelf interests of Royal Dutch Shell for $445m.Apparently, Shell will have a right of final offer for Woodside's assets in Libya should Woodside agree toproceed with the sale. According to Woodside, any sale of its Libyan interests will be subject to anacceptable offer and approvals by Libyan Government authorities.
Growth in online advertising could be facing some serious headwinds according to a freshly released reportby accounting firm Deloitte. The Media Predictions 2008 report believes online advertisers are gettingincreasingly frustrated by the lack of a standard measurement system, the report even suggests a "growingantipathy to online ads", newspaper The Australian reports on Monday.
Apart from online advertisers' increased scrutiny, the industry is also wrestling with growing opposition tothe tracking of online behaviour "whose main purpose is to enable the delivery of targeted advertising". Thereport finds the growing antipathy to online ads is a "key global trend" with internet users finding ads onthe internet more intrusive than in print media.
The latest figures show online advertising in Australia hit $247.7m in the September quarter last year, up6.8% from the previous quarter.
In case you missed it last week: gold producer View Resources ((VRE)) has been forced to call in theadministrators. Among the investors in the company is ASX-listed Lion Selection Group ((LST)) which owns7.1% or 31m shares in View.
Peru Is "Spectacular" And "Massive" For Contact Uranium
We couldn't help but noticing ASX-listed Contact Uranium ((CTS)) reporting its latest sampling program inPeru returning "spectacular" uranium grades, and for once the term seems well chosen with the companyreporting mineralisation of up to 34.75% U3O8 at its Kihitian licence in Peru. Apart from this, the orebodywould seem of a "massive" size as well. The plan is now to undertake a detailed mapping and samplingprogram with a view to having drill-ready targets by mid 2008.
Contact is headquartered in Perth and has assets to develop in Peru, Kyrgyzstan and Western Australia.www.contacturanium.com.au
According to UBS analysts, coal prices are expected to rise 80% and iron ore prices 55% from this year, withmany in the market expecting higher outcomes than this. Well, they got that right. FNArena believescurrent market consensus is more like a doubling of prices in the first case and 60%+ in the second.
Wednesday's release of US retail sales data for January is expected to have every trader, investor, theirpets plus everyone with even the most remote interest in the stockmarket glued to their pc screen thisweek. And just so we all know in advance: expectations have grown pretty gloomy over the past week.
Merrill Lynch economist David A Rosenberg expects to see retail sales to have declined for a secondconsecutive month. Why is this so bad? Because, explains Rosenberg, back-to-back declines in retail salesdo not happen very often. In fact, it has only happened twice in the past seven years (in the 2003 jobless
recovery and in the 2001 recession). Watch for sell orders to kick in if his assessment proves correct.
"Notice how economists have been tiptoeing around the "R-word", whispering it amongst each other, butnot quite ready to declare it in public. Economists have fretted and markets have plunged over worriesabout the credit crunch, economic slowdown, and possible U.S. recession. Well, the good news is thewondering is just about over; the recession appears to have arrived with the New Year. It almost seems likea relief to say it, doesn't it? Repeat after me, "The recession has arrived!" See, if you say it enough, thehorror of that word seems to just fade away. The old saying rings true today: "If it looks like a duck andquacks like a duck, it probably is a duck!"
"Don't get me wrong, the fiscal stimulus package just passed by Congress and the Fed's aggressive rate cutsin January will certainly help, but the relief may be too late to avoid at least one quarter of negative GDPgrowth. I expect the Fed will cut another 50 basis points from the Fed funds target rate by the March FOMCmeeting, and if financial markets continue to struggle, it may come sooner than that in the form of aninter-meeting cut."
(Wells Fargo senior economist Scott Anderson in what we believe reads like a Happy Recession! analysis) ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Can Chen Zhi Save The World ? "In most of the cities and towns of this country, this Wall Street panic will have no effect." - Paul Block,editorial, November 15, 1929. What a weight of global expectation hangs on the shoulders of the Chineseand Indian peasantry. With US service industries contracting at their fastest pace since 2001, with UKconsumer confidence falling to its lowest level since 2004, and with a strong euro and Jerome Kervielhampering the euro zone, just who is going to be picking up all the slack ? Answer: the likes of Chen Zhi, afarm worker in Zhejiang Province whom we just invented. Admittedly, Mr. Chen's earnings of roughly onedollar per day are unlikely to offset US household spending of c. $9 trillion - he'll just have to work thatmuch harder to afford all those yachts, cars, condominiums, lattes, HDTVs and handbags that willotherwise go unsold this year. The good folk at LongOrShortCapital express the sentiment slightly morebrutally (and also hint at the late stage frothiness of the Chinese stock market) as follows: "I get it. China isbig. There are a lot of people there and they are increasingly buying stuff. So when you present aninvestment to me, it's not useful to tell me how many people there are in China. You see, I know thatalready. That's why I own some Chinese companies already, before you came in here. So when I ask youwhy I should pay 50x earnings for this company, it's singularly unhelpful to start off by saying, "Did youknow there are a billion people in China ?" It doesn't make me want to buy the stock, it makes me want topunch you in the mouth or "decouple" your head from your torso. "I'll tell you what China also has. ABILLION POOR PEOPLE. A whole billion of them.. all looking to buy no things with their no money. Stick thatin your model and regress it." On the topic of Chinese market overvaluation, a comparison with previousmarket peaks and collapses is instructive (charts not displayed). As [Citigroup's] Patrick Perret-Green pointsout, the similarity in chart patterns between these markets is striking, "especially when they finally peak,fall sharply, bounce significantly and then embark on the 3rd wave death plunge. Shanghai looks to haveembarked on that." Which is not to say that the Chinese economy will necessarily flounder even if itsembryonic and foamy stock market succumbs to the law of gravity. In fact, the more likely "decoupling" thisyear will not be Asian markets mysteriously holding their own in the face of an Anglo-Saxon economicslowdown; rather, it will be the Chinese economy continuing to grow well by comparison to the West, evenif its own stock market collapses. This is still a nominally Communist country, after all. And no matter whathappens in Asia this year, its long term prospects look an awful lot more attractive than those of the Anglo-Saxon economies. Woe to a developed market economy when both its property market and its financialservices sector start to sink beneath the water line "As two spent swimmers that do cling together / Andchoke their art". Notwithstanding last week's continued equity market volatility, western shareholderscontinue to operate in baffled denial of what the global financial crisis means for the banking system: thecolossal unwinding of a decade's uncontrolled leverage; a critical (voluntary) retrenchment of lending;intrusive (involuntary) regulatory oversight of a sector that is incapable of policing itself; in short, the keydriver of economic activity in the western world has gone ex-growth for the foreseeable future. That iswithout further revelations of bad debts, malfeasance, connivance at misselling, and worse. We areentering a New Era for finance and nobody can say yet what it will look like with any confidence, but itdoesn't look like being terribly expansionist. John Brooks, in his excellent study of 1920s and 1930s NorthAmerican markets, "Once in Golconda: a true drama of Wall Street 1920-1938" (1999, John Wiley) citesJohn Maynard Keynes writing of what happens "to respectable and responsible people in times of excessivespeculation": "Amidst the rapid fluctuation of his fortunes, [the businessman] loses his conservativeinstincts, and begins to think more of the large gains of the moment than of the lesser, but permanent,profits of normal business. The welfare of his enterprise in the relatively distant future weighs less withhim than before, and thoughts are excited of a quick fortune and clearing out. His excessive gains havecome to him unsought and without fault or design on his part, but once acquired he does not lightlysurrender them.. With such impulses so placed, the businessman is not free from a suppressed uneasiness.In his heart he loses his former self-confidence in his relation to society, in his utility and necessity in theeconomic scheme.. He of all men and classes most respectable, praiseworthy, and necessary.. was now tobecome, and know himself half guilty, a profiteer." The roaring twenties ended with the sudden demise ofa sub-set of the US population who believed they had stumbled upon a formula for instant wealth. Thegaudy boom of the naughty noughties has ended with the sudden demise of an even more limited sub-set ofthe global corporate structure -trading-oriented banks- whose executives possessed more confidence thancompetence in their assessment of highly complex and fundamentally flawed financial instruments. Thecrowning irony is that while hedge funds have long been pilloried for supposedly piling up risks beyond allcompass, and have been consistently harried by traditional fund managers urging all forms of oversight andregulation upon them, the real systemic risks were being taken, and hugely underestimated, by banks -
Stories To Read From FN Arena www.fnarena.com
24 FYI
entities in the full view of the regulators. Quis custodiet ipsos custodes ? It is perhaps not a purecoincidence that those assets now generally rising in price -gold, oil, soft commodities- can be easily pricedand, even more importantly, easily understood. Tim Price Director of Investment PFP Wealth Management11th February 2008. Email: [email protected]
Quotes & Shorts: ECB To Start Cutting Interest Rates, And More... Not everything your team of FNArena journalists comes across can be put into a separate news story. Butthat doesn't stop us from sharing with you some of the noteworthy, outstanding or even bizarre views,opinions and news items we come across via an occasional amalgamation of non-interrelated Quotes &Shorts.
ECB To Start Cutting Interest Rates... Soon
"We have been forecasting for some time that the ECB would cut rates this year as growth slows and asinflation recedes. Trichet's comments following yesterday's policy meeting reinforce our conviction thatshort-term interest rates in the Euro-zone are headed lower. Whereas we previously projected that the ECBwould start to ease policy in the summer, we now think the easing cycle will begin this spring. If incomingdata show that growth continues to weaken, then there is a good chance that the ECB will cut rates by 25basis points in April. We also think that the ECB will cut rates by at least 50 basis points byautumn." (Wachovia economists in a Special Edition of their economic commentary) ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Departing present From Howard and Costello? "The RBA pays the price for misreading inflationrisks in 2006/2007. The RBA is likely to hike interest rates two or perhaps three more times in the monthsahead. In simple terms, domestic demand and GDP have been expanding at a rapid pace for such a longtime that capacity constraints are extreme. Based on the RBA's own forecasts, inflation will remain abovethe top end of its target until early 2010 and only in mid 2010 will it ease back to 3% - the top end of theband. One can presume that it will not be till very late 2010 or even 2011 that inflation will be within thetarget range unless rates are hiked substantially." (Stephen Koukoulas, TD Waterhouse) ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Quel Misere! "Meanwhile across the Atlantic, Europe seems to remain in almost completedenial of its own growing problems. We believe the focus of financial markets will now begin to switchtowards this region, and especially to that of the UK where a particularly hard economic landing now seemsto be a prospect. Europe as a whole is now slowing quickly as expensive currencies strangle exports, baddebt banking exposures slowly and reluctantly emerge, housing markets retreat and monetary policiesremain restrictive." (Macquarie economists find themselves on one line with colleagues at Wachovia, seeabove) ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Insurance Australia Group's Dividends Under Threat? Sustainedequity market losses may, of course, hold more significant implications for the insurers (and valuations) tothe extent that they impact upon capital strength, with Insurance Australia Group's ((IAG)) FY08 dividendoutlook potentially threatened by recent equity market weakness (in addition to material storm losses).(Macquarie analysts in a sector update on Tuesday) ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- For What It's Worth...Apparently there is a rumour going around about National ((NAB)) being interested in acquiring ANZ Bank((ANZ)). Whatever. ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- More Write-downs To Come Citigroup, Merrill Lynchand JPMorgan Chase face the biggest risk of write-downs on $148 billion of unsold LBO loans as the value ofthe debt plummets, according to Goldman Sachs research. Citigroup may need to write down $2.2 billion,on unsold loans, causing a 5 percent reduction in 2008 EPS. Merrill may lower earnings by 6 percent andJPMorgan faces a 2 percent cut in income. Banks can't find buyers for loans they underwrote to financerecord buyouts last year as losses sparked by the collapse of the U.S. subprime mortgage market sapdemand for all but the safest securities. (Bloomberg) ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Chinese Spy CaughtA former Boeing engineer has been indicted on charges of economic espionage in the theft of companytrade secrets related to aerospace programs, including the Space Shuttle, for China, said the Departmentof Justice on Monday. The indictment alleges that Chung took and concealed Boeing trade secrets relatingto the Space Shuttle, the C-17 military transport aircraft and the Delta IV rocket. (reports by newsagencies)----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Stories To Read From FN Arena www.fnarena.com
25 FYI
Quotes & Shorts: Rio Tinto Shares Towards $139.50?, And More... Not everything your team of FNArena journalists comes across can be put into a separate news story. Butthat doesn't stop us from sharing with you some of the noteworthy, outstanding or even bizarre views,opinions and news items we come across via an occasional amalgamation of non-interrelated Quotes &Shorts.
Rio On Its Way To $139.50? Here's some technical analysis on BHP Billiton ((BHP)) and takeover target RioTinto ((RIO)): RIO looks headed for $139.50 this week, after breaking resistance from bull flag patterntoday at $124.45. The stock should find strong support above $121.77. If RIO hits $139.50, BHP should riseto at least $40.55, assuming spread holds above 3.4x. ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
CommBank Lives Up To Expectations Commonwealth Bank ((CBA)) shares fell as much as 5.2% to a 14-month low of $46.84, after the bank missed analysts' forecasts with a 4% rise in first-half cash earnings,which investors took as a bad omen for Australia's other banks. (Well, at least readers of FNArena cannotsay they weren't warned about this). Also, we couldn't help but notice the following paragraph in an emailthat just entered our inbox (technical analysis driven investment tip): "If you're looking for a buyingopportunity for a moderate term position then I think CBA represents a great opportunity." (no furthercomments) ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Cockroach Theory Certainly Applies To AED Oil When it rains, it certainly pours for embattled junior oilproducer AED Oil ((AED)). As if recent news and rumours weren't bad enough, the company was forced toannounce on Wednesday it has stopped production at its Puffin Northeast oil field in the Timor sea, due todeveloping storms in the area. AED said it would have to disconnect its production vessel from the field,which has a daily production rate of between 6,000 to 10,000 barrels, and sail it to calmer waters should acyclone develop. ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Big Fears, But Mild Recession Only "It appears that the US economy is on the eve of a recession (or isalready in one). However, although there are significant downside risks, various factors suggest that all inall the recession could prove relatively mild. US recessions since the 1950s have on average lasted around10 months. Signs that the economy is bottoming out should therefore gradually become evident in thesummer. In the past stock markets generally anticipated the positive turnaround well before the end of therecession (with 2001 as a notorious exception)." (Quote from KBC Securities) ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Should The RBA Be Reading This? "Towards the end of 2008 inflation will have come down significantly in agood many countries. In that sense inflation considerations will not form an obstacle towards theinterestrate plans of most central banks." (Quote from the same KBC Securities) ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Central Banks Will Save The Day "The Fed's aggressive rate cuts hopefully will put pressure on the ECB tochange its hawkish, and backward-looking (in my view), monetary stance soon. If the ECB remains stubbornabout fighting the "inflation phantom", the epicentre of this financial crisis will shift from the US to Europe.This will prolong the turbulence in the global financial markets. But as and when both the Fed and the ECBmove in the same direction to cut rates, that will clear the way for a new bull phase for stocks. Experienceshows that aggressive rate cuts always ignite asset price inflation - leading to a new asset bubble, if youwould." (Chi Lo, research director at Ping An of China Asset Management Hong Kong). ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Stories To Read From FN Arena www.fnarena.com
26 FYI
Nine More Months Of Uncertainty "In our view the current climate of uncertainty will persist for another sixto nine months. We now reduce our expectations for EMEA equity returns in 2008. We maintain a strongpreference for Russia, Egypt and the OPEC markets." Credit Suisse strategists have scaled backtheir projected investment returns on anticipated lower earnings growth and lower valuation multiples forEMEA markets (EMEA stands for Europe, Middle East and Africa but is commonly referred to as the emergingmarkets in those regions). Credit Suisse expects a further 50bps of Federal Reserve easing before the end ofJune. ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------- The World Starts Looking Towards Japan Again "Our impression isthat about 80% of the investors we met are underweight Japanese equities. However, interest in theJapanese market is increasing as its dollar-based performance has improved relative to the internationalbear market conditions that have prevailed since start-2008. Only a few US investors strongly disagreedwith our view that Japanese equities are attractively valued." (Credit Suisse following a road trip visiting USinvestors earlier this month). ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Rudi On Thursday If making forecasts was as simple as adding up a few numbers, divide it by key factors and then multiply bycertain values, we'd all know what stocks to buy and when prices for key commodities would finally starttrending down. Unfortunately, the art of making price forecasts requires a little bit more, and then there'salways the sudden impact from the unknown event.
This year, so much seems true already, will be the year that the world will learn that power supply is notnecessarily a given. Already, we've read and heard about large scale power shortages in South-Africa andChina. As both countries have a major mining industry, the impact on international commodity prices couldpotentially be significant.
At the beginning of each calendar year securities analysts line up their price forecasts and some services,like Reuters, compile handy and compact overviews from these data. Last year, each of those overviewsindicated prices would fall for most base metals and, if my memory is correct, consensus predicted modestgains only for precious metals. As it turned out, the first six months saw many metals (remember nickel andlater lead ?) soar to new highs, while precious metals waited until the last months of the year to take offlike a rocket.
This year's forecasts are pretty similar, consensus doesn't see one single base metal improving in averageprice compared with 2007. Consensus in January, that is. (I suspect most of those forecasts were actuallymade before Christmas). Copper seemed like the main exception with the market predicting a rather stableprice development in 2008 compared with last year. Since those overviews were compiled and publishedprice expectations for aluminium have improved. Up to a point that some experts now genuinely believealuminium may finally have its moment in the sun and record an average price increase this year. Some areeven speculating on a significant price jump. I have an early suspicion that something similar is happeningwith regards to tin.
And oh yes, rather minor price increases had been expected for precious metals. Silver was even expectedto decline in price average this year.
I don't want to go into the "US recession but China will save us" discussion (I have a more important story totell), let's just say for now the matter is much more complicated than simply comparing the size of botheconomies, or the growth of their demand, to determine whether Super Cycle prices will last for muchlonger or not. Personally, I think most of the arguments brought forward about this matter are either toosimplistic, or manifestly incomplete. As I gain more and more insight into this matter with every passingday, I also think criticising securities analysts because their price expectations have been lagging actualprices over the past few years is equally too easy and too simplistic.
(I'd like to spend some more paragraphs on this matter, but unfortunately I have to move on)
The fact that metals prices are expected to decline this year is in itself not so strange. After all, globaleconomic growth is decreasing and this includes the three major developed economies on the globe: theUS, Japan and Europe. Add some slowing down in China as well and what you end up with seems prettymuch a straightforward conclusion. Except for the fact that it isn't.
Whether the copper market will end up with a surplus or a deficit this year (to pick just one out of thepack) is not solely dependent on how much copper demand will grow or fall this year - a factor that is toooften overlooked is the question how much of all the projected supply will actually be achieved?
This is where the world is about to receive a wake-up call - a serious one. Investors with a knack for basemetals and mining stocks better pay attention because this is only getting more and more exciting.
Power shortages will increasingly become a feature this year. In South-Africa, for instance, the problemsthat came to the surface over the past few weeks seem endemic of a deep ingrained, structural issue - not
Stories To Read From FN Arena www.fnarena.com
27 FYI
just something that -oops!- happened and will be solved tomorrow. South-Africa is a major producer ofgold, coal and platinum and mining operations will be affected by brown outs and blackouts in the nationalpower supply system. Has anyone checked what has happened to the price of platinum lately?
Imagine what would happen were the world's largest supplier of copper to experience similar problems.
Well, now we're mentioning it, Chile is actually a disaster waiting to happen. The reason why you haven'tread about this elsewhere is because the world, including the financial press, is all looking at China and itssnow storms and at Queensland, because that's where the floodings are, and at the US because we have yetto determine whether the world's largest economy is in recession or not. Chile is not high on anyone'sagenda right now, but I have a strong suspicion this will change in the weeks and months ahead.
"The only thing that remains to be seen is not whether the country goes through an energy crisis, but howdeep that crisis will be." Such is the conclusion drawn by Latin America specialists at US based researchersHallgarten & Company. As recent as February 6 a Bloomberg journalist picked up an admission from agovernment official that the Chilean energy system "is close to breaking down" (admission by Senator BaldeProkurica of the Chilean government mining and energy committee).
So what's happening over there? What's this coming disaster all about?
Chile is suffering from unusually dry weather, a gas supplier who doesn't deliver and soaring prices for fueland diesel. The country is highly reliant on hydroelectric power generation, but no rain means noelectricity. So the country has had to switch to an increased reliance on thermal power stations running onnatural gas or fuel oil/diesel. The problem is, however, Argentina is not supplying the gas it used to, so theonly alternative left is to generate as much power as possible from fuel oil and diesel - at a cost estimatedsome 80% higher compared to gas.
While the Chilean government is frantically trying its best to avoid a complete disaster, it is but a logicalconclusion that smaller disasters will occur over the next few months. Already, Chileans have been asked tobecome power efficient very rapidly; the usual 220 voltage on the national power grid has been reduced to198v for the time being. The industry has pledged to turn off non-critical machinery, while governmentoffices are operating under an enforced 5% cut in power consumption. Day light savings time has beenextended into March.
However, as is always the case under such circumstances, negative news simply brings out more negativenews. One of the largest thermal generators, Nehuenco I, taken offline for repair late last year won't comeonline for at least another five months. When operating Nehuenco I supplies about 11% of the country'sthermal power, which translates into circa 6% of total power supply. According to experts it is now plainimpossible for the remaining thermal generators to fully satisfy the country's power demand in the fourmonths ahead - and this is counting on the fact that rain will arrive in June.
Chile is the world's largest supplier of copper. There's little doubt the current problems will affect the localeconomy, and this includes the Chilean copper industry. How much supply will be affected is anyone'sestimate at this stage, but it doesn't take much to turn a finely balanced market (as copper is believed tobe at the moment) into a deficit.
My best guess is that some hedge funds, who may have been positioned to go short in case more negativenews from the US, China or Europe would erupt, are now reversing their strategy. As common logic wouldtell you, it is only a matter of time before Chile hits the international newsheadlines, and when thathappens it will mean bad news for buyers of copper.
Till next week!
Your editor,
Rudi Filapek-Vandyck (As always supported by the Ab Fab team of Sophia, Grahame, Greg, Paula, Chris,Pat, George and Joyce).
Quotes & Shorts: It's Getting Tougher For AMP, And More... Not everything your team of FNArena journalists comes across can be put into a separate news story. Butthat doesn't stop us from sharing with you some of the noteworthy, outstanding or even bizarre views,opinions and news items we come across via an occasional amalgamation of non-interrelated Quotes &Shorts.
Leaking Amps
There's just no way around it - wealth manager AMP ((AMP)) is going to suffer in the short term as marketsremain weak. This is the consensus opinion from analysts this morning who were all disappointed with thestalwart's first half result. (With the exception of the one broker recommending Sell -Credit Suisse- whothought the result was positive). Longer term the AMP is the AMP, and the value is there. This is theopinion particularly of the four Buy raters out of FNArena's ten brokers/researchers. But the average targethas fallen from $9.94 to $9.16 this week, with CS as low as $7.50 (about where the stock is now).
Little Leighton Holdings ((LEI)) was a star of 2007, which is more than you can say for that other LittleLleyton. But 2008 has not been kind to the construction company, with all this talk of recessions and higherfunding costs. Still, you'd think that raising your guidance from "30% growth" to "at least 30% growth" mighthave been a positive move, but instead the market wiped nearly 15% off the stock price at one pointyesterday. Let this be a warning to any company in this current result season: "We want numbers, notvague statements!"
ABN Amro and Macquarie both downgraded Leighton to Hold from Buy this morning, but bumped into Citigoing the other way. Most brokers had been behind the curve during 2007 as Leighton went from strengthto strength, but are now crying foul over PE multiples. Not Citi, who thinks there's plenty of growth upsideyet.
News Corp ((NWS)) owned NDS Group is facing a US$1bn damages claim over allegations it operated aworldwide "conspiracy" to leak the trade secrets of rivals and clients. If the case makes it ever to court, itwill be one of the largest industrial espionage trials in US legal history. NDS, based in Israel, has reportedlya history of using former spies, military intelligence officers, police officers and hackers in its fight againstso-called satellite pirates. In this case, competitors EchoStar and NagraStar claim NDS leaked securitycodes of their smart cards to these pirates. EchoStar has reportedly email proof about NDS executivesdiscussing efforts to hack other company's smart cards. Should make for an interesting court case.
Macroblog the Big Picture leaves no guessing about where it's author stands in terms of US interest ratesand the world's largest economy (in trouble). Here are a few quotes gathered on the blog today (February14 in the US):
Stories To Read From FN Arena www.fnarena.com
28 FYI
"When an asset like real estate becomes overvalued, even if you drop interest rates to zero, you can't forceconsumers to borrow more, because they've already borrowed too much. Nor can you force lenders to lend,because they're already puking on 'bad paper.' It's called a liquidity trap."
-Bob Campbell, San Diego Real Estate Timing
"The Federal Reserve's interest-rate cuts last month have failed to lower borrowing costs for manycompanies and households, increasing the chance of further reductions from the central bank. Companiesare paying more to borrow now than before the Fed reduced its benchmark rate by 1.25 percentage pointover nine days in January, based on data compiled by Merrill Lynch & Co. Rates on so-called jumbomortgages, those above $417,000, have increased in the past month, making it tougher to sell propertiesand risking further price declines."
And the last one from ABC News: "though the Fed has cut interest rates sharply in recent weeks, banks andcredit card companies are hiking rates on consumers."
CNN relaunches into citizen journalism. According to media reports, US news network CNN will enterYouTube territory with the launch of iReport.com, a new Web site built entirely on user-produced newsvideos and photos. The initiative was launched two years ago but of the 100,000 entries received only ahandful made it through the vetting process. CNN says the new site will allow user to post anything theywant.
Newswires are reporting Microsoft was deciding last night whether to raise its offer for Yahoo! or walk awayand use its cash to buy a number of web 2.0 companies after learning of Rupert Murdoch's interest in theonline search and content company.
There was intense speculation on Wall Street yesterday that Microsoft could start any shopping spree withan approach to Facebook, the social networking site in which Microsoft bought a tiny stake for $240m(GBP120m) in October. However, judging by the views and quotes by market experts in media and blogs,overall confidence in News Corp's ((NWS)) interest in Yahoo! is not particularly high. There's also anadvertising agreement with Google which is seen as limiting synergies for News Corp in case a deal withYahoo! would eventuate.
Brambles ((BXB)) management has announced it will "vigorously defend" a class action complaint against itsCHEP business in the US. Pallet recyclers are accusing the company of anti-competitive conduct.
"At times we have to remind ourselves that part of being a financial market economist is to call whatcentral banks are going to do, not what we would do. We find ourselves at just such a juncture today, withthe Bank's very hawkish recent commentary suggesting that it is set to accelerate the pace of monetary
tightening and lift the cash rate to 7.25% in March, and likely further to 7.50% in May.
"Such a revised outlook does not come without significant consequence in our view... It now looks to uslikely that consumer spending will struggle to grow by any more than 2-1/2% over 2008 versus the 4-1/4%we see it having risen over 2007." (Deutsche Bank economists Tony Meer and Phil O'Donaghoe)
"We're still concerned about the risk of further weakness in the market, with commodity prices potentiallyfalling more than they have to date and undermining resource stocks.
"While in the middle of corporate reporting, we are reluctant to advocate significant portfolio changes, butwe have nonetheless decided to recommend a further reduction in exposure to resource stocks and, for thetime being, a larger cash position than previously." (Deutsche Bank strategists in Australia.)
Coal. The mere mention of this word sends shivers down the spine of any environmentalist. The concept ofburning coal for energy dates back millennia, and its abundance in the earth ensures that were currentglobal consumption levels to remain static, there would be enough known reserves to last at least twocenturies. As such it is the cheapest way to produce electricity, but burning coal is also the fastest way toload the atmosphere with greenhouse gases.
If you think that environmental concerns have led the world to begin reducing its dependence on coal,think again. Nothing could be further from the truth. Providing power to the developing economies of Chinaand India alone in the next decade is going to provide a challenge for suppliers to even meet the growingdemand.
And that's before you start talking about steel production.
Coal can generally be divided into two categories - thermal and metallurgical. Thermal coal is used forfiring power plants. Metallurgical coal is used to fire the blast furnaces driving the process of turning ironore into steel. Metallurgical coal can then be divided into "premium" hard coking coal, less preferred semi-soft coking coal, and finally "low vol PCI" coal which is of a lesser standard again, being "low volatility" andused for "pulverised coal injection".
Last year Australia exported 250 million tonnes of coal - 45% thermal and 55% metallurgical. Australia is farand away the world's biggest exporter of coal, with daylight second and third before Canada sneaks inahead of the US. The world's greatest importers of coal to date are Japan, Korea and Taiwan. The reactionhere might be: what about China? China is also blessed with an abundance of coal.
Which is another reason movements in the coal price in recent years have failed to excite when comparedto oil, iron ore, base metals and uranium. But the global dynamic is beginning to change. As of 2008, Chinais expected to become a net importer of coal. And India, which is about to begin an ambitious plan toprovide electricity to every citizen, has no useful coal to speak of.
While such changes in the supply/demand dynamic have been gradual, suddenly coal has been thrust intothe spotlight given recent events. For all of 2007 in Australia, one coal producer's set of quarterly resultsafter another highlighted the same problem - we have the coal, but we can't get it to our customers fastenough. When we get it out of the ground, there aren't enough rail cars to load it on to, and there aretraffic jams down the line. Once it does get to port, then we all have to wait our turn to get the coalloaded onto a ship.
Then just to make matters worse, it rained. It rained in Queensland, it rained in WA and it rained in theNSW Hunter Valley, and then it rained some more. Pits were flooded across the country and production atsome mines shut down altogether. It will take months to return to full production. But it will take years toconstruct the infrastructure required to meet global demand.
Over in China, it snowed. And then it snowed some more, shutting down coal mines and electricity supply.The snow will eventually melt, but the snow has also served to highlight what is a fundamentally deeperproblem in China - the country needs more power plants to keep up with electricity demand. It didn't snowin South Africa, but South Africa has also come to realise as its mining industry has been forced to shutdown periodically that it, too, is short on power generation, and will be for some time to come.
The Chinese snowstorms also brought attention to the fact China is suffering the same problem asAustralia. It doesn't have sufficient rail infrastructure to avoid supply bottlenecks anyway. India has beenwatching, and has decided that when it builds all its new "ultra-mega" power plants they will all be locatedon the coast - next to ports. And when Australia completes its port upgrade plans currently on the table -
Stories To Read From FN Arena www.fnarena.com
29 Sell&Buy-ology
around 2010 - demand for Australian coal will have already risen beyond the new throughput capacity. Andrail constraints still won't have been alleviated.
With the amount of supply disruption going on in the world, spot coal prices have shot up dramaticallythese last months. Things will settle down again, but resource analysts are beginning to realise that thefundamental supply/demand story in global coal is set to reach a tipping point in 2008. From 2004 to 2007the price of coal increased by roughly 50%. Analysts now expect that prices are likely to double in 2008alone.
Even in the time of Mao Zedong, China was a voracious producer of steel. For some reason steel productionwas seen as a highlight of a triumphant communist regime, even if it didn't always find a use. When Chinabegan to properly industrialise in the early twenty-first century, steel production continued as a significantindustry, and so China began madly exporting steel to the world. This led to cyclical fluctuations in theglobal price of steel, as China cycled from under- to overproduction. But in the last year or so China's steelexports to the developed world have fallen dramatically in percentage terms. China's domestic economy isnow the substantial driver of the overall economy, led by a property and infrastructure boom.
From 2004 to 2007 the global iron ore price has risen 120%, including the big 71.8% jump from 2004 to2005. Negotiations are currently underway between Australia and China to set the 2008 price, andincreases of at least 50-60% are forecast. Iron ore and coal are the two main inputs to steel production, butwhile China boasts large coal reserves it can't say the same about iron ore. That's one reason why theChinese are very worried about a possibly merged BHP Billiton ((BHP)) and Rio Tinto ((RIO)), which wouldcontrol the majority of the global seaborne iron ore market.
Until recently, China hadn't been as concerned about the supply of coal. Indeed it has been a net exporter.But it has taken the current severe snowstorms to alert the world to the fact that China is desperatelyunderpowered. Half of its provinces are experiencing rolling brown-outs. China has initiated an ambitiousprogram to build several nuclear power plants in the next decade, and has also become serious aboutrenewable energy. But both these sources will only be a drop in the power supply bucket. China needs tobuild more coal-fired power plants, and quickly, lest its economic progress be stalled.
The Chinese government has now banned all coal exports, at least until March. If the ban is lifted, it stillremains unclear as to whether China will return as a net exporter once more, or will remain a net importeras it has recently become. China produces 2 billion tonnes of coal per year. Annual global trade in coalrepresents less than 1% of that figure. But the Chinese government may decide to continue with the ban.
China is increasing its coal production capacity, and forecasts are that supply could increase in 2008 by asmuch as 26%. Demand is only expected to increase by 20%. However, the increase in production might stillprove fruitless given China's rail infrastructure is not up to the task. And furthermore, the additional coalproduced is of a lesser and lesser quality, such that higher quality coals would still need to be imported forblending.
As far as steel production is concerned, industry expansion continues at a rapid pace in China. In 2005-06steel exports increased by a third. They increased again by a third in 2007. As the US and Europe arestaring down the recession barrel there has been concern the subsequent drop-off in demand for Chinesesteel would put a dent in Chinese economic growth, flowing right back to demand for commodities such ascoal. But the truth is that most of China's exported steel is now directed to the rest of developing Asia.Exports to the US account for only 8%.
Indian crude steel production is targeted to increase by 60% by 2012. Citigroup analysts believe this is anunattainable goal, but that does not detract from the fact that, either way, the growth in India's demandfor metallurgical coal will be "tremendous". India has basically no "met" coal of its own. On the thermalcoal front, India intends to follow China by powering its economic growth with coal-fired electricity.
India's other plan for 2012 is to substantially increase its power generation capacity. Half of the newcapacity will come from ten corporate-built "ultra-mega" power plants (I think that means "big"). As India isalready feeling the pinch from current thermal coal supply disruptions, six of these plants will be designedto run on lower quality coal imported from Indonesia. Indonesia is emerging as the world's biggest exporterof thermal coal as Australia, China and South Africa all suffer from supply disruptions. Reports suggest thecurrent coal stockpiles at Indian power plants are averaging only 9 days when 30 is considered safe. Justhow quickly Indonesia can increase its thermal coal exports will be a critical factor in the market.
But there is one small problem. Apart from Indonesia's coal being of a lower quality that requires blending,Indonesia, too, has grandiose plans to expand its own electricity generation capacity. It is, after all, theworld's fourth most populous country. To that end, there is a proposal in front of Indonesia's Minister ofEnergy for 50% of coal to be sold domestically. This would create big problems on the global supply side.
Back in the already developed world, the realities are yet to hit home. Japanese and Korean utilities arethe traditional big consumers of coal, and UBS suggests they are currently in a "state of denial" over what'sgoing on around them. Both are currently negotiating fiercely to set 2008 prices, but they are now doing sofrom a much weakened position. Furthermore, Japan had set itself an ambitious plan to expand its alreadysubstantial nuclear energy capacity, however a recent spate of earthquakes has put the frighteners throughall involved. The end result is that Japan is looking to increase its coal-fired capacity, and thus its importsof coal.
The contribution from North American exports is waning as both the US and Canada deal with rising costs,infrastructure challenges, and environmental considerations which are constraining thoughts of productionincreases.
The only flipside to the global demand/supply situation is the case of Europe, which saw a sharp drop-off indemand for coal imports in the last quarter of 2007. In the third quarter, imports registered a 22% declineyear-on-year. This is not because Europe saw its economy dramatically slow in that time, but because ofthe increase in the number of gas-fired power stations recently commissioned. Europe has been the leaderin carbon reduction and subsequent trading, and the additional cost placed on coal makes gas a much moreeconomical option.
Which brings us to the subject of carbon costs. Outside of Europe, plans for carbon trading are still beingformulated and an internationally generic system is a long way off. In Europe however, Phase 1 of theEuropean carbon trading scheme has been in place for a few years now. It was not a great success, as thecarefree issue of industry exemptions led to the price of carbon offsets actually collapsing down to notmuch. But Phase 2 came into force in January, and apart from sorting out the exemption situation, Europehas also stepped up the level of reduction requirements. The result is that the offset price which had fallento nearly zero has now leapt up to US$23 per tonne of carbon. It is likely the European model will form aframework for many other national schemes, and as such the traded price of carbon in Europe will offer abenchmark elsewhere.
But despite this additional cost to be borne by coal producers and consumers, Citigroup analysts for one donot see the global demand thesis changing much as a result. It will certainly take many years beforealternative forms of energy become mainstream. Nuclear energy will still only be a small substitute despitethe number of reactors being planned across the globe. Renewables are still not ready to be providers ofbase-load power. Gas is clearly an alternative that could make a mark in the medium term, but there is alot of infrastructure that needs to be built within a high cost environment. You only have to consider thelong delays surrounding the great PNG gas project to know that this is not an overnight solution either,whereas for developing countries power is a very immediate issue.
And there is a lot of effort been thrown into somehow producing "clean" coal, but at the moment thisconcept appears to be right up there with cold fusion - everyone talks about it but no one's actually doneit. Coal-to-gas or coal-to-liquid conversion, on the other hand, is very real and under development, and thisprocess does significantly reduce carbon emissions. What it doesn't do, however, is reduce the demand forcoal.
There are other sources of coal being developed across the globe, from Russia to Kazakhstan and Mongolia,from Mozambique to Columbia. Developed countries such as Russia all suffer from the same infrastructureconstraints. Developing countries not only suffer from such constraints, but are reducing coal exports asdomestic demand rises. Vietnam, for example, has been increasing its exports but now its domesticdemand is rapidly rising. Undeveloped countries are pretty much at the beginning of talking aboutinfrastructure, which will need to be built in far-flung places at great cost.
Analysts agree that while there is potential around the globe, we are once again in no way talking about anovernight fix.
Finally, the cost of producing coal (or any commodity) has been exponentially rising in past years, andanalysts were quite shocked by some of the cost increases revealed in the most recent round of Australian
coal producer quarterly reports. It is well understood that everything from labour, to skilled professionals,to equipment, and right down to even truck tyres is becoming more and more scarce and more and morevaluable. This is not a situation that is about to change in the foreseeable future. Those costs impact onthe bottom lines of coal producers, but are pretty quickly passed on. Coal is very much a "consumer staple"and not a "consumer discretionary" product.
And so to price.
The average price for thermal coal in 2007 was US$55/t and for metallurgical (hard coking) coal US$95/t.UBS is expecting 2008 prices to rise to US$100 for thermal and to US$170/t for hard coking. Citigroup ispredicting US$100/t and US$200/t respectively. JP Morgan (ever the conservative voice) has pencilled inUS$70/t and US$140/t. GSJB Were (often the frontrunner) has US$125/t and US$200/t. Macquarie hasforecast US$88/t and US$150/t, but suggests "significant upside remains" to forecasts.
Analysts tend to be conservative in general in their forecasting, as it's always more heartening for investorsif price predictions rise rather than fall. But witness late breaking news from Citigroup that small volumesof thermal coal were traded at US$125/t last week, up US$30 from the week before, and coking coal hastraded at a whopping US$270/t, up US$70. While immediate prices reflect current supply disruption issues,it is clear the buyers have become somewhat desperate. For the likes of Japan and company, currently incontract negotiations, this news is not good.
For those invested in coal producing companies, the news is all good, and appears will remain so for theforeseeable future.
Of the Australian coal companies listed in the S&P ASX 300 index, analysts lean towards Buy ratings for allof Centennial Coal ((CEY)), Gloucester Coal ((GCL)), Macarthur Coal ((MCC)) and Resource Pacific ((RSP)).Coal & Allied ((CNA)) is little covered individually as it is a subsidiary of Rio Tinto. Those brokers placingHold or even Sell ratings on Australian coal companies are focusing on short term issues of flooding andinfrastructure constraints. The Buy raters take these problems on board, but have put their faith in therising coal price.
It's The RBA Against The Australian Consumer This story was first published two days ago in the form of an email sent to registered FNArena readers.
By Rudi Filapek-Vandyck, Editor FNArena
Last weekend one of the Sunday newspapers carried an interesting news story by shareholder activistStephen Mayne, revealing the Australian Labor party is one of the richest political parties in the democraticworld. Probably of more importance to your average Australian taxpayer is that Mayne also found that thetwo freshly elected politicians currently associated with the Federal Government's future economic trackrecord, prime minister Kevin Rudd and treasurer Wayne Swann, "have a fabulous record when it comes tofinancial management".
Labor, Mayne revealed, does not only have a $10m margin loan with CommSec, but Rudd and Swann alsohad the investment nouse to buy shares in Commonwealth Bank and Suncorp-Metway, among otherinvestments made, from the late eighties onwards. Mayne estimates that what started off with $16.4mfrom selling a radio station in Brisbane in 1986 is today an investment portfolio with assets worth between$700m and $1bn.
The picture painted by Mayne of two cunning investors who know how to make a buck and let it multiple, isone that stands in sharp contrast with the general view among professional investors in the financial circlesof Sydney and Melbourne who believe that Australia decided last November to trade in its highlyexperienced, thoroughly-proven team of economic and political leaders, with a younger, yet inexperiencedand largely unproven team of Labor politicians.
Some commentators have suggested the Labor election win is responsible for offshore investorswithdrawing their funds from the Australian share market since November. As recent as last week an emailwas sent around in Sydney containing a chart of the All Ordinaries showing it had all gone downhill sincethe new government had leaped into power. (Regardless of your political view, but that is a bit rich).
The irony of this story is that those Labor sceptics will be hoping pretty soon they will be proven wrong asthe Reserve Bank intends to squash inflation back inside the 2-3% range (from 3.4-3.8% last month). It canhardly be overemphasised but this is not going to be an easy or smooth process. Official interest rates havejust been raised to 7%. With every extra step higher the chances of seriously disrupting the economicprocess in Australia will grow exponentially.
Already market experts are anticipating an uptick in credit card defaults, property foreclosures, corporatefailures and personal bankruptcies. Despite some experts questioning whether the RBA is setting upAustralia for the next recession, the central bank made it clear this week that official interest rates haveonly one way to go still: up.
TD Waterhouse economist Stephen Koukoulas believes Australia is being punished for the fact that inflationhas been systematically underestimated over the past few years. In a sign that he believes the RBAcurrently finds itself behind the curve, Koukoulas believes Australians better prepare for interest rate hikesat each of the next two following RBA meetings, possibly followed by another one later in the year. Thiswould take official interest rates in Australia to 7.75% at a time when interest rates in the US might drop aslow as 2%.
Because of the sharp deceleration in the US economy, interest rates in most developed economies areexpected to trend lower over the medium term. Not in Australia, however.
Even CommSec chief equities economist Craig James, usually among the dovish commentators in themarket, now believes the RBA will hike at its next meeting in March, and possibly one more time after that,in May. This scenario, James suggests, can only be prevented through some unforeseen crisis, such asanother shock from international finance institutions, or simply through a weaker local economy than is
Stories To Read From FN Arena www.fnarena.com
30 Weekly Analysis
currently anticipated.
Investors and borrowers better not hope for the best, says James, because the odds are very much infavour of higher interest rates: "investors and borrowers need to plan for higher rates and budgetaccordingly".
This sudden switch in the outlook for interest rates (most experts assumed 7% would be the peak in thiscycle) is already having an impact on the local share market. Under normal circumstances, share prices forthe likes of David Jones ((DJS)) and JB Hi-Fi ((JBH)) would have soared to new highs with released resultsbetter than market expectations and company management displaying full confidence for the year ahead.Instead investors are turning away from discretionary retailers fearing the RBA will take no prisoners in itsvigorous battle with the inflation dragon. In other words: those companies have been riding the peak inconsumer spending and as interest rates will rise further the only way seems down.
Economists at Macquarie put it as follows this week: with overall investments still strong, and expected toremain strong, and exports likely to rise (the Australian dollar should remain strong too) there is only oneway the RBA will achieve its goal: consumer spending must accommodate most of the slowdown.
Here comes the scary part: in its Statement on Monetary Policy this week, the RBA lowered its nonfarmGDP growth forecasts to 2.75% by the end of 2008 and to 3% by the end of 2009.
In effect, says Macquarie, to achieve these goals "consumer spending must slow to its weakest pace sincethe early 1990s". The economists believe this will be difficult given strong population growth, highemployment and the promised income tax cuts. "This suggests that if the RBA is serious about pushinggrowth below trend, then interest rates may need to rise sharply further."
For the record: Macquarie economists do not adhere to any doom and gloom scenarios for consumerspending in Australia for the year ahead - they believe the RBA is up against a still well-supportedadversary. A view supported by Craig James, though the CommSec economist does point out that mostsupportive factors from the past years seem to have peaked and are now reversing. Macquarie doesacknowledge, however, the risks for consumer spending are now skewed to the downside and potentiallydarker scenarios cannot be completely dismissed.
One of the reasons why Macquarie retains a positive view is because it believes inflation will subside andthe RBA won't have to lift interest rates as high as it currently believes it may have to. In case the RBA viewproves to be the more correct one, Macquarie sees a "host of innocent bystanders" who will be caught outby interest rates rising much further, including the domestic housing market and a range of businesses withhigh gearing.
This Report should be read in conjunction with our terms and disclaimer on page 19. 18
Financial News for the Bright and the Uneducated. And for everybody else in between.
FN Arena NewsBuilding the Future of Financial Journalism
www.fnarena.comTrials are free and without any obligation
This Report should be read in conjunction with our terms and disclaimer on page 19. 19
TeRms AND coNDITIoNs oF use, AND DIsclAImeRs
These Terms and conditions of use, and Disclaimers constitutes your agreement with News Network with respect to your use of its FN Arena website, its weekday news periodical, Australian broker call, as well as it’s monthly periodical Australian super stock Report, as well as any other publications (including articles) News Network may publish on its website, or anywhere else, from time to time. please read the contents of this page carefully as it contains important legal information and disclaimers. by entering and perusing the website, reading the Australian broker call or the Australian super stock Report, or, if you are subscriber, by entering the password protected part of the website, you acknowledge that you have read, understood and accept this agreement.
by accepting this agreement you acknowledge, understand and accept the following:
1. Reference to “FN Arena” and “News Network” means reference to News Network ltd, its journalists, directors, other employees, affiliates, agents, associates and subsidiaries.
�. News Network ltd is the owner of the FN Arena website and brand name.
3. Reference to “we” or “us” is reference to News Network.
4. Reference to “this website” or the “FN Arena website” means reference to www.fnarena.com, and includes reference to News Network’s weekday news periodical, Australian broker call, as well as its monthly periodical Australian super stock Report, as well as any other publications (including articles) News Network may publish on this website, or anywhere else, from time to time.
5. Reference to “news periodicals” means reference to News Network’s weekday periodical, Australian broker call, as well as it’s monthly periodical Australian super stock Report, as well as any other periodicals News Network may publish from time to time on this website, or anywhere else, from time to time.
6. Reference to “publications” in this agreement means any material, including articles, published or put in print on the FNArena website, or anywhere else, whatsoever, and includes News Network’s weekday periodical, Australian broker call, as well as it’s monthly periodical Australian super stock Report, and any other periodicals News Network may publish from time to time.
7. Reference to a “visitor” means, you, a visitor to this website, and includes a subscriber to Australian broker call and the Australian super stock Report, as well as any other publications or periodicals News Network may, from time to time, publish on this website.
8. News Network is a media company which employs financial journalists to report financial news. News Network’s journalists perform the required research and collect the information that is, ultimately, each day, published on this website and in News Network’s news periodicals. As is obvious, the process by which the information is collected and delivered to you is a purely journalistic one and, therefore, the comments, opinions and recommendations News Network reports on this website are not the opinions of News Network or any of its journalist or other employees. News Network is oNly and specifically a matter-of-fact reporter of industry signals suggesting price direction probability of some shares. News Network simply delivers the information – it does not create it.
9. Although News Network obtains the information published herein from sources deemed to be reliable, and given and received in good faith, it cannot and does not guarantee its accuracy. News Network does not take any responsibility either for the financial soundness or for the correctness of statement made or opinion expressed in the data or content reported by News Network, and cannot and does not guarantee the reliability and accuracy of the opinions of the brokers whose opinions, recommendations and forecasts it reports.
10. News Network publishes this website, all publications and its periodicals strictly for convenient personal, non-commercial, educational and informational purposes of its subscribers only. our goal is to provide the subscribers with a convenient starting point of potentially useful, but not comprehensive, content that can educate or otherwise enhance a visitor’s knowledge base and frame of reference.
11. News Network is NoT a stock broker or financial or trading advisor, nor is it an advisory service of any kind, and no advice or recommendations on investments or trading are made nor implied on this website. Nothing contained in this website is intended to be, nor shall it be construed as, advice or recommendation. Any investment or other decisions made by you must be based solely on your own evaluation of the targeted subject for investment, and your financial circumstances and investment objectives, and News Network will not be held liable for any such investments and decisions.
1�. It is distinctly understood and accepted that the shares referred to in the FN Arena website, News Network’s publications and/or periodicals have not been recommended by News Network. The content and or any comments found of this website, including the content and/or comments published in any publication and/or periodicals published by News Network, do not constitute a recommendation or endorsement by News Network with respect to any company, security, share or investment or any financial or investment product.
13. This website makes no representations, and, to the extent allowed by the law, specifically disclaims all warranties, express, implied or statutory, regarding the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any material contained in the website.
14. before making an investment decision, you must do your own research and rely on your own examination of the share, and the risk involved, and not on what you read on the FN Arena website, or in any publication or periodical. The content of this website is provided strictly for convenient personal, non-commercial educational and informational purposes only and News Network shall not be held liable for any investment decisions, sales or purchase decisions, which you may have made based on what you have read on this website or in the periodicals published by News Network from time to time, or in any other publications News Network may publish on its website, or anywhere else, from time to time. Anyone who makes investment decisions based on what they read on this website does so at their own risk, and agrees that they cannot hold News Network responsible and/or liable for any loss whatsoever.
This Report should be read in conjunction with our terms and disclaimer on page 19. �0
15. It is your responsibility to evaluate the completeness, accuracy and usefulness of any content made available on this website. If you are unsure, or in doubt about the meaning of any information, you should consult your financial advisor.
16. News Network does not guarantee any returns on investments made in any share mentioned on this website by the visitors. As any investor well knows, any investment opportunity, strategy or concept involves a degree of risk and investors should not invest any funds unless they can afford to take the risk of losing their investment. News Network strongly suggests that you consult your own financial advisors regarding the soundness of any intended investments, strategies or concepts, and discuss with such advisor your individual investment needs and goals. you may also wish to consult the broker who expressed the opinion we have reported on in the news periodicals we publish.
17. News Network shall not be held liable to any visitor of the FN Arena website, or any reader of its periodicals and/or publications, or anyone else who may have relied on this website, directly or indirectly, for any inaccuracies in the printed material found on the FN Arena website, in the periodicals and/or other publications, any typing errors, omissions, interruptions, timeliness, completeness, deletions, defects, failure of performance, computer virus, communication line failures, alterations of, or use of any content herein, regardless of cause, for any loss or damage resulting therefrom.
18. under no circumstances, including, but not limited to negligence, shall News Network be liable for any direct, indirect, incidental, special or consequential damages that result from the use of, or the inability to use, the FN Arena website, and any or the News Network’s publications and/or periodicals.
19. As a condition of use of the FN Arena Website, News Network’s publications and periodicals, you agree to indemnify News Network and all those affiliated with it from and against any and all liabilities, expenses (including legal costs) and damages arising out of claims resulting from your use of the FN Arena website, News Network’s publications and periodicals. If you are uncertain about this agreement or the contents of the FN Arena’s website, or are dissatisfied in any shape or from, with the content of the FN Arena website, or any of the publications or periodicals, or you do not agree with these terms and conditions, your sole and exclusive remedy is to discontinue using the FN Arena website, News Network’s publications and periodicals.
�0. News Network may, from time to time, publish advice, opinions and statements of various third parties, other then the ten stock brokers, and various other information and content providers. News Network does not represent or endorse the accuracy or reliability of any advice, opinion, statement or other information provided by these third parties. Reliance upon any such opinion, advice, statement, or other information is at your own risk.
�1. The FN Arena website may contain links and pointers to websites maintained by third parties. News Network does not operate or control in any respect any information, products or services on such third-party websites. Third party links are included solely for the convenience of visitors, and do not constitute any endorsement by News Network of any products or services provided by the third party link owners or operators. News Network has no control over any websites that we might link to and does not take responsibility for their quality, content or suitability.
��. News Network is not responsible for claims made by advertisers on the FN Arena website or in any of its periodicals. such advertisements are included solely for the convenience of visitors, and do not constitute any endorsement by News Network of any products or services advertised. News Network does not check the accuracy of the statements made by the advertisers. you assume sole responsibility for the access and use of third party links and pointers from the FN Arena website, as well as any purchases you may make from those third parties (including advertisers).
�3. All the content, information and material made available on this website are provided to you “as is” and without warranty of any kind from News Network whether express or implied, including, but not limited to, implied warranties of merchantability and fitness for a particular purpose, title, non-infringement, security or accuracy, nor does News Network endorse or take any responsibility for the accuracy or reliability of any opinion, advise or statement made through the FN Arena website, its periodicals, or for making good all or part of any loss and/or damage that may have been caused by the visitor’s reliance on any information, advise, product or service obtained from a linked website.
�4. News Network is not liable for any copyright infringements incurred by any outside content or information contributors, or by third parties who have links to this website, or advertise on this website.
�5. News Network reserves the right to make any and all changes to the FN Arena website, including the publications and periodicals, at its sole discretion without notice to you. News Network reserves the right to deny access to this website or its information to anyone at any time.
�6. This agreement shall be deemed to include all other notices, policies, disclaimers, and other terms contained in the FN Arena website, provided, however, that in the event of a conflict between such other terms and the terms of this agreement, the terms of this agreement shall prevail.
�7. News Network shall have the right, at its discretion, to change, modify, add or remove terms of this agreement at any time. changes shall be effective immediately. Notification of any such changes shall be made herein, therefore, you are strongly advised to read these terms each time you wish to access the FN Arena website or any periodical.
�8. No permission is granted to copy, distribute, modify, post or frame any text, graphics, video, audio, software code, or viewer interface design or logos. The entire FN Arena website, including the publications and periodicals, is subject to copyright with all rights reserved. The information contained in the website, including the publications and periodicals, shall not be published, rewritten for broadcast or publication or redistributed in any medium, or for any other reason whatsoever, without prior written permission from News Network.
�9. All original content is the copyrighted property of News Network.
