Should it be surprising
that the Australian economy is beginning to contract?
No.
In general, the Australian economy is composed of two sectors:
resources and financials.
The dynamics of the Australian economy is not unlike that
of Canada.
Take a look at the major index of Australian Stock
Exchange (ASX), the S&P/ASX200; two thirds of the market value
of this index is made up by financial, materials, and energy
companies. Like
Canada, the Australian banks and financial
firms have been smartly regulated and have largely avoided the
mortgage mess in the US and the structured financial
products that have brought down the likes of Citi, Bank of
America, and the Royal Bank of Scotland (RBS).
There has been a fair bit of colossal destruction of
shareholder wealth in the Australian financial sector such as
Babcock & Brown (symbol BNB on the ASX), a lesser investment
bank, and Centro Properties (CNP.ASX), both down more than 99%
since their 2007 highs. All things considered, though, banks
such as Commonwealth Bank of Australia (CBA.ASX), Westpac
(WBC.ASX), and the National Bank of Australia (NAB.ASX) have all
held up reasonably well.
Their success or failure going forward will depend on how
well the domestic economy holds up.
Australia has no subprime; the RBA
has not moved to panicked zero interest rate policies like its
Anglo-Saxon brethren; the unemployment rate is still at 4.8%.
So
what is going right and will it stay that way?
Commodities prices have not fallen very much.
Australia’s
central bank, the RBA, keeps its own index for commodities
prices. Most global
commodities indices are dominated by crude oil prices which we
all know have fallen from $147/barrel last summer to around
$40/barrel of late.
But the RBA’s index does not include oil (Australia
produces virtually no oil for export), focusing more Australia’s top export commodities
of coal, iron ore, gold, wheat, and beef.
Based on this index, prices have only corrected back to
last September, just before the collapse of Lehman Brothers and
the world economy went into a tailspin.
So how is it that Australia
commodities prices have corrected only back to the fall of 2008
when the rest of the world is comparing their economic malaise
to that of 1982 or 1974 or 1933?
The answer: annual pricing contracts.
Big resource players like BHP Billiton (BHP.ASX) and Rio
Tinto (RIO.ASX) renewed annual pricing contracts with customers
in China and
other parts of Asia just at the
right time. These
two companies, combined with VALE of
Brazil
form the bulk of the iron ore market.
Iron ore is the raw ingredient for steel production.
BHP and Rio
inked new pricing contracts at the exact peak of the market,
getting more than 80% price increases last summer.
This is holding up the
pricing index – and the economy by extension.
How long will it last?
Only about 6-9 more months, I expect.
Pricing contracts will be up for renewal this summer
(2009) and take affect by the fall.
The effects will bleed into results for the quarter
ending Sept. ’09 and the end of the year should be particularly
ugly for these companies.
This will ripple through to the overall economy into GDP,
into unemployment, into bank credit costs from defaults.
In relative terms, Australia has a sound economy and a
bright future. The
emerging economies need the coal, iron ore, grain, and meat that
its companies produce.
But to think that Australia is somehow immune to this
global recession is just wrong.
Australia’s
exports are mostly raw materials and are further back in the
global supply chain.
They will be the last domino to fall.
The government entered this downturn in good shape
fiscally and the currency has fewer failings than the British
Pound Sterling, the US Dollar, or the Euro.
Few big resources companies will fail (although many
small ones will) because China needs them to succeed.
On Feb 13, 2009 Rio Tinto signed a A$30 billion deal with
the Chinese Aluminum giant Chinalco.
Rio
overextended itself in the purchase of Canadian rival Alcan
during the boom time and was caught this year with far too much
debt. Chinalco was
all too happy to provide a mortgage on Rio’s
future. They get a
big stake in Rio but more importantly Chinalco will have far
more say in price of the raw materials it buys from
Rio going forward.
Expect this be the model for the next 1-2 years.
The Australian economy
will survive the inevitable recession but it may have to give
away some of its future pricing power to do it.
For more see:
http://www.individualglobalinvestor.com/Australia1.html
