Quarterly Newsletter - January 2011
Major Indices (as of 1/1/2011)
* PE ratios (based on historical
Commentary – Past 3 months
Second Quarter 10/11 financial year saw most share markets globally move slightly upwards (and sharp rises in commodity prices) as global confidence grew somewhat based on the USA doing a bit better, despite continued debt concerns in European countries.
Interestingly, however, the European Index went up despite the debt woes. Most likely it was led by a strong German economy offsetting the debt concerns in Southern Europe (Greece and Italy) and Ireland. The Germans continue to sell cars and machinery to the world, meanwhile the massive property boom and subsequent crash in Southern Europe has left the Governments there awash with debt.
Global share market Price to Earnings (PE) ratios are about the same or slightly lower and are generally at fair value or in some cases still a bit high.
Global exports are steady and economists are predicting not much change for 2011.
US employment is flat still hovering at around 10% unemployed, and Australia around 4.5% unemployed, improving slightly.
China and India continue to do well. An IMF GDP forecast for 2011
of 9.6% and 8.4% growth respectively is quite incredible in the current
The Baltic Dry Index (BDI) has recently weakened to 2,170, a bearish sign.
US retail sales forecasts are flat and likely to be down a bit due to bad snow conditions.
Global GDP is still low in all the western countries (especially bad in Europe and UK) with most of them hovering around 0-3.0%, apparently coming out of recession, with hopes for world growth in 2011 to reach 3.5% (IMFs Sept 2010 forecast).
It is definitely a two speed world - the slow developed and booming developing economies.
Global Interest Rates have started to increase only in the emerging economies such as China, India, and also in Australia this past 3 months, and most interestingly US long term bonds rates have risen sharply, as the US economy improves and recent strong oil price rises are causing some concerns.
The RBA (Australia) has again raised rates by a further 0.25% in attempt to prick the Australian housing bubble. Australia is the only western country in the table above where interest rates rose. Indebted householders are getting very concerned and house prices have just started to fall.
Currencies over the quarter were summarized by a weakening in the Euro and a further strengthening in the Aussie dollar to fresh highs. The Australian dollar (AUD) rose compared to all major currencies and reached parity with the US dollar.
Gold has increased further and is currently $1,405 per ounce.
Copper increased dramatically to $4.36 per pound a good sign that the construction industry is recovering, or at least Chinese demand is still strong.
Iron Ore and Coal prices were stable, having previously doubled from the old contract prices as they are now sold on the Spot market at a great price of $168/ tonne.
Soft commodities were significantly higher again lead by wheat and corn, and recent reports that China cannot feed its growing population, due to not enough arable land.
A recent trend may be that the Chinese are buying Commodities and stockpiling them rather than buying US Treasury Bonds. A wise move indeed.
Australian house prices
Australian properties are still trading at around 6-8x average salary compared to around 2-3x in the USA and many other countries. This still places Australia as having one of the most expensive property markets in the world making it hard to see property prices going upwards. Glenn Stevens (head of the RBA) continued to raise interest rates and the banks added to this with their own increases to make their net profit margins back out to record levels from around 2.4% in 2007 to now around 3%, thereby hurting the average mortgage holder in Australia.
I suspect worse is yet to come from the RBA, especially if, as I predict, the resources boom grows stronger.
Commentary – Forecast next 6 months
Whilst there are some positive signs from the US and off course Asia led by China, the World Share markets valuations are reasonably fair; however Europe is in trouble with a debt crisis that most economists think is unlikely to cause a second wave down in the GFC caused by the European Debt Crisis.
The Baltic Dry Shipping Index is negative and US Retail sales forecasts are fairly stagnant. Suggesting any recovery will still be weak or may indeed stall.
Share markets are likely to move sideways or slightly higher in the next few months assuming global recovery continues and the fear and issues around the European Debt Crisis start to subside.
Most markets PE ratios are fair and China is looking cheap if you look at their growth and undervalued currency.
Investors that hold significant cash should still be patient for now and only enter the market gradually or on large dips or phase back into the market over time; however investors who have been aggressively placed to benefit from the recovery should continue to cash up somewhat and lock in some profits just in case there is a second leg down to the GFC..
The Euro should be avoided as should any currency where the country has excessive debt levels as at last the world has begun to realize the huge problems it faces with many countries heavily in debt and no real solution to fix their trade deficits.
The emerging economies that are well managed and have strong trade surpluses and current account balances such as China and a lot of SE Asia, as well and parts of Africa and South America will continue to flourish. Their currencies will strengthen, and they will continue to buy commodities such as iron ore and copper to build cities to house their rising urbanization and affluence.
That is, we will see the wealth and currencies of the Western economies (excluding Japan) decline whilst the well managed emerging economies becoming increasingly wealthy. In effect a massive transfer from West to East.
What to do?
Continue to be cautious.
Aussie Dollar hits parity with the US Dollar on October 15, 2010
The Australian dollar had never achieved parity with the US dollar since it was freed to float on the currency markets by the Hawke government on December 12, 1983, and if you take a longer view, it is not at record highs.
That was until October 15, 2010 when the Aussie Dollar reached parity with the US dollar.
It was as high as $1.48 to the US dollar, for example, in the first half of the 1970s, when it was being arbitrarily set by the government, and used as a device to combat rampant inflation. It was fetching ¥422 in 1974, before Japan's status as an industrial superpower was confirmed, and today it buys about ¥83. It has climbed from a global crisis low of just over 48 euro cents to more than 70 euro cents but was above 60 euro cents before the crisis.
I agree with Ian Verrender from the Sydney Morning Herald who wrote this excerpt below on October 15, 2010.
IMF warning on global debt
The IMF said that global banks face a ‘wall of maturing
debt’ which presents risks for
the normalisation of credit conditions and that:
The Resources boom is just in its infancy
The International Monetary Fund (IMF) in its October
2010 World Economic Outlook Report, said that the growth cycle for
base metals might only be about half way through its course.
Demand from Asia, namely China, is fuelling the current commodities boom, and scarcity issues are also pushing prices higher.
The IMF’s report supports the view that Australia
could be in for a super cycle in
commodity prices. Super cycles describe the drawn out length of
time that it takes from
When you look at the graph below you begin to release why the Resources boom is only just beginning. As a population gets to the $5,000 per capita pa income level and up to about $15,000, the consumption of key resources increases exponentially. At first an individual can buy a bike, then a motor bike, then a car. Drive the car on a freeway/bridge or take the train to work. They also rent a unit, buy white goods, and buy a house. All of these things require increasing amounts of resources. Iron Ore and Coal are required to make Steel. Aluminum for Cars and windows, Copper for plumbing etc.
Looking at the massive number of people in the world just entering this $5,000-$15,000 (“middle class”) per capita pa income band, such as the Chinese(population 1.3billion people) Indians (1.2b), Indonesians(240m), Filipinos(90m) etc, then you begin to realize that the resources boom will get a lot bigger and last many years to come. GDP per capita is $45,000 for USA, $4,000 for China, and $1,500 for India here in 2010, but it is rising very rapidly.
In the next decade China expects to welcome 300 million to the “middle class”.
India expects 300 million, Indonesia 60 million and Philippines 25 million. Adding in the other global developing economies and you can easily see one billion (1,000,000,000) or more people entering the so called middle class all within 10 years. Imagine then, trying to make an extra 1 billion motor bikes, washing machines etc, and the amount of resources that will be required. It is unprecedented in our history.
In conclusion, this graph strongly suggests that we are just at the tip of the ice berg as far as what will happen in the coming 10 years for Global Resource companies. Also the graph below confirms this with the projected continuation of the urbanization of Asia and then Africa. The boom has only just begun.
CFS Global Soft Commodities Fund launched and on CFS First Choice soon
Colonial First State (CFS) launched a new Fund in 2010 that invests in the companies that are involved in the agricultural and soft commodities (Corn, Wheat, Soy, Rice, Coffee, Sugar, Wool, and Beef) industry and production. It is expected to be available on CFS First Choice in May 2011.
Note, the fund does not buy the soft commodities themselves. For example the fund will typically buy companies such as dairies, abattoirs, farms, fish farms, tractor manufacturers, fertilizer producers etc.
The main concept for investors to take interest in this Fund is that the world has more and more people each year and less and less arable land and water, upon which to grow food for the rising world population. Remember the worlds population is predicted to grow by 2.6 billion (2,600,000,000) in the next 40 years, or 65 million pa (by 2010 world pop exp to be 9.1b). Additionally more land is required to produce beef and other protein foods which become more in demand as populations get richer. The chart below shows this effect whereby more grain needs to be produced to produce Beef than chicken. So the demand for soft commodities and the companies that produce them etc will be driven by two key factors, - a rising number of mouths to feed and a shift up towards more protein intense foods. This bodes well for the Fund.
Electric cars are the future
The race is on to be the biggest producer and seller of the World’s most desirable product—the “Electric Car”.
China knows this is vitally important as does Japan and Germany. The USA under Obama is also finally waking up.
Just like selling cars propelled Germany(Volkswagon, BMW) and Japan (Toyota, Nissan, Honda), to become the worlds second and fourth largest economies respectively the race is on to see who will dominate the electric car industry.
The Chinese have thrown big money to start electric car production plants and Toyota in Japan have to date led the way with the Toyota Prius (hybrid electric and motor car).
In the US Barack Obama preaches about the importance of switching to the new economies of producing electric cars and Renewable Energy (Wind turbines, Solar, Hydro etc), but very little action is occurring. General Motors Holden need to move quickly otherwise the US will get further in debt buying electric carts from China and Japan.
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