Quarterly Newsletter - January 2011

Major Indices   (as of 1/1/2011)

Interest Rate(%)
Share Index
* PE ratio
GDP (2010) IMF
GDP Forecast (2011) IMF
Foreign Surplus (Debt) %GDP
All Ords
2010 - (5.0)
USA (Dollar)
S&P 500
2010 - *(14.5)
Largest USD deficit, 14.5 trillion
Japan (Yen)
Nikkei 225
127m (declining)
China (Yuan)
CSI 300
Hang Seng
Hong Kong
2010 - USD 2 Trillion
Number 1 largest surplus in the world
India (Rupee)
BSE 200
2009 - USD 277 billion surplus
Europe (Euro)
DJ Stoxx 50
725m (declining)
UK (pound)
FTSE 100

* PE ratios (based on historical earnings)
*NB: (14.5) refers to the % of GDP required to pay the interest on the national debt.
US 10 Yr Bond Rate – 3.37%    US 30 Yr Bond Rate – 4.5%
Source: Bloomberg


Oil - Nymex (USD/barrel) 90
Natural Gas (per million mbtu) 4.37
Coal-thermal ($/tonne) 110
Uranium (USD/pound) 60
Gold (USD/ounce) 1,405
Wheat (cents/bushel) 785
Iron Ore ($/tonne) spot price 168
Copper (USD/pound) 4.36
Nickel (USD/pound) 11.06
Zinc (USD/pound) 1.09
Aluminium (USD/pound) 1.09
Corn (cents/bushel) 614
Source : Kitco, quotemarkets


Leading Indicators

Baltic Dry Index (BDI) January 2,170 (bearish)
US Retail Sales Forecast
(USD Trillion)
January (forecast)
February (forecast)
March (forecast)
U.S. Retail Sales

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 world climate.
Other parts of Asia and South America, especially South East Asia continues to go along very strongly, oblivious to the Western world’s woes.

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.

Oil has moved up sharply over the quarter to USD 90, and Natural Gas also increased over the quarter. This has, as usual, pulled up virtually all the commodity prices quite strongly.

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 home price overvaluation warnings continue to build and prices are starting to level off or fall. Even the IMF warned in October 2010 that “a potential correction in house prices could hit household wealth and consumer confidence in Australia”.

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.

  • Aggressive and Growth investors should cash up a bit and lock in some profits or invest in the developing economies.
  • Keep some Cash or safe fixed interest. At least 30% for Growth clients, 40% for Moderate Clients and 60% for conservative clients. As Australian rates rise it may pay to hold more cash.
  • Avoid US and Euro/UK currency.
  • Invest in countries with currency surpluses and positive GDP (eg; China)
  • Avoid Bonds (they perform poorly when interest rates start to rise)
  • In the short term only, decrease or don’t increase exposure to overvalued share markets
  • Be cautious or don’t buy overvalued Australian residential property.
  • Invest in countries with currency surpluses and positive GDP (eg; China)
  • Hold some commodities or resources companies as well as soft commodities.
  • Hold some Emerging markets shares

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.

" 'SHOULD I buy some US dollars now?’ But my normal response is this: ''Why would you bother?''
The Australian economy is powering ahead, the American economy is a basket case. So what does that tell you? It tells you that longer term, the greenback will be weak and the Aussie dollar will be strong.
Add in the worst recession the US has endured since the 1930s, massive unemployment (10%), huge national debt and the looming possibility of a trade war with China and you start to understand the almost impossible position the US is facing right now.
But unless you are planning a trip Stateside (USA) over Christmas, there's no value in hoarding American currency at the moment. And if you are planning to go somewhere other than America, there's no point buying greenbacks, particularly given the hefty commission you have to pay to dealers every time you switch from one currency to another.


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:
‘ There has been little progress in lengthening the maturity of their [banks] funding and, as a result, over $4 trillion in debt is due to be refinanced in the next 24 months.
Funding problems could easily arise for specific institutions, prompted by renewed stress in sovereign debt markets, further weakness in real estate markets, or downside
surprises to economic activity.’
The IMF said that a stronger-than-expected recovery would now begin to slow temporarily during the 2010/11 financial year.

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.
‘Until now there have been few convincing signs of a persistent increase in the growth of metal supply, and an ongoing global recovery will preclude a strong offset from cyclical factors. This would mean that if demand continues to grow at the rates observed over the past decade, the current era of higher scarcity, rising metal price trends, and a balance of price risks titled toward the upside may continue for some time.’

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
initial discovery through to exploration and capital investment into natural resources, which can take 20 to 30 years.

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.

Food Type
Amount of Grain required
to produce 1kg of Food



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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NB : High Net Worth Financial Advising attempts to enhance overall return for clients by investing in undervalued regions of the world and undervalued asset classes, that have positive growth stories.

NB : The contents of this newsletter does not constitute personal advice and is general in nature, please see your adviser for personal advice suitable to your own needs and objectives.