Quarterly Newsletter - July 2011

Major Indices   (as of 1/7/2011)

 
Currency
(AUD)
Interest Rate(%)
Share Index
* PE ratio
(historical)
GDP (2010) IMF
GDP Forecast (2011) IMF
Population
(m=million)
Foreign Surplus (Debt) %GDP
Australia
1.00
4.75
All Ords
4,645
17.05
3.0
3.5
22m
2010 - (5.0)
USA (Dollar)
1.06
0.25
S&P 500
1,307
18.89
2.5
2.7
300m
2011 - *(10.0)
Largest USD deficit, 14.3 trillion
Japan (Yen)
86
0.1
Nikkei 225
9,828
18.94
-0.7
2.9
127m (declining)
China (Yuan)
6.84
6.06
CSI 300
3,045
Hang Seng
22,436
China
16.17
Hong Kong
17.08
9.6
9.5
1,350m
2011 - USD 2.8 Trillion, 5.1% GDP, number 1 largest surplus in the world
India (Rupee)
47
7.25
BSE 200
2,305
?
8.2
7.8
1,150m
2009 - USD 277 billion surplus
Europe (Euro)
0.73
1.25
DJ Stoxx 50
2,802
16.23
2.0
1.7
725m (declining)
 
UK (pound)
0.66
0.50
FTSE 100
5,855
?
1.5
2.3
60m
2011 - (8.5)
Global
N/A
 
 
15.42
4.3
4.5
6,300m
 

* PE ratios (based on historical earnings)
*NB: (10.0) refers to the % of GDP required to pay the interest on the national debt.
US 10 Yr Bond Rate – 3.09%    US 30 Yr Bond Rate – 4.36%
Source: Bloomberg

Commodities

Oil - Nymex (USD/barrel) 93
Natural Gas (per million mbtu) 4.36
Coal-thermal ($/tonne) 131
Uranium (USD/pound) 54
Gold (USD/ounce) 1,501
Wheat (cents/bushel) 640
 
Iron Ore ($/tonne) spot price 177
Copper (USD/pound) 4.13
Nickel (USD/pound) 10.30
Zinc (USD/pound) 1.02
Aluminium (USD/pound) 1.12
Corn (cents/bushel) 683
  [www.kitco.com]
Source : Kitco, quotemarkets

 

Leading Indicators

Baltic Dry Index (BDI) July 1,424 (falling and weak)
US Retail Sales Forecast
(USD Trillion)
July (forecast)
390
(falling)
August (forecast)
391
September (forecast)
358
U.S. Retail Sales


Commentary – Past 3 months

Fourth Quarter 10/11 financial year saw most share markets globally move slightly downwards as global confidence weakened on fears over US and European debt problems and stalling economies.

Greece managed to delay its day of reckoning by issuing 30 year Bonds to France and Germany and an Austerity programme. This resulted in the people rioting. Maybe a sign of future revolts against bad Governments.

Global share market Price to Earnings (PE) ratios are slightly lower and are generally at fair value or in some cases still a bit high. China is well valued.

Global exports are slowing and economists are concerned about global debt levels..

US employment is flat still hovering stubbornly at around 9% unemployed, and Australia around 4.5% unemployed.

China and India continue to do well. An IMF GDP forecast for 2011 of 9.6% and 8.4% growth respectively.

SE Asia and ASEAN continued strongly with the Philippines a top performer with 7.3% GDP growth and about 35% rise in share markets and 20% rises in property markets.

Europe and UK are still awash with debt particularly in the PIGS countries supported only by Germany and France. Their economies are weak.

The Baltic Dry Index (BDI) has recently dropped again down to a weak level of 1,424 another ominous sign.

US retail sales forecasts are lower as the US QE II (600billion Gov money printing) ends.

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 4.3% (IMFs May 2011 forecast).

It is definitely a two speed world - the slow developed and booming developing economies.

Global Interest Rates have mostly remained the same with the exception being India and a small increase in Europe. Interesting to note, in the booming Brazil, rates are high at 12.25% as is inflation.
US long term bonds rates have been falling, perhaps as investors question the safety of US Bonds.

Currencies over the quarter were summarized by very little change. The Australian dollar (AUD) rose only very slightly compared to most major currencies and reached 1.10 to the US dollar, settling now at $1.06.

Commodities
Oil has moved down over the quarter to USD 93 on Middle East troubles easing somewhat, and Natural Gas remained flat over the quarter showing its resiliency and strong demand.
Gold has continued its stellar bull run and is currently $1,501 per ounce.
Copper and the other base metals fell slightly.
Iron Ore and Coal prices were flat, having previously doubled from the old contract prices and Iron Ore now sells on the Spot market at a great price of $177 tonne, but there is talk of extra supply coming on and the Iron Ore price dropping back to around $100/tonne.
Uranium is still suffering from the Japan Nuclear accident languishing at $54/tone.
Soft commodities were mixed with Wheat higher (recovering) and Corn lower but generally trending upwards.

Australian house prices
Australian home prices have started to fall especially in the upper end (not top end).and are still grossly overvalued. A fall here is very possible.

 

Commentary – Forecast next 6 months

We may be on the verge of a very significant fall in financial markets due to the European and US Debt Crisis.

US and Europe is still to be avoided on debt concerns.

I expect the emerging economies to continue to do well, and the oil and resource economies.

A caveat to this is that if the US or Europe collapses under their mountain of debt then all economies and share markets will suffer.

The Baltic Dry Shipping Index is lower and weak.

US Retail sales forecasts are forecasted to fall slightly. This is suggesting a weak US economy as retail sales make up about 70% of US GDP.

Share markets are likely to fall.

Most markets PE ratios are fair or slightly overvalued and China is looking cheap if you look at their growth and undervalued currency.

Inflation is becoming a global concern and it would be wise to hold some commodities in your portfolio. Ideally a mixture of soft (food) and hard (energy/resource) commodities to hedge against the rising cost of living (inflation).

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 do relatively well. 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?

Be very cautious, BETTER TO BE SAFE THAN SORRY…..

  • Aggressive and Growth investors should cash up significantly and lock in some profits
  • Keep alot of Cash or safe fixed interest. At least 50% for Growth clients, 70% for Moderate Clients and 100% for conservative clients. Interest rates may collapse if we get another financial crisis; so long dated Term Deposits at good rates may be very worthwhile.
  • Avoid US and Euro/UK currency.
  • Consider Bonds (will do well if rates fall)
  • Sell Australian residential property unless it’s your home.
  • 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 or property.

 

US is WORSE than Greece – Bill Gross

The manager of the largest US bond fund, Bill Gross, made that statement when at CNBC recently in regards to the US financial structure.

When adding in all of the money owed to cover future liabilities in entitlement programs the US is actually in worse financial shape than Greece and other debt-laden European countries.

Much of the public focus is on the nation’s public debt, which is $14.3 trillion. But that doesn’t include money guaranteed for Medicare, Medicaid and Social Security, which comes to close to $50 trillion, according to government figures.

The government also is on the hook for other debts such as the programs related to the bailout of the financial system following the crisis of 2008 and 2009, government figures show.

Taken together, Gross puts the total at “nearly $100 trillion,” that while perhaps a bit on the high side, places the country in a highly unenviable fiscal position that he said won’t find a solution overnight.

Even the US Congress is now warning of a US Debt Crisis, The rapidly growing national debt could soon spark a European-style crisis unless Congress moves forcefully, the Congressional Budget Office warned on June 22, 2011. The report said the national debt, now $14.3 trillion and rising, is on pace to equal the annual size of the economy within a decade. It warned of a possible "sudden fiscal crisis" if it is left unchecked, with investors losing faith in the U.S. government's ability to manage its fiscal affairs. Interest on US treasury debt is payable on August 2, a deadline that may be extended, but for how long??

Some commentators have started to state publically that the US will soon collapse financially, triggering a collapse of the global financial system. This is a truly frightening thought.

To balance this below I look at Global foreign reserves and surpluses.

Debt Default – What’s next?

If we do get a default on US or European Debt it will most likely spook markets and possibly start a second wave down on the GFC. Either way the risks of a severe world-wide asset price crash appear high at present. Should this occur we will see a collapse of several countries currencies and asset values, forced sales of assets by the receivers (Chinese etc), and a rapid fall of the West and relative rise of the surplus countries in the East. But in the short term all will suffer as a Global Depression hits. Cash will be king, but it will need to be in the right currency. For retirees that is the currency where you live. For others the right currency will be those countries benefitting from globalization and with surpluses.

The only real products that have a chance to resist the fall are those that are essential for living--- energy (oil, gas etc) and food. But I fear even those will plunge in price if everyone is suffering from unemployment and having asset values collapsing.

Foreign Reserves- Global Imbalance --USA debt and Asian surpluses

Total Global foreign reserves are around USD 8 trillion.

Asian nations and Oil nations are the ones mostly in surplus led by China with around 3 Trillion USD in foreign reserves. Other big surplus countries include Japan, Russia, Saudi Arabia, Taiwan, India, South Korea, Hong Kong, Singapore, Brazil, and Germany. These 11 countries combined account for about 60% of world reserves or about 4.8 Trillion.

USA is generally the debtor owing the vast majority of the USD 8 Trillion, mostly in US Treasuries (including mostly Government bonds).

Important to note is that in 2000 Industrialized or developed countries held twice as much reserves as developing economies. Now in 2011, this has been reversed, with developing economies holding twice the level of reserves as the industrialized or developed economies.

An example of this is the Philippines, where its foreign reserves quadrupled in the past 10 years and now stand at 65 billion USD.

Whilst the US has definitely been a loser in global trade in recent years due to globalization and the rise of the developing super powers such as China and India, it has managed to pay very low interest on its debt because it has kept interest rates very low on its Government Bonds. Additionally, as the US currency (dollar) decreases in value then the debt it owes is also decreased. This leaves the debtors such as China with a capital loss on its US Bonds.

So it is likely that China and others will start to move away from US Bonds and invest more in commodities and other hard assets.

This may leave the US without a bank, and finally stop the massive lending to the US over the past few decades. The US dollar will fall significantly and the surplus countries especially China will see massive currency gains. US citizens will need to adjust to become savers, while the Chinese will hopefully learn to spend a bit more, so that the Worlds huge imbalance of payments can be alleviated without financial, political or other crisis. Let's hope this happens.


Assets prices to equalize in the Top 50 economies before 2050 due to Globalisation – “The World economies in 2050”

*China, Europe, USA, and India are likely to be the four major economies by far. China and India, to have the largest populations by far.

* Global equalisation of currencies, asset prices and salaries to occur for many countries, or at least what that currency is able to buy (example 2).

Example on Currencies: USD, Euro, AUD, Chinese Yuan, Indian Rupee all to have same purchasing power globally.

Example on Asset prices: A 1 bedroom unit in New York, Berlin, Sydney, Shanghai, or New Delhi to be all valued about the same. (This may be reflected in the currency, asset price or both). A unit in Jakarta, Manila, or Bangkok may be almost the same.

Example on Salaries: A US worker to earn the same as a worker from Europe, Australia, China, and India.

If the above sounds too unbelievable, go to a Chinese or Indian city now and check the price of a unit. For example, units in Shanghai are now worth more than New York. Unit prices in Manila doubled in the last 5 years, while those in the US, UK, and Europe all declined.

Conclusion: Buy property now at cheap prices in the Emerging Economies such as Philippines, Thailand, Indonesia, etc

Projections – Country GDP rankings up to 2050 (billions of USD)

* European Union GDP, is shown for comparison, but not ranked.

Mongolia to be the next boom mining country

In the past 10 years the big Global Mining companies have uncovered the single largest mining discoveries for decades in Mongolia, including the worlds largest copper mine, expected to provide over $100 billion of ore over the next forty years.

The country is in the middle of a mining boom, with enormously rich mineral resources of copper, coal, and gold.This has brought in mining companies such as BHP, Rio Tinto, Ivanhoe, and Centerra Gold.

It is possible in 10 years time that China will source most of it’s Iron Ore from Mongolia, and that Australia may lose market share. The Mongolian mines are closer to China and labour costs are cheaper. This means that China will prefer to buy from Mongolia and not Australia or Brazil.

If you invest in the CFS Global Resources Fund don’t worry because the mining companies are all there in Mongolia now, so you will be part of the boom. But if your investments are in Australian based mines, or the property in the Australian mining towns, then the boom may be reduced because of Mongolia.

Property in Mongolia has been booming as a result from a very low cost base just a few years ago. There is a severe shortage of quality housing. Ulan Bator is a Soviet-era city, ugly, badly planned. Accommodation is badly maintained, unattractive, and unsafe, and it is hard to convince expatriates to work in Ulan Bator.

However, this has provided an opportunity for a few companies which are building modern high-quality condominium buildings.

A decent apartment in the city centre (three rooms, good structural integrity) will cost a minimum of 60 million Togrogs (about US$55,000). The high end or newer apartments now range in price from US$85,000 to US$250,000.” Square metre prices are between US$1,100 to US$3,500

Rising demand for accommodation from foreign experts and an extreme shortage of housing have generated very high yields. In Ulan Bator, rental income returns (yields) on high-end property are around 18%. Rental income earned by non-resident individuals is taxed at a flat rate of 20%.

Capital Gains are considered as part of income and non-resident individuals are taxed at a flat rate of 20% on their capital gains realized from selling real property.

Buying costs are low with buy/sell costs of buying and selling a property are around 5.7%, including legal fees and the agent’s commission (together 3.5%) and resale tax (2%).

Foreigners can freely own property in Mongolia through the Immoveable Property Ownership Certificate, which is equivalent to freehold ownership.

Mining Super Cycle or Super Boom is on the way

The Global Resources boom still has many years to run thanks to urbanization in Asia, South America, and Africa. See graphs below that show the two waves of population (mostly China in the first wave and India in the second), that are a huge Tsunami that will mean a Mining Supercycle or Super Boom.

Sovereign Wealth Funds becoming larger and more important

SOVEREIGN wealth funds have enjoyed a meteoric rise, shrugging off the global financial crisis thanks to soaring commodity prices. The value of assets held by these government-controlled monoliths leapt 11 per cent to $US4.2 trillion last year - almost double all private equity holdings. The sector's value is tipped to hit $US5.5 trillion next year and $US10 trillion by 2015.

Among the countries that have gone down this path there is a recurring theme - commodity wealth. From the $US38.6 billion Kazakhstan National Fund to the $US627 billion Abu Dhabi Investment Authority, the trend was led by oil-rich states from the 1950s.

 

To find out more please contact an adviser at contactus@hnwfinancialadvising.com.au .

 

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.