First of all, it’s important to note that gold is one of Australia’s biggest exports. There are often huge correlations between the Aussie dollar (AUD) and gold. However, there are periods of disconnect there as well.

Let’s take a look at the chart below that goes back about four years.

Sometimes Commodities “Disconnect” from Their Currencies

If gold and the Aussie dollar always correlate, then the AUD/USD and gold should always head in the SAME direction. They often do. However, there are exceptions. I drew yellow arrows on the graph above to show you the exceptions to this rule.

For instance, in 2005 the Aussie dollar actually traded OPPOSITE of gold’s price. This means the U.S. dollar and gold both rallied at the same time, in the same direction. While that doesn’t happen often, it does happen.

Also, I’d like to point out how gold and the Aussie dollar have acted this year - particularly from about July up until now. Notice that most of the time, the AUD/USD and gold have similar “magnitudes.” In other words, they both rose and fell at a great degree.

In recent months, gold had a decent fall… but the AUD/USD just got absolutely unduly punished.

In fact, the AUD/USD pair has fallen about twice as much as gold has. So this shows that not only can their directions move differently (like in 2005) but also the magnitudes of these two can vary as well.

Correlations hold true generally, but there are times when they buck the norm. You want to be prepared for those times when they come. Don’t make the mistake of assuming that these com-dollars always dutifully track commodity prices.

The recent fall in the value of the Australian Dollar, while painful for Australians looking to travel overseas, has proven popular with many traders whose trading accounts are denominated in US Dollars.

From a traveller’s perspective, every cent that the Australian Dollar falls means less spending money in their pockets when they convert their Australian Dollars into US Dollars.

However, the sharp falls have eased the pain of those traders watching their US Dollar accounts erode in value with the strengthening Australian Dollar.

Imagine you were a trader who wanted to trade options on the US market. You open an account with a US Broker in 2002 and send over $A10,000 to fund your account. With an exchange rate of 0.5000, you now have $US5,000 in your account.

Now imagine you are a conservative trader and over those 6 years you managed to double your trading account. Your trading account is now $US10,000.

Now you decide to bring the money back to Australia. However, it’s 2008, and the exchange rate is now 0.9800 (98 cents). Suddenly, you need 98 US cents just to buy 1 Australian Dollar, whereas six years ago, you only needed 50 US cents.

Now your $US10,000 – which was double your initial investment - is only worth $A10,204. Nearly all of your gains have been wiped out by the exchange rate fluctuations. Can you see the importance of managing your currency risk?

Chart 1 below shows the weekly bar chart of the Australian Dollar (FXADUS in ProfitSource)

Chart 1

click to enlarge

As you can see, it is not just Currency Traders who are faced with the risks associated with changes in the exchange rate. Of course, had the trader waited until October to bring their US Dollars back to Australia, the exchange rate would have been much more favourable for them.

Anyone with any exposure to overseas currencies, whether through their trading, their travel plans, or business transactions needs to manage their currency risk.

So how can we go about it?

The simplest way to lock in the exchange rate today is to open an FX trading account. Let’s say we have some US Dollars sitting in a bank account in the United States.

If the Australian Dollar rises in value, the US Dollars will fall in value, meaning less Australian Dollars should we decide to bring the money to Australia. To lock in the current exchange rate, we can open an FX hedge by opening a currency position.

In any FX transaction, we are always buying one currency, and selling a second currency.

So in this case we would open a position that would buy Australian Dollars, and sell enough US Dollars to cover the money in our US bank account.

As long as there is enough money in your FX trading account to cover the margin on the trade, you will be able to leave this hedge open until you are ready to bring your US Dollars back to Australia. If Australian interest rates are higher than US interest rates, you can even be paid interest on your position, in what is called a “carry trade”.

If you have US Dollar exposure and you don’t check the exchange rates very often, it can be a good idea to hedge your position and lock in your exchange rate, to remove the possibilities of any nasty surprises.

There are other methods for locking in an exchange rate using Forward Exchange Contracts and options, however that is a subject for another article.

The Rate Cut That May Cost You Money
The latest news from the Australian Bureau of Statistics (ABS) was that the unemployment rate had fallen to 4.1% from 4.3% the previous month. These numbers were on a seasonally adjusted basis.

Source: ABS

The Reserve Bank of Australia (RBA) jumped too soon. That is one reaction after seeing the latest unemployment numbers from the ABS.

The other reaction is that the RBA has accounted for this because it wants to avoid putting the economy into recession. The argument would say it is not worrying from an inflation perspective either.

Consumers Expect Inflation Rate to Fall
At the same time the Melbourne Institute released its survey of consumer inflation expectations. It shows that consumers are feeling quite positive about the direction of inflation. The survey tells us consumers believe inflation will fall in September to 4.4%. We will wait to see how accurate this survey is. In the same survey 9.8% of the respondents thought the inflation rate would fall to below 3%, the RBA’s target level.

Let us suppose the great consumer has successfully predicted the inflation rate for the September quarter. The survey recorded 5.9% for July, 4.9% for August, and 4.4% for September. Yielding an average of 5%. This is still significantly above the RBA target band of 2-3%.

The ABS is due to release the September quarter CPI on 28th October. So, how did the Melbourne Institute survey perform in the previous quarter? The results were as follows. April 4.3%, May 5.2% and June 5.9% for an average of 5%. This was above the official figure for the June quarter of 4.5%.

We can’t extrapolate any further than to say that consumers overestimated inflation on average during the June quarter. It is possible they will do the same this quarter. The unknown quantity is what impact reporting of inflation expectations in the media has on the respondents.

Cost of Living Remains High
At the time when consumers were predicting inflation of 5.9% the media was full of stories about high petrol and food costs. Since then the price of petrol has moderated. Yet is still remains around $1.50 per litre, which is not that significantly lower than four months ago.

Because of this moderate decline in petrol costs there has been little comment in the press about it and therefore minimal commentary on the still high costs of living. Therefore, there is the reasonable prospect that consumers are being lulled into a false sense of low inflation and could be in for a shock when they realize their money isn’t worth quite as much as they thought.

We shouldn’t forget the unemployment numbers either. The RBA reduced interest rates this month because it believed that the economy was slowing. However, it did not want the economy slowing too much for fear of triggering a recession.

Although the RBA only made the decision this month, it had made it clear well in advance that an interest rate cut was on the cards. It is possible that Australian industry has pre-empted the RBA, anticipating the cut and hiring staff. The effect of this is to keep the labour market tight and potentially drive up wages and prices. Exactly the opposite of what the RBA is supposed to be striving for.

Boom and Bust
It could be argued the RBA’s intentions are admirable in trying to avert boom and bust cycles. The problem it now creates for itself is a continuous cycle of industry, the consumer and the RBA all trying to pre-empt each other’s actions.

In that context we were discussing the misfortunes of the Australian dollar during the last two months. But the same can be said for the stock market as well. During the current earnings season there has been a bit of a mixed bag with some showing excellent revenue and profits (BHP and Rio) while others have been woeful (Babcock & Brown).

At the moment, the outlook for a broad rise in the stockmarket doesn’t look good. Ever since the market topped out last October the S&P/ASX200 has continued to drift downwards, punctuated by false rallies on the back of over optimism.

But there is light at the end of the tunnel. The problem is that we can’t quite work out how long the tunnel is. There are positives that should ensure that Australia emerges from any economic downturn without too much agony.

As a resources led economy there is often talk that any downturn in the US economy will reduce demand for goods there, which will reduce demand for imports to the US from China which will reduce demand from China for Australia’s resources. Of course, this will have an impact but probably not to the degree that is feared.

Thanks to the massive demand for raw materials companies such as BHP Billiton, Rio Tinto and Fortescue Metals have been able to charge big premiums for their commodities. Any downturn in the US and Europe is bound to have some impact, however there is still ample room for Asian economies to grow without the need to rely on the US and Europe. Demand for Asian domestic consumption will be the next growth area as incomes rise and the standard of living rises with it.

Another insulator for Australia is the concentration of business in a small number of large companies. Many Australian sectors are in effect presided over by duopolies where the lack of major competition has allowed them to maintain healthy profit margins. The relevant smallness of the Australian economy makes it that much harder for new entrants on a large scale.

This allows them to maintain some of their margins without the fear of being undercut by competitors. And when competitors do come into the market they have to work fast in order to build up market share. A tough ask when consumers are comfortable the same brand they have used for years.

So what does that mean as investors? It really means that with the market having fallen so far since last year, the opportunities for value in this market are starting to present themselves so now is the time that investors should be starting to get back into the markets. Unfortunately, history tells us that for most retail investors they tend to exit the market just at the time when they should be getting back in.

This is pretty typical of professional traders. All the pros leave the FX market alone on holidays. In fact, my opinion is that the Forex market should post a sign that says “Enter at your own risk” during major U.S. holidays.

I say this because the Forex market is like a renegade switch on most holidays. The market is either “turned on” and your trades are moving like crazy (which means it’s hard to predict what will happen next). Or the market is completely “turned off,” and it’s about as interesting as watching paint dry.

More often than not, you’ll see BOTH scenarios happen on a single holiday. First the market will be switched on, and then it will suddenly switch off - or vice versa. Unfortunately, there’s never any telling which comes first…the “calm” or the “storm.”

So on any given holiday, I generally wait until the afternoon to check on the currency markets. Then I just wait for the “show” to start. Frankly, for a seasoned trader like myself, it’s fun to watch the markets move that fast.

But it’s definitely NOT time to start trading. Please keep that in mind for every holiday going forward.

According to the market it is a done deal, with interest rate futures pricing in at least a 0.25% cut, with a further 0.75% expected over the next twelve months.

The green line on the chart represents the level at which the market has priced in a 100% certainty for a 0.25% cut in the rate tomorrow. Currently the red line is above the green line at 116% which means there is a small expectation that the rate cut could be higher.

Therefore, expect the Aussie dollar to potentially rise a bit tomorrow if there is only a 0.25% cut, or fall quite a bit more if there is a 0.50% cut.

This is because the FX markets should have already factored in at least a 0.25% cut. If the RBA does nothing, well, a sharp rally in the AUD would be almost guaranteed.

So what lies ahead in the coming year, and a bit more for the world’s major mining group? How does it see demand and prices, and does the company still believe as strongly in the commodities boom, especially where China is concerned, as it has done in the past few years? The above graph shows the Australian dollar and the Chinese currency and they tell two stories: the Aussie’s weakness in the past month reflects the new belief that the bloom is leaving the commodities boom; the Chinese currency reflects its appreciation, which now seems to have stopped as the Government tries to keep the economy growing strongly. If that works, then despite some slow growth in coming months, there will be a revival in the value of the Aussie dollar, and that will be reflected in the performance by BHP (and its share price). But has the recent rapid drop in commodity priced, led by oil, the company’s major profit centre in 2008, caused any second doubts? From BHP Billiton’s point of view the coming year has two major tasks to do. The first is to complete or abandon the huge takeover for rival Rio Tinto. There’s not much the company can do until the European Commission rules on its 3.4 share $160 billion offer, probably around November. BHP’s CEO, Marius Kloppers said in yesterday’s profit briefing that the offer was value accretive for both sets of shareholders. “We believe the deal that we have on the table is value accretive for both sets of shareholders,” Mr Kloppers said on a conference call. Mr Kloppers said that the combination of BHP Billiton and Rio made “more sense than ever”. Mr Kloppers said the company was focused on the Rio Tinto proposal and scotched speculation that the group might move into platinum following Xstrata’s $US10 billion bid for Lonmin. BHP can continue to campaign publicly in favour of its offer, but until the EC rules, its powerless. The second is to navigate the company through the rapids of what is looking like a volatile time, with oil prices down, along with gold, copper, lead, zinc and nickel. Iron ore and coal remain high, but that could change if the bloom goes out of China’s boom. BHP is confident that won’t happen in the short or longer term: it sees greater volatility in prices, but no collapse in global price levels, even with the softening we are seeing in major economies. But it does see periods of weakness: not a turnaround in belief, more an acceptance of the current realities. Belief in the commodities supercycle is alive and well in the boardroom and management offices of the company. The big realignment of commodities and the US dollar is based on worsening economic prospects outside America with Europe, Japan and possibly China weakening. But BHP is sanguine. The company sees the strong possibility of slow growth in many western economies in coming quarters, but is confident the emerging major economies of China, brazil, India and Russia will not succumb to the slowdown. “The global economy has remained resilient in the face of significant structural weaknesses in developed economies. The continuing massive industrialisation in China is providing solid support to the global economy. “Over the past financial year there has been considerable weakening in most major developed economies. “The deflation of asset values within these economies has led to a reduction in wealth effect for consumers. “This appears to have ended the past decade’s unsustainable consumer debt driven economic growth, particularly in the US.

 

“However, a direct spill over into emerging market economies has remained largely contained.

“Emerging market economies have contributed more than their industrial counterparts to global growth since the year 2000.

“Led by China and India, economic growth in these economies has been strong with solid support from growth in domestic demand and strong trading activity with other emerging market economies.

“We expect short term global economic growth to slow as developed economies experience further weakening in the coming quarters.

“Liquidity is likely to remain low, and risk premia high for some time into the future.

“Rising inflation, particularly in food and energy, alongside weakening economic growth has restricted the flexibility of central banks to inject liquidity and stimulate their economies.

“Higher inflation will also have a likely negative impact on emerging market economies through their adoption of tighter monetary policies.

“However, emerging market economies should remain relatively strong on the back of continued domestic infrastructure investment and regional trade.

“While short-term disruptions may occur, we expect that their long-term economic growth will remain robust as they continue on the path to industrialisation.

“The 2008 financial year has seen higher average prices for most of our major commodities, than in the prior year.

“Demand for raw materials in the emerging market economies has remained strong. In particular, China remains a key driver of global commodity consumption through its position as a net importer of raw materials.

“China’s competitiveness and ability to innovate in downstream processing has been demonstrated again with sustained nickel pig iron production.

“In light of differing activity for the developed and emerging market economies, there have been mixed spot prices for key commodities.

“In particular, bulk and energy related commodities have tended to outperform the LME traded metals.

“The effects of current weaknesses in the developed economies on demand for our commodities should be minimal driven by ongoing strong demand from the emerging economies. Meanwhile, supply side pressures remain high.

“This has led to overestimation of the supply side response, and thus, price outcomes regularly being underestimated by industry observers.

“In the short-term, we expect prices to remain high relative to historical levels, albeit with higher volatility.

Looking to the longer term, demand for our commodities is expected to remain strong.

“We expect that higher long-run raw materials and energy prices and stronger producer currencies should place upward pressure on industry supply costs, and hence, prices of minerals commodities.

“We continue to expect that commodity prices will be driven by long-run marginal cost of supply.

“The world is confronting supply constraints for energy and mineral resources.

“While there are enough resources to satisfy the world’s appetite, the industry has not moved quickly enough to meet the growth in demand.

“We are continuing our efforts to meet these needs through a deep inventory of growth options. We have an abundance of tier one resources in fiscally stable regimes that provide us with a unique set of options to deliver decades of lower risk brownfield growth.

“We also have an extensive experience operating in emerging resource regions and the capability to capture additional opportunities as they arise.

“This experience enables us to continue to build and strengthen our position for long term value creation.”

 

 

Midday Market Roundup 18/08/08
August 18 2008 - Australasian Investment Review – (AIR)

 

We have started off the week OK – up 36 – the SFE Futures suggested an 8 point fall in the market this morning. Resources up 1.4%, Financials up 0.4% after another 6% fall from Babcock & Brown this morning with Babcock & Brown Power down 30.6% on news of a big provision. MQG also down 2.6%. Market is waiting for BHP Billiton’s result – Last year they came out at 3:55pm. Expecting record $15.7bn profit. Commentary on China all important and will set tone for the resources sector which has fallen over 25% since May 19th.

 

Wall Street finished higher on Friday – up 44 – The main point was oil and commodities down again on a rising US dollar. Goldman Sachs says the US dollar has bottomed. Continuing credit-related concerns amidst multi-billion-dollar buybacks of Auction Rate Securities plus some weak economic numbers.  Wachovia announced it will buyback $8.5bn worth of auction-rate-securities and pay $50m in fines, retailers close up 1.8% on better-than-expected 2Q results and the University of Michigan’s July consumer sentiment figures were up less-than-expected – suggest an economy still under pressure.

 

• Both BHP and RIO down 1.77% in ADR form on Friday.
• Metals mixed – Zinc up 1.33%, Aluminium up 0.22% and Nickel down 2.2%. Copper down 0.04%.
• Oil price down $1.59 to $113.46 on growing concerns about demand in industrial nations and the stronger dollar. Woodside up 122c to 5542c.
• Gold down $22.30 to $788.40. Newcrest up 40c to 2483c.
• US Bonds up with the 10 year yield down to 3.84% from 3.90%.

 

We have a busy week ahead with a host of results as we get into the guts of the reporting season. Most notable companies reporting include: Tuesday: CSL, Boral, Newcrest Mining, Wednesday: Coca-Cola Amatil, Perpetual, AGL Energy, Thursday: Amcor, Tabcorp Holdings, QBE Insurance and on Friday we have Wesfarmers, Caltex and Boral.

 

Results Today…

 

• Ansell’s (ANN) – GOOD - Final result has come in better-than-expected. FY net profit up 2.6% to $102.6m, better than $97.2m analysts’ had expected. Declared a final dividend of 15.5c. ANN up 5c to 1129c.
• Seek (SEK) – BELOW EXPECTATIONS - Has announced a 37.4% increase in FY net profit to $76.3m, stronger than UBS Warburg’s forecasts of $75m but below Credit Suisse’s bullish prediction of $80.7m. GSJB Were expected $78.1m. SEK up 5c to 514c.
• BlueScope Steel (BSL) – GOOD - Announces an underlying profit of $816m, up 27%. UBS Warburg expected $728m. After significant items, FY profit came in at $596m, down 13%. Declared a 27c final dividend, up from 26c last year. BSL unchanged at 1329c.
• Sino Gold (SGX) has posted a net loss of $2.6m compared to the $3.12m loss announced last year. Revenue of $100.2m. No dividend. SGX down 13c to 421c.

 

Other Announcements

 

• Babcock & Brown Power (BBP) announced it will take a total impairment charge of $452m relating to the takeover of Alinta. Reaffirmed EBITDA and has realized $40m from its decision to sell its Tamar power stations project. BBP down 30.6% to 30c.
• Babcock & Brown (BNB) has also confirmed its interim result guidance saying the guidance (profit warning) last week included the impact of the impairment charge. BNB down 19c to 426c.
• Talk of Commonwealth Bank of Australia making a $6bn plus takeover offer for BankWest having pulled out of the race to buy ABN AMRO’s Australian investment banking operations. CBA down 104c to 4265c.
• Straits Resources (SRL) announced they will sell their coal assets – Madagascar and Brunei - to its subsidiary Straits Asia for US$100.3m. SRL down 12c to 488c.
• Emeco Holdings (EHL) has successfully executed a 3 year $630m senior debt package. Cost of debt up 130bps after the refinancing. EHL up 0.5c to 109.5c.
• Perpetual (PPT) says funds under management fell slightly in July to $30.2bn from $30.3bn in June. PPT up 205c or 4.6% to 4705c. 
• Allco Finance Group (AFG) announces Credit Suisse Group has agreed to waive Rubicon America Trust’s (RAT) financial covenants and obligation to make a debt repayment until August 22. AFG unchanged at 48c.
• GSJB Were maintain their OUTPERFORM recommendation on Crown (CWN) and 1060c target price ahead of its result tomorrow. CWN down 1c to 825c.
• Fairfax Media (FXJ) only down 2c to 273c despite Citi cutting its target price on the stock by 22% to 291c from 371c. They say advertising outlook in New Zealand and regional Australia looks soft. FXJ down 2c to 273c.
• No indication from Treasurer Wayne Swan as to whether the government will approve Westpac’s (WBC) bid for St. George (SGB). He has also told the banks to follow the RBA’s lead and cut rates if the RBA does reduce interest rates at their next meeting.

After a longer than normal delay, commodity prices have entered a significant correction on the back of slumping global growth and a stronger $US.

Notwithstanding, occasional bounces (such as that seen in the last 24 hours) the downwards correction in commodity prices has further to go over the next six months or so.

The AMP’s Dr Shane Oliver says this is good news for the global growth outlook and for shares generally as it takes pressure off inflation and hence clears the way for lower interest rates.

But it is bad news for resource shares and the $A, as we have seen with its 12 cent fall in a month against the US dollar.

While the correction in commodity prices has further to go, their long-term trend is likely to remain up, he says.

 

---

Commodity prices have fallen sharply.

From recent highs oil, gold and copper prices have fallen around 20% and wheat and corn prices are down around 30%.

Of course this has occurred from very high levels, as evident below.

What is driving the slump in commodity prices?

What are the implications?

Is this the end of the commodity bull market or just a correction?

 

Commodity prices and the global growth cycle

In a normal global economic downturn commodity prices fall in response to slowing economic activity.

This takes pressure off costs and inflation, allowing interest rates to fall which sets the scene for an economic rebound.

This time around has been a bit different. Until a month or so ago commodity prices remained very strong being propelled by still strong growth in the emerging world (notably China), investor demand for commodities as a hedge against a falling $US, and speculative demand made possible by the growth of commodity funds and partly fuelled by investor scepticism with financial assets.

The problem was that the surge in commodity prices, notably for oil, was not only cutting into profit margins and consumer spending power but that it was directly adding to global inflation; this was keeping global central banks far more hawkish than they should have been.

So while the credit crunch meant interest rates should have been falling, in the US and UK and being increased in others (e.g., in Europe and Australia).

The end result has been more global economic pain than would normally be the case.

 

Back to normal

The past month has started to see commodity prices return to something like their normal relationship with the global growth cycle with sharp falls now becoming evident.

There are several reasons for this.

Firstly, recent data has shown that Japan and Europe are flagging just as badly if not worse than the US. In fact the recent flow of economic indicators suggests that both regions may now be in recession.

This is bad news for the emerging world including China because they will find it harder to divert their exports away from the already weak US.

Secondly, it has become increasingly clear that China, India and other emerging countries are also slowing.

Chinese economic growth looks like being 9 to 10% this year compared to last year’s near 12%.

As a result, Chinese authorities are now starting to back pedal on some of last year’s tightening.

Indian growth is likely to slow back to 7% from 9% last year with aggressive monetary tightening starting to bite.

Growth in Brazil is also likely to slow on rising interest rates.

Thirdly, the slump in share markets as oil went through $US120 a barrel in May and increasing evidence of falling oil demand indicated that the surge in the oil price was starting to “choke off” growth and hence oil demand.

Rising base metal inventories are also starting to become evident. See the chart below.

Fourthly, the realisation that growth outside the US is now slowing faster than that in the US has seen the $US break higher.

This in turn has suddenly removed investor demand for commodities, such as oil and gold, as a safe haven against a falling $US.

The combination of all of these fundamental developments has seen commodity speculators squeezed.

The favourite trade recently was long oil/short banks, but in the last few weeks it has suddenly reversed.

This has forced investors to close their positions, which has only added to the severity of the moves.

A pause, not the end, in the commodity super cycle

China may be slowing but is not about to collapse and the long term demand potential in emerging countries is huge.

China’s copper usage per person is less than half US levels and its oil usage per person is around 10% that of developed countries.

Rising income levels and the increased use of agricultural products for fuel will also see ongoing upwards pressure on agricultural demand.

Just as we have seen in the last six years, supply will struggle to keep up with commodity demand over the long term.

As such, the long term trend in commodity prices is likely to remain up. See the chart below.

In this context the recent pull back in commodity prices should be seen as a correction, but it likely has further to go.

Commodity prices remain well above their rising trend (as evident in the previous chart) and speculative positioning and sentiment regarding commodities is yet to fall back to levels associated with a durable rebound.

More fundamentally the economic news over the next six months is more likely to get worse before it gets better.

The next chart shows the relationship between a leading indicator of world growth (based on the OECD’s leading indicators for OECD countries plus Brazil, Russia, India and China) and commodity prices.

Normally there is a close relationship, but it broke down last year and into mid this year as the leading indicator fell but commodity prices surged.

But a more normal relationship seems to be getting reestablished. As can be seen below, the leading indicator suggests more weakness in commodity prices ahead.

Against this backdrop speculative positions in commodities are likely to be wound back further particularly as the $US now seems to be on a firmer footing relative to other currencies.

In the very short term commodities have become oversold and due for a bounce, but the trend over the next six months or so is likely to remain down.

 

Implications – the good and the bad

The cyclical down turn in commodity prices now underway has a number of implications

Firstly, the correction in commodity prices is good news for the global economic outlook and share markets generally.

Softer commodity prices will remove much of the pressure on inflation.

This in turn will help global central banks move towards lower interest rates and provide greater flexibility to deal with the ongoing credit crunch.

We expect lower interest rates in Europe, the UK, Japan and Australia over the next six months.

Secondly lower commodity prices will also help reduce corporate cost pressures and provide increased spending power for consumers.

To the extent lower commodity prices make it easier for a healing of the global economy it should be positive for global shares generally.

Thirdly, falling commodity prices are of course bad news for resources shares.

As such, there is potential for a further reversal of their relative out performance versus financial shares over the last year.

See the chart below in relation to Australian resources and financial shares

Given the relative importance of resources in the Australian share market, it is also likely to mean that Australian shares may under perform global share markets for a while yet as the commodity correction continues to run its course.

Asian shares are likely to be key beneficiaries of the correction in commodity prices given Asia’s high reliance on commodity imports.

Fourthly the commodity price downswing means the $A has entered a cyclical correction greater than any of the pullbacks seen in recent years.

While the $A is oversold having fallen 13% in four weeks, and so may have a short term bounce, more downside is likely in the months ahead, possibly to $US0.80.

Parity against the $US has been postponed probably till late 2009 after the commodity cycle turns up again.

And lastly a downturn in traded commodity prices will also dampen the terms of trade boost for the Australian economy, adding to the case for RBA interest rate cuts.

 

Conclusion

Commodity prices have entered a cyclical correction which looks like running a bit further.

While this is bad news for resources shares, the relative performance of Australian shares and the $A, it’s necessary to clear the way for lower interest rates to combat the credit crunch.

So overall it’s more good news than bad.

More broadly we think that the commodity super cycle remains alive and well, but a sustained resumption of the uptrend in commodity prices probably won’t get underway till some time next year.

Aussie Dollar Slips Under US89c

Whoa. While we slept off our stupid allergy over the weekend, the Aussie dollar went into free-fall. No-one wants to buy a currency at the top of its interest rate cycle. It’s trading below US89 cents this morning.

If you find yourself standing around a water-cooler this week with financial buffs, make sure you have something to say about interest rates. Otherwise there might be an awkward silence or two. This is what’s driving the currency markets at the moment. Rate speculation.

Banks Climb as Market Prices in Interest Rate Cut

For a start, everyone loves an interest rate cut. We don’t have one yet, but that doesn’t deter a horde of rampaging investors with a little bit of knowledge. So financials and retail stocks caught the buying bug.

The whole financial sector soard 5% in fact. Even the money markets are beginning to act as though the cash rate is 25-50 points lower. You’ll note the Bank Pain Index to your right has eased considerably this week. You can pretty much put that all down to traders’ expectations. They think a cut’s coming. They’ve moved early, pushing down short-term market interest rates.

What we want to know is whether markets rates will keep dropping.

If so, banks earnings will benefit. If not, they’ll continue sliding. We’re going for option B. And if their costs stay high, there’s every chance the Big Four will keep their rates up if the RBA cuts. But that isn’t a good thing. It means they’re running faster to stay in the same place. They’d be keeping prices high to maintain earnings, not grow them.

For Australia’s central bank meanwhile, things are way off the charts. It used to have a nice, easy formula of raising or lowering rates in response to consumer inflation. That plan’s holding up like a pavlova under an elephant. If it cuts rates this year, it’s basically admitting that.

We see the big drivers of inflation coming from gaps in supply (think oil) in the near future. That makes the RBA’s economic policy far less relevant than it used to be. Petrol prices are the new Reserve Bank of Australia.

Aussie Dollar Pushes Up Two Sectors

One of the victims of interest rate speculation has been the Aussie dollar.

Our falling currency might’ve helped push the miners up yesterday. Some of them (notably Rio and BHP) report their earnings in US dollars. Most commodities are traded in greenbacks. It makes sense. But this means that a rising Aussie D reduces earnings from the Australian shareholder’s perspective.

Manufacturers too. Our blazing currency hasn’t helped them sell anything overseas.

But while our dollar takes a rest, both of these types of companies could turn out to be short term trades.

Three Surprisingly Good Bottom Lines

As for Earnings results…the market got a bunch of good ones yesterday. But it was the most surprising, wacky collection of winners you’ve ever seen. Imagine Willy Wonka and a handful of Oompa-Loompa’s taking out the men’s 4×400m relay gold medal. Now you’re getting close.

The oddities began with this: online ticket portal Webjet (ASX:WEB) increased its profits by 134% last year. Airline prices are soaring. Yet this company managed to profit from that somehow. Its share price added 11%.

The only thing more Australian than a backyard clothesline is a football player being remanded in police custody. Hills Industries (ASX:HIL), the firm responsible for the Hills Hoist clothesline, somehow pulled off a 16th straight profit record.

That’s not bad. Especially when you consider how it must be hurting from steel prices.

And sleep specialist Resmed (ASX:RMD) added 66% to its net profit. Actually, that’s not surprising at all. This market’s enough to give anyone insomnia.

And as for the latest on Energy.

The market is up 132. Financials rocketing – up 4.2% after the strong lead from the US. The main theme has changed in the last 24 hours from inflation fears and pressure on interest rates to lower inflation and interest rate cuts. It is a very important change in market thinking and at the risk of crying “Wolf” is a significant foundation for a market rally from here….whereas other rallies have been little more than a thrashing herd changing direction. 

RBA set to cut rates in September with a 68% chance of a 50bp point cut factored into Futures markets. Property flying – up 3.8%. Building stocks strong.  SFE Futures were up 88 this morning. Resources also up 2.0% but getting left behind.

Dow up 331. Up 332 at best. Gradually rose all session and closed on high. Dow up the most in four months. All 10 sectors up. 7 sectors up more than 2%. 91% of S&P500 components up. FOMC leave the Fed funds rate unchanged at 2.00%.Key point: Oil fell to a 3-month low and resources fell - the talk on CNBC this morning is that the Fed expect commodity prices to fall allowing them to ease up on the prospect of interest rate rises. Some signs of growth - July’s ISM non-manufacturing index up more than expected. Crude down another 2.4%helped oil-sensitive stocks. Consumer discretionary sector up 4.4% (steepest advance in 5-years), Retailers up 5.3%, Airlines up 9.4% and Transportation up 4.9%. Commodities CRB Index lost 10% in July – steepest decline in 29-years as oil, copper and wheat prices plummeted. Energy underperformed on falling oil prices – only up 1.1%. Financials up a whopping 5.1% - helped by a rise in European banks after Paris’s Societe Generale posted better-than-expected earnings. AIG led the jump – up 12% on an upgrade to BUY at UBS. Mortgage related stocks jumped – MBIA up 8.79%, AMBAC 12.89%, the 2F’s (Fannie and Freddie) up 14.96% and 6.91%.

• Both BHP and RIO down in ADR form overnight, 2.09% and 2.42% respectively. BHP up 93c to 3675c. RIO up 311c to 11390c.
• Metals mixed overnight – Copper up 0.44% and Aluminium up 0.64%. Zinc down 1.31% and Nickel down 2.31%. Oz Minerals up 6.1% or 10c to 173c.
• Oil price down $2.74 to $118.71 on belief that a slower US economy will reduce demand. WPL up 69c to 5189c.
• Gold down $21.70 to $881.80. NCM down 71c to 2560c.
• Bonds down with the 10 year yield up to 4.02% from 3.97%.

Gold stocks getting belted again today - as a hedge against inflation Gold will struggle with the lower inflation theme.

Stocks that struggle with a higher A$ doing well today on hopes that interest rates and the A%$ have peaked. Talk of the A$ going under 90c.
 

Australian Housing Finance slumps 3.7% in June- more than the 2.0% expected – investor housing finance also down 0.3%. Weak numbers will support the RBA’s bias towards cutting rates.

Most Oil stocks up despite an overnight fall in the oil price.

Asciano (AIO) up 6c to 501c on results and comments that they have had approaches for their assets. The company rejected a private equity bid on Monday at 440c.

News Corp’s (NWS) up 4Q results see a 27% jump in net income. Said their pace of growth will ease and that more challenging economic conditions are ahead. Well received in the Us and here and benefiting from the fall in the A$. NWS up 3.84% or 62c to 1672c.

Corporate Express (CXP) half year results not flash and contains net profit guidance of $61.7m-$66.1m. CXP negotiating with possible acquisition targets. Weres think result disappointing and they are reviewing forecasts. CXP flat at 560c.

ResMed (RMD) announced 4Q net profit grew by 7% and FY08 earnings up 66%. CEO says well positioned to deliver strong growth in FY09. RMD up 13.65% or 55c to 458.

NAB announced the first phase of its Next Generation Platform initiative to replace core banking systems over the next 5-years. Up 90c to 2565c.

Beach Petroleum (BPT) announced substantial coal seam gas reserves upgrade – 282% jump in probable reserves at Surat Basin. BPT up 4c or 3.85% to 108c.

Newcrest Mining (NCM) says partial gas from Varanus island now flowing to Telfer mine – 50% of gas to Telfer under contract with Apache will now be possible. NCM down 2.7% or 71c to 2560c.

Tower Australia (TWR) said St George Bank’s switch to AIG Life as favoured new life insurance partner will impact around $60m on TWR’s $700m in-force book. No impact on FY08 with slight profit impact in FY09. TWR up 4.62% or 7.5c to 170c.

Tabcorp (TAH) tipped by Weres to spend $400m in capex for its Star City casino. TAH expected to write down the value of its Victorian gambling license in FY results tomorrow. Analysts consensus for net profit before one-offs is $515m, up 14% on last year. TAH up 21c to 877c.

PanAust (PNA) confirms high-grade Copper-Gold at Puthep, Thailand – project study at feasibility stage and to be completed 1H09. PNA up 1.5c to 70.5c.

Seven’s (SEV) FY year results yesterday sees brokers holding or cutting target prices this morning – acquisitions seen as the key to unlocking value - buyback to support share price. SEV up 11c to 850c.

PaperlinX (PPX) being tipped by JP Morgan to report FY08 net profit of $50m, 32% down on FY07 on August 21^st. PPX up 12.44% or 25c to 226c.

WA News (WAN) tipped by JP Morgan to post FY profit of $126m later today. WAN up 2.57% or 23c to 919c.

The loss on the Australian dollar extended on Friday night as it tumbled below 93 US cents in offshore trading after the market concluded that interest rates here will fall in coming months. The gloomy news on the economy has all but guaranteed that the next move in rates will be down: not at tomorrow’s Reserve Bank board meeting (although there is a slight chance of that happening) but at RBA board meetings next month or in October. The Aussie dollar fell from 95.84 in Sydney last Friday week to 92.92 in New York early Saturday. That’s a fall of around 3% on the week, which is a substantial move, given the tight range it has traded in over the past couple of months. The close is the lowest in more than two months and means the currency has fallen by more than 5% in just over a fortnight after peaking at over 98 US cents. The prospect of lower interest rates drags down the yield for investors, an attraction of the currency and Australian stock, property and other assets, especially since the RBA started boosting rates last August in the final round of rate increases. Helping to send the dollar lower has been the fall in commodities, which dropped 28% last month according to most indexes. Oil is down 18% in the last three weeks, but perked up on Friday on signs of renewed tensions between Iran and the rest of the world over its nuclear program. Iran said on Saturday it would not back down in its nuclear row with major western countries powers, voicing defiance on the day of an informal deadline set by the West over Tehran’s disputed atomic ambitions. Western officials gave Tehran two weeks from July 19 to respond to their offer to hold off from imposing more UN sanctions on Iran if it froze any expansion of its nuclear work. That would suggest a deadline of Saturday but Iran dismissed the idea of having two weeks to reply. The result will be a more volatile oil price this week, which could retrace much of the ground lost in the past three weeks. Perhaps Iran has a major oil sale to conclude and wants a higher price. Oil prices jumped higher Friday after the Bush Administration set the weekend as a deadline for Iran, a major oil producer, to reply to an international offer of incentives for a freeze in its nuclear drive. In reaction, New York crude for September delivery, rose as high as $US128.60 a barrel, before retreating to close at $US125.10, a gain of $US1.02 from Thursday’s finish. In London, Brent North Sea crude for September delivery went as high as $US127.94 on Friday. It subsequently settled up 20 cents at $US124.18. The AMP’s Dr Shane Oliver says the rapid downturn in the Australian economy is making it harder to see parity for the Australian dollar with the US currency, being reached in the short term. “In fact with the market now pricing in rate cuts the ride for the $A could be pretty rough over the next six months with a fall back to around $US0.85 a distinct possibility. “The long term trend in the $A is likely to remain up though in response to the long term rising trend in commodity prices but for now it is starting to look like parity has been postponed.” But any rise in tension in the middle east could see investors flock back to oil and other commodities, sending the Aussie dollar higher. The AMP’s Dr Shane Oliver says the next few months are likely to remain rough for shares. Shares have the potential to rally further in the short term as extremely negative investor sentiment is unwound. “However, it is too early to say that the bottom in shares has been seen. The still high oil price, slowing growth virtually everywhere, profit downgrades, inflation worries and the continuing credit crunch are all big short-term headwinds for shares and are likely to ensure a rough ride with possible further falls out to the normally weak September/October period. “Notwithstanding all the short term uncertainties, we still see shares rallying sharply later this year as the oil price falls further, more central banks including the RBA start moving to cut interest rates helping to improve confidence regarding the economic outlook and as investors start to take advantage of attractive share valuations.  For those prepared to take a long term view current share market levels offer great long term opportunities, but of course there could be further weakness in the short term. “Key signposts to look for to confirm that shares are on track for a sustainable rally are: a sharp and sustained fall in the oil price, reduced inflation worries, lower bond yields, more relaxed central banks, slowing US house price falls and a sustained improvement in credit markets.  Of these the oil price has started to move in the right direction, but needs to fall further, and the other signposts are yet to fall into place.

 

US shares slipped Friday, completing a volatile week, as investors chewed over a seventh straight month of job losses, a huge $US15 billion -plus loss General Motors and slumping the worst monthly sales figures for US cars for 16 years.

The three major indexes fell on Friday on Wall Street and ended the week with losses.

The Dow Jones industrial average was down by almost 0.5%, the Standard & Poor’s 500 Index was down 0.6% and Nasdaq composite index slid 0.6%.

For all of the market gyrations last week, all three indexes finished the week almost exactly where they started the week. 

The Dow lost 0.4%, the S&P 500 finished 0.2% higher, and Nasdaq ended less than a point higher from where it started the week.

 

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The Australian stock market is expected to open lower on Monday after a fall on Wall Street, but some companies will receive a boost from speculation of a rate cut by the Reserve Bank of Australia (RBA). 

The futures market was forecasting a 38 point fall for the ASX 200 after trading finished overnight Friday.

The market fell Friday around 1.5%, thanks to worries about financial shares after the Suncorp Metway earnings downgrade and further concerns about the economy.

The ASX200 fell 73.4 points, or 1.47% to 4904, while the All Ordinaries shed 74.6 points, or 1.48% to 4978.

And Premier Investments is within sight (so it says) of snatching control of Just Group, the clothing retailer. Premier says its $780 million is now backed by 46.3% of Just shareholders through arrangements or the share acceptance facility..

The offer of 0.25 Premier shares and $2.095 cash values Just at $3.88 a share, based on Friday’s closing prices. 

The extra cash and dividend promised by Premier would increase the price to $4.06. Just shares fell 7 cents on Friday to $3.25, Premier shares rose 8 cents to $7.14.

Premier last week said it may raise the cash part of its offer by 15 cents to $2.245 a share if it receives acceptances for 90% by Wednesday, August 6. Shareholders may also get a dividend worth 4.5 cents for each Just share.

Mirvac and AMP Capital, Australian-based asset managers, have stopped redemptions from some of their property funds as investors dump property assets amid the global credit crisis.

Mrivac froze three mortgage funds holding more than $243 million, according to a statement from the joint venture Mirvac AQUA’s. AMP Capital, the investment management arm of Australia’s biggest life insurer, halted withdrawals from $NZ420 million in a New Zealand property fund, two days after Suncorp-Metway Ltd. suspended a $NZ249 million fund.

And in good news, Apache Corp, the US energy group, says it now expects gas from its Varanus Island (off the WA northwestern coast) plant to be available this week in limited quantities. The plant was shut after an explosion on June 3.

The company says partial sales will begin in the “next few days” with initial production expected to be 110 million cubic feet of gas a day. That should double later in August, with full output of 330 million cubic feet by year-end.

The June 3 blast damaged pipelines at the plant and cut 30% of Western Australia’s gas supplies. The disruption left mining companies and small businesses scrambling to secure fuel in the state. 

The state’s Chamber of Commerce and Industry claimed the accident could cost the economy $6.7 billion. The news will be welcomed by Santos which has a joint venture with Apache in one of the producing fields serviced by the facility.

 

 

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And, amid weak markets in Europe, Asia and the America’s on Friday, none were as damaged as Ireland’s market where the main index, the ISEQ Index dropped the most in over 10 years after a leading drug company’s shares plunged 46% on news of problems with a new drug.

Elan Corp, Ireland’s biggest drugmaker, confirmed of two new cases of a deadly brain infection in patients taking its Tysabri drug for multiple sclerosis.

The Index plunged 6.5%, or 281.92 points, to 4,089.7, on the news, the biggest drop since October 1997.

The index had earlier fallen as much as 9.5%, under the 4,000 mark for the first time in five years, on the news.

Bloomberg reckons the ISEQ, is the third worst performing index in Europe after Ukraine and Bulgaria.

That’s a bit of a joke: they are highly speculative emerging markets. Ireland is a much more developed economy and the loss is terrible for a market heading for its second loss in a row.

That’s after a decade or more of boom-like conditions that caused the country to be called The Celtic Tiger. Now it’s more like The Celtic basket case.

Ireland’s economy is facing recession and the weakest performance in almost a quarter century.

Elan accounts for around 7% of the Index’s weighting, so the loss on Friday was terrible.

The two cases, from the European Union, were the first since the drug was reintroduced in the US in 2006.

Bloomberg said on Friday that the cases of the disease, progressive multifocal leukoencephalopathy, were confirmed this week, Elan’s partner Biogen Idec Inc. said.

Earlier last week Elan shares slumped after its experimental treatment for Alzheimer’s disease, bapineuzumab, was linked in a study to a brain-swelling side effect. The stock collapsed last week, losing 65% overall.

 

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And the latest commodity price index from the Reserve Bank shows that in July the Index rose by 3.0% (on a monthly average basis) in SDR terms, following an increase of 3.1% per cent (revised) in June.

The RBA said the largest contributors to the rise in July were increases in the prices of coking coal, thermal coal, gold and beef.

The prices of wheat and nickel fell.

In Australian dollar terms, the Index rose by 2.8% last month, following an increase of 2.4% (revised) in June. (And if the 5% fall in the value of the Aussie dollar is maintained for August, there will be another nice rise this month for the index.)

The RBA said that inclusion of ABS export price estimates in the Index for coking coal, thermal coal and iron ore has resulted in an upward revision to the level of the Index in April and May, and a downward revision to June.

Preliminary estimates for these commodities have been incorporated into the Index for July.

While the increase in iron ore contract prices is now incorporated in the Index, contract price increases for coking coal and thermal coal are still flowing through to export prices.

So there will be more revisions and rises this month, and a bit more if the Aussie dollar remains around 92-93 US cents.

 

 

Attention for investors here will be on the market financials like the banks, June 30 companies reporting and the Reserve Bank board meeting tomorrow, but we should also not take our eye off the US Federal Reserve’s interest rate decision early Wednesday morning, our time. There are also corporate reports in the US, Europe and Britain that could influence markets, while some important statistics will also be released and could influence markets, especially our jobs numbers for July on Thursday. All in all it will be another week of volatility for investors to contend with.It was a year ago this Tuesday that the RBA lifted interest rates to 6.50%; that was the start of four increases that the credit crunch later turned into at least six, or 1.50% or more on mortgage and other rates. Here we have the Reserve Bank board meeting tomorrow: no change is expected. The Fed tomorrow night, our time and the Bank of England and the European Central Bank on Thursday night, our time. After the flood of poor economic news in Australia last week, there’s a small chance of a cut here, but not much. What will be interesting is whether there’s a change in its post meeting statement to signal that an easing is in the offing. The money market has already priced in a 20% chance of an RBA cash rate cut on Tuesday and a 90% probability of a move by October, with two cuts by next February. Australian statistics due for release include the June quarter and 2007-08 financial year house price index, and job ads today, housing finance and employment and unemployment figures for July on Thursday. Unemployment could show a small rise to partly reverse the surprise jump in the number of new jobs in June. The June full year and half year profit reporting season will also start to kick off with stocks such as AXA, Seven network, News Corp and West Australian News due to report. The AMP’s Dr Shane Oliver says his group expects overall profit growth for 2007-08 to come in pretty weak at around +3%, down from +15% in the previous financial year. “The economic back drop to this reporting season is the toughest since 2000-01 as growth has slowed sharply and costs have picked up. All sectors, including resources which have been hit by rising costs, are likely to report soft results for 2007-08. “However, while the results are unlikely to be the disaster the market is currently priced for after its 30% slump from last year’s high, the focus over the next few weeks of the reporting season is likely to be on the outlook statements released by companies and these are likely to be disappointing. “While market expectations for 60% growth from resources in 2008-09 are reasonable given the latest surge in coal and iron ore prices, consensus expectations for 5 to 10% growth in the rest of the market are likely way too strong and will be revised down.” he wrote. After Friday’s shock earnings downgrade from insurer and bank, Suncorp Metway, anything is possible. Important results this week will include transport and infrastructure operator, Asciano. It’s been a constant mention as a possible victim of the credit crunch and had to abandon a stalking takeover attempt of Brambles at a big loss. Its shares have risen recently, so perhaps the company might be out of trouble. Its price has bounced from less than $3 a share to $4.15 close on Friday. The shares rose 71 cents alone last week! Media groups, News Corp, Seven Network and West Australian Newspapers all release final profit this week. Seven is stalking WAN and recently lifted its stake to over 22% in a major creep up the register. News Corp’s newspaper operations in the US and Britain will take a hit and some analysts believe its US Pay TV, film and TV business may also be hurt by indifferent performance and falling consumer spending in the recessed US economy. Tabcorp is another group of interest to report since the Victorian Government snatched its gaming licence post 2012 away from it. The company’s shares have been weak ever since and there has been talk of some corporate activity. In the US the focus will be on the Federal Reserve which is expected to leave interest rates on hold and highlight the offsetting upside risks to inflation and downside risks to growth.

 

The Fed last week added extra liquidity moves to help a still “fragile” financial system which will push its help out into January 2009.

Friday saw the 8th US bank to be seized and closed by regulators this year: it was only a tiddler with just over $US250 million in assets and based in Florida. 

But the news of the failure, coming on a Friday after trading ended, will worry investors again: it’s the third Friday in a row that a bank failure has been announced.

The key US regulator, the FDIC, warned four other small US banks Friday to either get new capital, stop lending in some areas, or to stop issuing credit cards. This can be a precursor to later problems as managements struggle to find new capital or income streams.

We will also get US data for pending home sales, personal spending and the Fed’s preferred measure of core inflation will also be released, while in London The Bank of England also meets to consider interest rates, as will the ECB.

Both central banks will most probably leave rates steady, although the Bank of England is under enormous pressure to ‘do something” to ease the economic pain and the slide towards recession.

Like here, the US and other major economies, rising inflation seems to be the least concern in Britain for most people these days, even with high petrol prices still cutting demand at retailers.

US corporates reporting this week and likely to influence the market are tech bellwether Cisco Systems, consumer products giant, Procter & Gamble and troubled insurer American International Group. All are due to report on Tuesday, US time.

US analysts say that even if the earnings reports are solid and bring some relief, US investors will be on edge as concerns about the impact of the credit crisis on the economy persist. 

That’s especially so after Friday’s report on Friday showed US unemployment rose to 5.7% in July, its highest rate in four years, as employers cut 51,000 non-farm payroll jobs.

That’s why the spotlight will fall on the Fed’s statement that will accompany its rate decision on interest rates early Wednesday morning, our time.

The poor jobs report, along with lower-than-expected second-quarter US economic growth figures, have helped cement views that the Fed will keep benchmark lending rates steady at 2% for several months.