Rudi On Thursday

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Why would you want to own Australian banks? Banking analysts at Credit Suisse didn’t explicitly ask the question in their sector update this week, but their message was nevertheless loud and clear: why would you want to own shares in Australian banks?

Credit Suisse’s report, published on Wednesday morning, summarises in essence all the elements that have been repeatedly brought to investors’ attention over the past quarters via FNArena news stories, features and our own analyses: the golden era is over, tougher times lay ahead. In the analysts’ own words this becomes:

“We see banks entering a multi-year period of ‘mid-single digit’ EPS growth, with further downside risks from foreign currency translation risk (20% of earnings), wealth management exposure (12% of earnings), and asset quality uncertainties.” (By the way, what Credit Suisse describes as “mid-single digit EPS growth” for the next years (multiple) is regarded a best case scenario).

What caused the analysts to further lower their projections for the years ahead this week is the fact that recent economic data have indicated the demand for credit in Australia, both from businesses as well as from consumers, is slowing down. Credit Suisse does not believe renewed take-over speculation will prevent the sector from underperforming in the year ahead. Yes, the banks seem inexpensively priced, but there’s simply a lack of positive catalysts, the analysts surmise, especialy when one considers the risks that are still attached to the sector, and the rather benign growth outlook.

Credit Suisse analysts have now downgraded the sector to Underweight (which means that if you are running a portfolio representative of the Australian share market you should reduce the relative weight for the banks below their actual weight in the market; for all others this translates as “do not go near”). The analysts note this week’s sector downgrade brings them in line with the stockbroker’s Australian market strategists who believe there’s more credit crunch misery to come in the second half of this year, along with commodities driven inflation.

No doubt, many an investor didn’t need reminding that the Australian share market’s balance has shifted towards a leadership role for energy and resources companies. One only needs to look at the index of energy stocks in Australia since March to see where most (if not all) of the share market action has been situated lately.

Nevertheless, as I tried to point out in my Weekly Analysis this week (available as a news story on the website tomorrow morning for those subscribers who have missed the email), it would appear the easy gains have been made in that end of the market as well. Certainly, a few developments this week seem to point into this direction.

First of all, Fed governor Ben Bernanke has come out in unequivocally strong support of the US dollar. Though this may seem like simply another attempt by US policymakers to try to stop the inevitable (which is a weaker greenback), this time could be different.

For starters, it is not tradition for Fed governors to come out and make statements about the US dollar. Strictly taken, the greenback is outside Fed territory, which is interest rates and their relationship to economic growth, jobs creation and inflation. So maybe this extraordinary move could mark an important signal to the markets. Is the world fed up with carrying the burden of a continuously weakening US dollar, including authorities in the US?

I have already seen the first comments by marketwatchers who believe Bernanke’s move was directly aimed at investors and speculators in commodity and energy markets. Remember that financial authorities have already started to look into who could be responsible/blamed for the extraordinary rise in oil prices. Personally, and I think I have made this very clear over the past few weeks, I am convinced the rapid surge from US$90 per barrel to US$135 per barrel we have seen recently has more to do with investors jumping on the same train than with Peak Oil or any other fundamental changes in the oil market. Fact remains, however, those who are paying record prices at the bowser don’t really care who’s to blame, they still have to pay record prices for petrol.

In what seemed like an echo of my Rudi On Thursday story from last week, analysts at Citi have tried to come up with a comprehensive analysis this week about the impact of high oil prices on Australian companies. Their conclusion was that with the notable exception of energy producers and some resources companies (specifically precious metals producers as their product tends to have a positive correlation with oil prices), nearly every other company in the market will ultimately experience a negative backlash.

There are other developments that should equally demand investors interest. Two of the major stockbrokerages in Australia updated their thoughts and views on resources this week, and both updates are remarkable in their own right. Let’s start with GSJB Were, partly owned by Goldman Sachs (from US$200 crude oil fame) and one of the firm supporters behind the concept of a Commodities Super Cycle over the past years.

GSJBW resources specialists conducted what they call a “reality adjustment” for base metals this week. As a result of this, price forecasts for copper and aluminium were slightly lifted, as has usually been the case when securities analysts updated their price forecasts since 2003, but price forecasts for lead, nickel and zinc were cut, and significantly so. As such, this week’s update by GSJBW might mark a turning point in the cycle (forecast product prices do no longer automatically move up when being updated).

As a direct result of this, GSJBW has decided to downgrade all nickel stocks under its coverage to Sell. If you wonder why Independence Group ((IGO)) was one of the biggest losers on the Australian Stock Exchange today, you now know why.

It has to be said the broker continues to have a positive view on aluminium and copper, projecting further price rises for both this year and next. The outlook for the others is for significant price falls, specifically for nickel and for lead.

Sector specialists at Merrill Lynch put more effort in their update as they came up with a complete overhaul for the metals and mining sector, including stock recommendations, valuations, price targets and forecasts. No less than eight stocks under coverage saw their rating changed. I didn’t even bother to attempt counting all the other changes.

The three stocks upgraded to Buy by Merrill Lynch are Gloucester Coal ((GCL)), Oxiana ((OXR)) and Zinifex ((ZFX)). The analysts have taken the view that it is best to depart from the recent winners in the market, such as the coal producers (other than Gloucester), suggesting investors have already pushed up many share prices so high, there’s no more upside left for the next twelve months.

Similarly, Merrill Lynch has not selected one single oil producer, or gas producer, or coal seam methane company. Instead the broker advises to be selective regarding stocks in the energy universe, and to pick a stock like Paladin Energy ((PDN)) instead. Merrill Lynch just increased its price target for the uranium producer to $7.65, implying more than 30% upside potential from the current share price.

Of course, for that potential to materialise the negative trend for uranium prices will have to stop. So far, however, there has been hope, a lot of hope and anticipation, but no concrete proof of better times arriving. Industry consultant TradeTech lowered its long term price benchmark to US$85/lb in the past week. Fellow consultant Ux Consulting followed up by cutting the weekly spot price by US$1 to US$59/lb.

Wow, uranium priced below US$60 per pound! You’d have to go back to mid-2006 to experience that for the last time. Merrill Lynch only expects to see a modest recovery in spot uranium prices during the remainder of calendar 2008, to something in the order of US$75/lb.

Merrill Lynch likes iron ore, gold and steel, plus some selected energy stocks (in essence Gloucester and Paladin). The analysts previously had a preference for nickel among base metals, but that has now changed.

BMO Financial Group’s Global Portfolio Strategist, Don Coxe, who I extensivey introduced in my editorial from February 27, has a slightly different take on things. This week, he too advised BMO’s clientele to reduce exposure to base metals. Coxe advised them to increase exposure to energy and agricultural products instead.

Coxe’s latest insights make, as per usual, for an excellent read. Take the following paragraph for instance:

“It is too soon to predict that the double hits to consumers will trigger a stagflationary recession. However, there can be no doubt that optimistic economic forecasts will have to be scaled back. In the US alone, the one-third increase in crude oil prices means a drain from domestic consumers to oil producers abroad of roughly [US]$300 million per day. This is surely the greatest transfer of wealth without a war in the history of the world.”

Coxe also believes developed countries are much better equipped to deal with oil at US$124 per barrel than developing countries, including the so-called BRIC nations. India in particular is seen as vulnerable if the current high oil price environment persists.

For the US, however, expensive oil simply means total impact from the housing crisis will be much, much worse.

Till next week!

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by Greg, Chris, Sarah, Paula, Todd, Joyce, Grahame, George and Pat)

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