The Sorrow Of Australia (*)

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

By Rudi Filapek-Vandyck, Editor FNArena

A few snippets from the week past:

– When measured in renminbi, China's Q1 GDP growth was actually negative, quarter-on-quarter, a fact not seen since early 2009 (!)

– Gold has violently corrected before in years past and on each occasion it was the result of contracting liquidity the world around

– Europe represents 8% of the global population, 25% of global GDP, but 50% of global social security

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Australia truly is The Lucky Country. Whereas fellow commodities powerhouse Canada remains closely linked to the world's juggernaut-in-trouble, the US, and Russia is being absorbed by corruption and megalomania, and with South-Africa located at the most Southern tip of what still remains the poorest continent, Australia's window looks out on the global growth engine for the next multiple decades, China, and in a wider sense India and the rest of Asia.

Unfortunately for Australia, being lucky has nothing to do with intelligence. A fact again highlighted this week by think tank The Grattan Institute which now predicts all governments in Australia, state and federal, are at risk of posting huge budget deficits in the decade ahead. According to Grattan, combined state and federal budgets are at risk of ballooning out to a combined deficit of at least $60 billion a year by 2023; equal to 4% of the country's GDP.

Certainly, if I were still living in Belgium this news would have raised both my eyebrows. How to explain this in the context of a never ever seen explosion in demand, production and prices for natural resources, of which Australia has plenty? Sorry, but for someone who doesn't live in Australia the Grattan assessment is simply inexplicable. While this news will make for a few good jokes around the bars and cafes spread around the world, the sad side of this story is that those predictions are more than likely correct.

I am probably not the only one who believes Australia risks having little to show in a few years time for the fact that it was at the centre of potentially the most powerful upswing in natural resources the world has ever seen.

Of course, it is hard to deny today's wealth and comfort inside the Australian society is at least partially the result of the boom in commodities demand and prices, but again, it all seems more related to "luck" than it is to policy or design. Growth concerns are rising over what lies ahead from the second half of 2014 onwards, while governments at all levels appear unable to match revenues and spending, all at a time when Australia is still lacking infrastructure, its hospitals are in many respects more third world than developed world and the country's education appears deficient when compared internationally.

Welcome to The Land of Oz, mate, where She'll be right rules in between all four coastlines!

Making matters worse, the experience of living through the Great Commodities Super Cycle hasn't exactly been different for investors in the Australian share market. Australians are proud that one of "their" companies is now the world's mightiest, the world's biggest and the world's best when it comes to industrial commodities. The problem is, once again, BHP Billiton ((BHP)) has not been a good investment in the years past. On my observations, both commentators and investors have difficulties in acknowledging this. Even so, this is not an opinion or a personal view, it is a fact.

Even journalists cannot get their head around this. The Australian Financial Review reported over the weekend that shares in Fortescue Metals have now fallen to levels not witnessed since 2009, while BHP shares are at their lowest point in nine months. Well, that settles it then. Except for the fact that BHP shares are also at levels from 2009. If one wants to be really anal about this, BHP shares haven't generated anything in terms of investment return since 2006. That's seven long years, and counting. In between we saw some wild rallies with BHP shares touching or approaching the $50 mark three times.

It never lasted and, more importantly, the shares have kept on returning to the low $30s which is why there has been no net return outside the twice yearly dividends over the past seven years. Unless, of course, one had actively traded the stock: buying when rallies started and selling when the tide turned. Which is exactly what I have been advocating since mid-2008. Resources stocks have been much better for traders than they have been for investors over the past four years.

Post the Lehman crisis, it has been my view that resources stocks are turning into a more questionable investment vehicle. Firstly, because economic growth is wobbly, uneven and more vulnerable to just about anything. Secondly, because China is either a disaster waiting to implode, or it will noticeably slow down, or both (only the future will tell). Thirdly, because supply will catch up, as history shows it always does, eventually. Fourthly, costs were rising faster than product prices. The latter went unnoticed when times were good, but the effects would reveal themselves at some point. And they have.

It has also been my prognosis that economic cycles will be shorter and sharper in the post-Lehman era and that's not a comfortable environment for highly cyclical, highly capital intensive, highly leveraged companies such as BHP Billiton.

I know this is a one-sided, one-dimensional angle on things, but think about all those billions that have gone into shares of Rio Tinto ((RIO)), Fortescue, Newcrest Mining ((NCM)), Woodside Petroleum ((WPL)), Santos ((STO)) and others, simply because they were an important member of the ASX200 index. Compulsory superannuation means just about every Australian's super starts and ends with resources stocks.

Has it really all been but a blessing or is it more like a curse? Like the Russians never seem to be able to get their economic act together because crude oil and gas are so important for government finances, not to mention Venezuela, or Saudi-Arabia?

The good news, for investors, is that resources stocks' relative underperformance has now fallen to such extreme level that a catch up inevitably should be on the cards. This is also the view of quant analysts at Macquarie who on Monday released a report that showed the relative gap between industrials and resources stocks in the Australian share market has never been as wide as it is today, except in 1986.
 

It is no coincidence that at the same time the relative outperformance of lower risk equities has surged beyond one standard deviation from historical ranges. During this rally from mid-2012 onwards, I have repeatedly questioned how much risk appetite there really is, out there. Forced buying of dividend stocks by investors who are otherwise unable to support their lifestyle in Australia is not exactly text book evidence for increasing risk appetite. The recent sell-off in gold and in resources stocks in general suggests, at the very least, that many a market expert has been too eager to announce a new bull market for equities.

Another fact to consider is that resources equities are best purchased when prices are low. Commodity specialists at Standard Bank, having tarnished their market-timing reputation on multiple occasions, published exactly that acknowledgment in one of their sector reports and it remains a truth universally seldom acknowledged by investors and experts alike. Note that I haven't used the term "cheap" as valuations are extremely rubbery and flexible in the world of commodities, but "low prices" tells the story for what it is.

Finally, nobody tends to invest in commodity stocks for dividends and there's a very good reason for this: earnings tend to fly high and sink low, attaching high risk to future payouts. An exception can be made for a company like BHP Billiton, which has proven quite a reliable payer of growing dividends to shareholders. As such, history shows the shares tend to find natural support around the 4% forward looking implied dividend level. During last week's sell-off the implied dividend yield rose as high as 3.9%, after which a bounce followed.

(Paying subscribers can look up this info at all times via Stock Analysis on the FNArena website).

The good news from the dividend-support angle is that BHP Billiton should enjoy many more years of abundant cash flows as the company remains a low cost producer of iron ore and copper and prices for both are likely to remain well above the company's production cost levels. This means shareholders should continue to enjoy higher dividends in the years ahead. This means the 4% yield support price level for the shares will steadily rise too.

(This story was originally written on Monday, 22 April 2013. It was published on that same day in the form of an email to paying subscribers).

^(*) Belgian writer Hugo Claus, who for many years had been a serious candidate to win the Nobel Prize for Literature, published his piece de resistance, The Sorrow of Belgium, in 1983. As a growing up teenager with creative ambitions at the time, the novel left an ever lasting impact on me. It tells the story about a divided Belgium where a substantial part of the population collaborates with the German Nazis before, during and after WW II. It is this legacy that remains a soul wrenching dilemma deep inside the soul of this idiosyncratic country. I don't think it's too far fetched to draw a parallel with Australia's relationship with natural resources, even though not everyone will agree.

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website)

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Rudi On Tour in 2013

– I will present and contribute during the 2013 National Conference of the Australian Technical Analysts Association (ATAA) at the Novotel in Sydney's Brighton Beach, June 21-23

– I will present to members of AIA NSW North Shore at the Chatswood Club on Wednesday 11 September, 7.30-9pm

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