Tag Archives: Agriculture

article 3 months old

Rudi On Thursday

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)

article 3 months old

Regulation Looms

By Greg Peel

Ever since the first cave dwellers started lending each other spears and flint stones, some power-that-be has attempted to regulate the market. Regulation always comes as a response to some disaster or other, and is always way, way behind the curve. Often regulation is applied in a hysterical knee-jerk response and can be more destructive than protective. In other instances regulations are rightly applied to protect the innocent.

The last big bit of legislation to hit the Australian financial industry was broker disclosure laws - the ones that ensure you now receive a 200 page report every morning from your broker of which 190 pages are a legal waiver. These "Chinese Wall" amendments ensured clients could not be ripped off by stockbrokers touting a deal for the simple reason their own firm was underwriting it. They also meant brokers and advisors must reveal whether they indeed own shares in a company they are recommending. They came about in concert with US changes, and despite the extraordinary amount of paper work involved are valuable in protecting innocent parties.

While these laws plug a hole, often regulation is put in place after some new financial product has imploded and there is much wailing and gnashing of teeth. While everyone is making money and happy, regulators couldn't give a hoot. But as soon as the general public is hurt, the witch hunt begins. Pre-emptive regulation is considered to be against free-market principles, so new products are rarely scrutinised until great wealth has been lost. It doesn't matter that those new products were often created with the specific intention of exploiting loopholes.

As soon as free-market principles result in innocents getting hurt, the regulators start playing the blame game and with the government on their back, start to look important by enacting all sorts of after-the-fact laws. It matters little that a quick look into something like - I don't know, subprime mortgages? - might have resulted in earlier regulation, but then that might have interrupted lunch.

The problem with financial innovation is that by its nature new products will operate beyond existing regulation, and as soon as one door is closed innovators will set to work on opening another. To switch metaphors, regulators will stick their finger in one hole in the dike only to see another leak sprout beside it. Regulators cannot be clairvoyant, but they could try opening their eyes every now and again.

At least Australia's new government has an excuse - it's a new government. This morning treasurer Wayne Swan and corporate law minister Nick Sherry announced a "green paper" on new financial services industry regulation. Ostensibly a green paper is a draft which is open to scrutiny and invites industry representatives to contribute to its final form. The intention of this particular paper is for relevant existing state laws to be scrapped and a new national system established to regulate such services as mortgage broking, margin lending, non-bank lending, trustee funds, debentures, property "spruiking" and a whole range of credit card issues.

It's pretty hard to argue that this is not a sensible move, as long as the government asks for and receives advice from the right people. One only need look at the Opes Prime situation to decide that laws on margin lending, for example, are long overdue. The fact that margin lending has been around for decades, however, speaks little for previous governments of any stripe, or for existing regulatory bodies. The credit crisis has shown ASIC up as being about as effectual as the UN (ie, not) and the ongoing role of the ASX ((ASX)) as both a regulator and corporate entity as bordering on criminal.

If you want to change anything, the first should be to remove the ASX's powers to self-regulate in the very market from which it profits.

But there has not yet been more than cage-rattling on that front to date. Along with the government's financial services green paper however, came yesterday's indication by the treasurer that Australia's "four pillars" banking policy will continue to be upheld.

This policy simply prevents any of the Commonwealth Bank ((CBA)), National Bank ((NAB)), Westpac ((WBC)) or ANZ ((ANZ)) from inter-merging. It was a policy first put in place in the 80s when Keating deregulated the banking industry, and its original intention was to protect The Bush. It now seems to have evolved into a wider policy of maintaining competition in the banking industry lest Australians be screwed.

Testament to the policy is the fact Australians pay such extremely low bank fees. Almost miniscule. That's why you often hear praise for Aussie banks at barbeques and pubs.

The four pillars policy is not just an anachronism and an abject failure, it is quite simply hypocritical. Where's the Four Supermarkets policy? Where's the Four International Airlines policy?

As long as regulators keep a watchful eye - and yes, that's a stretch - Australian banks could quite happily inter-merge without any elevation of risk to the consumer. Take CBA for example. It spent years alienating its customer base by closing branches and reducing personal interface wherever possible. Customers responded by leaving in droves. It has since spent years trying to go back the other way in order to try and win customers back.

Then look at Australia's regional banks. Why do they exist? Because Australians had already made up their own minds that four big banks are just one big cartel anyway. If four big banks became three or two, you can bet your bottom dollar other financial institutions would spring up to service those disgruntled by a lack of competition. At least that's something the government allows.

It has been argued the four pillars policy has protected Australia from massive subprime losses. That's rubbish - no one stopped any bank from issuing mortgages of a subprime nature.

Anyway, it looks like we're stuck with it. The big banks are annoyed because as a quartet they are each too small to have sufficient critical mass to be competitive on a global scale. Together that could be different. But one could argue that together they could have been Citigroup, and sitting on a 60% reduction in share price right now. We will never know.

It was noticeable that Wayne Swan did not mention St George ((SGB)) yesterday, nor mention anything about "five pillars". UBS suggests we can probably take it as read that the government will not be opposing the Westpac-St George merger, as long as the ACCC doesn't.

UBS also suggest the ratification of four pillars instantly makes regional and smaller banks more valuable, as the big four can only look downwards for acquisitive growth in Australia, not sideways. It will be interesting to see what transpires when the first Chinese bank sticks its hand up to take over CBA. Without market cap size the Australian banks would have to rely on government intervention to prevent such a move.

But on to the US. Apart from disasters in financial markets this past year the other issue has been rising food and energy costs. The Americans have decided food and fuel prices are high because of greedy speculation by the few and something should be done about it. The fact that the US is the most obese nation on earth, and consumes more petrol per capita than any other nation by a wide margin, has nothing to do with it.

Regulation in the most speculative markets of all - futures markets - is conducted in part by the Commodities and Futures Trading Commission. It is no secret that the CFTC is currently sniffing around and looking at ways to curb rampant speculation in futures markets, in order to bring down food and fuel prices for average Americans. And the CFTC has recently appointed a new commissioner - a highly ranked official in the National Farmers Union. You can imagine just what farmers think of speculation in futures markets.

As analyst Dennis Gartman yesterday suggested, "Our guess is that Mr Chilton will look and look and look until he finds the smoking gun he wants to find, and when it is found it will be confiscated...to much fanfare!"

What this means is stand for some potentially significant changes to US futures trading regulations which will be intended to curb speculation and thus reduce prices. And be warned - if the CFTC goes overboard the effect could be some very meaningful falls in commodity prices in a very big hurry. As to what the CFTC plans to do about Chinese demand for food and oil has not been revealed.

The upcoming presidential election has also provided some interesting policy offerings, such as the latest one from the Democrats. They want to impose a 25% windfall profit tax on oil companies if oil companies do not plough sufficient money into researching and developing alternative energy sources. That's right - the oil companies are to be fined for selling too much oil to Americans. Here's an idea, how about GET A SMALLER CAR.

The other mob are no better, with McCain suggesting an excise holiday. That'll help. (Sound familiar too).

The bottom line of all of this is that once the regulators start moving in, markets can become very anxious and volatile, rightly or wrongly. Be warned.

article 3 months old

Questions Remain For AWB

By Chris Shaw

Having guided on earnings last month the AWB ((AWB)) first-half profit result of $48.6 million pre-abnormals was broadly in line with broker forecasts, though in the view of JP Morgan it disappointed in quality terms as the earnings mix was skewed towards the lower multiple trading businesses.

The other major issue in the broker's view, and the one that justifies its Underweight rating on the stock, is that the result didn't address the tough capital position the company finds itself in, as during the period its working capital increased by almost 80% to $1.16 billion.

This leads the broker to suggest management has only a couple of options, being to either raise equity, slow down the expansion of its international business to free up some equity or limit its participation in wheat exports. If either of the latter two choices were made JP Morgan sees substantial downside risk to its earnings forecasts longer-term, while the first option would also put downward pressure on the share price in its view.

Factoring in the result the broker has trimmed its forecasts modestly, such that it is now forecasting normalised earnings per share (EPS) of 24.9c this year and 26.7c in FY09, which compares to Macquarie at 26.4c this year and 21.8c in FY09 and Deutsche Bank at 25c for both years. Consensus forecasts according to the FNArena database are 25.2c this year and 24.7c in FY09.

While JP Morgan is the only broker in the FNArena database to rate the stock as Underweight, others to research the company continue to point out the difficulty in forecasting earnings for the company make it tough to generate an appropriate valuation and therefore a rating for the stock.

As an example ABN Amro has lifted its estimates for this year by 33% to 24.3c and in FY09 by 11% to 25.1c post the half-yearly result, while pointing out in its view earnings risk in FY08 remains to the upside if additional rain means a better than expected crop.

In its view the loss of the group's monopoly position with respect to the wheat desk in Australia, while a negative, is also an opportunity as it opens up new growth options such as entry into new markets the company would not have been able to pursue if it still had the monopoly. 

Deutsche Bank points out this diversification is already underway, as the latest result shows only 20% of group earnings now come from wheat pool related activities. The broker notes management is now more focused on driving new revenue streams, but legacy litigation will continue to impact on earnings for the next couple of periods and so make forecasting earnings accurately very difficult.

With that in mind the broker retains its Hold rating, FNArena's database showing three holds and JP Morgan's Underweight recommendation. The database shows an average price target of $3.08, compared to $3.01 prior to the result and a median target price according to Thomson One Analytics of $3.10.

While offering some exposure to the soft commodities sector JP Morgan makes the point among the Australian agricultural stocks ABB Grain ((ABB) remains its preferred exposure, while ABN Amro's summary is while the restructuring is showing some progress more work remains to be done.

Shares in AWB today are weaker in line with the broader market and as at 12.45pm the stock was down 18c or 5.3% at $3.21, which compares to a trading range of $2.02 to $4.38 over the past 12 months.
article 3 months old

The Overnight Report: It Must Be Friday

By Greg Peel

The Dow closed up 48 points or 0.4%. The S&P rose 0.3% and the Nasdaq fell 0.1%.

The Dow peaked earlier at +122 before Wall Street decided to go to lunch and not come back. Profit-taking after a positive but trying week killed off the early rally which was sparked by a largely positive jobs number. The Nasdaq became the odd man out when tech frenzy got a bit of a wake-up call. Sun Microsystems' poor result saw its shares fall 22%.

The April jobs figure showed a fall of only 20,000 jobs when a figure of 75,000 was the consensus. The unemployment rate, which many had presumed would rise again, fell from 5.1% to 5.0%. This was a positive influence and the mood was boosted by an increase of 1.4% in March factory orders when only 0.2% was expected.

The US dollar continued its recent buoyancy on the news, the euro falling again to US$1.5424. However, the positive economic data provided confusion for commodity prices, which shrugged off a rising dollar and squared back after some significant falls this week.

Gold rose US$3.70 to US$855.60/oz after having tested support at US$850 yesterday. The Aussie was little changed at US$0.9351.

Base metal prices were mostly stronger in London, led by copper and aluminium which both clawed back 2%. Metals are finding it difficult to speculatively reverse on the stronger greenback as warnings of supply weakness intensify. The positive US data also challenges any reasons to sell.

Wheat also found its way back 2.5%.

And it was back to normal programming for oil. The Turkish government must be long crude, as after oil finally looked like it might fall below US$110 again Turkey decided to fly a couple of bombing raids into Kurdish northern Iraq. Here we go again. Oil jumped US$3.80 to US$116.32/bbl, which would have also helped the decisions to profit-take late in the stock market.

The SPI Overnight rose 60 points, which was a very strong response after a big day on Friday and nothing dramatic from the Dow. Given the ASX 200 closed right on very significant resistance at 5700 on Friday, the futures are indicating a solid break of that level on Monday. The market has tried to climb the mountain to 5700 on many occasions in 2008 before succumbing to weak influences. If a break of the level is emphatically consolidated on Monday, then we could be set for some real strength. It would be unsurprising if the index decided it better do a bit of work there first however.

The ongoing internet war took another tedious step late on Friday as Microsoft supposedly upped its bid for Yahoo. The figure was not released, but is suspected to be US$35. The earlier offer was US$31. Whatever happens between Microsoft, Yahoo and observant protagonist Google will surely pique the interest of the antitrust watchdogs. This could go on for a while.

Investment guru Warren Buffet's Berkshire Hathaway announced  profit of US$904m in the first quarter; 64% below the US$2.6bn the firm achieved in the first quarter of 2007. Bummer.

Late News: Micrososft later withdrew its bid for Yahoo altogether. Yahoo told Micrososoft US$35bn was still pathetic and it wanted US$53bn.  Microsoft's response can't be printed.

article 3 months old

Expectations Rising In Oz Agribusiness Sector

By Chris Shaw

A worsening of trading conditions and poor profitability combined to produce a deterioration in conditions in Australia's agribusiness sector in the March quarter according to National Australia Bank's latest Quarterly Agribusiness Survey, but recent rain means confidence in the sector's outlook is showing some improvement.

The better rainfall of late means production expectations are being revised up and this is generating improved confidence levels in both commodities and suppliers, examples being wheat up 49 points to a +48 rating and beef increasing by 22 points to a +19 rating on the bank's index. Confidence among those in the cotton, sugar and dairy sectors also rose, showing the improved conditions are having a broad impact across the agribusiness sector.

This improvement in confidence levels is also flowing through into higher expectations in terms of profitability as the bank's agribusiness economist Frank Drum notes the outlook here among participants in the survey rose 6 points to +32 in the latest survey, though for a number of respondents higher interest and exchange rates continue to be areas of concern.

A lack of demand is also seen as hampering profits in the coming year by 36% of participants, while Drum notes 7% saw the drought as the most likely negative impact over the next 12 months, an improvement from the 18% who listed it their number one issue in the December survey.

Given concerns over the level of the currency the use of hedging continues to increase and with reasonably favourable results of late, the survey showing 41% of those using hedging are currently experiencing favourable results, up from 33% previously, against 25% in unfavourable positions.

From an individual industry perspective the food manufacturing and wholesaling sectors reported the largest declines in operating conditions, thanks in large part to increases in raw material and fuel costs that saw input prices rise faster than final product prices during the period. The survey showed only the retail sector recorded improved conditions among those exposed to the agribusiness sector.

The falls in sales margin reported as a result of higher input costs are unlikely to be reversed in coming months, Drum noting respondents in general expect relatively flat margins in the current quarter, though the rain-related improvement in conditions is expected to deliver some improvement in terms of profitability during the period even allowing for an expected fall in forward orders.

As with the rest of the Australian economy availability of labour remains an issue, Drum pointing out while employment growth continued during the March quarter more than half the participants in the survey see a lack of suitable labour as a constraint on output in coming months. This is not impacting on planned capital expenditure, Drum noting this has increased on the back of the general improvement in outlook thanks to the recent rains.




article 3 months old

The Overnight Report (Thursday): The Greenback Growls

By Greg Peel

The Dow closed up 85 points or 0.7% while the S&P added 0.6% and the Nasdaq 1%.

The market recovered from an early low of down 57 to rally to a peak of up 93 before settling back at the death. The earnings lead-in was poor and the earnings results in the session were mixed.

Retailers Amazon and Starbucks had set a sombre tone in terms of the consumer economy with dour guidance released after the bell on Wednesday. Apple's seemingly strong result failed to inspire as well. During the day further badly-accepted results came in for 3M (Dow component of Post-it Note fame) and Motorola. One interesting result was that of fast food chain Chipotle Mexican Grill which beat the Street handsomely and scored a 10% sales increase for the quarter. But the shares were slammed down 9% when the company suggested the second quarter would be a different story following soaring prices for corn, rice and beef.

On the positive side, a good result was posted by general insurer AIG (Dow) and a great result was posted by Ford. Surging sales into new markets offshore saved Ford from the dire local market and the shares shot up 12%, dragging General Motors (Dow) along with them.

The news on the economic front was also mixed. Much heart was taken from the weekly jobless claims number which fell 33,000 to 342,000 when consensus had a 3,000 rise pencilled in. But then March durable goods orders fell 0.3% for a third successive monthly drop.

The really bad news came from new home sales figures. March new home sales fell 8.5% to a seasonally adjusted 526,000 when economists had expected a number of 577,000. New home sales are now down 36% over 12 months and 62% from the July 2005 peak. Inventories of new homes completed fell for the twelfth consecutive month, which those looking for a silver lining took note of. However, this is hardly a surprise given the housing slump started two years ago. Reality is that the supply of new homes for sale increased to eleven months-worth, given demand has crashed for those new homes which are only "new" because they've never been sold, but one might say are getting "old" by the day. This is the highest level of supply since 1981.

These data were the catalyst for the Dow's initial weakness, but they were soon forgotten. More was made of falling jobless claims (a volatile weekly figure) and the fact that the durable goods orders result would have been an increase if one ignored transport. The housing numbers, well...we're all just so bored with those. Who cares if the housing situation is getting worse rather than better, forcing more foreclosures which will lead to more mortgage security write-downs and more lost earnings in the financial sector? Not Wall Street!

Wall Street is playing on the notion that the worst scenarios had already been priced into the financial sector at its nadir, and that the financial sector traditionally leads non-financials out of a slump. And so it was that suddenly the financial sector looked cheap on a greenback-flip.

For the last six months if there had been any notion the Fed would not cut rates then the market would have tanked big time. For the last few weeks all the talk has been of a US dollar that was sliding into oblivion on the back of unprecedented injections of liquidity from the Fed and a consensus that the Fed would cut to 1%. Well that all changed last night, apparently. Kicking off some dollar strength was a statement from ECB chairman Jean-Claude Trichet that a strong US dollar was necessary for a healthy global economy.

Trichet's statement seems to have finally put paid to any suggestion the ECB might actually raise its interest rate to fight burgeoning inflation, despite the central bank's previously hawkish tone. To top that off, a Wall Street Journal article published last night suggested the Fed would cut once more - by 25bps - and then that would be that (leaving the rate at 2%). The US dollar subsequently surged against the euro, dropping around two "big figures" to US$1.5688. The dollar was also strong against the other majors.

The US dollar rally was seen as a green light to buy financial stocks. Why? because if the Fed's not going to cut then things simply can't be that bad anymore. Wall Street subsequently piled into financials, pushing the sector index up 4%. The counter-trade was to sell commodities, and the materials sector. The Dow made its near 150 point turn-around on the rising dollar. If there had been talk the Fed wouldn't cut rates again back in February, it would have been the other way around.

Thus the theme of "the worst is over" gains traction. Just don't mention those housing numbers. Also helping the stock market to rally last night was, finally, a fall in the price of oil. Crude dropped US$2.24 to US$116.06/bbl. That oil fell on the same rally in the dollar that spurred on the stock market in the first place is not of consequence.

Goodbye gold. Down US$18.20 to US$886.60/oz.

The Aussie also copped it, falling close to a US cent to US$0.9399.

Base metals should thus, in theory, cop it too, but the real brunt was borne by recent record-breaker tin which saw some profit-taking, while aluminium broke and fell 3%. Lead was weak, but copper mostly hung in there given uncertainty surrounding the Chile situation and it, and friends zinc and nickel, were only slightly changed.

Despite the strength in the Dow the SPI Overnight lost 24 points. There is still another session tonight on Wall Street to influence the Australian market on Monday, but in the last couple of days the local market has traded independently, ignoring leads from the Dow. It's been all about the specific stories in the local material and financial sectors. Late on Thursday ANZ Bank ((ANZ)) caused a stir when it announced another 10 basis points rise in its standard variable home loan rate.

This announcement took many by surprise, given (a) it came a day after the bank released it's half-year result (why couldn't it have made the announcement then?), and (b) seemed to contradict the ANZ CEO's assertion that cost of funds had "stabilised". Bank analysts would not have been all that shocked however, given it has been recognised the banks had yet to make up for lost margins. While a rise in lending rates will go some way to easing the margin pressure, the flipside is less demand for loans and the potential to push wavering mortgage holders and businesses over the edge into delinquency.

The ANZ announcement ensured the local market closed weak on Thursday. What was totally ignored by the local market was a 9% single-day rise in the Shanghai market following the cutting of stamp duty on Chinese share transactions. While this was understandably ignored given (a) the stamp duty cut only benefits locals (the Hang Seng managed only a 1.5% rally), (b) the Shanghai index has already fallen 40% this year, and (c) it was a tax rally, not an economic rally, it is ironic to note that back in February 2007 it was a 9% single-day fall in the Shanghai index that proved the butterfly that started the subprime tornado.

The lead-in to Wall Street's session on Friday will be provided by results from tobacco giant Altria (good - up 1.2% in the aftermarket), plastic fantastic American Express (good - up 1.8%), and software monopolist Microsoft (bad - down 5%), all Dow components. (Actually no - Altria got the toss recently).

article 3 months old

The Overnight Report: Thin And Volatile, But Up

By Greg Peel

Those who understand the game of rugby union will appreciate that the US equity markets have moved from a 15-man test series to an interim round of Sevens. There's action all over the field but only a handful of players. The rest of the squad is currently sitting it out on the bench, waiting for a sign from the coach that it's time to go back to the real stuff.

The Dow closed up 54 points, or 0.4% last night having been down 30 early and up 122 at lunch. The S&P also rose 0.4%, while the more volatile Nasdaq posted a healthy reversal to jump 1.3%. Some M&A activity among tech stocks was the good news on Times Square.

The session opened with a round of very weak March same-store sales numbers from retailers. However, while the numbers themselves were worse than expected the market is no longer surprised. Thus it was a case of buy the fact, given (a) retailers have been trashed within an inch of their lives and (b) Wal-Mart actually increased its first quarter guidance following a 0.7% SSS rise. Wal-Mart is like Woolies and K-mart put together, and as such is the classic defensive non-cyclical retail play.

On the economic data front, the US trade deficit blew out another 5.7% in February. Usually such blow-outs are attributed to Middle East oil imports and cheap imports from China but this time it was different. This time the big moves were in food, industrial supplies, and capital and consumer goods. The Fed will no doubt be wary - the board's growing inflation fears are playing out. This reduces the likelihood of further massive cuts and brings forward the chance of hiking before too long.

Thus the US dollar rallied last night, spurred on by a 25 basis point cut in the Bank of England's cash rate to 5.00%. As expected, the ECB left its rate unchanged at 4%.

Welcome news came from the weekly jobless claims, which actually fell 53,000 to 357,000 following a big rise last week. The monthly average is an increase of 2,500 to 378,250. Economists consider a number over 400,000 to be recessionary, so despite the volatility of the weekly numbers the signs are supposedly that employment is hanging in there. Mind you, employment numbers are one factor that lags significantly.

This news helped to send the Dow running, and another boost was added when one analyst upgraded Intel to Buy. Chip-makers have been in the deep fryer of late, so this news was another fillip for the Nasdaq surge. There's also supposedly now a battle going on for Yahoo between a Time Warner-AOL team in the red corner and a Microsoft-News Corp ((NWS)) team in the blue. The market's not particularly enthused however - Yahoo shares are still trading under the level of the Microsoft bid already on the table.

One sector not to share in whatever spoils there were last night was our old friends financials. Ahead of next week's official results it was revealed Lehman Bros was forced back in February to liquidate three funds to the value of US$1bn and purchase another US$800,000 of distressed assets from other funds, all of which now sit on Lehman's books. Old news perhaps, but enough to ensure financials remain friendless at present.

After big jumps yesterday both oil and gold drifted off on a higher US dollar. Oil fell US76c to US$110.11/bbl while gold fell US$5.60 to US$928.90/oz.

Base metals prices saw a bit of profit taking after an early run that saw the official London closing price of copper hit US$8884/t - above the previous closing high of US$8820/t. However the stronger US dollar was enough to halt the break-out and copper fell later in the session and consolidated back at base camp - not quite yet ready for the final assault. All metals slipped a bit.

(Of course, the more we keep talking about this supposed copper break-out the less likely it is to happen, but let's not get cynical.)

The SPI Overnight fell an entire one point. Yesterday the ASX 200 wasted no time in breaching the 5500 support level, and having done so fell heartily. Apathy in the futures market overnight suggests a 50 point rise in the Dow will not provide any impetus to break back through today. The ceiling is 54 points above.

article 3 months old

The Overnight Report: Commodities Explode, Again

By Greg Peel

You'd think with all the accelerating talk of a US recession, of a recession that might be deeper and longer than previously expected, of a flow-on effect into Europe, Japan, and ultimately China, that global demand for oil would be falling.

Nup.

At least not according to the US government's weekly inventory figures for West Texas Intermediate - forever until probably now the benchmark for global crude demand. Everyone expected those inventories to rise on falling demand but instead they fell and the market was confounded. The balance was an effect from falling imports, suggesting global oil production is being directed elsewhere. As the US prepares for the summer driving season, talk is of US$4/gal gasoline.

Mind you, many commentators scoff at these weekly numbers, which often belie logic and can put yo-yos to shame. Nevertheless, last night's numbers were enough to send crude to a new record intra-day high of US$112.21 before settling at US$110.87/bbl, up US$2.37 from the previous close.

At the same time oil was hitting its highs, Wall Street was coming to terms with a pre-market announcement that United Parcel Service had reduced its first quarter profit expectations, and saw a gloomy outlook as the recession and higher oil prices take effect. Not a great day for oil to trade to a new record. UPS - America's biggest freight company - is considered an accurate barometer of domestic economic activity. 75% of UPS' income is derived within the US.

UPS shares only fell 3% on the news, but its gloomy outlook set retailers off and then the rising oil price set off transports and then retailers some more. As an example of the market's sentiment at present, Bed, Bath & Beyond, which one presumes hails from Manchester, beat the Street with its earnings after the bell but added downbeat second quarter guidance. Its shares were then trashed in the aftermarket.

The three indices told the tale last night. The Dow, which has a big weighting from oil giants Exxon and Chevron, fell 49 points or 0.4%. The S&P, representative of the broad market, fell 0.8%. The Nasdaq, loaded with tech stocks, fell 1.1%. It seems the attitude to tech has changed in 2008 compared to 2007. Whereas previously they were considered defensive (50% of income from outside the US), now they're considered a recession risk (50% of income from within the US).

There was more bad news in the financial sector, if that is at all possible. As the commercial and investment banks have been selling what they can to boost capital, the proportion on balance sheets of what they can't sell - the so-called "Level 3" assets such as CDOs - has risen. The implication is thus that there will be yet more write-downs. Everyone has been waiting for a "kitchen sink" ending to the write-downs, but in reality this is a myth. While the US housing market continues to slide asset values must also continue to slide, prompting "chaser" write-downs. To stop the write-downs, the housing market must plateau.

Investment bank shares were thus sold again last night. Lehman fell 7%. Citigroup, on the other hand, saw a rise as it announced the sale of $12bn worth of leveraged loans to an as yet unnamed party (possibly private equity). This is good news for Citi's balance sheet, but it also represents US$12bn of positions Citi will never recover any profit from. It is bailing out at the bottom. The expectation is growing that all banks will be forced to cut their dividends.

When you add that all up, a 49 point fall in the Dow is not too bad. Indeed the low point was 108 points down. But what we are seeing is a classic bear market drift following the "bear trap" rally on the first day of April. April Fool's day no less. (A big cheerio to everyone at Ruse Capital). Bad news is largely expected, and investors are priming for the cycle-leading rally which will take the market out of the depths of despair. But as recession talk intensifies, the bottom line is share prices = earnings forecasts, and those are looking gloomy.

It didn't help matters that the US dollar had a weak night last night. Traders bought into the euro in anticipation of no rate cut from the ECB tonight accompanied by more hawkish rhetoric. The dollar was sold against all major currencies however, with the UPS news not helping. The yen was thus bought, which means weakness for the Aussie. It slipped a third of a cent to US$0.9280 in the latest round of the custody battle.

Gold followed the lead of a weaker US dollar and stronger oil price to add $19.20 to US$934.50/oz, spurred on by the overnight release of the annual GFMS report which called gold at US$1,100/oz this year. (More on that today).

But arguably the most anticipated market at present is base metals. On a falling dollar and rising oil, it soon became apparent the Chinese, who had been strangely absent this month, were caught short. The result was copper surged 2.5% to break through to US$4.0123/lb, just shy of the all-time high. Aluminium - a metal for which 2% is considered a substantial move in recent times - jumped over 4%. The others added 1-2%.

Grain prices, which have also been undergoing a pullback of late, charged ahead once more. Corn, beans and oats were all up 4-6%.

The SPI Overnight fell 22 points. The ASX 200 closed yesterday at 5520, so we may be back to test support at our significant 5500 level once again today.

article 3 months old

Rudi On Thursday

Question: would oil be at US$108.50 per barrel if it wasn't for the weaker US dollar?

Answer: one can never be too certain about these things, but I'd be inclined to think the answer is negative.

Similarly, the market entrance of investors and speculators ("financial market participants") into resources and energy sectors has had a sizeable impact as well. This is even more so with more and more financial products being developed that allow investors to diversify into base materials ("stuff") without having to choose between listed companies on the share market.

It is usually argued that playing the commodities theme via the share market is a less risky option as futures markets, and especially those for commodities, can be notoriously volatile. Witness, for instance, the movements in the gold market over the past month. However, not only is there now a whole plethora of new investment products available that are easier accessible than futures, now that producers are struggling with higher costs, a tight labour market and unfavourable currency movements, one has to question whether playing the commodities theme through the share market is not simply equal to taking on board a few extra layers of risk?

Investors will have noticed shares of listed companies do not always trade in synch with price developments of the underlying product. This was especially the case during the first three months of this year when global equity markets were going through a severe de-valuing phase, while prices for the likes of gold, copper and oil were recording new all time highs.

No matter how hard one believes in the concept of the Commodities Super Cycle, I am sure that at times investors find it easier to lose money than to actually benefit from it.

The share market aside, we can safely say that the direction of commodity prices is being determined by three key factors: supply and demand dynamics, investor activity and the US dollar. Get the first one correct, but one of the other two wrong and you can still end up miserably wrong. In addition to these three key elements most commodities will have at least a fourth important element in play. For oil that's the so-called geopolitical factor.

Geopolitics can also be important for the direction of gold, but at times selling by central bankers can play an even more important role (or as is presently the case: selling by the IMF). Sometimes, and this is especially the case for agricultural products, government policies need to be kept an eye on as well. The most obvious examples of this would be restrictions on genetically modified crops, or on imports and exports and the push to promote ethanol as an alternative to oil products.

The problem with having so many factors in play is how do you know what is more important and when? For example: many a resources skeptic will argue the sector's outperformance in the first quarter had more to do with speculators seeking alpha than anything else. Others have been arguing for months that commodity prices have been predominantly enjoying the automatic push from a sliding US dollar. But what's going to happen once the greenback finds its bottom? (The problem with this thesis thus far has been that the US dollar has simply continued falling even though it has been forecast to find a bottom at various stages throughout the past years. And as long as the Federal Reserve continues cutting interest rates, and others such as the ECB, the RBA and the Bank of China do not, this is likely to remain the trend).

Many silver market watchers believe increased supply will push the market into surplus this year. Yet, many others, including highly regarded industry consultant GFMS Ltd, argue that it is increased investor demand that will continue pushing silver to new highs (get the first one correct, but the second one wrong and you likely end up still miserably wrong). Similarly, spot uranium would have never reached as high as US$136/138/lb last year if it wasn't for excessively bullish investors who kept on buying product on the spot market, only to find out later there were no other buyers once they started looking to crystallise their paper profits.

Lee Jee-Hoon, research fellow at the Samsung Economic Research Institute in Korea, has tried to assess the importance of all of the above factors for commodities. He concentrated his analysis on the top four contributors of the IMF Commodity Price Index -crude oil, wheat, copper cathodes and iron ore- in an attempt to forecast future price movements. Here are the conclusions of his analysis:

Price movements of West Texan Intermediate (WTI) crude oil futures between January 2007 through February 2008 can be attributed in the order of 40.3% to what we all would describe as "speculative money"; geopolitical risk "only" represented 39.7% of the price movements, while the US dollar's weakness is believed to have contributed 4.5% with supply/demand taking up the remaining 1.8%. (Those with a quick mind, and a penchant for instant mathematics, will have observed that the teller has stopped at 86.3%. Unfortunately, it is not clear where the remaining 13.7% has gone. We have to assume that only the most important price contributors have been listed).

Even if those figures are not necessarily 100% correct (after all, what is?), if our Korean researcher has done a relatively good job, this should give investors a much clearer insight into what determines the direction of the oil price - it certainly is not the direction of the US dollar.

As far as his price prediction for calendar 2008 goes, Lee Jee-Hoon refers to the Asian standard, the Dubai crude, which he predicts will average 24% higher in price this year compared with 2007, with the price in the first half of the year expected to be higher than in the second half "as speculative buying, geopolitical risks and the [US] dollar's value are expected to calm down or even reverse".

As you would have expected, one cannot take the example of crude oil and extrapolate it to other commodities. For wheat, for example, Jee-Hoon's analysis has revealed that speculative money plays a role of 48.1% (which is much higher than in the case of crude oil), while government policy actions take up 16.8% in direct influence. The US dollar comes third with a direct price contribution of 15.6%. Supply/demand dynamics only account for 1.4%.

The forecast is for an average price increase of 33% this year for wheat.

Let's move on to copper cathodes. Surprisingly, perhaps, the main price factor for copper is... the US dollar, with Jee-Hoon ascribing as much as 54.8% of  copper's price rise to the US dollar's weakness. This is, explains Jee-Hoon, because Chile is the largest producer of the metal and therefore everytime the US dollar weakens against the Chilean peso the price of copper has to go up to make up for the loss.

Supply/demand characteristics rank second (as opposed to crude oil and wheat) with a calculated contribution of 26.1%. Speculative money only comes third with a direct contribution of 7.2%. There is a little twist to the copper figures: labour strikes' importance receives a 0.0% - but that's because there were none, explains Jee-Hoon.

His forecast is for the price of copper to average US$8,340 per tonne this year, 12.5% more than in 2007. Similar to crude oil, he expects to see a higher price in the first half than in the second part. The main caveat he has built into this forecast is: in case of any labour strikes in the second half, the outlook could change materially.

Which brings us to iron ore. Amidst all the stories we hear, and read, about an extremely tight market for iron ore, not in the least because global demand for steel has continued to surprise to the upside, Jee-Hoon has come to the conclusion that 55.4% of the price of iron ore is being determined by US dollar weakness. Chinese demand only comes second with a direct contribution of 32.2%. Market dominance of producers is placed third with a relative price importance of 12.4%.

In his end conclusions, our Korean researcher acknowledges the above mentioned factors cannot be seen as being totally independent of each other; there is an interaction such as, for instance, that a change in the supply-demand balance will attract more speculators.

As far as the overall conclusion goes, this is what Jee-Hoon has to say:

"Overall, it appears speculative investing, [US] dollar depreciation and geopolitical risks have driven the strong surge in commodity prices since January 2007, not supply/demand dynamics. In particular, speculation money and the dollar's depreciation appeared to account for 56.5% of the recent price spikes on average.

"Since speculators account for more than 40% of the four commodities analyzed, the recent price spike can be seen as only a temporary phase. If demand eases from China and other emerging markets, speculative activity could also roll back. Consequently, market watchers could not dismiss the possibility of sudden and big drops in commodity markets."

Till next week!

Your editor,


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

article 3 months old

The Overnight Report: Holding Fast

By Greg Peel

The Dow closed down 16 points, which is as good as unchanged, while the S&P rose 0.2%. The Nasdaq yet again outperformed with a 0.6% rise.

So many times over the past few months have we seen Wall Street string together a couple of up-days, only to have the relief dashed by some new piece of poor data, or some other weak news or event. Well last night there was plenty around to be considered bad news, but this time a greater confidence has pervaded Wall Street and there was no familiar sell-off.

While no one expected the consumer confidence numbers for March to be good, there was still a shock in store. The Conference Board March index fell to 64.5 from 76.4 in February, while economists had expected 73.0. This was the worst reading since the 2003 invasion of Iraq. If that wasn't bad enough, within the total index is the "expectations index" (how you see things ahead) which dropped to its lowest level since the Arab oil embargo of 1973.

It just goes to show that talk of a recession is the factor that will most likely cause one.

The other hardly surprising, yet still dire, piece of data was the Case-Shiller house price index for January, which fell 10.7% year on year. That's the worst result since Mr Case and Mr Schiller got together in 1987.

This is the sort of stuff that could have seen the market wipe out most of its recent gains in one fell swoop only a couple of weeks ago, but the post-Bear Stearns market has a new, brighter face. As it was, the Dow did get hit to be down on the data 99 points but it was all very brief. Having quickly recovered, the market then settled into sideways mode. Sideways in this market is as good as bullish.

The market also largely took into its stride some downgrades in the financial sector. Ever since the credit crisis began, analysts from various brokerages have been playing a game of "pot calling kettle", and some traders have become disinterestedly circumspect. JP Morgan and UBS cut earnings forecasts for Merrill Lynch, suggesting more write-downs will be forthcoming, while Merrills in turn downgraded Bank of America and a couple of other regional banks. Merrills analysts no longer have a single Buy rating in the financial sector. (A cynic would say that's a perfect Buy signal).

The fact is that write-down talk was big news late last year but is now simply expected. The financial sector entered 2008 with fourth quarter write-downs and suggested more write-downs will follow for the first and maybe even second quarters. So this is old news.

One bright piece of news was an earnings guidance upgrade from agricultural biotech and Dow component Monsanto. Love 'em or hate 'em, Monsanto represents that element of the US stock market in which many are placing great faith - those companies which derive more than 50% of revenues from outside the US. Monsanto shares jumped 10%, and it is notable that another sector with large offshore earnings - tech - has been outperforming even the stronger broad market these past few days.

The Monsanto news was also a bit of a fillip for hard-hit commodity prices in general. Wheat, for example, jumped 4.6%. But given the weak consumer and housing numbers, it was back to business as usual for the US dollar, which fell against all major currencies. This meant a green light for traders to jump back in and buy every commodity that was trashed last week.

Base metals took off in London, posting big gains to the official close mid-session before settling back a bit in the afternoon. By day's end, rallies of 2-3% had been posted across the spectrum.

Oil wrestled with falling consumer confidence and a lower dollar to manage a US36c rise to US$101.22/bbl.

Shattered gold had a big turnaround, rising US$23.80 to US$939.00/oz, while even more shattered silver topped that reverse to gain 5.5% to US$17.91/oz.

The Aussie gained close to US1c to US$0.9162.

After the big gain posted on the Australian bourse yesterday, the SPI Overnight added only another cautious 12 points last night. There's little to suggest today won't be another up-day, particularly in the materials sector, but boy - we'd hate to see the market get too cocky.