Gold News

New Aussie Bull Market

Or so the current pop in banking and even mining stocks might seem...
FOR THE first time in a long time, I'm seeing a large chunk of the smaller, less visible part of the stock market start to move higher, says Greg Canavan in The Daily Reckoning Australia.
It's not just the big Australian banks or the other large dividend payers contributing to the market's gains...although that is where most of the investor focus still seems to be.
What's causing this broader rise in the market? Interest rates are clearly the driving force, and the lower Dollar must be having an impact too. But it's not because investors think lower interest rates are going to magically boost the economy and company earnings.
Rather, the recent interest rate cut and expectations of more to come have simply sparked a big move of capital into the market. It's anticipating a speculative melt-up as the world's central bankers keep pressing the interest rate button in the vain hope that it improves 'animal spirits' or 'confidence'.
You might think it is strange and perverse that the market can be so bullish, and bestow its 'wealth' on many people, at a time when the economy is the weakest it has been in many, many years.
But that's what happens in a world dominated by central banks. For now, cheap money trumps all else. And while that is the case, it doesn't pay to be overly bearish...not in the short term anyway.
Which is a difficult thing for me to say. Longer term, I am hugely bearish on the prospects for the global financial system. In the next few years, I think you're going to see all sorts of problems as global debt levels completely engulf the productive capacity of national economies.
For now, the market action is telling bears to get out of the way. The recent spike to new highs sends an important message. Take a look at the recent performance of BHP Billiton (ASX:BHP) to see how bullish market sentiment is right now. Since mid-January, BHP's share price has surged by nearly 30%.
Are things all of a sudden better for the Big Australian? Or is it just a case of the bulls running over the bears for the time being? I suggest it's the latter.
Take this article from the
"BHP Billiton believes lower diesel prices and the weaker Australian Dollar could deliver a bigger boost to its full-year financial results in August than the half-year results published this week.
"The mining giant revealed a 29 per cent decline in the cost of producing iron ore in Australia over the six months to December 31, as cost-cutting combined with currency movements and lower diesel prices to reduce the damage caused by sliding iron ore prices.
"The lower diesel prices delivered a $US233 million ($298 million) boost to the profit line, BHP's financial statements show."
Hang on a minute...
Diesel prices fell in the half because oil prices fell. BHP is a massive producer of oil. So where some of its operations benefit from lower input costs because of lower energy prices, the oil division's losses more than makes up for it. Talk about glass half full!
And keep in mind that the pace of the oil price decline only really picked up in November and December last year, meaning the oil division only really suffered for two of the four months in the half. If oil prices don't pick up quickly, it's going to be a tough full year for BHP's oil earnings.
It's true though that a falling Aussie Dollar is helping over at the iron ore operations. Lower costs are helping to offset the sharp fall in the iron ore price. But this is the very thing that will continue to put pressure on iron ore prices for the next few years at least.
As BHP (and RIO) continue to lower costs and churn out ever greater quantities of iron ore, it puts pressure on the price. This will eventually wipe out the marginal producers who just can't compete on the cost front.
The question is how far will the iron ore price drop? So far, the price weakness reflects the big supply increase. But demand, if steel output in China is anything to go by, has at least held at high levels.
There is a huge amount of excess steel capacity in China and mills produce more than is really needed. If China decides to enforce structural changes to its steel industry, then the iron ore price could head down into the US$40-50/tonne range. The risk to prices is clearly to the downside.
Yet the market prices BHP on 16 and 16.5 times earnings over the next two years. This is expensive for a resources company and tells you the market expects an earnings recovery in the years ahead.
A recovery from what though? The biggest commodity boom in Australia's history? Iron ore may have peaked back in 2011 and fallen over 60% from its peak, but it was a massive bubble. Bubbles can deflate 80-90% before prices start to recover.

Greg Canavan is editorial director of Fat Tail Investment Research and has been a regular guest on CNBC, ABC and BoardRoomRadio, as well as a contributor to publications as diverse as and the Sydney Morning Herald.

See the full archive of Greg Canavan.

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