The trans-national miner said it is pushing ahead with expansion plans in iron ore while it awaits competition authority clearance for a JV with BHP Billiton

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By Michael Trinkle, ForexTraders

For the first time in 70 years, the Australian Federal election has failed to deliver a majority party in the country’s lower house of parliament. The election was held on Saturday, August 21^st and was the closest race in decades.

The race eventually finished with no clear majority party in power, resulting in a so-called hung parliament. The last time there was a federal hung parliament in Australia was in 1940.

Election Results

Voters gave minority support to Tony Abbott’s Liberal National Party coalition, giving them the popular vote with 21 Parliamentary seats in Saturday’s election.

This left Julia Gillard’s former ruling Australian Labor Party with the largest set of 70 seats. The second largest set of parliamentary seats went to the Liberal Party with 43 seats.

In addition, the Green party won one seat, the Nationals got seven seats, the CLP or Territory Party won one seat, two seats went to independents and five seats remained “doubtful”.

Initial Reaction of the Aussie in the Currency Markets

The Aussie initially fell against all of the major currencies as the results of the election were released indicating a hung parliament. The rate reached as low as 0.8857 in late Australian trading.

Furthermore, Australian bond yields fell after the news, although mining stocks such as BHP Billiton Ltd. and Rio Tinto gained on the increased prospects of a controversial proposed mining tax being scrapped.

Aussie Recovers in a Delayed Reaction

Nevertheless, while the initial reaction to the elections was a falling Australian Dollar, the Aussie has since managed to recover some ground in early trading in Europe and the United States.

Also, the hung parliament may well have been factored into the market on Thursday and Friday when the AUDUSD rate traded significantly lower.

Perhaps as a result, AUDUSD has now recovered to trade at 0.8914. This is up somewhat from the low level of 0.8840 that was seen last Friday before the election results were announced.

The Continuing Case for the Aussie

The political uncertainty resulting from a hung parliament can often adversely affect and weigh upon the value of a country’s currency, and this can certainly impact a currency like the Aussie.

Nevertheless, buoyant Australian fundamentals – as well as firm commodity prices and a high rate of interest in Australia – continue making a case in favor of the Aussie versus other countries with poorer economic prospects.

The fact that the initial reaction to news of the election was an initial sharp decrease in the value of the Australian Dollar – only to see the market subsequently recover and take the rate higher – tends to indicate that the Australian Dollar could well continue heading upwards even in spite of this new political uncertainty in Australia.

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The National Union of Mineworkers says more than 600 workers have downed tools at Exxaro’s mineral sands unit while 1,700 workers at a Rio Tinto-BHP JV have threatened to do the same

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The Daily Reckoning

Hmm. Let’s see. Last time BHP Billiton made a tilt at a high-profile, big money acquisition, the whole world went pear-shaped. As the statisticians say, correlation is not causation. But M&A activity seems to pick up when company directors have run out of other ways to increase earnings. It does not always work out well for shareholders. Case in point, BHP’s shares are down today by 3.5%.

In case you missed it, Marius Klopper’s outfit made a $43 billion bid for Canadian firm Potash. The bid values the world’s largest fertiliser producer at $130 per share. That’s a 16% premium to Monday’s closing price. It’s also nowhere close to what Potash thinks it’s actually worth.

Potash CEO Bill Doyle told Bloomberg that the bid was a, “highly opportunistic and an ill-disguised attempt to exploit an anomaly in the equity market valuation of Potash Corp.” Tell us what you really think Bill. Analysts say a bid north of $150 per share more accurately values the company.

As pick-up lines go, you’d have to say BHP’s first attempt – what’s a nice Canadian fertiliser company like you doing in the blue light district of the share market – was a failure. So the bid has gone hostile with BHP set to appeal directly to Potash shareholders. They say every man has his price, don’t they (whomever they are)?

There are two interesting parts to this news – aside from the valuation mating dance. The first is the timing. This would be the biggest merger since 2009, when Merck went after Schering Plough. Mergers don’t always come at market tops. But there does seem to be a few cases of CEOs riding high on confidence prior to making an acquisition that destroys shareholder value (AOL-Time Warner). And don’t forget the proposed BHP-Rio Tinto stitch up became public at the apex of commodity prices.

The second interesting part to this news – which hits us especially hard right before lunch – is that it’s about food. Potash is used to increase crop yields. It’s the potassium that does it. Incidentally, potassium has the chemical symbol “K” on the periodic table which comes from the Latin “Kalium” which itself apparently comes from the Arabic “al-kali,” or plant ashes.

But back to hungry people. There are more of them. The chart below shows how quickly the world’s population has grown since crop yields started increasing via mechanised farming, the green revolution, and petroleum-based fertilisers. The world’s population has doubled in roughly 50 years.

A lot of those people are in this part of the world, the Eastern hemisphere. They are all just as hungry as people in the West, you would presume. And if you’ll indulge us for a second there’s an intriguing point to be made here: inflation increased calories consumed per day. It makes perfect sense when you think about it.

If the creation of money out of thin air, not backed by anything, accelerates the use of land, labour and capital, why would food be any different. If you bring forward housing demand, say, by making grants and keeping credit cheap, aren’t you “bringing forward” people with cheap money and cheap energy? And aren’t you accelerating the depletion of arable land by increasing the demands upon it because of the “brought forward” population?

This reveals the central and egregious blunder of the Keynesians. You enjoy the short-term gain without thinking of the long-term pain. Any kind of artificial stimulus that makes things appear easier now usually makes things worse later. You rob from future demand and you usually accelerate the misallocation of capital (giving everyone $900 to spend in a country with one of the highest household-debt-to-disposable-income ratios in the world).

Inflation stimulates an unhealthy appetite. It makes you fat – right before it starves you. By the way, one reader asked us to show China’s population pyramid. As you know, China is the source of so many projections about future Aussie corporate profits, jobs, and government taxes. Have a look then.

Whaddya reckon?

It’s not a big fat base. In fact, it reminds of a warning we heard about China a few years ago: China will grow old before it grows rich.

But even though the base – in comparison to the middle – is narrower – the total numbers are incredibly large. It will be intriguing to see how it pays out. Will China’s numerically large middle class be able to foot the bill for the health-care needs of ageing population? Or will the one-child policy become a no-grandparent policy?

One thing to remember about China: it’s 5,000 year old civilisation currently being “run” by an ideology with a very short and bad track record for economic management. We reckon old traditions, like caring for and respecting your elders, will win out over putting a bullet in their head to save on health-care costs.

But modern fascism and nationalism are pathogens infecting the human spirit. This is probably true of most politics these days. Once they take hold in the mind and the heart, they have a way of making people do (and justify) idiotic and often monstrous things. This is why the modern Warfare/Welfare state is dis-integrating before our very eyes.

It’s running out of resources to consume in an unproductive way. It’s inefficient in redistributing the productivity of the private sector. And at its black heart is infected my envy, sloth, malice, and a lust for power. So unhealthy.

Do we exaggerate? Not by much, if it all. Elections always demoralise us. Thank goodness we can get back to being upbeat next week. And tomorrow, we’d like to tell you about the real spirit of enterprise. We’ll also reveal an astonishing secret. Until then!

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China is the biggest power house for all the mining companies in the world now. With the liberalization of the gold market, more and more mining companies are now focusing on China market. Recently, mining giant Rio Tinto announced that its profit doubled in the first half of the year due to the demand from China.

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China is the biggest power house for all the mining companies in the world now. With the liberalization of the gold market, more and more mining companies are now focusing on China market. Recently, mining giant Rio Tinto announced that its profit doubled in the first half of the year due to the demand from China.

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The Daily Reckoning

Here’s a riddle for your Thursday: how much of Australian retail consumption has been/is being supported by high house prices?

It’s a little research project we’re working on and if you have any suggestions, don’t be shy about sending them into to dr@dailyreckoning.com.au. Why bother?

It’s a given that increases in household wealth support higher consumer spending. For one, when people see their share portfolios or housing investments go up, they are, in fact, richer on paper. This may give them more disposable income to actually spend. Or maybe they just feel richer and spend more freely (the wealth effect).

But one thing we recall seeing at the peak of the U.S. housing bubble is a massive increase in borrowing against home equity. Home equity lines of credit (HELOCs) were a popular way for lenders to expand the lending boom and for borrowers to “cash in” on rising house values to support consumption. The house was an ATM.

Is that true in Australia? We’re looking for evidence that either confirms or refutes the thesis. But we’re having a hard time finding credible data. One area that you might look at, based on the U.S. experience, is refinancing activity. Why?

As rates bottomed in the U.S., and then as the fear that rates would rise took hold, millions of people refinanced their homes to take advantage of low rates. Often the refis captured much higher house prices, which meant the new mortgage was larger than the old mortgage, albeit it a lower interest rates (and much less actual equity for the borrower).

Many mortgage providers offered cash-out refinancing options which allowed you to “extract equity” from your asset, an asset which was rising in value anyway. A telling sign of the top in U.S. home prices was when refi activity eclipsed new mortgage finance. There weren’t as many new buyers. Just existing buyers trying to reshuffle the financing furniture in order to support consumption and put off the mortgage day of reckoning.

Granted, we have no idea if anything like that is happening yet in Australia. But we’re having a look. In the meantime, median house prices were up 3.1% in the June quarter, according to data from the Australian Bureau of Statistics. The year-over-year gain in capital cities, according to the ABS was 18.4%.

That data is in conflict with data from RP Data Property reports. The RP data showed just 0.1% rise in house prices in the June quarter and a 0.7% fall in prices for the month of June alone. The RP data includes units and townhouses as well as stand-alone homes. That drop, if confirmed, would be the first monthly drop in 17 months.

Of course you know our position on the whole thing: Australian house prices are just one of many manifestations of leveraged asset bubbles worldwide that are now deflating with the credit depression. It has to make Aussie banks incredibly nervous.

On the one hand, they have large exposure to commercial and residential real estate. On the other, much of their domestic lending is dependent on wholesale borrowing internationally, where the cost of capital is going up faster than the Reserve Bank is raising the cash rate. And there’s an election this month, which makes it really hard to raise mortgage rates independent of a hike in the cash rate without inviting a “super profits” tax down on your head from agile political pick pockets.

But for all this worry that falling asset prices will lead to falling retail spending, lower GDP growth, and bigger government budget deficits, by far the most interesting housing bubble going right now is in China. Chinese regulators are instructing banks to conduct an honest-to-goodness stress test in which banks reckon the impact of a 60% fall in residential house prices.

Wow! Sixty percent? That travishamockery of a European stress test didn’t even assume a default on sovereign debt, just lower growth and falling bond prices. The Chinese appear to be seriously wondering what would happen if a large portion of last year’s $1.4 trillion in new lending turns out to be lost or non-performing.

Bloomberg reports that, “A deep slump in China’s property market may further slow the nation’s economy, which grew at a less-than-forecast 10.3 percent pace in the second quarter. China is still the fastest growing major world economy. Concern that China’s economy may cool due to a real-estate slump erased an early rally in U.S. stocks.”

The prospect of loan losses as a result of house price crash in China would be bad news for Chinese banks. And while we concede there’s probably a lot we don’t’ know about the Chinese property market, Caixin analyst Andy Xie reckons there are enough empty apartments in China to house nearly 200 million people, which is a lot of people and suggests a lot of bad loans.

Of course, only in China could you say that it may be possible to absorb that amount of space through internal migrations off the farm and into the city. In other words, if you really worked at it, you could say that that much surplus housing inventory isn’t an issue in a country that has so many people on the move. Sooner or later someone’s going to buy it and move in, right?

We’ll see about that. But in the meantime, the issue for Australian investors – and companies like Rio Tinto, which is set to spend nearly a billion dollars expanding its iron ore capacity in the Pilbara – is whether China’s housing boom has been boosting demand for coal and iron ore and what would happen to that demand if the boom goes bust.

Remember, last week we relayed the startling statistic that Chinese banks could struggle to recoup nearly 23% of the loans made to finance local government infrastructure projects. This aspect of China’s credit boom may have been even more supportive of base metals and iron ore prices. And if it goes, then the index of commodity prices published by the RBA this week (with a heavy bias to the contract prices of coal and iron ore) might look more like a “M” this time next year.

If you read the RBA release you’ll see that the big increase (51%) in the index is largely based on estimated increases in iron ore, coking coal, and thermal coal prices. It’s an expectation that things will keep chugging along. These estimates, in turn, are used by both political parties in Australia to estimate the amount of revenue generated by royalties and/or the Mineral Resource Rent Tax. Both parties reckon a return to surplus based on the increases in commodity prices.

Hmm. Has anyone reckoned what would happen if prices fell as they did in 2008 and beyond?

Granted, with oil hovering at US$82, gold nearly $1,190, and speculators in the position to take advantage of easy money in the US and Japan to invest in higher yielding assets, it may not seem like commodity prices can actually fall. But if the big driver behind commodity prices for the rest of this year is speculation and not fundamental demand (because bubbles are popping all over the joint) then would you be an investor in resource shares right now, or just another speculator?

Mind you, there’s nothing wrong with speculation, as long as you know that’s what you’re doing. It’s when the price signals you’ve been given turn out to be bogus (because of funny money) that many people find out they were actually speculating and not really investing. See Bill’s note below on prices.

All that said, we reckon shares would certainly be a better inflation hedge than bonds over the long term. But you might have to wait an awfully long time for a rebound in corporate earnings to start pushing share prices up. We meant to expand on this discussion this week with a look at various “alpha” and “beta” strategies for the share market. But we’ve almost run out of week.

For now, we’d say that all this anxiety about deflation and falling prices and the inability of monetary policy to produce inflation is just a prelude. The inflation will come when the Fed finds unconventional ways to get money into people’s pockets by by-passing the banks altogether. There are ways. And then? Stay tuned!

Dan Denning
for The Daily Reckoning Australia

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