Today’s Money Morning is about Dutch Disease. How do you save and make money from the Australian economy’s coming boom, bubble and bust?
But first, someone should let Federal Resources Minister Martin Ferguson know that the mining boom need not be ‘over’. Here’s what he said: ‘The commodity price boom is over. Anyone with half a brain knows that.’
Finance Minister Penny Wong disagrees. ‘No, I think the mining boom has got a long way to run.’ We’re not sure which half of her brain she’s using.
But Wong may be correct on this. Never mind the plunging iron ore price, which has halved over the last twelve months. And don’t worry about BHP’s abandoned Olympic Dam plans.
The Italians have a sure fire solution to keeping the mines ticking over. All you need is around 350 kilograms of explosives per 100 miners and the mine need never shut down. Here is how the mining stimulus plan works:
‘Up to 100 Sardinian miners armed with hundreds of kilograms of explosives have barricaded themselves nearly 400 meters underground in Italy’s only coal mine to put pressure on the Rome government to protect its survival.’
Like sardines in a can…
This redefines digging a hole and sticking your head in it. If you’re wondering how on earth such a stimulus plan might work, consider that the same strategy worked for the Sardinians in 1984, 1993 and 1995. At least the Italians want to work. Here in Melbourne, a protest turned violent when police allowed several construction workers to continue working instead of joining the protest. How dare they work!
Report Sends Warning on Australian Economy
Anyway, the goose that lays the golden egg may be cooked. A report by research firm Variant Perception has caused some controversy. No longer are Australia’s problems just the ramblings of crazed Money Morning editors. Here’s what analyst Jonathan Tepper had to say about Australia’s fake prosperity:
‘Australian growth has been dependent on two huge bubbles: a domestic housing market that is one of the most overvalued in the world and a reliance on the Chinese fixed asset investment craze.’
Why is a housing bubble fake prosperity? Because house prices can tumble. A huge amount of wealth you thought you had can disappear very quickly. All it takes is for house buyers to refuse to go into vast amounts of debt.
And that’s even more likely to happen now that the other part of Australia’s fake prosperity is in doubt: the resources boom. It’s really a resource curse. Jonathan Tepper says Australia will suffer from Dutch Disease. In fact, he says we’re a ‘classic case’.
What’s Dutch Disease? It’s when the resources sector dominates an economy, and that causes other parts of the economy to flounder. So when the resources boom ends, only the floundering bits remain.
You can probably guess how Dutch Disease got its name. But it’s a surprisingly recent name coined by the Economist in 1977 after the Netherlands discovered vast natural gas fields. Sound familiar?
So how do you make and save money from Australia’s Dutch Disease? Well, the sickness plays out in the following way. First there is a crash in the economy as the booming part takes a big hit. That’s started already. Resource companies have cancelled projects and Fortescue Metals has lost 40% of its share price since May.
The Australian Dollar About to Fall?
Next up, the currency crashes. If you think the first part of the disease was bad, this will really hit you. According to Tepper’s report Australia has a vastly overvalued currency and a ‘terrible international investment position’. But it gets worse. Here’s why the two are set to cut your retirement savings painfully.
The international investment position Tepper refers to is the ratio of Aussie investment overseas compared to foreign investment here. The reason it matters so much is that if foreigners get spooked and pull their money out of Aussie investments, it will hit Aussie asset prices, including the Australian dollar.
And even though Aussies invest abroad, we don’t have enough overseas investments to offset the plunge.
Australia isn’t alone in this. Other countries with terrible international investment positions include New Zealand and three of the famous PIIGS caught up in the European sovereign debt crisis – Greece, Spain and Portugal.
Tepper specifically mentions that Australian government and bank debt owned by foreigners resembles that ‘seen in the European periphery’.
That’s not all; Tepper also says on every count the Australian dollar is overvalued. Even if foreigners aren’t spooked and don’t sell their Aussie assets, the Australian dollar can still plunge. If the resources crutch is kicked from underneath our dollar, that would leave the Australian economy without a major export.
But it’s the Australian dollar’s plunge that provides the hidden opportunity. It’s the third part of Dutch Disease. You see, exporters would benefit from being able to sell their goods for lower prices. More on this in a moment. But first, which are the investments most at risk? According to Tepper it’s the miners and the Australian banks.
Tepper says investors should ‘Buy CDS in big four banks.‘ That essentially means betting on their default risk rising. For your typical punter, it means you should avoid investing in the Australian banks. Even if they do have a juicy dividend yield.
As for Australian mining stocks, the real worry is the miners that are feeding China’s investment bubble. That’s iron ore, copper and other industrial metals. If you’re not convinced that China’s zombie economy is in for a hard landing crony capitalism style, you haven’t seen Greg Canavan’s presentation yet.
Where to Make Money Afterwards
Now for the opportunities to make money. The third stage of Dutch Disease is the recovery. Manufacturers and exporters tend to make a dramatic recovery under favourable exchange rates. And once the miners stop stealing all the capital and talent, it flows into other industries.
Exporters like Cochlear (ASX:COH) caught our eye this time last year. We wrote about the company in Australian Wealth Gameplan. It’s up around 25% since, without including dividends. Meanwhile, the ASX200 is back to where it was.
But Greg Canavan has just added an even better sounding opportunity to his watch list. It’s an exporter as well. And it produces something our office consumes every day. It’s not strictly industrial, but the same factors are at play.
Best of all, the good produced is seasonal, which means exports to the northern hemisphere. And investors have badly beaten down the stock, due to an unfortunate but temporary development. In other words, it’s cheap, it exports and it produces real stuff. There are plenty of similar companies on the ASX.
Now all we need is a buying opportunity. Bring on the crash!
Nick Hubble
Editor, Money Morning
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