“If you can’t beat them, go to Tasmania for Christmas and have scrambled eggs and a flat white on Salamanca Place while the sun cooks your skin to a crisp through that big hole in the ozone layer,” we always say.
We don’t always say that, of course. Never said it, really. Thought it. And just typed it. But as global markets are quiet (oil at $62, gold at $621), headed into the Christmas weekend, we found our self digging deeper into today’s Australian Financial Review for some perspective on the year behind us and the year ahead.
First, though, a quick word about oil and gold. The gold/oil ratio has remained at around 10 ($600/$60) for most of the last four months. In other words it would take you ten barrels of oil to buy an ounce of gold. That ratio could be exactly the same next year, but with oil at $100 and gold at $1,000.You read it here first.
A 66.6% gain in either gold or oil would have to impress even Australian investors, who have been enjoying three years of milk, honey, and fat. In an article titled Double-Digit Returns Forever, Norelle Hopper writes that, “Australia’s superannuation funds have delivered their third consecutive year of double-digit returns, thanks to their higher exposure to domestic share portfolios that have outperformed most other markets. Even the traditional default option where most of us park our money—the median balanced super fund—returned 14 per cent for the year to June, according to research house SuperRatings. Other big funds have returned 18 per cent and even 20 per cent.”
It wasn’t supposed to be this way. And in most other places in the world, it isn’t. The tech wreck set European and North American investors so far back that they’re only now back into positive numbers—after six painful years. But in Australia, the much-anticipated era of low-level returns (which spawned the hedge fund industry in the U.K. and the U.S) was a no show.
“If you go back before the last three years, everyone was trying to prepare fund managers for a lower return world. Australian funds have been lucky because they have a strong home country investment bias and the biggest single exposure to the Australian stock market, which has outperformed virtually every other market in the world,” says Tony Cole of Mercer Investment Consulting.
If the lower-return world never arrived, you can thank China and the commodity boom, which have been keeping low returns at bay going on four years now. The returns have been so good that some investors are starting to think this whole investing shtick isn’t so hard after all. David Chessell at Access Economics describes the situation this way, “To get the higher returns” the conventional wisdom went after 2000’s bust, “you have to assume higher risk. That is not our experience. We’ve had higher returns and lower volatility. It’s the Holy Grail that everyone is looking for.”
And here we thought the arrival of the Baby Jesus was a few days away. Turns out the heavenly secret to investing has already been found! Or has it? Could it be, dear reader, that this holier-than-thou kind of investment confidence that high returns come without any risk is the pride that goes before a big fall?
“Once you go to three years of 20-something per cent returns, people start to think 20 per cent is normal. We get habituated. You start to think it’s normal. It’s not normal. It’s like the Stockholm syndrome,” says Frank Ashe Associate professor at the Centre for Applied Finance and Macquarie University. He’s right. Long stretches of double-digit returns are not normal. Statistically, speaking, they are anomalous. So what is it about this time that’s different? How is the resource boom—the driver of the big returns—immune from the cycles that deliver lower-than-average returns after years of better-than-average returns?
Trevor Sykes has the answer in Why the Resources Boom May Last Longer Than You Think. “Lesson one in economics is that when excessive demand causes an increase in prices, it also triggers extra supply that will come on stream and restore prices to equilibrium. But there are reasons to believe that this paradigm may not work entirely according to the textbook in the resource industry now—at least as far as some metals are concerned over the next few years.”
Normally when we hear this kind of talk in concerns us. After all, resource and financial stocks make up 68% of the share market. That’s a lot of superannuation eggs concentrated in two sectors. If the resource boom sours (obeys the cycles of economics), won’t superfunds suffer? It all hinges on the economics of metals mining.
Sykes continues, “Low global metal prices between 1998 and 2003 resulted in low exploration expenditure. That is now accelerating again, but the lead times to bring on new supply mean that resources found now will not be developed until the next decade. Meanwhile, the giants have decided that it is quicker to acquire new supply (mines) by taking over existing companies that my exploring—hence the mega-mergers occurring in the resource industry…According to Credit Suisse analyst Peter O’Connor, supply looks like being especially tight for the next couple of years in nickel, zinc, and platinum.”
This makes sense to us, as does the observation that there are fewer firms and nations controlling the production of key resources. It’s an informal mining cartel. But there’s nothing sinister about it. It’s simply too expensive and time consuming an industry to enable the kind of instant start-up competition you get in the digital world. In the lean times, that’s what makes resource stocks awful. In the boom times, it’s what lends them a boost.
The only real question now is what will the future hold. Same question as always isn’t it? And here we will make two final points. First, financial panics are a regular feature of economic life. They are disruptive and destroy real wealth. But if 19th century America is any example, panics can come and go without disrupting the fundamental economic story driving the global economy.
In the 19th century, that meant American continental expansion and the increased production of raw materials for export to Europe. The currency got ruined a few times. The stock markets crashed. People lost jobs and wealth. But the uber trend of national economic ascendancy stayed on course for decades.
If that is the case for China in the 21st century, what a breathtaking country it will be, which brings us to our second point. China’s appetite for raw materials may last longer than our appetite for speculating on when it will end. There are 500 million people to lift from poverty. There are gleaming cities to be built. That will take lots of metal, which is why China has transformed itself into the world’s largest producer of steel, as well as consumer of metals like zinc and copper. It’s a metallic revolution, and Australia is the chief supplier.
We thought of this as we began reading Isaac Asimov’s “Foundation” this morning, rolling down the runway at Tullamarine into the sky. The future certainly has plenty of risks. But it will has spectacular possibilities. Most of them in 2007 will begin with energy and metal. Who knows what it will look like? Here’s how Asimov described the future of the planet in the opening pages…maybe he was describing China without knowing it.
“He could not see the ground. It was lost in the ever-increasing complexities of man-made structures. He could see no horizon other than that of metal against sky, stretching out to almost uniform greyness, and he knew it was so all over the land surface of the planet. There was scarcely any motion to be seen—a few pleasure craft lazed against the sky—but all the busy traffic of billions of men where going on, he knew, beneath the metal skin of the world.
There was no green to be seen; no green, no soil, no life other than man. Somewhere on the world, he realized vaguely, was the Emperor’s palace, set amid one hundred square miles of natural soil, green with trees, rainbowed with flowers. It was a small island amid an ocean of steel.”
Here’s wishing you and your family a great weekend, a Merry Christmas, and a Happy New Year.