Australia’s Current Account Deficit Up 4%

Good morning Australia. It’s another triple digit mid-day decline on the Dow. Is this the Obama Rally?

Just kidding. Obama looks like he has locked up the Democratic nomination today. Wall Street may not like the prospect of an Obama Presidency.

It’s kind of amusing to watch CNBC as analysts try to explain why the market has taken a sudden turn for the worse. Lehman Brothers is down 8%. Uh oh. GM’s monthly sales were off by 30%. Uh oh.

Of course none of this should have too much of an affect on Australian stock prices. The Reserve Bank elected not to raise the cash rate from 7.25%. The RBA concluded that the last eight rate hikes have made borrowing sufficiently expensive that household and business credit will not contribute to overheating in the economy. Phew!

But if people can’t or won’t borrow more, that doesn’t meant they won’t have more money in their pockets. There’s always an increase in income to drive domestic spending. That income—in the aggregate—comes from Australia’s record terms of trade, as we mentioned earlier this week. As far as we know, there’s not a lot the Reserve Bank can do about that. Wage pressures have to be building.

The share market didn’t find the rate news much of a relief from the weakness in U.S. financial stocks. The Aussie financials were down and so were the miners. If the miners and the banks are down in Australia, the index is down. The only exception is energy, where Santos is making waves in the LNG market.

For the record, we still think banks stocks are dogs. Globally, banks continue to de-leverage and raise capital. You might make a spirited argument that the worst of the housing-related losses have been taken. But, even if that point were generously granted, you’d still have to ask where in the heavens bank earnings are going to come from?

The only possible answer is that the credit cycle is reversing and interest rates are headed lower. This may possibly be true in Australia. But it can’t possibly be true anywhere else in the developed world. The ECB remains hawkish. The Fed never got tight in the first place. And the Bank of Japan is in no position to raise rates with the Japanese economy in a fragile state of expansion.

So once again, Australia is the weird looking kid on the global block, with a cycle that seems to be at odds with everyone else’s. What will it mean for the Aussie dollar? Well, the RBA won’t cut rates until it sees signs that inflation is slowing down. And it’s going to be months before that happens (if it does happen, that is.)

In the meantime, you’d expect traders to sell the Aussie dollar if they don’t think interest rates are headed higher. Yet that did not happen en masse yesterday. On the economic front, building approvals were up 7.8% on a seasonally adjusted basis. This gave the Aussie a little nudge and countered the prospect that interest rates may have topped out.

Since we’re going on the record today, we can’t see the Aussie getting a lot weaker against the greenback this year. The rate differential between the two currencies favours the Aussie. And if rates aren’t driving the pair, then it would economic growth.

You can go ahead and forecast a bottom in housing, a top in oil prices, and a major rebound in the U.S. in the second half—all of which would drive the greenback higher and probably lead to a significant rally in U.S. stocks (and selling in BRIC and emerging markets, including Australia.) But it is easier to write out that scenario and actually believe it.

Still, there are some folks who believe that the U.S. is scraping along the bottom, albeit in prolonged fashion. We think these people fail to realise that the world is witnessing a structural reallocation of capital away from Western markets and toward developing markets. Granted, this theory allows for big rallies in U.S. shares.

However, for our money, it’s best to focus on the long term compound growth in earnings available in the emerging and developing world, than trying to trade rallies in the U.S. stock market, where a decade of managing corporations for short-term profit has put U.S. companies on the back foot in global competition. The game has changed.

There was more perplexing news on the economic front. Australia’s current account deficit was up 4% to $19.49 billion, according to the Australian Bureau of Statistics. The deficit on goods and services rose by $1.4 billion, or 22%.

It’s pretty strange that you have a country in the middle of arguably the greatest export boom of all time—and you’re running a current account deficit. The trouble is, despite its continental size, Australia is small in terms of population. It is hard for an economy of this size to produce the diversity of goods available in the world. There are not enough human resources for a truly diverse economy.

And with globalisation, why would you produce things locally you can buy on international markets? There are some things you want to do locally so you don’t have to rely on trading partners (energy, food, banking). But Australia’s trade and current account deficits seem to be structural in nature. The country will always import capital goods, textiles, and consumer electronics—things not likely to ever be made competitively in Australia.

Is it time to look at base metals again? Zinc, lead, nickel, and copper all came off the boil last year. Meanwhile, energy and bulk commodities (coal, iron ore, phosphate) all zoomed ahead. But now, maybe things are heating up in the base metals again.

Melbourne-based Jervois Mining announced that is has been approached by a Chinese consortium to develop the Young nickel deposit in NSW and produce 50,000 tonnes of nickel a year. When we get back to Melbourne next week, we’ll ask Gabriel and Al what they think of base metals prices and base metals stock and report back to you.

Dan Denning
The Daily Reckoning Australia

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