Banking on Stocks


If the Australian stock market were a 20-20 cricket team, it would be about 1/80 after the first five overs. In other words, it would have the game well in hand, even if it were early on. Plenty of wickets to play with. Plenty of runs on the board.

In fact, the stock market resembles at T20 game more than test cricket. Every news event matters in today’s market the way every ball matters in T20. And sometimes you see wild swings, big risks taken, and a distinct lack of strategy. But it sure can be exciting.

The Aussie market opens in the context of the S&P 500 making a five-year high. Last week’s minutes from the December Federal Open Market Committee meeting scared investors for all of about one trading day. The idea that some Fed governors may support ending the bond buying program this year doesn’t seem to worry anyone too much – maybe because no one believes it.

There are other signs of first-quarter euphoria around. The iron ore price is up 70% from its August lows of last year. It’s back over $150. BHP Billiton and Rio Tinto both believe the rebound is due to Chinese restocking and the cyclone season in the Pilbara. In other words, they think the eventual spot price will be lower. But that hasn’t stopped investors from cheering.

But even the commodity/China story we’ve all grown to know, love, and depend on is taking a back seat to another trend in the market. High-yielding Australian stocks are the current ‘it’ investments for global investors who want yield. The evidence of this is that fact that the Commonwealth Bank (ASX:CBA)has a market capitalisation of $100 billion.

CBA is still half the size of BHP in terms of market cap. But its new shiny $100 billion cap makes it the ninth-largest bank in the world, by market cap. If you strip out the state-owned banks in China, CBA is the fifth-largest bank in the world. It trails only HSBC, Wells Fargo, JP Morgan, and Citigroup.

This news confirms the point Greg Canavan made in his ‘Fuse‘ report late last year: Australia is a two-speed economy with an oversized banking sector, and is dependent on China. In that same report, Greg also suggested there would be a concerted effort by the news media and the investment industry to promote stories that give you the impression that everything’s fine. Everything is not fine, Greg reckons.

Despite the underlying anxieties of the bears that something’s not right, there are signs that the market could go higher before it goes lower. Take the Volatility Index, or VIX, for example. You can see on the chart below that the ‘fear index’ fell nearly 38% in one day last week. It’s back near a 52-week low. The US ‘fiscal cliff’ deal led to a giant sigh of relief, and then a rally.


For Aussie investors, though, the chart below may be even more instructive. It shows the Australian dollar hitting a four-year high against the Japanese yen. We’ve been keeping our eye on this chart and want to ask Murray about it now that he’s back in the office. On a technical basis, the 50-day moving average has crossed the 200-day moving average, which is usually bullish. But the Relative Strength Index (RSI) is over 70, which usually means a security is overbought (see what happened to the VIX when the RSI went over 70).


There are more than just technical trends going on here, though. The Japanese are now on the front lines in the global currency war. With new political leadership and a central bank that’s happy to flood the front with money, the Yen is showing weakness. That weakness could lead to more global investors borrowing cheaply in Japan and then investing in high-yielding Australian stocks or the Aussie dollar. You’d have a catalyst for higher share prices right there.

And really, who is going to complain about higher share prices? We don’t mind them at all, even if we mistrust them. And sometimes a share price is driven by particular events within its industry or by some news within the company. For example, we tipped a platinum group metals (PGM) stock in The Denning Report in late October, after getting back from a trip to South Africa.

Palladium prices were near 52-week low. The sentiment on South African mining was awful. And the share itself was trading just above a 52-week low. It was a total contrarian punt.

Today, palladium is about $100 higher. Not only that, but US car sales are at a five-year high. The demand for PGMs is largely driven by the auto-catalyst market. And outside Europe and North America, car sales are ticking along nicely. When you throw in the good US news, you get a pleasant convergence.

The net result was that we told readers to take an 85% pre-tax profit on the trade. There could be more upside. But when you make over 80% in less than 70-days in a market like this, you take some money off the table and count your blessings (and thank your contrarian instincts).

And for the record, there’s reason to believe 2013 could be the year the big money is made in shale stocks. The easy money has already been made. But a report on merger and acquisition activity from Citigroup’s Australian Hedge Fund Sales Desk reckons that several of Australia’s would-be unconventional shale gas players could be takeover targets this year.

It will be an interesting sector to watch. Some key horizontal drilling is taking place in the Cooper Basin in April of this year. It’s the first time a horizontally drilled well will be fracture stimulated in Australia. Up until now, it’s all been vertical drilling, with excellent flow rates.

Even better flow rates of gas on the horizontal drilling will go a long way toward establishing a definitive resource size for some of the shale gas players. If a major oil and gas company wants to get a bargain on one of the shale players, it may want to buy the company before the drilling results are out. It’s a gamble. Bad results would lead to over-paying now. But good results could lead to a higher asking price later.

By the way, every time we mention the shale stocks, we invariably get mail from at least one reader who accuses us of putting greedy profits before the environment and safe drinking water. But this complaint is more of an ad hominem attack than an understanding of the science behind the drilling. The method has been around for years.

And even the paper of record, the New York Times, published a leaked document from the New York State Department of health concluding that horizontal drilling and hydraulic fracturing is safe. According to the Times:

‘The state’s Health Department found in an analysis it prepared early last year that the much-debated drilling technology known as hydrofracking could be conducted safely in New York, according to a copy obtained by The New York Times from an expert who did not believe it should be kept secret.’

Undoubtedly, this will not be enough to satisfy opponents. But we reckon that’s because for some of the opponents, the objections are not about the science – which is what it is – but about the idea of growth. That is, there are some people in the world who think the world is already too big, too industrial, and too dirty. They oppose new energy because it’s conflict with their view of how the world should be.

This is a very different kind of objection than people who are rightly concerned about water safety. But as we’ve said all along, that is an issue for the scientists and the health experts to resolve. And when they look at it objectively, without the green-coloured glasses of a radical, anti-growth philosophy, it’s just another way to extract energy that has to be managed properly to be safe.

In any event, we should probably stop trying to win, or even have this argument. You can’t argue with someone who’s coming from an orthodox position. So we won’t.

In the meantime, even though there are clearly great chances to cherry pick good stock stories, we can’t help but feel that this whole game is rigged. That may be an orthodox position itself. Or it may be grounded in the fact that the rules are constantly changing to favour certain interests.

For example, banks have managed to out-flank the global banking regulator to water down requirements for how many liquid assets they must hold. The Basel Committee for Banking Supervision proposed a Liquidity Coverage Ratio (LCR) that would require banks to hold enough liquid assets to cover all expected outflows over a 30-day period. It proposed that banks would have to meet this standard by 2015.

This was the key reform for preventing another GFC, according to the regulators. Banks would have to be more prudent in their risk management. They would not be able to put themselves in a position where they were unable to cover big losses by selling liquid assets. Their assets would have to be a lot more liquid. No single back could threaten the stability of the global financial system.

But according to Dow Jones Newswires, banks have watered down the original proposal significantly. They now only have to have an LCR of 60% by 2015. The full 100% liquidity buffer won’t be required until 2019. Bank of England Governor Mervyn King says that the phased introduction of the proposed regulation ‘will insure that the new liquidity standard will in no way hinder the ability of the global banking system to finance a recovery.’

Ah yes. Do you see what he did there? This delay gives banks permission to proceed with aggressive lending and balance sheet expansion. That’s the key to bank profits. Tighter liquidity standards limit bank profits. It’s no wonder the banks resisted them.

Under the new rules, banks will even be allowed to use stocks, corporate debt, and residential mortgage backed securities for up to 15% of their LCR. Never mind that those assets can all be illiquid in a crisis. We’re sure only the highest-quality assets will be counted.

This is the banks that own central banks making a back-door attempt to slowly reflate the global bubble. They can’t do that if their forced to own liquid assets. They must be allowed to reflate bubbles in exotic securities and high-risk investments. That’s what’s good for the banks. Of course, last time that didn’t turn out so well for everyone else.

Dan Denning,
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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3 years 9 months ago
Relaxation on a tightening on treatment of covered bonds was part of this global relaxation and implementation slowdown. This slowdown will only live for as long as market risk remains absent for banks. Trouble is that market risk now depends on sovereign risk and the Fed’s central charade that they are fixing things with liquidity and the ever expanding balance sheet – and that is now risk a plenty. And as if on queue …. displayed on Prudent Bear this week : “In a world of businessmen and financial intermediaries who aggressively seek profit, innovators will always outpace regulators;… Read more »
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