Rising Resource Prices Keeping Aussie Economy Afloat

We have good news for Australia. Earnings are going up for some companies! Rising resource prices for tangibles like coal, iron ore, and gold should continue to generate earnings growth for Aussie exporters. It's true that energy costs are rising for Aussie producers and the strong local dollar puts a dent in earnings.

When you get right down to it, though, the resource sector has a much better chance to grow earnings this year and next than the financial sector. The resource boom is, "generating an enormous amount of income for the Australian economy and it is not obvious that it is going away any time soon," Reserve Bank governor Warwick Mckibbin told David Uren in today's Australian.

Treasury economist David Gruen agrees. He points to the larger contributions to global growth from countries like China, India, Brazil, and Russia. "At this stage, there is every indication that this pattern of relative contributions to world growth will be repeated in 2008."

The big drivers are agricultural exports (recovering from the drought) and mineral and energy exports, driven by Asian growth and high global energy prices. The charts below from ABARE show the total dollar value of select Aussie exports to various countries in 1996-1997 (the grey line) and 2006-2007 (the orange line).

Gold to India, iron ore to China, aluminium and thermal coal for power to Japan. What's not to like about that earnings picture? Lucky country indeed.

Barring a total collapse in resource prices-something we addressed earlier this week-we agree with the basic thesis that these sectors and these mineral, energy, and farm exports will drive earnings growth in the resource sector. But what we're after is what to do about it.

Deeds, not words!

We feel more optimistic about the smaller resource stocks in the market that we have at any time since we moved to Melbourne in 2005. The combination of bad news at Opes and the gloomy outlook from Bernanke makes for a lot of negative sentiment and frankly, despondence, hopelessness, despair and (if we're really lucky) capitulation. That's perfect.

Not that we are taking pleasure in other people's misfortune. But this really is the time when you want to be a buyer: when other investors must sell. You have a relatively positive earnings outlook for select commodities (especially energy and energy alternatives). And you have an open playing field, where most investors have fled to cash and blue chips. You also have a lot of forced selling (see Opes note below).

The risk is obvious. Markets as a whole could go down. But as we've learned, even in down markets, companies that grow earnings tend to do well. Going against the earnings trend isn't easy. But it does happen.

We've acquired a new research tool at the Old Hat Factory and have been putting it through its paces to prove the point to you. We asked Gabriel to run a simple report on the best performing ASX-listed shares over the last 52 weeks with a market capitalisation over A$100 million.

We excluded the micro-caps not because we don't love them (they were, in fact, our first love in 1998 when we ran a Penny Stock Tip sheet in America), but because we wanted to prove that you can still make money in stocks even if you aren't trading illiquid penny dreadfulls.

Top Performing ASX shares with a mcap of A$100m or better in the last 52-weeks

Forget Macquarie Bank. The real millionaire factory in Australia is resource prices, West Australia and all that gold, iron ore, and uranium!

"Minemakers is a little explorer, mostly a mine developer," Diggers and Drillers editor Al Robinson said as we hunched over the desk, scanning the results for a little penny stock gold." It's also a phosphorous play. Phosophorous prices are way up with global fertilizer prices. Yeah... that's a good little story. Lots of earnings potential."

You'll see a lot of other miners on the list. There's one share tip from the Australian Small Cap Investigator on the list. We aren't saying which one, out of respect for paid up subscribers.

We will tell you it has something to do with coal, which has lately been in the news owing to the fact that Australia gets 80% of its electric power from coal and that oil is still above US$100 and looking like it will stay there for quite some time.

You also have a few iron ore plays on the list. Mount Gibson jumps out because just this week Australia's Takeovers panel quashed an attempted takeover of the company due to what the panel said were, "unacceptable circumstances."

Chinese steel-maker Shougang loses out on the decision. But the panel is not trying to discourage Chinese companies from investing directly in Australian companies. In this particular case, Shougang already owned a sizable position in Mount Gibson due to its stake in Hong Kong-based APAC Resources Ltd. which owns 20.2% of Mount Gibson's shares.

Under Australian law, a shareholder must make a formal takeover bid once it acquires more than 19.9% of a target's shares. Shougang already had a 9.3% stake in Mount Gibson, courtesy of a January deal with Russia's Gasmetal Holdings Ltd. Shougang's association with APAC would have given it a back-door holding larger than 19.9% in Mount Gibson, triggering the necessity for a takeover bid.

So this bid didn't go through. But don't expect it to be the last. Sinosteel is still pursuing the first ever hostile Chinese bid for an Aussie company with its $1.2 billion offer for Midwest. And keep in mind that Mount Gibson produces a small amount of ore, just six million tons (compared to 120 million for Rio Tinto).

The desire by Chinese steel markers for Aussie ore is a long-lasting one. It should animate the juniors in the iron ore sector for the next few years. There are lots of good trades and investments to be made. And not just iron ore, but coal, bauxite (for alumina and aluminium), and other Aussie minerals. It will be a good time to own tangible assets, or the shares in takeover targets.

By the way, we'll keep playing with our new research tool and let you know what we find as we find it.

Finally, we don't have anything to ad to the Opes story that you can't read in the other papers. It's shocking, though, that's for sure. Today's Financial Review reports that the liquidation of the Opes' $1.2 billion portfolio has affected almost one quarter of the stocks listed on the Australian Stock Exchange.

"Australia and New Zealand Group is already almost a third of the way through its sell-off of 677 different securities, including shares, options, and warrants in 579 companies ranging from blue chips to market minnows."

The legal system is firing up, with Opes client's seeking to block the sale of their share portfolios. These investors are challenging whether ANZ and Merrill Lynch actually own the shares. At least five companies went into trading halts yesterday as ambiguity over who owns big blocks of their shares set in.

What a mess. Word for the week: transparency. Earnings transparency this year will come from companies with real assets on the balance sheet and rising prices for those assets. Yes, it sounds so simple a fifth grader could figure it out. But right now, keeping it simple-in a world of complex financial instruments-is not a bad strategy.

Dan Denning
The Daily Reckoning Australia

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