Coal Under Fire and Heat Leaves Aussie Housing Market

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It looks like a quite start to the week for the Aussie market. Stocks in New York closed down slightly on Friday. Gold was up a bit, the iron ore price fell, and oil fell too ahead of the ‘failure’ of talks in Doha over the weekend.

You might recall that the oil price spent most of last week rallying on the rumour that this meeting of oil-producing countries would result in an agreement to freeze output.

But the meeting failed to produce an outcome. According to the Financial Review, Saudi Arabia wouldn’t agree to anything unless Iran did too…and Iran wasn’t even there!

Talk about a poorly prepared meeting!

The outcome — or lack thereof — will likely see the oil price sell off again this week. That means it will head back into the US$30 a barrel range. That’s nothing to be overly concerned about though.

The important level to watch is the US$35 a barrel mark. That’s the low from early April. If the price holds above here, there’s a good chance that oil has bottomed.

Speaking of a bottom, I wonder if the worst is over for the coal industry. Last week, US coal giant Peabody Energy filed for bankruptcy protection. Bottoms are usually characterised by the failure of a major player in the industry.

In this case, it’s fair to say that Peabody is a major global coal player. While Peabody’s Australian operations are unaffected by the bankruptcy protection, it is partly responsible for the company’s problems.

In 2011, Peabody paid US$5.1 billion to buy Macarthur Coal. It was funded with debt, right at the height of the coal price boom.

The short story is that Peabody just had too much debt, and when the coal price fell it put too much pressure on the balance sheet. It’s the same old story. In every cycle you’ll see a company buying into growth using debt. The leverage works in the short term, but when the cycle turns it eventually crushes shareholders.

Is that the predicament facing Aussie property investors in the years to come?

As far as investors in apartments are concerned, it could well be. The cycle looks to have turned as a huge wave of supply hits the market. From today’s Financial Review:

Lawyers are sharpening their pencils before a rise in disputes between buyers and developers, as record numbers of off-the-plan apartments are due to settle in a slowing market. 

Arguments between off-the-plan buyers and developers due to differences in the final product and the expected purchase happen regularly. But an estimated 44,784 apartments are due for completion and settlement this calendar year across Sydney, Melbourne and Brisbane, up almost a quarter on last year. This is as values fall and lenders, pulling back on their exposure to the sector, are putting buyers under pressure to stump up more equity when they settle. The Reserve Bank of Australia is worried.’  

The big question is whether the weakness in the apartment market will translate into a weaker overall Australian housing market.

One company feeling the pinch is McGrath Ltd [ASX:MEA]. The predominantly Sydney based real estate agency listed on the stock market in December last year.

Having fallen 40% in less than five months, the shares are now in a trading halt, while McGrath prepares to update investors.

That update came this morning, and the news wasn’t good. The company now expects listings in north and northwest Sydney to be 25–30% lower than forecast. Apparently this weakness just materialised in the first half of April.

McGrath points the finger at a slowdown in Chinese buying. In its update, it blamed the slowdown in listings to a ‘continued reduction in Chinese buyer activity in the north western Sydney region.

Hmmm…maybe the tax office crackdown on illegal buying of established properties is having an impact?

McGrath’s poor performance since listing doesn’t necessarily mean the property market is in decline. But it does tell you the heat is well and truly out of the market.

Agents rely on turnover to generate sales commissions. A strong market encourages turnover and that flows into the pockets of agencies.

The performance of McGrath tells you that prices are no longer rising and, because of this, volumes are declining from last year’s peak levels.

This development bears close watching. The last thing the Australian economy needs right now is a housing-led slowdown. But I’m afraid that’s probably what it’s going to get.

The RBA engineered the land price and construction boom by sharply cutting interest rates from 2012–14. The plan was to offset the looming mining investment slump. It worked out…but perhaps a little too well.

While Australia’s economic growth through the transition period has been decent, the slump in mining investment still has a few years to run. If this plays out while housing construction growth begins to slow, as seems likely, there is a question mark over where the growth will come from.

Household consumption is the obvious choice. It’s by far the largest source of growth in the Australian economy and has been strong on the back of rising land prices. But if prices stop rising, or even fall somewhat, it will cause consumers to pull back, and the Aussie economy will weaken.

This might not sound like a big deal. After all, we’ve been managing in a weak economy for a number of years now. But, thanks to a big increase in debt, households are far more leveraged now. As you saw in the case of Peabody Energy, lots of debt and falling prices (equivalent to a slowdown in economic growth) isn’t a good combination.

Greg Canavan,
For The Daily Reckoning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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