The ‘Explosive’ Risk to the Upside

The ‘Explosive’ Risk to the Upside

Nice. Very nice. That’s how I feel about the way the Aussie stock market is shaping up right now. It’s broken into a 10-year high this week.

If you’ve followed me for a while, you’ll know I’ve encouraged you to take advantage of any weakness and buy the dips. Can the bull keep running?

I think it can. That’s certainly a high probability, if the Australian Energy Market Operator (AEMO) knows what it’s talking about. The Australian reports this morning that AEMO’s latest report is calling an end to the Australian east coast gas problem.

That might be news to all the businessmen who’ve been bleeding from high costs over the last few years. But the AEMO is apparently saying a combination of new supply, renewable capacity and a Northern Territory pipeline will ease the pressure.

That could potentially show up in higher earnings on the stock market if gas prices do come down. That would be another lift for the Aussie market over the next year. We can only wait and see on that. But it’s potentially very good news.

Perhaps we can say the same about interest rates staying down in Australia. There’s a growing suggestion that the RBA won’t raise interest rates until 2020. That could ease fears that Australia’s indebted homeowners aren’t going to be choked from higher mortgage costs and help drive consumer spending.

The wildcard is always that the RBA doesn’t have as much control over funding costs for the banks as it likes to pretend. What happens in overseas credit markets matters.

But there’s no sign of major trouble on this front, either. In fact, if you strip out the trade war rhetoric, we have a pretty good outlook, if you ask me.

Where I have been slightly off base lately is expecting the Aussie dollar to hold up. So far, it’s kept slipping down. That’s good news for any company with US dollar-based earnings, of course, but it’s not helping any of us when we fill up the car each week.

I would never presume to call a ‘bottom’ in any market. They can always go far lower than any of us expect. But because I see such a bright outlook for commodities, I do wonder if the Aussie dollar might rebound sooner than you might think.

I did get a bit of support for this idea yesterday. I was on the phone with hedge fund legend Jim Rogers. We had a bit of a chat about it.

Part of the conversation was Jim telling me that he’s still holding a large chunk of US dollars for his own portfolio. But he was open to the idea that the Aussie dollar could show relative strength against the US dollar compared to a lot of other currencies.

One wonders if other institutional money managers based overseas are wondering the same thing. It could drive a lot of international buying of Aussie stocks.

Australia is largely a commodity play, as far as the rest of the world is concerned. If I’m right that we’re on the cusp of another major commodity rally, then the ASX and the Australian dollar could surely catch a strong bid.

The central bankers of the world might want to pay attention. They keep wandering around the world, wondering what happened to inflation. It’s still below their targets.

They should be careful what they wish for. The dynamics at play in the commodity space could see much higher prices break out at some point in the near future.

Look no further than the oil market. The head of one of the largest producers in the Permian Basin has just said the region will have to shut down wells because the pipelines to get the oil to market are full. Production could stay flat for a year while more capacity comes online.

Granted, there are other shale regions in the US. But the ‘Tier 1’ locations are less abundant outside the Permian. That means the world may need a lot more supply from outside the US.

That’s not so easy. For example, Libya’s main storage port has spent this week partly on fire after it was deliberately set alight. And we have Venezuela collapsing as a society.

That leaves the burden on Saudi Arabia and Russia.

Not so fast, though. Hedge fund specialist Pierre Andurand is warning them about capping the upside of oil too fast by bringing in new supply. That’s because it could leave them with no spare capacity whatsoever.

He told the Financial Times:This is a recipe for explosive price action to the upside.

I agree.


Callum Newman Signature

Callum Newman,
Editor, The Daily Reckoning Australia