Data Diary

Australia’s current account – recycling the trade surplus

Posted on 3 September 2010 | No responses

The release of the latest current account data by the ABS (here) was met within universal approval.  It’s not hard to see why – a bumper trade surplus has Australia within sight of the other side of the ledger:

Here we have the current account deficit pulling back under $5bn for the first time in the better part of a decade – driven by exports of coal, iron ore and all sorts of resource rich items. Of course, that worrisome red worm (generically ‘capital flows’) is the one that is denying Australia the current account surplus we so richly deserve. This is the fat finger of our foreign debt burden coming back at us.

It’s an issue of ‘banana republic’ proportions that is likely to resurface if our trading partners decide to throttle back on the imports.

As we discussed back in June (here), our net foreign debt to GDP puts us amongst some awkward company. While that is not the same as saying we have reached our credit limit, it does suggest that our sensitivity to global risk premiums is high. It also hints at how the market might come to view our lucky country economy if things go pear-shaped in China.

Looking at the growth in debt to GDP slightly differently consider the following chart:

Now remembering that GDP is the sum of consumption, investment, government spending, and the trade balance (C+I+G+X-M) then this chart raises the obvious question as to where did all that debt go?  There seems to have been a leak somewhere as GDP growth trailed behind that of debt.

The answer lies in the definition of ‘investment’.  It doesn’t include the acquisition of pre-existing or ‘secondary’ assets.  If we borrow $100,000 to buy an established house, this investment in isolation does not make it into the GDP figures.  Mind you, it’s likely that some of the new debt will flow through to GDP – the person who sells the property spends some of their winnings on consumption, those good souls who earn a clip off the ticket can afford to pay themselves, and the banks can take their interest margin etc.  The point is the increase in debt will be greater than the GDP effect.

Given our housing habit has been the key driver of our demand for foreign debt, we can surmise that the ‘leak’ has been house prices. Access to debt has enabled our market to bid up established house prices ahead of the growth in our income.  GDP lags growth in debt – and in house prices.

Here we get to the sting in the tail.

Our debt may be swapped back into Aussie dollars (a very good thing – it’s analogous to borrowing in your own currency), but it is still a fixed term liability. Repay, rollover or default – those are our options.

If we choose to repay – that is, join the global trend to deleveraging – then, there this will drag on GDP.  If consumers increase their savings rate, either the government steps into the breach, or GDP must retrench. This is the problem currently facing the US economy. At least we have the luxury of a trade surplus.

Rolling over the debt until wage inflation catches up looks mighty appealing in this context.  Still there is that refinancing hump that is facing our banks in 2011/12.  Let’s hope that China is still the bull at the mine-gate come maturity.

Gold to base metals ratio – why is it low?

Posted on 2 September 2010 | No responses

One further thought following on from our previous post (here) – if the RBA Commodity price index is at record highs, why is it then that industrial metals are trading historically cheap relative to gold?

Perhaps it is a reflection of the uncertainty that prevails across the markets.  There has been enough talk about the debasement of paper money to suggest that some are buying gold as an alternate currency.  Also, with the ZIRP in place across most of the developed world, the negative carry of holding gold has fallen appreciably.  Still the point remains, if fundamental demand for metals is so strong, why is the base metals to gold ratio at levels not seen since the start of the Great Moderation?

RBA commodity price index – back to its highs

Posted on 2 September 2010 | 1 response

The good news keeps on coming – the RBA released its commodity price index yesterday (here):

And from the RBA:

Over the past year, the index has risen 53 per cent in SDR terms. Much of this rise has been due to increases in iron ore, coking coal and thermal coal export prices, although all components of the index increased over this period. With the appreciation of the exchange rate over the year, the index rose by 38 per cent in Australian dollar terms.

The miracle growth in China’s economy has treated Australia well.  Of course, while the prices for Australia’s export commodities are back to their highs by the RBA’s reckoning, our equity market remains well below its peak:

The fact is – risk appetite is just not what it once was. Without the bottomless credit-creation cup, the leveraged risk taker has vanished. Risk premiums have risen pretty much across the board.  Assuming all else were constant, this in itself could go a long way to explaining why the All Ordinaries remains ~33% off its peak.

But all else ain’t constant. Credit was all pervasive prior to the GFC. The end of the developed world’s thirst for leveraged consumption has also strangled the West’s nuts-and-bolts economies. Structurally higher levels of unemployment, declining house prices, and recurrent concerns about the strength of government finances continue to undermine the developed world’s economic growth.  Under the new world order, uncertainty lauds it over those willing to push out the risk curve.

History would suggest that once started, the impulse to deleverage is difficult to stop.  A balance sheet recession requires the debt to be overcome. This will take time.

Which perhaps is the key point – leverage will continue to fall – at the very least in relative terms (relative to incomes, GDP, however you think about it).

In this less-liquid environment, the macro trade dominates. We get a couple of optimistically spun data points, the risk markets rally. Funds flow out of perceived safe havens and up the risk curve.  A bad data grab will send the flows into reverse.  Sentiment, and the stop loss mentality that comes with it, drives short term market direction.

In this context, China has been swimming hard against the tide.  The fact that it has maintained ~10% GDP growth rates is a testament to its willingness to borrow against future demand for its goods – most hopefully from the emerging Chinese consumer, less so from the Western world. Capital investment has been a key pillar of this growth strategy – and hence Australia’s resources have been in hot demand.

The question is then how long can China continue to hold out against the currents?  There are some pretty deep pockets betting that it will succumb sooner rather than later. Still, as the longevity of the credit boom showed, unsustainable circumstances can be sustained for an unreasonably long time.  Till then the Australian trade balance will shine.

Australian July credit – last true believer buys another house

Posted on 1 September 2010 | No responses

RBA financial aggregates for July were released yesterday (here) – in brief:

• Housing credit increased by 0.5 per cent over July. Over the year to July, housing credit rose by 8.1 per cent.
• Other personal credit was flat over July. Over the year to July, other personal credit increased by 3.2 per cent.
• Business credit fell by 0.4 per cent over July. Over the year to July, business credit declined by 5.0 per cent.

To throw a little shawl around these statistics, the following chart provides a longer term context:

Business continues to paydown debt – even in the face of the rising tide of capital investment in the resources sector.  At the same time, leverage in relation to housing remains surprisingly strong.  To get a sense of how the Australian household wallet is evolving consider the following chart:

I may be suffering from selection bias here – after all, housing credit is still growing at an annualised rate of ~8% – but it looks to me like the trend for growth in housing debt is down.

So how is this credit demand flowing into the money creation machine?  Looking to M3 – the squeeze on money supply growth is continuing:

It’s a less than glowing endorsement for the demand side of the domestic economy.  Its interesting then to consider what the increasing preference for term deposits means for the velocity of money and risk preferences in the Australian economy.

So while term deposits reached a minimum of 23% of M3 in late 2007, they have now risen to ~33%.  Wonder whether they could revisit the 40% levels last seen in the mid-90′s?

Australian building approvals for July 2010 – momentum to the upside

Posted on 1 September 2010 | 2 responses

Australian building approvals data for July released by the ABS yesterday (here).

ABS Building Approvals show that the total number of dwellings approved rose in July 2010 following falls in the previous three months in seasonally adjusted terms.  According to the ABS, New South Wales (9.7%), Victoria (12.1%), South Australia (8.3%) and Tasmania (4.4%) recorded more dwelling approvals this month, while Queensland (-18.3%) and Western Australia (-4.9%) recorded less dwelling approvals in seasonally adjusted terms.

Our approach is to remove the seasonality bias by reviewing data on a 12 month rolling basis.  In this context, building approvals for new dwellings continued to rise in July but look to be peaking as the rate of expansion slows:

This is consistent with recent home lending data (here) and the liklihood that the demand/supply situation looks to be broadly in balance around ~170,000 new dwellings per annum (see here for background):

One further development that is notable is the changing nature of new dwellings.  The following chart maps the ratio on new houses to new units across the last 30 years.  We can clearly see the distorting effect of the recent first home buyers assistance:

Couple high house price to income levels with the baby boomers vacating their nests over the coming years, and think we can expect this ratio to plum new depths.

Letting go of the carry trade

Posted on 23 August 2010 | No responses

Leverage, like many of our hedonistic pleasures, can be a pernicious addiction.  With the benefit of hindsight the Great Moderation that met it’s demise with the onset of the GFC was as much a product of consistently rising debt levels as any other variable.  It has left the majority of the developed world with ‘too much of a good thing’.  For the system to reboot, leverage needs to retrench one way or another.

The carry trade has been a longstanding pillar in the creation and recycling of leverage through the global economy. So it’s a good place to explore how leverage is evolving in our post GFC economy.

The carry trade during the credit boom

Consider the following chart of some prominent carry trade pairs across the last decade:

While the AUD tends to be a high yielding currency against all-comers, in a relative sense the AUDUSD will more closely track demand in the commodities that Australia exports (that are generally priced in USD) than its counterpart AUDJPY. It’s notable then that across the entire period between the bursting of the tech bubble and the GFC, AUDJPY traded at a premium to AUDUSD. This outperformance is remarkable in the context that commodities were the beneficiary of strongly growing demand across this same period.

This relationship came to an end during the mass liquidation of 2008 – since that time, the AUDUSD has outperformed the carry trade driven AUDJPY.

The carry trade post-GFC

But like any good drug, leverage is proving hard to give up.  Witness how the recent attempts by the Fed and its compadres to resurrect the liquidity party have flowed through to these same currency pairs:

While the Fed’s quantitative easing program was in full swing, the AUDJPY once again outperformed its commodity linked peer, the AUDUSD. Note that within this microsm of government fuelled liquidity, China undertook its own massive stimulus package that encouraged stockpiling of commodities on a grand scale.  Still the AUDUSD played second fiddle.

So we come to more recent events.  Government stimulus has receded as a primal mover in fund flows.  Leading indicators are tipping over.  Risk markets are on edge.  And once again, AUDUSD has taken the lead over AUDJPY. Liquidity as a function of the carry trade is on a ebb.

Without the carry trade, fundamentals matter

In this environment, the macro trade dominates – the fundamental view determines the flows. Perhaps the decline in EURJPY in this post GFC environment is a sign of what the world might look like without the carry trade. It may be the precursor to the next round of deleveraging. Less vicious than the forced selling of GFC part 1 – but perhaps as difficult nonetheless.  We’re watching the AUDUSD closely for a lead.

Australia’s election result

Posted on 23 August 2010 | 2 responses

A hung parliament.

Is that a gallows metaphor?  Is it equine in origin?  Or is something that you do to dead meat?

Either which way, sounds like we could be headed for the abbatoir.

One intriguing development from the Australian election is that the Greens polled over 10% of the primary votes.  They will not only have the balance of power in the upper house, Labor needs their support to form a minority government (assuming Labor can get there – which is no certainty).  It’s as if Australia has taken a large step towards the European political balance (and away from the US model).

This is not a bad thing if the Greens get it right.  For example, it is likely that sometime in the not-too-distant-future the government will be called upon to spend large sums to support the domestic economy.  If we are going to have a whole lot of new roads, bridges and housing developments, then having them built with an eye to how it impacts our longer term living standards has got to be a good thing.

The rise of the Greens in Australia as indicative of more than impatience with the major parties.  For the first time since Thatcherism and Reagonomics were in vogue, the electorate has signalled that the myopic short-termism that has become entangled with free-market politics is on the nose.

Chinese growth hormones and other performance enhancers

Posted on 20 August 2010 | No responses

Australian equities have benefited from two major trends over the last couple of decades (casting aside the credit bubble on the grounds that it hurt).  They are 1) the growth in our compulsory superannuation investment pool and 2) the growth in China’s demand for all things resources.  It’s interesting then to compare and contrast the relative contributions of the finance and resources sector to our national wealth.

If there was any doubt about the importance of the umbilical cord between Australia and China, the following chart mapping the relative performance of some of the world’s stockmarkets bears this out:

Australia’s economy, that was being at risk of being left behind in the sandpit in 2000, has ridden the China bull all the way to the bank. We can see the importance of the resources sector in driving this performance in a comparison of the materials to the financial sector over the same period:

The sucking sound emanating from the financial sector is profoundly disturbing.  Remember that over the same period our pension savings pool rose from ~$500bn to ~$1,500bn, and our household debt climbed from $350bn to $1,250bn currently!

One more perspective on this – consider the following chart from the ASX (here) that gives a breakdown of market capitalisation by sector in 1989 and 1999:

In the midst of the Asian crisis, admittedly as a swathe of Australia’s mining sector was being repossessed and the average return on shareholders equity was just north of zero, the market capitalisation of the sector was ~$100bn in comparison to ~$200bn for the finance sector.  Fast forward to today, and the financial sector is around $425bn versus a resources sector closer to $400bn.

With the Australian economy at best stalling, hope our surrogate continues to take their vitamins.

Smoke signals from the Fed – ‘send more paramedics’

Posted on 19 August 2010 | No responses

Hardly a vote of confidence in the recovery this return to quantitative easing – even if it is balance sheet neutral. Apparently, liquidity remains fragile.

Consider where the CBOE put-call ratio was at the start of quantitative easing proper – when global liquidity was truly in a catatonic state:

While the ebullience that marked the first half of the year has subsided somewhat, current conditions are hardly indicative of an all-out squeeze.  It’s also interesting is that looking to the breakdown of the ratio, the volume in both puts and calls has fallen to levels not seen since Dick Fuld had the keys to the gym.

My sense is that it is wishful thinking to imagine that we have passed beyond the volatility that has characterised the last couple of years.  Maybe fatigue is setting in – people have just lost interest?  More likely we are passing through the end of one cycle and into another.  The government inspired rally in risk expired some months ago, until the next round of stimulus money gets put to work, the pull of debt deflation will have its way. No wonder Treasuries have been pushing to new lows – even dragging lesser credits in their wake:

Chances are that the risk curve will splinter once the motivation for the move in long yields is recognised.  A balance sheet recession is not good for anything but the most pristine of safe havens.  Volatility is cheap around current levels…it’s just a matter of theta.

Australian unemployment –

Posted on 18 August 2010 | No responses

Suffering from bandwidth constraints hence the brevity of posts – but still let’s introduce a couple of charts on Australian labour force, for example headline unemployment:

Now given the mix of employment growth over the last decade (construction, services and retail with mining contributing strongly recently), the auspices suggest that the best of the unemployment numbers are behind us.

Which, given that CPI has been scraping along the bottom for a league or two, suggests that the best of days for the misery index are behind us:

For the uninitiated, the Misery Index  is simply the unemployment rate plus the inflation rate.  I’m yet to find raw long term data for Australia, but here’s the US experience (US data here) with the S&P500 in log form as an overlay:

Or to view it a little differently, following is the misery index with the performance of the S&P500 mapped as the percentage change in the last 12 months average against the next 12 months average.  A cursory glance suggests that if you get your timing right on the misery index peaking, the next 12 month return is pretty attractive.  We might come back to this….

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