Invitation to give a keynote address at an iron ore conference: $0.
Cab fare to the iron ore conference: $20.
$5,000,000,000 in market capitalisation lost in your own stock after you speak: Priceless.
BHP moves the market
Resource stocks and commodities led global declines on Tuesday night as all the China bears cited BHP’s comments on iron ore “flattening” as confirmation of everything they believe in.
But let me let you in on a little secret: neither BHP, Beijing nor the good Lord himself knows what Chinese steel production will be in 2020. Nobody has a crystal ball, particularly when it comes to commodity pricing.
The reason BHP ADRs (-3.3%) got hit harder than most is because global investors, reading a Bloomberg headline, correctly questioned, “Hey, if you are bearish on iron ore, why are you going ahead with record capex spend?”
I think BHP need to clarify their position because I actually don’t think their iron ore presentation was bearish at all (eg. a predicted iron ore floor price of $120 a tonne). The problem was the global financial press focused on one word and one word only – flattening – and that was the end of the story.
It’s not structural
It looks like a bubble, smells like a bubble, but it’s “structural” – really?
The biggest difference between my view and the Reserve Bank of Australia’s view is they believe flows into Australian bonds and the Australian dollar are structural, while I believe they are nothing more than cyclical. Yes, they are massive and unprecedented cyclical flows, but to believe they are structural (ie. permanent) and then set policy based on this is a huge error in my view.
The RBA seems to believe global bond and currency investors are giving a huge vote of confidence to Australian fiscal and monetary policy settings. In my view, that is total rubbish.
We are the only G20 nation in the world not trying to lower our currency, which is in turn interpreted as a ‘high dollar policy’, while our cash rates are the highest in the G20. Demand for Aussie dollars and Aussie-dollar bonds is driven by nothing more than interest rate differentials and our unwillingness to intervene in our currency.
Rates are the key
I will guarantee you that on the day the US Federal Reserve (or European Central Bank for that matter) raises interest rates in 2013, the fallacy of this demand for Aussie dollars Aussie-dollar bonds being structural will be exposed. We are simply the global high-yield parking lot, but when those interest rate differentials start narrowing, all this money parked in Australia will head for the exit and the Aussie dollar will be down around US95 cents.
The other question the RBA can’t answer, in fact they conveniently ignore it, is this: if the world is so bullish on Australia, why is our equity market one of the worst performing in the world?
Just so we are very clear, I believe the Australian dollar’s price has NOTHING to do with commodity demand. It’s got NOTHING to do with capex into WA. It is all about global interest rate differentials.
Rates and the Aussie will fall
But the good news is the central bank will be forced to cut cash rates shortly and they will disprove their own structural thesis. The consistently weak domestic data, combined with rising unemployment, low inflationary pressure, falling commodity prices, zero credit growth, falling property prices, weak retail sales and elevated wholesale bank funding costs, will force the RBA to start cutting cash rates again as soon as the April board meeting.
There is currently only a 22% chance of an April rate cut priced into debt markets, which means when the RBA does cut rates the very crowded long Aussie-dollar carry trade will get a surprise
My view remains that upside in Australian large-cap equities will be capped until we get physical confirmation of lower cash rates and a lower Australian dollar from the RBA. That day is not as far away as the consensus currently thinks.
Nothing about this is structural; nothing. It’s time to short the Aussie dollar before it destroys its own demand.
My best advice is to hedge the 2013 Colorado ski trip now.
IAG Convertible Preference Shares (IAGPC) – At a 4% margin, the price is right
IAG has launched a new convertible preference share (CPS) issue primarily to fund the redemption of the $350 million fixed-rate IAG Reset Preference Shares (IAGPA) in June.
The security structure is similar to that adopted on the recent Westpac CPS (WBCPC) and ANZ CPS3 (ANZPC) issues. IAGPC has one new feature called a Non-Viability Trigger Event. This is a more subjective test whereby conversion of IAGPC into IAG shares is required if APRA determines that IAG would become non-viable in the absence of conversion, or a public sector injection of capital.
The most comparable security to IAGPC is the IAG Reset Exchangeable Security (IANG), both with issue margins of 4% (reflecting the grossed-up value of franking). While the duration of IAGPC is up to 2.5 years shorter than IANG converted at the first optional exchange date, this benefit is neutralised through the time value of money of paying half-yearly dividends and the Non-Viability Trigger Event.
Overall we assess a fair value margin of 3.85% (same as IANG). This provides a 0.6% premium to the 3.25% WBCPC issue margin, reflecting the more volatile nature of insurance earnings.
Issue overview
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.