Steen's Chronicle: Australia - the opportunity of the decade?

Australia editorial I wrote for Saxo Capital Markets in Sydney…

Steen's Chronicle: Australia – the opportunity of the decade?

• Australia remains its own worst enemy
• The perfect storm over emerging markets and China is about to lift
• Gold and soon A$ offer cheap value and long-term opportunity

 

By Steen Jakobsen

I love coming to Australia but I'm afraid the "love" is not mutual – for many years I have been the impolite guest who dared to point out that reality is around the corner for the "lucky ones".

 

The reality being that an economy can't grow from unproductive investment into real estate, banking and the service industry, which has been Australia's response to the collapse in mining investment and growth.

Now fast forward to end of 2015 and Australia is flirting dangerously with recession as Q2-2015 GDP QoQ printed a weak +0.2% QoQ only avoiding a negative number due to an increase in government spending of +2.2%. 

To illustrate how weak a +0,2% GDP number is it's important to understand that technically, Australia has difficulties going into recession as the demographics component rises +1.5% due to strong population growth. (Source: Macroeconomics.com)

I remain deeply sceptical of Australia's own ability to renew and reform but think that global macro trends will finally enforce the much needed changes to the Australian "one trick pony economy".

Australia remains a political mess with no accountability even within any of the political parties. The cost of doing business in Australia relatively high as unions, arcane labour market laws and little flexibility on the regulatory side makes Australia highly expensive to operate in. The collapse in mining investments was there for everyone to see, but no one from the policy side reacted and worse they even incentivised investors and savers to go long more speculative real estate to replace the lost growth.

I will argue Australia has resigned to accept that the future of Australia is in the hands of the global macro trends, a sad result, as Australia is one country which could design and dictate its own future.

Australia, you have everything: resources, landmass, smart people and demographics. You need to set up a more ambitious agenda and accept that reform and change is the way forward.
The best way to illustrate the uphill struggle for Australia is to look at Australia's terms-of-trade – the price of goods between Australia and its trading partners:

The below chart is from Wall Street Journal:

 

The terms of trade have collapsed more than 30% since the commodity cycle peaked in 2010/11 and like the rest of the world the "deficit" in GDP growth has been filled by expanding the credit in the case of Australia from households significantly.

Australia and its currency AUD is an excellent proxy for world growth – being long the AUD you are long: China, world growth, iron ore, agriculture, metals and short the USD – the exact things I want to be long right now.

The last few quarters of macro trends has been a perfect storm for emerging markets and Australia but the help is around the corner in my opinion: The storm was started by the fact that global debt since the Great Financial Crisis has increased by 57 trillion US dollars (Source: McKinsey report: Debt and not so much deleveraging) or an increase in debt to GDP globally by 17% to 286% on average!

In other words, the slight growth experienced since the GFC is and has almost entirely been financed through extending more cheap credit. Half of the $57bn of new debt was originated by Australia's major trading partners: Emerging markets and China. They funded their deficits and negative capital flows by going to the US capital market and raising USD debt. This worked smartly as long as interest rates were "low for longer…." and the USD remained cheap. But when the dollar started appreciating the problems began to show:

 

• A strong dollar reduces the demand for commodities, increasing the capital needed to finance emerging market economies, which then import less capital goods and other commodities reducing the exports from developed markets like the US, Europe and Australia.

• No-one benefits from a stronger USD in a global economy where money is based on a FIAT money system, financed in USD, with USD reserves and USD as the transaction currency for most goods traded! Welcome perfect storm!

Australia has everything – resources, landmass, smart people and demographics. 

But reform is essential. Photo: iStock

 

However there is a silver lining: By definition the path of least resistance for higher growth then becomes a cheaper USD! Something which I think will start to happen especially now that Federal Reserve managed to lose the little credibility it had left post its non-hike in September.

Fed windows on hiking rates is closing: US growth remains disappointing, China and world growth keep going down, lower commodity prices is lowering inflation which means that going into October there is my estimation equal chances of the Fed's next move being a hike as being a cut in rates (quantitative easing mark 4!). This a dramatic change since this summer, but also something which could save Australia from the abyss of recession.

Saxo Capital Markets main scenario for balance of 2015 and into 2016 is this:

•  Fed will not hike in 2015. We'll see a weaker USD. 

• Gold (& silver) will be the best performing asset class into the end of Q1-2016. SCM sees gold in 1400/1450 by end of Q1-2016.

• AUDUSD is a buy below 0.7000 – SCM estimates the long-term rate needed to support the Australian economy is approximately 0.8000

•  Mining and metal companies are trading at a deep discounts and emerging markets are the only place in the equity space where you can find both fundamental value and opportunistic plays. Of course going long emerging markets here needs to be selective and with tight stops but the value is immense.

• China will continue to weaken on top-line growth, but everyone I talk to in shipping insists that freight going to China remains high, indicating a potential for a positive surprise story on China at the end of 2015. Don't forget China started cutting rates in late Q1 and the normal lead-lag time on monetary policy into the economy is six to nine months and finally, no one it pricing the incoming Silk Road plan properly.

 

I have personally moved 20% of my assets into gold-related investments and I will begin to increase my exposure to both the AUD itself and the mining sector in Australia over the next few months – the macro case is there:

The market is oversimplifying China risk and underestimating what the Silk Road will mean combined with a highly likely additional global easing coming from European Central Bank and the Bank of Japan certainly but also increasingly likely from the Fed (Q4).

Now I need the price action to confirm the view.

I'm the most optimistic I have been on Australia in the last decade but for one reason only: It can't get much worse!

Safe travels,

Steen Jakobsen, Chief Economist & Chief Investment Officer, Saxo Capital Markets.

 

– Edited by Clare MacCarthy

 

 

Med venlig hilsen  |  Best regards
Steen Jakobsen  |  Chief Investment Officer

 

Saxo Bank A/S  |  Philip Heymans Allé 15  |  DK-2900 Hellerup
Phone: +45 39 77 40 00  |  Direct: +45 39 77 62 23  |  Mobile: +45 51 54 50 00

 

Research: http://www.tradingfloor.com/traders/steen-jakobsen

Please visit our website at www.saxobank.com

 

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FED comment: Big loss for FED and a big win for volatility

 

Conclusion: Very dovish & "guidance" is now a total joke.

 

New excuses: Global trade incl. reference to China & emerging markets, but expecting China or EM to improve btw now and next meeting is pure fantasy!

 

Economic projection: Lower dots incl. negative yield from one FOMC member.

 

 

Yellen is not only losing the market but also her boardroom - her Q&A was far from impressive and reeked from "class room" teaching and far from reality of negative impact of zero-bound.

 

I fear FED's window on hiking is closing and fast - this will create furthe uncertainty with several market players already putting odds of Fed hiking and cutting 50/50!

 

FED clearly have failed to provide consistent guidance and the "success" of the labor market is about to change negatively as this "pretend-and-extend" increases volatility and uncertainty.

 

Into closing market is:

 

Stocks: Small down

FX:  US$ much weaker

Gold: Much higher...

 

I remain w. rest of 2015 being a theme of:

 

·       Weaker US$, higher gold, and now preparing for recession by Q1-2016 in the US.

 

·       Stocks: In doubt - we took out double top at 1997 in S&P-futures but closed below - "positive" incl. chances of global easing (-...if it works for assets, which I doubt" )

 

·       "negative" - clearly no topline growth, and PLENTY of volatiity into both October and year-end.

 

Bad performance & night for FED.

 

Attached:

 

2 Yrs notes – massive move..

 

 

 

BN) Yellen Decision to Delay Fed Liftoff Points to Global Risks

(1)

 

+------------------------------------------------------------------------------+

 

Yellen Decision to Delay Fed Liftoff Points to Global Risks (1)

2015-09-17 19:55:23.598 GMT

 

 

     (Updates to add graphic.)

 

By Craig Torres

     (Bloomberg) -- The Federal Reserve kept its policy interest rate unchanged, showing reluctance to end an era of record monetary stimulus in a time of market turmoil, rising international risks and slow inflation at home.

     "Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term," the Fed said in its statement.

     Thursday's action signified more than anything the committee's uncertainty about how global events, such as the slowdown in China, translate into their outlook for U.S. growth.

 

                      'Tactical Delay'

 

     "Discretion is the better part of valor," Ethan Harris, co- head of global economic research at Bank of America Corp. in New York, wrote in an e-mail. The move is a "tactical delay" to gather more information on risks to the forecast, and "as the labor market recovery rolls along, and with capital markets already showing signs of calm, the pressure on the Fed to hike will build at each meeting going forward."

     The decision featured the first dissent this year by Richmond Fed President Jeffrey Lacker as policy makers faced one of the toughest decisions of Chair Janet Yellen's leadership of the Federal Open Market Committee. 

 

                        Yellen 'Put'

 

     It also bears its own set of risks, such as the perception of a "Yellen put," or the view that market volatility could stay the Fed's decision again.

     "They put more emphasis on things that could go wrong than things that are going right," Harm Bandholz, chief U.S.

economist at UniCredit Bank AG in New York, said before the decision.

     The U.S. economy is posting steady job gains and solid household spending. Fed officials, anxious not to tighten policy prematurely and risk having to reverse course and cut rates back to zero, weighed solid domestic fundamentals against uncertainties about the international outlook.

     "The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced but is monitoring developments abroad," the statement said.

 

                      Global Developments

 

     Slowing growth in China has rippled across the world, hitting commodity-producing countries hard. The MSCI Emerging Markets Index, which captures stock markets in nations such as Brazil, Chile, Egypt and China, is down 14 percent this year.

     "The outlook for the global economy is being marked down and that is why markets are reacting," Laura Rosner, U.S.

economist at BNP Paribas, said before the decision. Market developments are giving policy makers "fundamental, new and real-time information," the former New York Fed staff analyst said.

     Domestically, Fed officials are also grappling with an inflation rate that remains too low, rising just 0.3 percent for the 12 months ended July, according to the personal consumption expenditures price index, the Fed's preferred measure.

     "The case for not going is that the inflation picture is still extremely murky, especially in light of developments in China," Ward McCarthy, chief financial economist at Jefferies LLC in New York, said before the decision.

     The PCE index has run below the Fed's 2 percent target for more than three years. "They need to clarify" their inflation target strategy, McCarthy added.

     Officials Thursday said they don't expect to attain their 2 percent goal until 2018, according to policy makers' median forecast.

 

 

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Macro Digest: Global recycling of capital has come to full stop!

 

 

This morning I will follow up on my theory of US$ leading all cycles, which many people have objected to on Tweeter and understandably so, as it entails actually understanding and educating yourself – something which generation of day traders have happily ignored since the GFC.

 

When productivity is collapsing…. As it is…. Flat for both 2013 and 2014 the only way to keep the massive debt financed is through lower yield or expansion of monetary base…..

 

 

Reference:

 

McKinsey report: Net new debt issued since GFC: 57 trillion US$

 

 

The US$ based/linked economy – where "path of least resistance" remains a weaker US$

 

 

So world is issuing more and debt at lower and lower yield in order to pretend-and-extend – that worked until US$ - the currency denominator got too strong &……..Recycling stopped:

 

Here is the new charts:

 

 

This is Global Reserves (YoY%) vs. S&P-500 (Yoy%) – World reserves has dropped close to 5% - (5% less recycling)

 

Meanwhile the day traders believe more QE as promised by Draghi yesterday will help and save the day, but…. But….

 

 

Pretend-and-extend to infinity => stronger US$ = lower commodity prices = less recycling= higher marginal cost of capital = lower EM growth = less export and more deflation? Don't believe then take a look at these indicators since US started QE!

 

That's the theoretical argument, which few of you accept, or rather like.. but here is facts (which of cause is irrelevant…these days)

 

Central banks' balance expansion incl. Japan and ECB is flat YoY…….w. BOJ + ECB expected to do more later in year….

 

 

 

 

 

Conclusion:

 

The micro structure of capital markets have changed – forever – the combined lower energy prices + China slow-down + lack of productivity + pretend-and-extend + QE and strong US$ have forced the market into higher volatility, less leverage, US$ dependence and lower growth as capital consumption is tax on future growth…..It's time to get a new playbook which is more flexible, accepts two way directions and a move towards investment in productivity and education the only two things which can break the negative circle…

 

Safe travels ,

 

Med venlig hilsen  |  Best regards
Steen Jakobsen  |  Chief Investment Officer

 

Saxo Bank A/S  |  Philip Heymans Allé 15  |  DK-2900 Hellerup
Phone: +45 39 77 40 00  |  Direct: +45 39 77 62 23  |  Mobile: +45 51 54 50 00

 

Research: http://www.tradingfloor.com/traders/steen-jakobsen

Please visit our website at www.saxobank.com

 

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Editorial: The costs and benefits of lifting sanctions against Iran

Dear All,

I'm in no way a Iran scholar, but I was kindly asked my Middle East publication to 'think about" Iran and its impact on the region after deal with the US. The below is my submitted answer and does in no ways reflect thinking I have an answer to the full impact. Clearly Iran's role is "path dependent" – ie. it can go in many direction – with that disclaimer out of the way – safe travels,

 

The costs and benefits of lifting sanctions against Iran

• Deal to lift sanctions against Iran drawing nearer
• Oil price likely to recover into the second half of 2016
• Post-sanctions growth in Iran will boost the whole region

 

Iran's oil industry and its economy as a whole have been crippled by the sanctions 

imposed in 2012, but this era may be drawing to a close. Photo: iStock

 

By Steen Jakobsen

 

"A drowning man is not troubled by rain" — Iranian proverb

 

This proverb captures why Iran and the US were and are almost desperate to strike a deal to lift Iranian sanctions.

 

For Iran, the harsh sanctions in place since 2012 are crippling the economy and making the country less and less dominant within the region. For the US, Washington is increasingly struggling to formulate a coherent Middle East strategy which caters to its "special" relationship with Israel, Saudi Arabia, the Gulf States, and Iran.

 

As such, it sees a need to move Iran back online and, through the re-establishment of diplomatic and commercial ties, maintains its role as a supplier of protection and stability

 

There are so many potential interpretations of this deal, but in terms of business prospects, the oil supply story is the dominant one.

 

The negative impact: oil price under pressure

 

According to the International Energy Agency, Iran produced 2.87 million barrels/day of oil in July 2015 and the most optimistic forecasts expect this total to rise to 3.4-3.6 million b/d by Q2'16 – an increase of 500-700,000 barrels a day. This potential new supply from Iran has seen oil prices sink to below $40/b (WTI) before the recent reaction higher.

 

What makes the oil market defensive is not only the potential addition of Iranian oil, but also a US oil sector which continues to pump 700,000-1,000,000 b/d more than last year and 222 million barrels in floating storage. To put this into context, the daily global production of oil is 95 million b/d for 2015, but the IEA sees this growing by two million b/d over the next two years.

 

The low oil prices will deflate activity in the region and put upward pressure on governments to facilitate investment and jobs away from the oil sector. A much-needed change is now being forced on governments through extremely low oil prices.

 

Saxo Bank expects that oil demand will rise in line with the IEA's two million b/d estimate and maybe slightly more as we remain positive on global demand seeing its low between now and Q1'16. 

 

The extra two million b/d should mean that by the time Iran is fully able to export more oil, the market should have a larger overall appetite. I see oil averaging $50/b for balance of this year and $55-60/b next year, meaning the worst period lies between now and the next three months.

 

Positive impacts: Iranian CAPEX spending, tourism

 

We have to understand that by the time Iran fully complies with all the conditions in the deal, we will be into the second quarter of 2016. 

 

Furthermore, lifting the sanctions does not mean that Iran is able to float the world with oil starting on day one, as Tehran's access to capital and hence investment in the oil sector has obviously been constrained. 

 

The Iranian government estimates that it needs $200 billion in new oil and gas investment by 2020. More support for CAPEX will come through the release of $100 billion worth of frozen assets which will most likely be used to invest in infrastructure and oil and gas investments, meaning Iran will represent a net demand on regional oil services and equipment. 

 

Iranians will also slowly start to travel (as we saw in China and Eastern Europe), facilitating a much-needed increase in tourism to the Gulf region. Add to this the fact that economic theory states that free trade and open borders create a net gain, and one can gain a larger perspective on this event and its implications.

 

The post-sanctions rebirth of the Iranian economy could prove a boon 

for regional tourist destinations such as Dubai. Photo: iStock

 

Geopolitical risks and black swans

 

It's both impossible and naïve, however, to refrain from analysing the potential geopolitical fallout from the deal, or what we might call the "black swan" risk.

 

Israel is fiercely fighting the deal and is using its political leverage in Washington to get it scrapped. At present, it looks like the deal will be a close race as US president Barack Obama is getting closer to obtaining the necessary votes but is still short, leaving his veto as a potential second-best solution to ratifying the deal.

 

The Gulf states have been publicly positive from a diplomatic perspective, but it seems that the deal is raising concerns about security and its standing vis-à-vis the US in private. This comes at a time when the US is becoming energy-independent, hence the fear is that the US increasingly will reduce its strategic and military involvement.

 

How the Iran deal ends up changing the business landscape in the Gulf Region over the next few years is path-dependent: If Iran complies fully, moves towards normalisation and opens its borders, the deal will strengthen the region. More openness, more open borders, more influence and increased commercial ties will improve conditions not only for Iranians but for the whole region. 

 

History dictates that the more business is done over borders, the richer the countries involved. Add to this the release of pent-up demand for foreign goods and services from 77 million Iranians and Iran could very well be the positive factor for regional growth in 2016 and 2017.

 

On the other hand, if this proves a "one step forward/two steps back" scenario, then not only Iran but the whole region as well will be worse off in terms of both economics and stability. 

 

Having a plan and an agenda is better than the opposite. The plan is flawed, but this still represents a move in the right direction so that Iran and the greater region can use its energy and resources to build on the positive changes that have transpired in their economies and business since the 1960s.

 

In others word, the region is not drowning, but it's getting more and heavy rain. Let's hope the downpour will fertilise the ground... 

 

I think it will.

 

The oil wealth available to Iran after the lifting of sanctions could provide 

a wellspring of growth where there is presently a desert. Photo: iStock

 

— Edited by Michael McKenna

 

Steen Jakobsen is chief economist and CIO at Saxo Bank

 

 

Med venlig hilsen  |  Best regards
Steen Jakobsen  |  Chief Investment Officer

 

Saxo Bank A/S  |  Philip Heymans Allé 15  |  DK-2900 Hellerup
Phone: +45 39 77 40 00  |  Direct: +45 39 77 62 23  |  Mobile: +45 51 54 50 00

 

Research: http://www.tradingfloor.com/traders/steen-jakobsen

Please visit our website at www.saxobank.com

 

This email may contain confidential and/or privileged information.
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Macro presentation: The end of a cycle

 

Dear All,

 

Please find enclosed my latest macro presentation for H2-2015:

 

 

It charts out my main (highest probability path) for markets. Needless to say I believe we are at the end of a cycle – the suspension of business cycles – and about to engage a new full cycle business cycle including boom-and-bust.

 

Included is also my new overview model for why this cannot work – the pretend-and-extend plus my main take on investments:

 

 

 

Long gold, short US$ and using FED's hike as catalyst for buying commodities and EM.

 

Safe travels,

 

 

Med venlig hilsen  |  Best regards
Steen Jakobsen  |  Chief Investment Officer

 

Saxo Bank A/S  |  Philip Heymans Allé 15  |  DK-2900 Hellerup
Phone: +45 39 77 40 00  |  Direct: +45 39 77 62 23  |  Mobile: +45 51 54 50 00

 

Research: http://www.tradingfloor.com/traders/steen-jakobsen

Please visit our website at www.saxobank.com