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Storm warning - Australia's good economic climate will not last indefinitely

18/04/2013

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

Maybe it is just the dismal weather the UK has been enduring but, here on the value perspective, we have been noticing a lot of favourable comments about Australia of late. Nor is it simply the prospect of some sun that seems to have caught people’s imagination – in an economic context, the country had a ‘good’ global financial crisis and indeed the last time it saw a decline in GDP was back in 1991.

But are things really so rosy ‘Down Under’? We would suggest not and for reasons linked to the health of Australia’s enormous mining and other commodities-related industries. This section of the economy has been buoyed by very high, and in some cases all-time high, commodity prices to the extent resources now account for nearly a fifth of Australia’s GDP – double the level of just eight years ago.

However, dig deeper – pun intended – and you will find the boom in resources-rich Western Australia, which accounted for almost 90% of the whole country’s GDP growth in the second half of last year, is obscuring the fact non-mining states, such as Victoria, South Australia and Tasmania, are already in recession.

Tell-tale signs of this ‘two-speed’ economy have been in evidence for a while – for example, in local services businesses – although sometimes people choose to ignore them. Now, however, Australia could be said to be suffering from a sort of economic Dutch Elm disease, where the commodities boom has strengthened the currency to such a degree it is killing off the country’s other export industries – not to mention tourism, as many people are finding they can no longer afford to go there any more.

These problems are being compounded by a housing market that stands at elevated levels but which is now coming under pressure because of an oversupply of new houses. Excessive development along the Queensland coast, for example, means high-end properties are now seeing falls in value of between 40% and 50%.

Investors may currently view Australia as an economic success but how much of that is down to timing? The country has been a huge beneficiary of the commodity bull market and especially demand from china but, as we have discussed in articles such as ore-full prospect, we are likely to see a significant increase in the supply side of resources in the coming years.

As one chief executive of a large US mining equipment manufacturer put it: “to make returns, projects can no longer assume rising commodity prices and new mines need to come online in the lower half of the global cost curve. High-risk, high-return projects are out in favour of predictable returns.”

None of this is good news for Australia although it may take a little while for the full effects to filter through. Mines are long-term projects and those that are already in train are likely to be completed. It is the future projects that are being curtailed and the people who will see the downturn first are associated businesses such as equipment suppliers and mine developers.

So Australia’s good run may still have a little way to go – as we often say, a value approach to investing does not enable you to time anything with precision. What it does enable you to do is to have a healthy dose of scepticism and we would suggest that is now important in relation to the prospects for Australia and indeed all commodity-related plays.

 

Author

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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