One sector that should profit as Australia tips into recession

Compared to most of the developed world, post-financial crisis life has been good for those living ‘down under’ in Australia.

Sure, their cricket team is no longer the best in the world. But thanks to Chinese demand for raw materials, the economy has grown strongly.

Unlike Britain and the US, there was neither a recession nor a property crash. That meant there was no need for Australia’s central bank – the Reserve Bank of Australia – to slash interest rates.

Savers in Australia can still get inflation-beating savings rates (remember them?). And the Aussie dollar has leapt by more than 50% against its US counterpart since early 2009.

However, all good things must come to an end. And in Australia, the cracks are already starting to show.

Here’s why Australia’s run of luck looks set to end – and how you can profit from it…

Australia’s biggest asset is its biggest headache

Australia’s biggest problem is China.

With its vast appetite for raw materials, China was the key driver of Australia’s boom times. But it also left Australia dependent on the country.

The trouble is, China simply isn’t going to need as much by way of resources in the future. And that’s true, whether it suffers a “hard” landing or not.

As we’ve noted before, China is at the point where its cost advantage from cheap labour is over. High transport costs, rising wages, and competition from cheap energy in America has made the whole ‘outsourcing’ equation far less enticing.

So China now needs to learn how to compete on quality, not just price. Such a switch takes time and will also hit the growth rate.

At the same time, China has to navigate a massive property and credit bubble. If it can do that while avoiding a nasty slowdown, it’ll be one of the few countries in history to ever do so.

As a result, China’s demand for many of the raw materials used to make basic industrial goods, will either fall, or simply not grow as rapidly as in the past.

A large proportion of these are mined in Australia. And this drop-off in demand is already hurting the country. Exports fell by 3.8% in 2012. As a result, Australia’s trade surplus has turned into a deficit.

The Australian housing bubble is deflating

At the same time the hugely expensive housing market is starting to implode. On the surface, you might not guess it. In fact, official statistics show that house prices actually rose by 1.6% in the last three months.

But dig a little bit deeper and a different picture emerges. Property Observer notes that while estate agents and builders aren’t cutting prices – yet – they are offering a lot of side deals that amount to the same thing.

We’re talking gift cards with $10,000 on them, free cars and even cheap land deals. Residential lots on the Gold Coast are being offered with discounts of up to $120,000.

This allows the property market wheeler-dealers to keep sales moving, while maintaining the pretence that headline house prices aren’t falling.

But even with these discounts, less business is being done. According to the Australian Bureau of Statistics, the number of loans fell by 10.3% in November. Building approvals are also down.

Finally, banks are starting to make it harder to get a mortgage. M&G notes that the spread (the gap) between the Reserve Bank of Australia’s key interest rate, and the rate charged on home loans, is going up. It is now at levels not seen since the mid-1990s. This should also help speed up the fall in house prices.

This is all happening despite the RBA’s attempts to boost the economy. Since November 2011, it has cut the key rate from 4.75% to 3%.

There are likely to be more cuts on the way. While the RBA kept them steady at its last meeting, it explicitly said that it expects “to ease policy further in the near future”. It also talked about growth being “a little below trend”. Reading between the lines, it seems as if even they know that the game is up.

And as the Bank of England and the Federal Reserve have shown, this is just the beginning. Rates could fall a lot further. It may even be just a matter of time before a troubled Australian economy feels it has to join in the currency wars. This could trash the value of the Aussie Dollar.

A stock that could profit from a weaker Aussie economy

So, how can you profit from this?

One way is to focus on the falling Aussie dollar. We’ve been bearish on the Aussie dollar for quite some time, and we haven’t seen any reason to change our minds. You could spread bet it (sign up for our free MoneyWeek Trader email to learn more on this), or you could play it in the longer term via the ETFS Short AUD Long USD (LSE: SAUP).

However, if you don’t fancy messing about with currencies – which are ultimately speculative punts – another idea is to buy Australian gold miners.

Obviously, we are bullish on gold, as a store of value. But Australian miners should also benefit from a drop-off in wage pressures, if Australia goes into recession.

Jane Andrews of Smith & Williamson Oriental Growth Fund particularly likes Regis Resources (AUS: RRL). Regis has performed well and is currently ramping up production at its mine. Trading on 13 times forward earnings, it is due to pay its first dividend at the end of the summer, and is continuing to explore other goldfields.

• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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8 Responses

  1. 08/02/2013, Dyadco wrote

    Matthew, your article is quite accurate.

    The Australian economy is suffering also as it has one of the most financially incompetent governments in her history.

    From a position of surplus when this Left Wing govt took power, it has been borrowing at an alarming rate and has left the country more vulnerable to external shocks.

    Added to this, Australia produces 1.5% of the world’s carbon now has a Carbon Tax as well as a Mining Tax to further inhibit growth in this area.

    The election due in September (yes, ALREADY called!) should be devastating for the present government, but its what they do between now and then that may make the situation worse.

  2. 08/02/2013, Dyadco wrote

    The housing market is showing very few signs of contracting and Gold Coast properties have been “off the boil” for 5 years now.

    Its the situation in Sydney and Melbourne that will turn the tables. At this stage, there is little sign of that happening and a lowering of interest rates is delaying the inevitable.

    Gold mining equities are well worth a look and I hold Regis as well as other gold miners.

    Being a regular visitor to China and Asia as a whole, I do see some contraction in the Chinese importation of raw materials, BUT when one sees what is happening in Indonesia, well, it just doesn’t seem to be a big contraction…rather a temporary lull.

  3. 08/02/2013, Changing Man wrote

    I have been watching Australian gold miners since last year following the recommendations of Money Week’s “resident gold expert”! I constructed a dummy portfolio of 10 miners including Regis and watched the portfolio drop 10% in 2 months with a huge volatility. One share only (CGA Mining) is up (by 13%) while the rest are down by as much as 27% ( Resolute Mining).
    Even if you are prepared to accept this volatility my biggest issue with holding any Australian stocks is the difficulty of trading in real time (when our stockbrokers are open for business, their markets are closed).
    I concluded that I may as well just invest in a fund like Blackrock Gold and General and get a 11% exposure to Aus gold miners. I can’t see that in the long term Aus miners will perform any differently to global miners being largely dependent on the global price of gold?

  4. 08/02/2013, CarlJ wrote

    I’m not saying you’re wrong, but MW is starting to sound like a broken record on this issue. After 2008 you said Aus would crash, but along came the Chinese stimulus. The prediction was repeated when commodity prices took a dive, but they staged a comeback. Don’t bet on an imminent collapse – Aus is just another unsustainable situation that, like everything else in this distorted world, can be sustained for far, far longer than you think.
    PS: After tax, no way can you get an inflation beating interest rate in Aus (or anywhere else).

  5. 08/02/2013, Changing Man wrote

    Ps couldn’t find the Australian Dollar short by the symbol you gave? Found it under “SAD”! Hope the outcome of any subsequent investment in it won’t be sad by nature! If it starts to follow the benchmark it shouldn’t be?

  6. 09/02/2013, Dyadco wrote

    CarlJ.

    check out AGK and ORG notes on the ASX.

    They are returning approx 3%+ over the Reserve Bank rate.

    When I purchased them, I was buying on a 7.75% yield. It has dropped a bit since then as the price has gone up…but still worth a look.

    ChangingMan, I think that for the average investor, to go with a managed fund is probably the best option.

    Also, there is a potential currency risk.

  7. 12/02/2013, CHRISTIAN wrote

    I am SOOO glad that sick house prices in Audtralia are fslling Giod willing they will not just fall but TOTALLY CRASH!! and about time so that poorer ordinary people can afford fro somewhe r to LIVE not to invest Housea re not for investment but so us poorer folk can get a roof to sleep under. Get a life all those who lust after money and profits. We are only her for solomg then w efface GOD to give an account and this will not be our bank a/c either!! Lets us think of others live s not your GREEDY SELVES. Turn to God bfore it stoo late and don’t rely on your stupid SELFISH investments

  8. 23/03/2013, Mark wrote

    Sadly I hope Australia does have a recession.
    The greed of some people causing unaffordable house prices which then forces up prices for everything else.
    Young people have no chance but the ageing older generations have everything and will then expect young people to keep the economy going to fund there old age .
    A correction in this economy is long long overdue.

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