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.

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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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