A Topsy-Turvy World
As Monday morning kicks off we wonder if this week will be any better or worse than last week. Has much changed over the weekend?
The G20 finance ministers met in Washington. The G7 finance ministers also met. And then in Europe the Euro Zone leaders plus Britain got together for a fireside chat. Based on the likely usefulness of these meetings we may have been better off sending in Ali G to sort things out.
It still amazes us how topsy-turvy the financial world has become. While we are still digesting the sight of pin-striped capitalists pleading for the government to come to the rescue and bail-out the financial market, our brain now has to deal with seeing the Socialist Worker Party in the UK protesting against partial nationalization of some of the UK’s biggest banks.
With any luck this week will be a bit quieter, although based on the 6% rise in the market so far this morning that could be a bit too much to ask for.
Financials vs Resources
While it has been the financial markets getting all the headlines, the resources sector has been taking just as much of a hiding.
The S&P/ASX200 Materials index has fallen by 31% during the last three weeks.
Meanwhile, the S&P/ASX200 Financials (ex-property) index has only fallen by 18%.
Why such a difference? For a start, mining and energy companies don’t have even the remotest chance of getting bailed out by global governments. In fact, just the opposite. The government is imposing windfall taxes on natural gas production which will be especially onerous on Woodside Petroleum.
For an industry that contributes so much to the Australian economy it’s fairly safe to say that it gets a bit of a raw deal compared to the financial services sector. Not that we are advocating a taxpayer funded bail out to the likes of BHP Billiton or Rio Tinto. Far from it.
But consider this. During the past couple of months the price of crude oil has fallen from a peak of USD$150 to the current price of around USD$80. That works out as a 47% fall. This could therefore have an impact on oil company profitability. On the plus side it should result in cheaper energy and fuel costs to industry and households.
During the same period the finance sector has experienced an increase in funding costs. The near collapse of the credit market has meant that financial institutions have been reluctant to lend out money to each other. When they have done so it has been at a higher cost, as the chart below shows.
Typically the LIBOR rate will almost mirror the interest rate set by the central bank, as shown by the USD LIBOR rate and US Fed Funds rate shown above. But as banks became less able or willing to lend money, the cost of money (interest rates) became higher. Much as you would expect when supply falls.
The result was the threat of banks becoming unable to raise capital on the market and the potential for them to go bust. Fortunately for the banking system, governments worldwide have gone to the rescue.
That won’t happen with the resources sector. But there is a positive side to this for mining and energy companies. It is something we will elaborate on in the next Australian Small Cap Investigator. In a nutshell, resources companies can be broadly divided into two categories – the cashed and the not-so-cashed.
Investors and analysts will now be taking a more studied look at individual companies rather than assuming that every company will perform as well as its peers. For those that are cashed up it means the ability to continue on with their projects, and even to potentially consider buying up some of the stressed and not-so-cashed companies.
The global economy has changed over the last few months and with it the valuation of most listed companies.
It is looking more and more like the time to go bargain hunting is just around the corner.
Cheers.
Kris.
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