Addicted to Resources

Good morning reader.

It’s a new year.

But, it’s the same old story.

Nothing much has changed.

We’re tempted to say nothing has changed. But that wouldn’t be true. Things, even little things change.

Even so, as we see it, the big things are just the same.

We won’t list them all here. You already know what they are. We spent the entire length of 2010 talking to you about them.

You know and I know that we shouldn’t treat the fourth of January any differently to the 31st of December.

However, investors do. And commentators do.

Changing a number at the end of the year does funny things to attitude of investors.

It’s like the proverbial spring clean.

Dusting away the cobwebs of last year and opening the doors and windows to the fresh air of this year.

The problem with this approach is that it assumes just because something is old it’s less important than something new and fresh.

For instance, if popular opinion is anything to go by, Facebook is better than Gold. Because Facebook is new and is used by billions. Whereas Gold is old and is only used by cranks and crackpots… OK, the cranks and crackpots could be applied to Facebook as well, but you get our point.

But don’t get us wrong. We like old stuff and new stuff.

We like Gold, so we own some. And we like the Apple iPad, so we bought one. See, we aren’t stuck in the past.

That’s fine, but what’s happening in the markets today?

“Wheat Rises to Five-Month High as Australia Flood, U.S. Cold Threaten Crop” reports Bloomberg News.

“As the rain comes down, coal prices rise and GDP goes on the skids” says the Sydney Morning Herald.

No wonder Diggers & Drillers editor Dr. Alex Cowie looked jolly as he bounded into the office this morning. The “Stock Doc” has been long coal stocks since March last year.

But being long coal stocks isn’t much good if the mines are flooded and the companies can’t sell the stuff. Which is why the Stock Doc had an extra spring in his step – he’s long African coal plays.

Not much danger of flooding in them there parts you’d think.

But we did laugh at the comment from our favourite rail company, QR National [ASX: QRN]. It advised the market that, “Until these highly unusual weather impacts subside, it is not possible to make a full assessment on Full Year published earnings forecast.”

Oh dear. Still, the stock is still over 10% higher than its listing price. Which is better than a poke in the eye.

But that said, even as we enjoy the fourth day of the new year, we’re still struck by the lopsided nature of the Australian economy.

How it relies on natural resources for just about everything. That without the demand for Australia’s natural resources the Australian economy would die.

We thought about that as we settled down over the holiday to watch one of the excellent 30 for 30 documentaries on sports network ESPN.

To celebrate the thirtieth anniversary of that sporting network, it commissioned thirty documentaries. Each highlighting a key sporting event or sporting drama during the past thirty years.

This one in particular was called “The Two Escobars”. As you’d expect, it retold the story of two people with the same last surname – Andres Escober, a Columbian footballer. And Pablo Escober, a Columbian drug lord.

Neither was related to each other.

To cut a long story short – the documentary went for about two hours – Forbes magazine estimated that Pablo Escobar was one of the world’s richest men in 1989. With a wealth of around USD$9 billion.

Back then, according to The Pittsburgh Press:

“The Sultan of Brunei… is still the world’s wealthiest man with an estimated fortune of $25 billion…”

King Fahd of Saudi Arabia was next with $18 billion, with the Mars Family coming in third with $12.5 billion.

Australia’s Queen, Elizabeth II was the fourth ranked billionaire with $10.9 billion. As we recall, 1989 was before her annus horribilis, which was when the whole royal thing started to go pear-shaped.

As an aside, we tittered at the following statement in the article, “British real estate tycoon Gerald Grosvenor is ninth… [with an] estimated wealth of $6.9 billion.”

We’re not sure “tycoon” is the best way to describe Gerald Grosvenor. A man more commonly known as the 6th Duke of Westminster. A man whose tycoonery extends to being in the fortunate position of inheriting vast swathes of land in central London.

It would be like describing Her Majesty as a tycoon. Or Prince Albert of Monaco as an entrepreneur.

As for the 1989 top ten, not a single mention of Bill Gates or Warren Buffet. Instead, the top ten was dominated by… Japanese real estate billionaires.

Considering how Japanese real estate has performed since then, it might be a warning to the Australian property goons about how quickly apparent wealth can vanish.

But anyway, back to our Pablo Escobar story…

Mr. Escobar made his billions selling drugs to Americans and Europeans. Whether you’re in favour of the legalisation of drugs or not is irrelevant.

The simple point is that Mr. Escobar, like many Australian mining companies, made a mint from exporting a natural resource overseas. Not that Australian mining companies export drugs mind you.

As you can imagine, even though the trade may have been illegal, it brought much wealth to Mr. Escobar and his cronies. And some of it even filtered through to the poor people of Medellin.

As the documentary explains and as our pals at Wikipedia also point out:

“Escobar was a hero to many in Medellin (especially the poor people)… he was credited with building football fields and multi-sports courts… Escobar was responsible for the construction of many churches in Medellin… [he] frequently distributed money to the poor through housing projects and other civic activities…”

Of course, Wikipedia also points out that:

“The increased murder rate was fuelled by Escobar’s giving money to poor youths as a reward for killing police officers, over 600 of whom died in this way.”

In one instance Escobar heard of 700 people who lived in a rubbish tip. Each day they’d scrounge what they could and we dare say, either eat it, wear it, or sell it.

Escobar was so distressed by this that he built a bunch of houses for these people to live in. Whether they continued to “work” at the tip is unknown.

In 1993, Escobar was dead. Shot by police while on the run.

As you can imagine, the death of Escobar and the war on the drug trade by the Colombian and US governments didn’t do much to maintain the wealth of the drug lords. Nor of the cronies who benefited from it.

In an instant, the flow of cash from overseas was slashed. And local wars broke out as the drug lords fought to keep up their revenues. With fewer drugs being exported that meant the drug lords needed to get market share in other ways – by killing their competitors!

In a nutshell, the economy of Medellin was propped up by what was largely an unsustainable export market. Many were wealthier than they were before, thanks to the export of drugs and the import of cash.

Many were able to piggy-back off that by providing services and products to those that directly benefited from the exports. But when the drug exports collapsed… there was no import of cash. With no cash coming in, there was no demand for the products and services offered by the businessmen.

In other words, these businesses relied on the export of drugs continuing.

While the comparison with Australia isn’t identical, it does show how it’s possible for one industry – resources – to provide finance for many other industries.

This is pretty much the argument we tried to make before the Christmas break. That billions of dollars of cash flowing into the Australian economy from overseas is used by banks to finance a whole bunch of other industries.

But what happens when the export of resources and import of cash slows? What is there for the Australian economy to fall back on?

The housing sector… the retail sector… the manufacturing sector…

Nope. All three, plus the rest are financed by Australia’s resources sector.

The Australian economy is just as reliant on the export of resources as the Medellin economy was reliant on the export of drugs.

The Australian government tried and failed to wage a war on the mining industry with its Resources Super Profits Tax (RSPT). But the real threat to the mining industry and the Australian economy is from overseas.

How much longer can China – and Dr. Cowie’s favourite, India keep feeding their insatiable natural resources addiction?

The Stock Doc says commodity prices “will keep rising this year on the back of a weak dollar, strong Asian demand, improving US demand, and ongoing supply problems.”

He could be right. And he could be right that “coal, copper, tin, gold and silver will be the star performers.”

Even so, our commodity crash radar is on high alert right now.

But we’re not foolish enough to bet against it just yet. For now we’ll keep one foot in the resources sector while the other foot keeps the door to the exit ajar.

Cheers,
Kris
For Money Morning Australia

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