Owning assets that are not correlated to the Aussie dollar or the main drivers of the Aussie economy is even more important now that the mining boom is over. Yes, yes, I know that there is still billions of dollars of capacity expansion in the resource sector on the books. I don’t mean exports will collapse. But I do mean the big share price gains that come from massive earnings growth at the miners are likely over for some time.
Even the folks in government are banging this drum now. They have to, because government surplus projections were based on mining tax revenues that will now be much smaller than projected. This will result in larger government deficits. But don’t take my word for it.
Resources Minister Martin Ferguson knows this as well as anyone. In late July he spoke at the Australian Minerals Research Centre in Perth. He all but declared that the era of high commodity prices is over.
He said that the Chinese will no longer pay premium prices for Aussie iron ore and coal. Global supply has grown, thanks to increased production. Chinese demand has moderated. That sweet spot where supply remained tight and demand continued to grow is now behind the Aussie economy. High-cost Aussie producers with low-grade deposits will be pushed to the margin in this new era.
‘We’re not going to see iron ore at $US180-$US190 a tonne, we’re not going to see thermal coal at about $US170 [a tonne], coking coal at about $US320 a tonne any more…The only way we will maintain our revenue stream as a country, at a state and federal level, is if we expand capacity.’
Talking about the national revenue stream is another way of talking about the earnings available to Australia’s publicly listed companies. Ferguson’s arguing that the only way to maintain those earnings is to increase production.
Yet production is already soaring. In late July, BHP Billiton reported that it produced a record 174 million tonnes of iron ore in the financial year ending in June. It was the 12th consecutive year of record-high iron ore output. The company expects to produce 181 million tonnes in the 2013 financial year.
Even with lower prices, BHP can turn in large profits on these higher volumes. It still has some of the highest ore grades in the Pilbara and some of the lowest extraction costs. But its guidance essentially confirms what Ferguson predicted.
This raises a real problem for investors. You don’t pay a premium for earnings when the forecast for resource prices is moderate or even negative. You pay a premium for earnings growth. When growth declines or slows down, the premium disappears.
Here’s the problem in a nutshell:
Australia is a relatively small economy that’s heavily invested in houses and mines. Aussie investors are overexposed to two industries – banking and mining – and in general don’t put much thought into hedging this risk, or even seeing it as a risk.
That’s fair enough. For the last twenty years, housing and mining stocks have been great investments. It wasn’t a liability that the share-market was dominated by those two industries. It was a strength. But that era is over.
The end of the era for high commodity prices will be bad news for your portfolio, unless you take steps now to diversify your country and currency risk.
Editor, Australian Wealth Gameplan
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Written by Dan Denning
Dan Denning is Editor in Chief at The Daily Reckoning and the Publisher of Port Phillip Publishing.
Dan is also the investment analyst and editor of The Denning Report. His high-level, macro-economic and stock market forecasts are read by more than 35,000 high-dollar investors and fund managers in over 70 countries.
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