In yesterday’s Money Morning, I argued that for the ASX 200 to put in a decent rally and break out of its four month trading range, the banks would have to join in.
One fundamental factor contributing to bank performance is the recent rise in bond yields around the world, caused by the view that the US and global economies are gaining strength.
As the Financial Times reported yesterday, the yield on US 10-year Treasury bonds jumped 30 basis points in September, the largest move of the year. Higher long term bond yields are bullish for banks, as they assist in improving the ‘net interest margin’.
This is the difference between what it costs a bank to borrow and what the bank earns from lending.
It certainly seems to be helping the global banking sector. The chart below is the Betashares Global Banks ETF – currency hedged [ASX:BNKS]. It broke out to new highs in September. The rally in bond yields no doubt helped.
Once again, if you’re looking for a crash in global equity markets because of too much debt or because the problems of 2008 haven’t been resolved — or whatever other reason — it’s just not on the horizon.
Think about it. Banks carry a large portion of the world’s debt on their balance sheets. If that debt were in trouble, it would show up in bank shares prices first.
That’s just not happening. There is no global credit crisis or 2008 repeat in sight.
That doesn’t mean our banks should be trading at new highs too. Thanks to our property price ‘super cycle’ and exposure to the Chinese economy, the domestic banking sector is in a different part of the cycle than its global peers.
But our banks can still rally from here. They’re not expensive: Fully franked yields of around 6% will attract capital in this low interest rate environment. As long as the RBA holds off on raising interest rates too quickly, banks should gain increasing investor support.
The RBA did just that yesterday. As expected, the central bank kept rates on hold, again. They will likely do so for a few months more, or at least until signs of higher inflation start to come through the system.
There’s also better news on the energy front — if only relatively better.
The Financial Review reports today that the government’s intervention in the east coast gas crisis is having an impact. Asian LNG spot prices have soared 35% in the past month. Meanwhile, spot gas prices in Victoria and New South Wales were on Tuesday at their lowest level since January this year.
The government’s threat to control export volumes means that excess gas (over and above contracted volumes) will supply the east coast Australian market rather than go to the Asian ‘spot’ market.
As a result, prices have shifted, with the threat of undersupply now transferred to Asia.
While this sounds good (and it is in a relative sense) Australia is still losing business. If policies were in place to develop adequate supplies of gas, we’d be able to supply our domestic market with well-priced gas as well as supply the Asian market and thus increase export revenues.
Instead, we’re now opening the door to US LNG exports to come in and take market share away from us in Asia.
Just because politicians have partially and temporarily solved a problem of their own making doesn’t mean they have done a good job. Although that is how they will no doubt sell it.
But the reality is that higher prices in Asia should be a target for our exporters. Instead they’ve been forced to send that more profitable gas supply to less profitable markets.
From an investment perspective, there are a few ways to play this. Australia desperately needs to develop new sources of gas to supply the domestic market. There are a number of small companies developing their reserves now to do this in the years to come.
I have four of them in the Crisis & Opportunity portfolio. One of the picks is up nearly 100% since I tipped it just a few months ago. That tells you capital is flowing into the sector to come up with a solution to the east coast supply deficit.
If you want to get access to my east coast gas plays, as well as a few small-cap conventional oil investments, click here.
Editor, Crisis & Opportunity