Time to look at Australia

By Neville Bennett

Friday 14th February 2003

Financial markets are clumsy brutes. They move like the biblical juggernauts, crushing all who get in their way. The investor must respect their power and try to anticipate movements.

They might adopt the mindset of a judo expert, willing to use the power of their awesome adversary to their own advantage. As markets move, investors must consider their changing circumstances and, if necessary, act to limit damage or, better still, take advantage of new opportunities.

Usually only small tactical adjustments are the most that is required. Yet, there are occasions when the market movements are great, and potentially supportive of major plays. These are strategic rather than tactical, and require good generalship.

Sometimes a retreat is called for. For example, those who cashed up in the Japanese bull market in the late 1980s and invested their capital in government bonds made superb returns for a decade as interest rates plunged from double-digit levels to close to zero. There were huge capital gains on long bonds and excellent coupon rates.

Other opportunities arose to take profits in the US stock bubble that broke in the April 2000 "tech-wreck." Previous articles have advised in good time of good strategic opportunities in hedge funds, UK property and gold.

Another strategic opportunity is apparent as the Kiwi dollar is worth 93Ac. This is near record levels in recent times and the top of a cycle last reached in 1995. It ranged as low as 75Ac in 2000. In the cycle it ranged from 93Ac to 75Ac, a margin of 18Ac.

Thus the kiwi has appreciated 20% against the Aussie dollar in the last couple of years. While nothing is certain, it seems the kiwi will decline again in the near future.

The National Bank forecasts 82Ac in September 2004, a fall of about 12%. Kiwi investors have a chance of making 12% gross, if that happens, by making a play in Aussie-dollar-denominated assets. (This leaves aside considerations of brokerage and tax, etc.)

This potential gain could be increased if the assets chosen perform particularly well. But even if their performance is on par with New Zealand investments, the play is worth considering as it still offers some positive rewards.

Australian financial markets are broader and deeper than New Zealand's. Even without considering the warrant and option opportunities, it is apparent the ASX offers better exposure to the oil and gold markets than the NZSE.

Gold and oil are especially attractive as their prices are appreciating. Gold has risen 25% in the last year and oil has risen from $US26 to $US34 a barrel. Are gold and oil good plays?

Perhaps they are worth a small speculation but the market is not excited. Novus Petroleum has lost 47% this year, Oil Search 50% and Santos a few cents. In gold, Newcrest and Sons of Gwalia are down and Lihir Gold (often regarded as the pick of gold stocks) remains at $A1.50.

The market believes the rise in these commodities is temporary and the shares fully priced. If the Iraq situation becomes more complicated these values will be reconsidered. The gambler would buy a few options.

A more serious step would be to invest in hedge funds. Most are performing well, as expected in bear markets. Ord Minnett gives capital guarantees and usually produces returns above 10% a year.

In general, the Australian outlook is not rosy. Growth has been respectable but seems to be slowing with the global downturn, the drought, falling commodity prices and a deflating housing boom, which is affecting household confidence. A supply shock is not impossible if oil prices rocket. The outlook could be for slower growth and higher inflation neither of which are good for equities.

My guess is the interest rate yield curve will steepen. The National Bank agrees, predicting the 10-year Aussie rate to rise from 5.6% to 6.5% next year before gradually slackening again. Except for some potential capital loss in the short term if fixed interest investments are realised, the investor in Aussie fixed interest can expect some good yields and long-term capital gain. An Aussie play can be low-risk and profitable.

Clearly investors will consult a broker but it is suggested here the fixed-interest market is worth some investigation. Timeless principles of credit diversification and maturity diversification should not be neglected (see "How laddering works," NBR, October 18).

By way of illustration of possible opportunities, the following examples are taken from a reputable website . Bonds are issues by the federal and state governments. Tasmania is presently offering 6.25%.

There is also paper issued by listed companies. For example, AMP is offering 8.25% on perpetual notes and Coles Myer 8.11% on stock maturing in 2005. The pick of bank stocks is National Australia Bank offering 7.05% on perpetual notes.

The details merely illustrate an important point: good securities are available in Australia. Yields of 5-8% are general.

If these were purchased now and the New Zealand dollar were to depreciate relative to the Australian currency, then a gross yield of 10-12% could be conservatively expected. Should the kiwi lose value again, an Aussie investment will be a comforting silver lining in a cloudy sky.

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