Research Watch

A mining boom or bust myth buster, Iran, WWI and oil, the great maple syrup heist, Irish bonds, the Grexit and Greece’s Porsche boom.

PORTFOLIO POINT: This is a sampling of this week’s best research notes. In a world of too much information, we hope our selection helps you spot the market’s key signals.

Amid a sustained slide in the prices of Australia’s most relied-upon resources, Research Watch this week presents a wrap of commodity analyses that highlight opportunities at home and abroad. Macquarie has identified the local sector that has historically benefitted most when commodity prices fall alongside the Australian dollar, while Credit Suisse dismisses talk of iron ore settling “anywhere near” the historical lows seen in the early 2000s – expect a modest rebound soon, they say. Further afield, JPMorgan says investors have become complacent about the prospect of a war between Israel and Iran, which could have unexpected ramifications for the price of oil – and oil stocks – while a giant maple syrup heist threatens to disrupt the global supply of Canada’s “liquid gold”. Elsewhere, Felix Salmon argues there’s no reason to fear hyperinflation in a productive economy – although others point out central bankers are testing the limits of history – and researchers follow a procession of Porsche Cayennes to the home town of Greece’s biggest tax cheats. On video, John Clark and Bryan Dawe discuss the state of Australia’s mining boom.

Invest for the end of the boom...

(John Conomos of Macquarie Group, September 4)

Or hold on for a modest mining recovery...

“Our feeling is that the current [iron ore] adjustment is in large part a move to a lower trading range: In trend terms, global steel production looks to be increasing now at around a 2.5% p.a., while seaborne exports of iron ore continue to grow at an 8% p.a. pace. With global growth momentum weak, and China’s steel demand having moderated, we now believe that the opportunity for a return to a market in shortfall has diminished. It is worth noting, however, that markets tend to overshoot to the downside during dramatic events. Given the cuts to Chinese production under way, and a ‘buyer’s strike’ by mills, while the risk in the near term is for further falls, we expect prices to rebound to around $US100 in Q4, before slowly eroding towards longer-run averages over subsequent years. Importantly, however, we consider it most unlikely that prices will settle anywhere near the historically low levels seen in the early 2000s, which we feel will prove to be the historical outlier.” (Ric Deverell of Credit Suisse, August 31)

Iran, WWI and oil...

“In our view, the probability of a unilateral military strike by Israel against Iran has increased from low single digits (2% to 5%) in January 2012 to low double digits (10% to 15%) in August 2012. We think conventional wisdom vastly overestimated this risk in 1H2012, lost interest when missile volleys did not occur by June, and now underestimates the importance of recent threats by the Israeli leadership and the soul-searching public debate taking place within Israel about the wisdom of a pre-emptive strike. … We spotlight 10 lessons from [Barbara Tuchman’s analysis of the causes of World War I, The Guns of August] and how they apply to commodity risk today:

It is a nearly universally held belief that an Israeli attack must result in a large oil price spike, at least at first. Markets seem to be ill-prepared for the very real potential outcome that an attack could be followed by a strong downdraft in petroleum prices, like the one that followed Japan’s Tohoku earthquake last year, despite the loss of 1.2 mbd in Libyan crude output. If an attack occurred, we would not be surprised if the initial impulse were a smaller-than-expected and briefer-than-expected oil price spike followed by a stronger-than-expected oil price decline. ... [The decline would be driven by] large and unexpected damage to global commodity demand, while simultaneously boosting oil supply through release of strategic oil stocks.” (JPMorgan via Sober Look, September 2)

Maple syrup shock?...

“Quebec police are on the hunt for a sticky-fingered thief after [up to $30 million] of maple syrup vanished from a Quebec warehouse. … Anne-Marie Granger Godbout, executive director of the [Federation of Quebec Maple Syrup Producers], said the theft shouldn’t put the global supply of maple syrup at risk, but warned it could allow the thief to undercut legitimate producers. … Quebec produces between 70 and 80 per cent of the world’s maple syrup, with the bulk of export sales taking place in the United States, according to the federation. … Sylvain Charlebois, who researches food policy at the University of Guelph, said any disruption in the maple syrup supply could damage hard-earned gains the industry has made in global markets. … ‘If they’re not concerned, they should be,’ he said of the federation. ‘This is such a fragile industry, and any loss on the supply side could be devastating.’” (The Globe and Mail, September 2)

There’s no reason to fear hyperinflation...

“By looking down the list [of the 57 episodes of hyperinflation recorded in history], strikingly, what you don’t see are any instances of central banks gone mad in otherwise-productive economies. … Hyperinflation is caused by many things, such as losing a war, or regime collapse, or a massive drop in domestic production. But one thing is clear: it’s not caused by technocrats going mad or bad. For that matter, there are no hyperinflations at all in North America: the closest we’ve come, geographically speaking, was in Nicaragua, from 1986-91. In fact, if you put to one side the failed states of Zimbabwe and North Korea, there hasn’t been hyperinflation anywhere in the world since February 1997, more than 15 years ago, despite the enormous number of heterodox central-bank actions in that time. … In fact, I’d hesitate to categorise hyperinflation as a narrowly economic phenomenon at all, as opposed to simply being a symptom of much bigger failures at the geopolitical level. Those failures are exacerbated by hyperinflation, of course: there’s very much a vicious cycle in these episodes. But you only ever find hyperinflation under extreme conditions, and, with a single exception (Peru), I’m not even sure I can find any genuine democracies on this list.” (Felix Salmon, September 4)

But we are journeying into the unknown...

“While economic history has been great in so far helping us understand the state of the world, many variables are now outside of any previous historical observations. … Core long-dated bond yields have hit their all-time lows in 2012. In Holland (our longest time series), 10-year yields hit their lowest level in 495 years’ worth of history back in June this year and are only around 20bps higher now. The most important global benchmark – 10-year US Treasuries – also hit its all-time low (1.39%) in July, with data going back all the way to 1790. … At the very front end, base rates have never been so low, for so long, for so many. Several countries are at or around all-time lows, with the UK (our longest time series) at the lowest level since the Bank of England’s inception in 1694 – 318 years ago. … Meanwhile the Bank of England also provides us with the longest record of central bank balance sheet activity in the world, with data going back to 1830. In 2012 we have rocketed past the previous record level of the size of the BoE balance sheet relative to GDP. Similar trends are being seen elsewhere. Can we really say with any confidence how this experiment will end?” (Jim Reid, Nick Burns and Stephen Stakhiv of Deutsche Bank, September 4)

A big bet on Irish bonds...

“A leading US figure in bond investment has emerged as Ireland’s single biggest private sector creditor by aggressively buying Irish government bonds. The large bet on the country’s economic recovery has been placed by San Francisco-based Michael Hasenstab, who runs the Templeton Global Bond Fund. Franklin Templeton funds, mostly managed by Mr Hasenstab, at the end of June held Irish government debt to the value of €6.1bn, according to FT calculations. … The size of Irish bond purchases by Mr Hasenstab’s fund has raised eyebrows at some asset managers, who say the robust performance of Ireland’s bond market this year has been caused partly by its aggressive purchases. “It’s a punchy bet,” said one senior rival bond investor. “It’s quite unusual to hold such a large position  . . . Templeton building up such a large position has been a major driver for Ireland’s performance this year.’” (Financial Times, September 2)

Monitoring the Grexits...

“Even as Greece desperately tries to avoid defaulting on its debt, American companies are preparing for what was once unthinkable: that Greece could soon be forced to leave the euro zone. Bank of America Merrill Lynch has looked into filling trucks with cash and sending them over the Greek border so clients can continue to pay local employees and suppliers in the event money is unavailable. Ford has configured its computer systems so they will be able to immediately handle a new Greek currency. … JPMorgan Chase ... has already created new accounts for a handful of American giants that are reserved for a new drachma in Greece or whatever currency might succeed the euro in other countries. … Peter Frank, who advises corporate treasurers as a principal at Pricewaterhouse, added: ‘Companies are asking some very granular questions, like “If a news release comes out on a Friday night announcing that Greece has pulled out of the euro, what do we do?” In some cases, companies have contingency plans in place, such as having someone take a train to Athens with 50,000 euros to pay employees.’” (The New York Times, September 2)

Mapping Greek tax cheats...

“We begin with the new observation that banks lend to tax-evading individuals based on the bank’s perception of true income. This insight leads to a novel approach to estimate tax evasion from private sector adaptation to semi-formality. We use household micro data from a large bank in Greece and replicate bank models of credit capacity, credit card limits, and mortgage payments to infer the bank’s estimate of individuals’ true income. We estimate a lower bound of €28 billion of unreported income for Greece. The foregone government revenues amount to 31% of the deficit for 2009. Primary tax evading occupations are doctors, engineers, private tutors, accountants, financial service agents, and lawyers. … The circled area (specifically, the dark area in the middle of the circle) is Larissa, an area... that has the largest number of Porsche Cayennes in Europe.” (Nikolaos Artavanis (Virginia Polytechnic Institute and State University), Adair Morse (University of Chicago Booth School of Business, NBER), Margarita Tsoutsoura (University of Chicago Booth School of Business), June 25)

Video of the Week: Is the boom over?...

John Clarke and Brian Dawe discuss the state of Australia’s mining boom.

Graph for Research Watch

(ABC, August 30)