Take a bow, Australia

A handful of leading resource-related Australian stocks shine in the ‘CARBS’ report, an extraordinary global research exercise.

PORTFOLIO POINT: Australian stocks shine in extensive global research by Citigroup.

Australia, you have no idea how good you look – especially through the eyes of European investors, who are peering into a financial black hole.

Two tests over the past week support the view that Australia has never looked more appealing as a safe haven in a deeply troubled financial world, with that rarest of all attractions: growth.

The first test involved my visiting London to see whether reports of the British and European banking crisis have been exaggerated. They have not, and were confirmed earlier this week when Standard & Poor’s Ratings Services put most of Europe on a negative ratings watch.

Included in the 15 countries likely to be downgraded within the next three months are six that currently carry the coveted AAA rating: Germany, France, the Netherlands, Austria, Finland and Luxembourg.

The second test involved digesting a monster piece of “crystal ball” research by a team of analysts from the US investment bank Citigroup Global markets. That 124-page document gave Australia high marks as a member of a unique five-country club with the unusual acronym of CARBS.

Of course an investor might reasonably take this latest acronym with a pinch of salt. As the concept has taken off overseas, there have been some sceptics. One correspondent to Britain’s Daily Telegraph suggests: “As for the CARBS report, it is more advice on dieting from cakeshop proprietors. Any chance Citigroup might advise people to withdraw their money from the stockmarket and keep it under their mattresses? No!”

And no doubt that implicit criticism always has a place, but the point for Australian investors is just how well we –and some of our key stocks – may benefit here.

Australia is the A in CARBS. The other members are Canada, Russia, Brazil and South Africa. Linking those countries is their dominant position in the production of commodities, with Citi arguing that “they represent a distinct asset class”.

The CARBS argument is essentially a variation on the earlier “BRICs” acronym, created by another US investment bank, Goldman Sachs, and comprising Brazil, Russia, India and China.

As the Citi report suggests: “As the West sinks into decline and Asian growth shifts to consumption, the question is how these commodity-producing countries will fit into the new world.”

The answer, according to the numbers generated by Citi, is very well, and best illustrated by these comments: “CARBS are the new carnivores. If commodity prices stay high, the CARBS should be avid buyers of the distressed assets of the West.” (The entire report is attached. Click here.)

Interestingly, Citi is not suggesting that mining and oil stocks represent the best investment entry points at this stage of the cycle.

“We see the best opportunities in providers of infrastructure,” Citi said. That advice is based on an assessment that financial pressures in Europe and the US are likely to take the edge off commodity demand, and commodity prices – though not off volumes, with CARBS countries planning to increase commodity exports by 44% over the next 10 years.

“Australian-listed stocks likely to be winners from that trend of increased export volume are Orica (ORI), as a provider of explosive and chemicals to the mining industry, Leighton (LEI), as a builder and operator of infrastructure such as railways and ports, and Boart Longyear (BLY), as a provider of mineral drilling services.”

Pure-play resource stocks in the Australian section of the Citi report are the usual suspects: BHP Billiton, Rio Tinto and Santos. Interestingly, though, it must be noted that Citi did not include Woodside in its choices. The broker also somewhat bravely recommends Leighton Holdings. It also avoids all non-resource related stocks while overseas analysts in other CARBS nations were happy to recommend retailers and telcos.

(To read more on the Australian stocks detailed in the report see today’s interview with Tony Brennan, the Sydney-based Citi analyst who was a member of the report team.)

CARBS club members control commodity assets valued at $US60 trillion, 29% of the world’s land mass (but have only 6% of the world’s population), and produce between a quarter and a half of most major commodities.

The dominance is shown most clearly in eight commodities with the CARBS owning more than 30% of the world’s platinum group metals (PGMs), potash, uranium, nickel, iron ore, gold, bauxite (aluminium), and coal.

The ownership of the assets is reflected in a table showing share of global production in 2010 with Australia’s strong position in iron ore, nickel, bauxite and uranium standing out, but with a smaller share of global coal output because it is mined in most countries.

In Australia, most commodity-export growth has been achieved by the so-called bulks, essentially iron ore from WA and coal from Queensland, and NSW to a lesser extent. The big driver in the Canadian and Russian commodity-export sector has been oil (and gas), South Africa’s top performing sector has been precious metals (gold and platinum), while Brazil shares Australia’s preference for bulks.

Interest in the concept of CARBS being a distinct asset class of fast-growing countries holding dominant positions in a range of commodities was on display at the annual Mines & Money conference in London.

The Australian Day component of that event attracted an audience of about 200 investors interested in the stories of mainly small-to-medium explorers and producers. The main event more than filled the old Agricultural Society hall in Islington with exhibitors occupying every square inch of the grand old space.

The contrast between the buoyant mood inside the hall, and the dour chill sweeping the streets of central London could not have been more stark, with the difference explained by the fact that Australia (and the other CARBS members) are selling commodities that Asia wants, whereas Europe has already eaten its future.

According to the report, rising rates of tax are also a threat to investment, as are rising cost pressures, and the potential for the commodity-price cycle to move into reverse.

Citi, however, takes the middle road on commodity prices. It discounts the potential for a continued rise in prices, and for a wholesale collapse in prices. “The core Citi scenario is that commodity prices will be broadly flat going forward,” it said. “This means that the old story of constantly outperforming markets is over and investors will need to focus on new drivers.

In Australia’s case those new drivers are mainly in the field of logistics, such as railways, ports and other services.

In Australia and Brazil, that means there are plans to double, or triple commodity production, which, in a future of flat prices, adds weight to the argument that now is a time to increase exposure to the resource sector service providers.

Interesting as that suggested switch to service providers might sound there is a second investment theme which the Citi researchers have not emphasised – the relative outperformance of Australian mining and oil equities, even in a flat commodity-price outlook, when compared with what’s on offer elsewhere.

In other words, Australian investors would do well to maintain their exposure to domestic resource stocks as earnings are maintained, even in a climate of rising taxes and costs, because so much of the rest of the world looks awful.

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