The Carol Austin Interview

Michael Pascoe interviews Carol Austin, chief economist of Contango Funds Management
Carol Austin: We see it as a correction. We were actually anticipating a correction because the market had run so hard and, in particular, metal prices have spiked off on the back of a lot of speculative interest.

Michael Pascoe: Just a correction though?

The underlying fundamentals remain very good. China is strong. Demand out of China remains strong and supply remains tight so we see metal prices as under fundamental pressure but that upward pressure was augmented by speculative activity and it was just running far too hard in the last couple of months. It was up 30% in the last quarter. That is a very hard run on top of substantial increases.

What drives a spike like that? '” 30% in one quarter.

What happens is that speculators see a trend that’s emerging, see the opportunity for it to run further and they add to the demand coming from fundamental demand and they push prices beyond their fundamental limit. As a consequence, we’re expecting some of that froth and bubble to come out of the market and a correction. You can’t pick when it’s going to happen and unfortunately you can’t pick how severe it will be, but the underlying fundamentals remain really strong for our commodity producers.

So the fall in metal prices sparked the fall of the stock market this week, but should the market be looking through what’s happening to metal prices, because they’ve been Mickey Mouse for a while anyway?

It ran up on the back of those metal prices and it will come back on the back of those metal prices. It’s very much driven by the spot price.

We’re seeing the creation of commodity funds, metals funds in the United States running off the China story. To what extent is that really blowing [off] the top now?

We don’t think that the Europeans and the Americans understand the China story as well as it’s understood in Australia, so there’s been a surprising lack of overseas interest in resource companies until recent times. Indeed, part of the reason the market ran so hard in December and January is that overseas funds that have got out of resources realise they’ve got out too early and started to pile back in again. So we don’t think they understand it as well as it’s understood in Australia. It’s partly distance and it’s partly that we live with it every day.

So the dip we saw in the market in October was a major buying opportunity?

When markets are running very hard they get very nervous and when people have made substantial gains, at the slightest hint of a problem they’re prepared to get out and bank the profits. What you saw in October was fears about inflation re-emerging in the United States; and the Fed getting out and beating a very severe anti-inflationary drum and telling the market that if they didn’t behave they would hike rates at a more aggressive rate than people were expecting; and that fear of higher inflation, fear of tighter monetary policy, fed into the equity markets and they pulled back substantially.

So what happens to the psychology of investors who’ve pulled out in that dip and then it takes off?

They get very disappointed and part of the reason that the market ran so hard in the last couple of months is that people that pulled out in October and didn’t re-enter the market saw it rally strongly in November and December they realised that they had got out too early and they piled back in again. Those people are going to be feeling very sorry if they came back in early or mid-January.

The medium to longer-term investor just has to be prepared to wear these shocks?

You can’t pick these individual ups and downs. You can’t pick the peak and you can’t pick the bottom. The fundamental investor looks at the underlying trends and has to look through this volatility. We think demand for commodities remains very strong and we think supply is tight and we think the commodity prices will remain high on the back on that. The earnings of commodity companies are going to be really very strong in the next year, and that’s going to underpin good share prices for them.

If there’s still more American and European money to come, then as the China story spreads, does that almost guarantee ongoing volatility in this market?

I expect ongoing volatility. We are late in the cycle in terms of several years of good commodity prices and so people get nervous the longer a cycle runs, so you can expect volatility. You have to look through that and say what are the fundamental earnings of these companies going to look like in 12 months’ time. We think given the supply and demand fundamentals they’ll be good, and they’ll be good relative to industrial companies and good relative to companies offshore.

Beyond China, is the Indian story being hyped at the moment '” being lumped in with China?

A number of developing countries are expanding at a solid pace. India’s one of them. India is not as resource intensive, so we don’t take as much notice of India in Australia as we do of China. Most of their growth is in the service sector, which doesn’t use very much iron ore and coking coal, etc, but India is growing at a solid pace and importantly its demographics mean that it can continue to grow for 30 years. China’s going to bump up against demographic constraints in 10–15 years’ time.

The one-child policy coming home to roost?

The one-child policy means that their workforce is going to slow and actually contract as we go forward, but you’re not looking at that problem for a decade so we have a decade of very strong stimulus to the Australian economy coming out of China.

All things working out nicely without an X factor '¦ Could that underwrite the Australian economy then for decades?

It certainly can underwrite particular sectors of the Australian economy. At the moment, the resource sector is booming and importantly sectors that service it '” so infrastructure development, transport '¦ all of these things are also booming. Once the cycle matures and it’s simply a matter of extracting from existing industries, we’re going to have to look more broadly for other sources of growth in this economy.

So what do we need to be investing in to get that broader opportunity?

We’re not going to be able to compete in the manufacturing stakes or only a very specialist part of that. We’re going to have to compete in services and we’re going to have to compete in things like medical technology; in education, which means we need to invest in education to grow the skill base of our population.