The toxic combination turning investors off Australia

Australia has been a successful yield play for international investors in recent years, but now the world is turning its back on the lucky country.

With one notable exception, the world is turning its back on Australia. And it’s hard to see how the world's love affair with the ‘lucky country’ can be restored in the short term.

The exception, of course, is the almost desperate effort by Chinese and other Asian investors to buy into Sydney and Melbourne apartment developments and other properties. But I’ll come back to that.

First, it’s important to identify what's happened that's turning investors off Australia.

In recent years, Australia has been one of the world’s best money-making plays. Investors would borrow on the world markets at token interest rates and invest in Australian high-yield debt and equity -- particularly bank shares.

That strategy is now going horribly wrong and those who pursued it in recent months are getting a beating. The world is anticipating that the looming end of quantitative easing (money printing) in the US will send global interest rates higher, pushing up the cost of money for those wanting to play the yield game in Australia.

Worse still, currency traders are suddenly waking up to the fact that our iron ore, coal and gas income will be much less than expected, so the Australian dollar is finally falling. And it could fall a lot further.

As overseas investors start unwinding their positions, they will sell their high-yielding shares, and the share prices of our banks and other higher-yielding shares will start to fall. The widespread belief overseas that Australian banks are lending into a housing bubble will gain more traction, and the process will snowball further.

Last night the Australian dollar fell below US89c, providing sickening losses for those who have been playing the Australian yield game unhedged. The smart players are clearly exiting.

And then we find the Chinese steel industry politely telling Australia not to assume the same rates of steel production growth that we have seen in the past. Apart from the mad iron ore mining bulls, most people knew this was going to happen but the Chinese statements underline the fact that iron ore and coal are going to be in chronic oversupply for many years to come.

The iron ore price last night fell below $US80. Given that base metals also fell, that put the dollar under further pressure. Naturally BHP, Rio Tinto and other mining shares are hammered.

In addition to all this, the world is facing a big rise in defence spending due to extremists in the Middle East threatening the West. Australia is one of those countries named as a target. If the threats are carried out, it will be disastrous for our tourism and leisure industries. It will also see global investors send a lot of money to the US, which is seen as a safe haven. Normally we would have received some of this money, but this time around stronger forces are dissuading global investors from using Australia as a safe haven.

And so we have a nasty cocktail that is reversing all the forces that boosted Australia in recent times. However the falling dollar will provide some relief to a great many industries and will help local employment, so that’s good news, although it may rekindle some inflationary forces.

Coming back to Chinese investors buying up our dwellings: on paper they have received a beating due to the fall in the Australian dollar, but they are helped by the fact that our currency has not fallen as far against the Renminbi, given the rise in the US dollar. With rising property prices in Sydney and Melbourne, there’s no sign yet of Asian investors running from our property market.

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