Interest Rates in Australia and What this Means for the Aussie Dollar

Invast Insights

Week Commencing October 28, 2013

www.invast.com.au | 1800 468 278

This week we look at the following topics:

1.0 Where interest rates may be heading in Australia?

1.1 What this means for the Aussie dollar

2.0 Feedback from our Gold seminar

3.0 Monthly portfolio review

3.1 Proposed portfolio changes

4.0 BHP’s quarterly production report



1.0 Where interest rates may be heading in Australia?

Inflation has been the secondary consideration for the Reserve Bank of

Australia (RBA) for most of the year, the primary focus being jobs and

economic growth. Nothing scares central banks more than runaway inflation

and it was only less than two years ago that Glenn Stevens was sounding

alarm bells of inflation from the mining boom. In early 2008 the annualised

rate of inflation was printing in the mid 3% range while global financial

markets where heading south. Glenn Stevens – while speaking to investors in

London – in January 2008 played down the falls on financial markets and

warned that “uncomfortably high” inflation was the key problem facing the

economy. Then the global financial crisis hit.

Our point here is that Glenn Stevens has a history of stressing on inflation.

Last week’s 1.2% quarterly rise in inflation was above market expectations of

0.8% - it’s the first warning sign that low interest rates are starting to have


an economic cost on the Australian economy. The trimmed mean measure -

which the RBA watches more closely - is still running at 0.7% for the quarter

which isn't as high as the seasonally adjusted headline rate. The year on year

rate of trimmed mean inflation is at 2.3% which is still within the lower end of

the 2-3% target band range.

While inflation from the mining boom has precipitated, housing this time was

the key standout inflation contributor, up 2% over the prior quarter and 4%

on the prior corresponding period. Higher house prices do provide economic

benefits as the wealth effect flows through but the unintended consequence

on other parts of the economy cannot be ignored either. You can't have a real

estate boom without prices flowing into other parts of the economy, the RBA

knows this very well.

At Invast we think further housing price rises are likely in 2014 - the residential

property market remains very buoyant. Property developer Mirvac (MGR)

recently updated the market across its business divisions and advised that


its residential property development business was performing very strongly

with just under $300m of contracts for the sale of property secured during

the first quarter of the 2014 financial year.

The 1.2% rise by itself would not constitute a panic scenario if other economic

data was pointing downwards, but the RBA now finds itself with an

unemployment rate well below 6%, rising lending and retail numbers and

some positive signs coming out of the mining and resource space which has

been subdued for most of the year. It’s very difficult to see the RBA cutting

further from here unless we see unemployment rise above 6%. For now we

think rates are on hold and probably likely to rise mid next year - there will be

few analysts maintaining any forecasts to cuts off the back of these numbers.

Next is a breakdown of the September inflation composition basket – as

measured from the Australian Bureau of Statistics:



1.1 What this means for the Aussie dollar

It’s hard to bet against the AUDUSD at the moment given the growth in

Australian inflation and lackluster jobs numbers out of the US economy,

which would postpone tapering until at least the first quarter of 2014. We

have previously written that a non-farm payroll number in the USA in the

order of 250-300,000 would trigger the market response but last week’s sub

150,000 print is miles away in terms of where the job market stands at the

moment.

Traders will continue to back the AUDUSD towards parity even though the

vulnerabilities of the Australia economy have not yet been completely

addressed. We still fail to see where the GDP growth gap from lower mining

investment will be covered. House prices are rising in Australia but housing

activity – as measured by building approvals – are still at levels below those

needed to offset the decline in mining investment as a proportion of GDP.


1.2 AUD/USD Technical Outlook

Below are our short and medium term views on the AUDUSD based on the

above proposition.

We expect the AUDUSD to trade between 0.9500 and 0.9750 over the short

term, our focus is towards 0.9715 as the short term key level for the pair. At

0.9715 we see the 50% retracement of the drop from 1.06 – 0.8890 earlier this

year. The AUDUSD is severely overbought at this stage and as long as

AUD/USD fails to achieve a close above 0.9715 on the daily chart, we expect a

correction towards 0.9500 to occur before any further push towards parity.

Level 0.9500 is a key support for the pair in the past, and as recently as two

weeks ago was the key resistance. The level is also the 38.2% Fibonacci

retracement from 1.05821 – 0.88473, we believe bids are lined up around this

key level.


Image: AUDUSD daily chart via Invast MT4 platform


Over the longer term we could still see a potential for further push close to

parity, right around 0.9900 where the 61.8% retracement is located. Overall

technical still points to a potential correction first, as such we prefer shorting

the pair near current levels, until the overbought condition eases off and

buying back the currency at around 0.9500 support.


Image: AUDUSD weekly chart via Invast MT4 platform


2.0 Feedback from our Gold seminar

We recently hosted Robust Resources (ROL) Managing Director Gary Lewis at

our Gold Seminar in Sydney on Friday 25 October to a full house of guests.

Lewis spoke about his company’s growth from humble beginnings, its ability

to structure deals and form solid relationships in foreign countries including

Indonesia where Robust has attracted very significant partners and sources of

funding. Lewis also spoke about the outlook for gold and other base metals

which are due to see pricing pressure into the future based on demand

fundamentals and current supply. He stressed the weak sentiment in markets

at the moment particularly towards the junior mining space. This fits well with

our view published last week to commence purchasing mining stocks. As we

write, the ASX200 Materials index is sitting above 10,000 compared to last

week’s lows of 9,800.


The seminar also heard from Invast’s own analyst team which made the

following points:

• Continuing to see upside support for the gold price based on technical

levels and fundamental evidence including the increasing marginal cost of

production – something we wrote about in early September

• Inflation is likely to be a major investment theme over the next five years

and gold is just one method of hedging this risk, others include investing

in stocks which will see their earnings inflate also.

• The United States and other major advanced economies do carry very

high levels of debt but they are also likely to address this by printing their

way out of the problem, as opposed to collapsing. Traders need to capture

opportunities here.


We plan to hold similar seminars over the next few months – for any

suggestions on topics please speak to your account manager and pass

through your ideas to the research team.


3.0 Monthly portfolio review

It’s been a rocky ride for the Wealth Creation portfolio over the month – our

long gold position hasn’t worked out to plan but we continue to see upside in

the yellow metal and have previously written about why we hold this

position. The short S&P500 position has just turned positive thanks to a rally

in the Aussie dollar. Elsewhere, the portfolio is performing brilliantly. Empired

and Tandou are holding ground with reasonable returns while Adslot has

continued to shoot the lights out. The one single exposure has returned

$6,750 from a $10,000 investment – more than offsetting any short term

losses on the gold exposure. We purposely built this portfolio for the risk

tolerant investors, one who is looking at creating some wealth and willing to

take risks.

The portfolio aim was a target about 10% per annum. The return to date is

sitting at a very comfortable 12.8% - not bad for just two months of

implementation. If we annualise the return since inception we see a gain of


76.8%. So far, so good. We think the next few months will see more upside for

Empired as the distortion from the recent capital raising works through the

market. There is more blue sky for the stock if results match expectations –

which we think they will. We plan to speak to Empired’s CEO in the next few

months and will publish our thoughts on the chat.

The Wealth Preservation portfolio is also in line with expectations having

delivered 1.8% return in the two months since inception. This isn’t an

exceptional result but the aim with this portfolio was always about stability.


When the market rises the portfolio will underperform but more importantly

when things turn south, the list of quality names and diversity is expected to

hold up a lot better. Woodside Petroleum has given away some of its recent

gains but energy prices remain very favourable and we see the stock rising

above $40 per share sometime in the new year. The Japanese market

exposure – IJP – has also been relatively flat but we remain big believers of

the turnaround in the Japanese economy and are here for the long term, at

least three to five years. Westfield continues to disappoint but it’s only a

matter of time before the market starts looking outside of the banks and

resource stocks to find value and with a comfortable 4% plus yield, we aren’t

in any panic.


Our drawdown portfolio is holding up very well considering the ultimate aim

is to generate a return of around 5% excluding franking credits. The

annualised return since inception is now running at almost three times our

target although this number should be treated as caution. There will be

volatility in markets over the year ahead. The portfolio has so far generated a

return of 2.6% when we include dividends due from TAHHA in mid November.

The cash balance is slowly growing and we will look to reinvest the proceeds

when the bank balance grows to around $5000. For the time being, our


selections are bank balance grows to around $5000. For the time being, our

selections are unchanged and we continue to outperform cash term deposits

at a very comfortable level. It’s worth noting that the TAHHA and GMPPA

securities have not only delivered a nice dividend but also recorded

reasonable capital growth as more and more investors search for yield.


3.1 Proposed portfolio changes

At this stage we don’t have an immediate urge to change any of our portfolio

holdings. We are thinking about removing Woolworths from the Drawdown

Phase portfolio and replacing it with a higher yielding, corporate bond or

hybrid type of exposure – something that can add capital upside as the

market increases its risk appetite. We’re keeping a close eye on Healthscope

Notes issued on the ASX under the stock code HLNG – these are securities

paying a coupon of 11.25% in quarterly payments which reset in mid 2016.

Based on the trading price at the time of writing, the yield to maturity is

currently running slightly above 8.5%.


The reason for the high yield is that the market is concerned about

Healthscope’s high debt levels – gearing currently sits at around 62% with

total net debt of $1.57bn. We don’t think Healthscope runs a major financing

risk and note that the Healthscope Notes rank higher than common equity.

Healthscope reported operating earnings growth of 8.3% for the 2013

financial year and is backed by a portfolio of solid assets in the hospitals and

pathology space. If we continue to see an increase in risk appetite on the

market and improved results from Healthscope we will be adding the notes to

the portfolio and removing Woolworths sometime in the New Year.

Next is a brief snapshot of Healthscope’s view on the market segments in

which it operates, sourced for a presentation the company made to the ASX

on 28 August 2013.


Image: Healthscope 2013 result presentation slide 6


4.0 BHP’s quarterly production report

We published the following initial impression on the BHP quarterly

production numbers on the Invast website on 22 October 2013 titled “BHP

under promises and over delivers”.

The large, top tier mining companies have learnt lessons from the recent

downturn. Their effort to cut costs and focus on ramping up volumes is so far

progressing well, good enough to offset any weakness in commodity prices.

Today's quarterly from BHP looks solid on face value - under promising on

iron ore and over delivering by increasing the production guidance for the full

year to 212 million tonnes. A big tick here. The iron ore price has held up

relatively well and BHP, Rio Tinto, Fortescue and Vale are the key global

beneficiaries of this. Cash from operations is swelling very quickly.


For us the iron ore story is no real surprise, what we really like from this

quarterly is the improvement in the petroleum division - an important

earnings contributor alongside iron ore. Petroleum has seen major investment

by BHP and many in the market have doubted the decision to go here - but

with energy prices solid and production volume ramping, BHP's board now

seems justified in its tilt to increase energy exposure. Total petroleum

production increased by 6% on the prior quarter and is comfortably above

the 60 million barrels of oil equivalent level which will please the market.

A few of the metals divisions have disappointed, but these are largely

insignificant to the overall earnings composition. Copper needs more

improvement but the copper price isn't exactly buoyant and so BHP has time

up its sleeve.


Bottom line: BHP is the most attractive mining company in the world and

currently trading on an undemanding price to earnings ratio of around 13-14x

depending on which estimates are used. Invast published a report yesterday

calling a major rally in material stocks and we think BHP is right on the top of

our priority list in terms of buying opportunities. The link to the report is

contained below. There is nothing in this quarterly to suggest BHP is

becoming complacent in its capital management either which means the

balance sheet is likely to improve by a large factor over the next two years.

Keen to attend one of our seminars? Check out our trading education seminar schedule.

http://www.invast.com.au/resources/seminars.aspx














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Interest Rates in Australia and What this Means for the Aussie Dollar