Communism to the Rescue!

November 11th, 2008  by Cale McCulloch

Closing Data

	current	change	%
Dow Jones	8870.54	-73.27	-0.8%
NASDAQ	1616.74	-30.66	-1.9%
S P 500	919.21	-11.78	-1.3%
FTSE 100	4403.92	38.96	0.9%
Nikkei 225	9081.43	0	0.0%
SPI Futures	4033	-65	-1.6%
All Ords	4,060.00	53.4	1.3%
Oil	62.19	1.13	1.9%
Gold	746.5	12.3	1.7%
Silver	10.22	0.257	2.6%
Aluminium	1956	-19.5	-1.0%
Copper	3761	-129	-3.3%
Lead	1446	-24	-1.6%
Nickel	11405	-50	-0.4%
Tin	15100	0	0.0%
Zinc	1080	-22.5	-2.0%

We saw the Australian stock market rally modestly yesterday as strength in resources on the back of the Chinese stimulus package was dampened by the weakness in financials following the NAB's announcement that they would be tapping the Institutions for some $3 billion. Banks were sold off heavily on concerns that banks like CBA and ANZ will not be able to tap the market as easily after being beaten to it by the NAB, and given the recent provisioning by the two for losses to the "Bad Boys" of the Australian share market, concerns increased that they may both need to.

But the big news of the day was the 4 Trillion Yuan stimulus package announced by the Peoples Republic of China! This is a huge number, and do not make the mistake of comparing this to the Bail out happening in the US as the two are vastly different. The 4 Trillion Yuanthat China will inject over the next 2 years (roughly) is not to save the banks, but to save the people and encourage continued growth in the economy through out the Global slowdown that we are seeing unfold. The funds will be pumped largely into infrastructure spending, on roads, rails and housing, all of which will serve on main purpose, which is to provide jobs to the people of China in tough times, and thereby increase income and spending in the region.

The hidden message of the Chinese government was this:

IF THE EXPORT LED GROWTH STRATEGY THAT WE HAVE USED IN THE PAST WILL NOT FUNCTION AS THE GLOBAL ECONOMY SLOWS, WE WILL EMPLOY THE MASSES OURSELVES, AND MAKE UP FOR THE SHORTFALL IN SPENDING THROUGH THE USE OF OUR OWN FUNDS UNTIL THE GLOBAL ECONOMY RECOVERS AND WE CAN GO BACK TO EXPORTING TOYS!

So what will this strategy mean for China and the Australian resources sector? Firstly, I think that it is good news for the Australian miners as infrastructure requires large amounts of Steel (the main ingredients being IronOre and Coal, with the end product usually galvanised requiring Zinc). But one of the biggest impacts for China that has been largely over looked will be the fact that in order to inject such funds the country will need to gradually step back from the management of it's own exchange rate. Let me explain, although the country records large budget surpluses, the funds for such a package are more likely to come from the USD 1.2 trillion that they hold in reserves as a result of decades of exporting to the US, with out the need to convert the currency back to Yuan. Hence we should gradually see the USD reserves of China sold and Yuan purchased through out the implementation of the package, thereby leading to an appreciation in their own currency. Although this sounds bad for the countries exports (as they become more expensive), but the raw materials imported by the industrial giants will become cheaper, and demand should increase.

All in all the package should have a positive impact on Australia (as well as Chinas other suppliers), this will show in time.

Mean while the RBA has said that while the Australian economy may yet avoid a recession, times will get tougher in the coming months (and so there have been more calls for further rate cuts). But more rate cuts does not mean that people go back to borrowing funds to buy houses as many seem to assume, the Economy will need to find a new equilibrium just like the market. To outline the process, we should see a series of events occur moving forward:

1. Rates will continue to be eased in an effort to make loan repayments less of a strain on households and companies.
2. The consumer and corporate efforts to save money will result in lower demand and investment spending, leading to higher unemployment (this is called the Paradox of thrift).
3. Inflationary wage and resource pressures of the past will become deflationary as unemployment rises.
4. Prices and wages will reach a level where corporations will believe they can begin moving inventory once again, and begin to expand once again. And so the cycle will start again.

It is important to understand that this is the economic cycle (in simple terms), but that the market is forward looking. Although corporate earnings will probably get worse over the next 12 months, much of this has already been priced in, and when the bad results begin to come out they will likely be accompanied by statements of a far more positive nature about the future.

The rally which began in Asia yesterday was short lived in the US overnight as on concerns about Goldman Sachs and Google's earnings. Following on from HSBC statement in Europe that provisions for bad debts related to the US will be higher than expected USD 4.3 billion, re-igniting concerns that the worst may not yet be over for the Financial sector!

Contact your Freeman Fox Stockbroker on 07 3031 9960 or 1800 003 369 Ext 7.

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