General Macro Observations

[sydboy007]

1. I guess you mean that Aust corporate debt looks alright, and possibly so does Aust Gov't. Just FYI only, yield spread on BBB (as an example) has now compressed to levels not seen since the start of the GFC. I think it is clear to most that risk was underpriced prior to the GFC, so maybe this is as good as it gets for corporate credit?

I think risk is still being under priced for a lot of debt. Just have to look at the genworth IPO to see how close to the GFC level of risk ignorance things have gotten, or as you mention the way BBB debt yields have plummeted. But that's the plan by the central bank cartel. pump up assets, make people feel wealthy so they'll spend, then hope when you normalise rates the economy doesn't collapse and the FIRE sector doesn't have too big a hissy fit along the way.

2. Yeah, good stuff. Part of the reason you've done so well is that nominal bonds came in and affected the discount rate applied to the expected real coupon/capital stream and probably also a compression in the credit spread. Just watch out for extending that expectation.

Having said that, linkers definitely have a role to play. You mentioned FIIG in an earlier post about how much you need to live on $30k or something....I opened an account.

I don't expect another 10% gain next year, but I will get a real 3.4% over CPI which is not too bad in a financially repressed world. I'd much rather be in a floating rate style bond now than fixed rate. Considering inflation has taken off recently I'm in a better position than someone in cash or a TD.

Glad you signed up with FIIG. I find them one of the few decent financial organisations out there. At least they're not all about the sale, or that's my perception of them. I just wish they'd create their own listed bond fund. There's so many decent higher yielding corporate bonds I can't access, especially in foreign currency which I think is a good hedge for the eventual return of the pacific peso. I will really miss AKY when they finally sell down all the bond holdings by the end of 2015. It's been a nice yield play of around 6.5%. If your risk profile is a bit higher you might like AYF and the diverse range of hybrids it's invested in. 7% yield is not bad.

3. In relation to rising rates, you'd think so. But then why do they keep falling? Liability matching, less supply of US bonds meeting with increased demand from people leaving equities?? Lower equilibrium rate assessment? PbOC reserve management and FFX management?

All of this affects macro variables which then affect the stuff we invest in.

If you are saying this is severely rigged...yep. But somehow, sometime, gravity takes hold. I want to know where the most egregious gaps are between a rigged situation and what it should be in reality. The markets are bigger than the banks ultimately. The banks are also reacting to macro developments.

As to McMansions...no doubt about it that they need to act calm whilst the house is on fire. Ahhhhhhhhh!!!

I suppose I'm most worried aboout when reality and gravity take hold again. Just about nothing is actually priced on the fundamentals. It's all about the relativities against artificially constrained government bonds prices. The fact is pretty much every Government can't afford to have rates normalise or they'll be bankrupted, they have to blind the bond holders to rises in inflation in the hopes they can slowly steal back the value of the debt, and hope they don't piss off the voters too much and head down the path to viva les resistance :behead:

 

[DeepState]

I think any talk of Japan's lost decade(s) need to be viewed slightly differently. I'd argue they've done amazingly well for at first a rapidly aging population, and probably the last decade or so, for a falling population. When you view per capita GDP for the country things don't look too bad.

Conversely you look at Australia and it seems we've got good GDP growth so things should be sweet, but once you look at the per capita figures you start to notice the paint falling off and what's probably termite damage hollowing out much of the structure.

I do think Japan is borked unless they can get enough nuclear power stations back on line that they can significantly reduce their LNG imports. Since the fukushima shutdown it's decimated their trade surplus. The only reason their massive govt debt hasn't been an issue is the trade surplus.

Too many CADs and maybe Soros will decide to take them on :viking:

1. Japan's GDP per capita is flat line relative to Australia's for the last 20 years. More concerning is their growth has largely been financed by government budget deficits which have ballooned whereas private sector debt has been static. That's a nasty combination, particularly when it is so sustained and ultimately has to be repaid with a smaller and less productive population. Maintaining a trade surplus does not assist with increasing demand for JGB in of itself. Particularly given the trade surplus is at least partly financed by official reserve accumulation. Australia's growth has been financed in a more sustainable manner - not necessarily saying it was a great thing and could not be improved.




2. The Soros thing, I think, is quite a real scenario. If BoJ is printing beyond the level of government debt issuance, this usually leads to abandonment of a currency. Even if Japanese nationals are super sticky with the purchases of JGB via their own personal savings or via large investment pools, there is a point when this becomes ridiculous. All it needs is a catalyst and the sharks circle and attack with force and a self-fulfilling prophesy comes into being. LTCM, BoE, Fragile 5, Asian Financial Crisis etc.. JPY is not beyond reach. But this is a weird one because you are trying to force the currency to appreciate in order to break the economy.

 

[sydboy007]

Quite an interesting article

http://www.macrobusiness.com.au/2014/06/economic-implications-of-the-iron-ore-crash/

The chart for just how far the mining capex cliff falls is scary.

The chart of investor financed mortgages is mind blowing. NSW is just like mentos in a sealed coke bottle that suddenly shot up

iron ore seems to be heading in the one direction now, and not a good one for our incomes. Have no idea why FMG and RIO are doing so well when their lifeline is slowing been bled out.

How we resolve the anoying high AUD I'm not sure. being a deficit nation leaves us with little options than to be a more desirable destination to park money, so we have to continue with our (relatively) high interest rates.

Maybe Soros will target the AUD soon. Certainly on a fundamentals basis it's at least 10% over valued, and I'd say going into late 2015 it probably should have a leading 7 than the current 9. Then again, predicting forex more than a few minutes is a mugs game, but the probabilities seem to be on my side.

 

[burglar]

... iron ore seems to be heading in the one direction now, ...

Can anyone send me a telex when it bottoms?!!

 

[qldfrog]

Quite an interesting article

iron ore seems to be heading in the one direction now, and not a good one for our incomes. Have no idea why FMG and RIO are doing so well when their lifeline is slowing been bled out..

one of the stories around is :
while IO collapses, RIO and FMG with very low production cost still make a profit, so they carry on flooding the market at no loss and killi all the competitors.
not so sure it makes sense but think about it:
a ton of coal is cheaper today than a ton of Iron ore (basically ton of dirt)
So even at 90$ a ton, IO is still a great business
Not so good for the AUD and the budget...

Considering iron abondance on earth you will quickly find that the real price of iron ore should be in the 20$ per ton range not $100 if coal is only worth 75$ a ton. anyway I diverge.

 

[DeepState]

Can anyone send me a telex when it bottoms?!!

Let's say that demand for iron ore (imported and domestic) remains unchanged from 2013 levels, recalling that China 'only' consumes 70% of the seaborne market. That equates to something like 1,300 mtpa:




There are grounds to believe consumption should grow:




...but let's just say annual demand remains static.


This results in a rational iron ore price of around $80USD per ton. This corresponds to Treasury estimates as per the budget, which I think allows for constant currency from the looks of things:




As additional supply comes on stream, the cost curve should flatten and further displace high cost Chinese mines. When looking at the steel intensity of GDP, the uplift of steel demand at early industrialization falls away and demand cannot be expected to grow anywhere near as rapidly, so prices will fall. But it seems hard to imagine mines more efficient than, say, Vale's will come along in volume. Hence Treasury's estimates look very reasonable...at least to me, on constant currency.

 

[sydboy007]

This results in a rational iron ore price of around $80USD per ton. This corresponds to Treasury estimates as per the budget, which I think allows for constant currency from the looks of things:

As additional supply comes on stream, the cost curve should flatten and further displace high cost Chinese mines. When looking at the steel intensity of GDP, the uplift of steel demand at early industrialization falls away and demand cannot be expected to grow anywhere near as rapidly, so prices will fall. But it seems hard to imagine mines more efficient than, say, Vale's will come along in volume. Hence Treasury's estimates look very reasonable...at least to me, on constant currency.

Prob is a lot mines will hold on past the point of rationality. Or it makes financial sense to run at a loss if you are like some of the QLD / NSW coal mines that find it cheaper to sell at a small loss than to break their contracts.

There's also the problem of India coming back onto the export market next year, and from the looks of it they are scaling up pretty fast.

Then you also have to get the inefficient suppliers in China to close down, which is 50 50 depending on how slow their economy is going and how fast they want to try improve the air there.

I wont be surprised if spot prices go below $80 for awhile. There is going to be a massive oversupply by the second half of 2015. Will be interesting to see if Atlas Iron and FMG can survive the coming storm. I'm expecting them to fall into Chinese ownership or at least control.

Hopefully the falling iron ore and coal prices will tank the AUD down to a more liveable level.

 

[DJG]

Here's another cost curve chart.

It's expected that chinese miners stop production at and under the $90 mark as they have low costs (of shutting down)/quick to shut down production.

It's meant to be a natural support level.

Time will tell.

 

[Ken Oath]

Can anyone send me a telex when it bottoms?!!

X 2

Love the thread guys but I'm as confused as an octopus with a set of bag pipes by these charts.

 

[Julia]

Telex?

 

[DeepState]

1. Prob is a lot mines will hold on past the point of rationality. Or it makes financial sense to run at a loss if you are like some of the QLD / NSW coal mines that find it cheaper to sell at a small loss than to break their contracts.

2. There's also the problem of India coming back onto the export market next year, and from the looks of it they are scaling up pretty fast.

3. Hopefully the falling iron ore and coal prices will tank the AUD down to a more liveable level.

1. Yep, but irrationality in this market clearly cannot last indefinitely. In all likelihood, markets will look through unsustainable price levels to some degree. Those rational costs were at levels where the marginal producer is not making economic profit.

2. India is a very small player in the scheme of things. There is talk of 11.5mt of ore sitting in Goa which might be released (although it might be retained given India's own needs). But this needs to be considered against 1300mt of annual production/supply. Additional production is marginal relative to the existing curve and I don't think it should be thought of as a game changer.



3. It is interesting that these fair value models focus on two sides of the current account ledger. The Terms of Trade component sits on one side and the interest differentials component sits on the other. The models suggest that the AUD is overvalued when both components are taken together. Yet the AUD continues to defy. Why?

The Terms of Trade are the Terms of Trade. I accept they are doing what they are. But the interest rate differential component is understating the current value of the Australian yield relative to RoW. In a world where we are awash with money such that interest rates on the short end are as close to zero as the monetary mechanisms allow, interest differentials matter a whole lot more than they did before.

Check this out. Carry trade (AUDJPY) vs S&P 500. The world is a carry trade. There is a hunt for yield and there is a hunt for risk bearing. Same same.



The demand for Australian yield can be seen in the compression of AUD 10 yr vs US Treasury 10 yr:



...This obviously flows on to corporate credit which has grown enormously as a recipient of international funds (at the expense of our banks). We have discussed corporate yield compression against gov't earlier in the thread and this is another supporting factor for this viewpoint.

Until the world's monetary circumstances normalize, we may not see as weak an AUD as might have been imagined from historical relationships of a different era.

Isn't it ironic that by keeping our house in order, in the way that it has been done, the price of our goods and services becomes less competitive? But that's the function of markets.

 

[DeepState]

X 2

Love the thread guys but I'm as confused as an octopus with a set of bag pipes by these charts.

Gold! I mean, 62% Fe Iron Ore!

Which charts are confusing you most? Happy to assist if I can.

 

[sydboy007]

Here's another cost curve chart.

It's expected that chinese miners stop production at and under the $90 mark as they have low costs (of shutting down)/quick to shut down production.

It's meant to be a natural support level.

Time will tell.

I really question that FMG is down below $60. I wonder what costs have been left out of that figure, or maybe it ignores their massive interest bill?

My understanding is RIO has the best at around $43, BHP at $45 , FMG up around $70 with over $8B in debt still on the books, AGO around $80, BCI around $70 - though admittedly that was early in the year so maybe some cost cutting is coming through.

My understanding is a falling AUD helps those costs curve down, but slowly since a lot of fuel / equipment contracts are in USD.

Prob the best thing to happen at BHP is the fact they haven't made any Rio stoopid purchases during the boom. I'd expect they're biding their time for the eventual shakeout of the market and can pick up some decent assets on the cheap, unless the Chinese outbid them.

 

[sydboy007]

Between the continued falling in construction (large employer) and the continued run down in inventories things don't look good for next financial year.

http://www.thebull.com.au/articles/a/46427-figures-even-gloomier-than-they-look.html

The number of residential building approvals fell by six per cent in April.

That fall was bad enough, but it followed two consecutive falls of about the same size.

And the less-noticed estimate of the value of approvals for non-residential buildings - hotels, hospitals, offices and so on - recorded a serious slump of 27 per cent.

That also followed a run of three increasingly steep falls.

As a result, the April value of approvals, residential and non-residential combined, came in at $5.88 billion, $2.31 billion below the average for the final quarter of last year.

Most economists look first at company gross operating profits, which looked strong in the March quarter with a rise of 3.1 per cent.

But half of that gain came from inventory revaluations which aren't included in GDP because they represent windfall gains rather than actual production.

And the other major chunk of income comes from wages which, the ABS said, rose by a tiny 0.2 per cent in the March quarter.

Unincorporated business profits increased strongly, but is a small part of the total of all three measures, which rose by just 0.9 per cent.

And that's before allowing for inflation, and GDP is typically measured in "real" or inflation-adjusted terms.

After falling by 0.6 per cent in the previous three months, inventories fell by 1.7 per cent in the March quarter.

That means less production for any given level of spending, to the tune of about 0.5 per cent of GDP.

Ahead of the figures, economists' forecasts for GDP growth in the quarter were centred on 0.8 per cent - in line with the long-run average.

 

[sydboy007]

http://www.bloomberg.com/news/2014-...llion-bond-market-renders-models-useless.html

Just last month, researchers at the Federal Reserve Bank of New York retooled a gauge of relative yields on Treasuries, casting aside three decades of data that incorporated estimates for market rates from professional forecasters. Priya Misra, the head of U.S. rates strategy at Bank of America Corp., says a risk metric she’s relied on hasn’t worked since March.

After unprecedented stimulus by the Fed and other central banks made many traditional models useless, investors and analysts alike are having to reshape their understanding of cheap and expensive as the global market for bonds balloons to $100 trillion. With the world’s biggest economies struggling to grow and inflation nowhere in sight, catchphrases such as “new neutral” and “no normal” are gaining currency to describe a reality where bonds are rallying the most in a decade.

Globally, bonds have returned an average 3.89 percent this year for the biggest year-to-date gain since 2003, index data compiled by Bank of America Merrill Lynch show. The advance decreased yields on 10-year Treasuries by more than a half percentage point to 2.48 percent, the fastest pace over the same span since 1995, while borrowing costs for the riskiest U.S. companies tumbled to a record 5.94 percent last week.

“The biggest mistake for people is they think interest rates are merely a projection of where the economy is supposed to go,” Bianco said. “It’s the Fed and the way they have changed the markeplace.”

 

[kid hustlr]

I really enjoy reading these threads and listening to you guys speak, but the more I read them the more I'm convinced I will never be a fundamental/macro based type investor. This discussion in the main goes way over my head yet quite often I'm left asking myself 'This is all well and good, but how can I make money from this?'

---

I find the rising bond values over the past months to be interesting (as well as confusing). In this new world of buy everything I feel something has to give, yet I'm not sure how or what.

I feel when I sit back in my chair as an Australian investor I see:

- Low Aussie bond yields
- Middle of the road p/e valuations in the ASX200, by no means appealing valuations.
- Expensive property prices (one could argue on both a long term fundamental level and even short term given the recent increase)

So again I'm left asking myself - Where do I put my money??

 

[DeepState]

I'm left asking myself 'This is all well and good, but how can I make money from this?'

---

So again I'm left asking myself - Where do I put my money??

Maybe your aim might be to understand the shape of risk in your portfolio. Even if you cannot predict this stuff directionally, you can gain a sense of which way the risk will break or whether there is a lot more/less risk in the system than might be priced. The medium term stuff moves in big, slow, cycles. With prices moving more extremely as they move like extrapolations of the tide. Whilst never perfect, it can help to determine where you might be on this cycle and just be a little more sensible with your choices.

As you would know, risk management is crucial to successful portfolio management. If you hold a single stock, what happens to that stock's performance is - for the most part - largely determined by its own actions. Once you group that up into a portfolio, that influence washes out and the dominance of macro factors comes to the fore. Since you are exposed to it one way or another, being an investor might require at least some background knowledge of where the pressure points are. No-one is saying you need to be Soros plotting to crack the JPY. Just aware to the risks.

It's the short term timing stuff that is super hard (not worth pursuing?) but your horizon might be longer. Once you move into the multi-decade horizons, I guess macro matters less again as it washes out and quality shines through as long term returns become all that mattered and short/medium term risk concepts are less important for you. Whilst Buffett is quoted liberally in this Forum, not many of us can really hack his kind of horizon (although his actual actions suggest a shorter horizon is how he invests in reality).

I am deploying assets too. I can't find much which offers a decent reward for risk borne and it's been this way for a while and just gets worse. There are pockets which are alright though. Fair is the new cheap. I can't stand the thought of adding duration risk. Whilst AEQ is much more reasonably priced than the US equivalent, it'll get dragged down if the S&P deflates as I think it will/should although not by the margins predicted by the CAPE models. US equities are expensive even with the lowered yield and earnings growth is still not really coming through and much of the earnings growth is coming from financial engineering or unsustainable-growth boosting initiatives.

If you can't stand to take outright directional positions, the best ideas seem to me to be in spread trades. This is just a different style of investing that applies the same skills but repackages them. Pair trading is an example. So SKC is in the zone. One thing I feel though is that 7% per annum is the new 10% per annum and reaching for the old hurdle would be like doing high jump with the bar set at 1.80m (which you did in high school) at aged 70. Not a good idea. We just have to make do with what we get presented with today and not pretend that it is otherwise. A fortune saved is as valuable as a fortune made.

 

[burglar]

... A fortune saved is as valuable as a fortune made.

A Train Controller once said "Sometimes an empty wagon is more valuable than a loaded wagon!"

 

[DeepState]

A Train Controller once said "Sometimes an empty wagon is more valuable than a loaded wagon!"

A Train Controller once said "Sometimes an empty wagon is more valuable than a loaded wagon...of telexes"

 

[burglar]

...of telexes"

Sorry folks, I did mean "Facebook"!

From the urban dictionary:

facebook
a stalkers dream come true
facebook addict #1: dude you know that hot girl who lives upstairs, i totally got her screen name and cell phone number off of facebook
facebook addict #2: awesome, now you can totally stalk her