More trouble for Aussie economy…

  • Aussie housing market is changing
  • Don’t worry…
  • ‘Flash crash’ disappears
  • OPEC’s big move
  • Get gas
  • Climate change update

It’s piling up.

By ‘it’s’, we mean trouble.

Business investment down. Economy on the edge of recession. Housing market on verge of collapse.

You see — trouble.

Then again, we’ve said that for a while — eight years to be precise. So what makes now any different?

We’ll opine on that for you shortly. So please, do stick around. First…


Overnight, the Dow Jones Industrial Average gained 1.98 points, or 0.01%.

The S&P 500 fell 5.85 points, or 0.27%.

In Europe, the Euro Stoxx 50 index added 13.19 points, for a 0.43% gain. Meanwhile, the FTSE 100 gained 0.17%, and Germany’s DAX index added 0.19%.

In Asian markets, Japan’s Nikkei 225 index is up 367.06 points, or 22%. China’s CSI 300 is up 0.62%.

In Australia, the S&P/ASX 200 is up 52.13 points, or 0.96%.

On the commodities markets, West Texas Intermediate crude oil is trading for US$49.81 per barrel. Brent crude is US$52.31 per barrel.

Gold is US$1,170.30 (AU$1,580.59) per troy ounce. Silver is US$16.42 (AU$22.17) per troy ounce.

The Aussie dollar is worth 74.04 US cents.

Aussie housing market is changing

Yesterday we noted how building approvals had slumped. They had fallen by 24.9% compared to this time last year. Analysts had expected a drop — but only a 6.2% decline.

So, that’s a big miss.

The monthly number was bad, too. This was down 12.6% compared to the previous month.

That’s another big drop.

Today, the news appears to have worsened. Australian business investment (capital expenditure) fell 4% for the quarter. That was more than analysts’ estimates of a 3% drop.

Business building fell 5.7% for the quarter, and business investment in equipment and machinery fell 1.9% for the quarter.

That’s not a good sign.

And if it could be argued that, even if the business sector is weak, the Aussie housing sector is strong…even that looks strained.

As Bloomberg reports:

Apartment prices in Melbourne fell at the fastest pace in more than two years in November, reinforcing concerns about a looming oversupply of units in Australia’s second-largest city.

The 3.2 percent month-on-month drop is the largest such decline since May 2014, according to figures from data provider CoreLogic Inc. This dragged down the overall increase in dwelling values across the nation’s state capitals to 0.2 percent, the smallest rise since March this year.

Don’t underestimate the significance of this.

In hindsight, it perhaps isn’t surprising that Aussie house prices didn’t collapse. In the UK, US and Ireland, new home building is generally supply driven.

That is, a housing developer will develop a housing estate and build ‘cookie-cutter’ housing, where one house after another looks almost identical. Due to space constraints, and tradition, in the UK and Ireland, many of the houses are also terraced houses — identical inside and out.

That works fine during a housing boom. The developers can barely keep ahead of the demand, so they build them first and hope to sell them before, during, and after the building process.

It’s money for old rope.

But that doesn’t work so well when the market collapses. People that placed deposits end up withdrawing. The demand for housing falls, and tens, hundreds, and thousands of newly-built houses remain empty.

And for those who have already moved into their new house, it’s just as bad. The glut of empty houses makes it almost impossible for them to sell theirs, even if they wanted to.

Generally, the setup is different in Australia. House and land packages are the most common deal in new estates. The buyer buys the land and the house. Building only begins once the buyer has settled on the deal.

The upshot is that there shouldn’t be a glut of newly-built, but unoccupied, housing, because house and land deals are primarily demand driven.

The worst likely consequence for a developer is that, in the event of a housing collapse, they’re left with excess land. And, generally, their only risk if a buyer defaults is the amount spent on construction between progress payments.

However, that make-up has changed fast in recent years. The building of higher density unit and apartment blocks isn’t new, especially in the inner suburbs. But there’s little doubt it’s becoming more prevalent.

Not just in inner suburbs, either, but in the outer suburbs, too. There has been a marked increase in developers buying adjoining blocks of land, knocking down existing houses, and then building higher-density units.

Where six houses may have stood, each on a quarter-acre block, today, a good developer could likely squeeze 18–30 units (or more) on that same area.

No doubt, that results in a nice investment return for the developer. The problem is that these developments skew the Aussie new-build housing market further away from the traditional demand-driven setup, and towards the UK-style supply-driven setup.

The banking establishment appear to be aware of this. As Bloomberg notes:

Record low interest rates put in place by the Reserve Bank of Australia to help ease the economy’s shift away from mining investment and combat low inflation have helped to spur a housing boom in the nation’s biggest centers and the central bank has repeatedly voiced concern that apartment gluts are developing in central Melbourne and Brisbane.

“Risks around the projected large increases in supply in some inner-city apartment markets are coming to the fore,” the RBA said in its quarterly financial stability review in October.

The apartment glut is obvious. You only have to look at the Melbourne skyline and compare it to the skyline of 20 years ago to see how it has changed.

There isn’t much in the way of new office buildings. But there sure as heck are a lot of new apartments.

But, don’t assume this is the only place the Aussie housing crash will play out. The destruction of the typical quarter-acre block in the near and outer suburbs will play just as big a part.

We’ve predicted an Aussie housing crash for eight years. One of these days, we’ll be able to say, ‘We told you so.’

We’re just not quite sure when that will be.

Don’t worry…

Meanwhile, don’t fret. At the market close, the S&P/ASX 200 index is up 59.73 points, or 1.1%.

The market speaks: Don’t worry!

‘Flash crash’ disappears

Speaking of the market, there’s nothing we like more than a flash crash. Today, the Aussie market experienced such a thing. And here follows the photographic proof, courtesy of the Sydney Morning Herald and Bloomberg:

chart image

Source: Sydney Morning Herald, Bloomberg
Click to enlarge

The market fell 1% in a matter of seconds, before instantly rebounding.

Interestingly, as if by magic, just three hours later, all evidence of the flash crash has been expunged from the Aussie market:

chart image

Source: Bloomberg
Click to enlarge

Is this a cover-up? Investors should be told.

OPEC’s big move

Internationally, the biggest news overnight was from OPEC (Organisation of the Petroleum Exporting Countries). OPEC and Russia have agreed to cut production levels by up to 1.5 million barrels per day (MMBPD), to around 32.5 MMBPD.

The announcement caused oil futures prices to rise up to 10% in overnight trading.

We’ve written on this subject before. For much of the past eight years, OPEC has been an irrelevance.

As the oil price soared, and as US shale oil production gained market share, no one much cared about OPEC production quotas.

And, to be fair, it seemed for a while that OPEC didn’t care much about them, either. That’s the only conclusion anyone could draw after OPEC consistently produced more than they said they would.

But then something changed. By at least 2014, OPEC realised that increased shale oil production in the US could have a major impact on OPEC’s influence.

They worried that, if they let things get out of hand, shale oil production technology would become so advanced, that the average cost of production would fall from US$40–50 per barrel, down to the production costs that Saudi Arabia enjoys — around US$10 per barrel.

In that case, why on Earth would the US want Saudi oil, if it could exploit the vast, previously untapped reservoirs of Texas, the Dakotas, Montana, and elsewhere?

So OPEC implemented what you could either call a ‘free market’ or a ‘scorched earth’ policy on production, depending on your view. That meant not only openly increasing production levels, but also not making any assurances that OPEC would cut production if prices fell.

The result was a collapse in the oil price. Evidence of which is in the chart below:

chart image

Source: Bloomberg
Click to enlarge

From US$107 in June 2014, the price fell to a low of US$26 in February this year.

There are many arguments about why Saudi Arabia and OPEC allowed the price to fall so far. Our simple view was that it was nothing more than OPEC showing the US that it had the power to move the oil price if it chose to do so.

Naturally, as the oil price fell, so did the number of active rigs in the US. Remember, shale oil drilling is much more expensive than conventional oil drilling.

The chart below shows the active rig count in the US, stretching back over the past five years:

chart image

Source: Bloomberg
Click to enlarge

You can see the correlation for yourself between the oil price and the US rig count. After reaching a low in May, the number of active US rigs has risen nearly 50%. That’s in tandem with the oil price, which has nearly doubled since the February low.

The question now is whether OPEC really will cut production. Each OPEC member has its own motives. Many of its members are cash-strapped and politically unstable — Venezuela, for one.

If social issues arise in any one of the OPEC member countries, it may be hard for that country to resist increasing production in order to hand out social welfare ‘bribes’ to its citizens.

If that happens, it wouldn’t take much for others to follow suit. The next thing you’d know, the oil price would be on the slide again, and OPEC members and non-OPEC members alike would rush to increase production before prices fell even further.

For now, as with any supply and demand play, when supply falls, the price goes up, and the market loves it. Just note that, even after this price spike, the oil price is still below the recent high.

We shall watch with interest to see if the bullish trend lasts.

Get gas

Our colleague, Greg Canavan, responded to the OPEC move in today’s Daily Reckoning. Here’s what he wrote:

Despite the volatility and bearish opinions that oil would fall back to its lows of earlier this year, the fact was that the trend was moving higher.

A good rule of thumb to use is that the probability is higher that the trend will continue, rather than reverse. Of course, trends do reverse. But when you put a little analysis around it, you can fine-tune your thinking and increase your chances of success.

For example, rising oil prices over the course of 2016 told you that the outlook for global economic growth was improving. When Trump won the election, and bond yields started heading higher, this was another sign that growth prospects were improving.

Against this backdrop, the odds were in favour of oil continuing to trend higher, OPEC meeting or not.

I’m not just engaging in hindsight analysis here. I’ve been building the Crisis & Opportunity portfolio up with energy exposure over the past few months. The decision to do so was on the basis that oil had bottomed and would move higher from here.

It was also due to some digging I did into the Aussie energy market. There’s a little-known part of the Aussie East Coast gas market that stands to benefit enormously from rising energy prices. These are the companies that will benefit from the East Coast LNG revolution that the Aussie market has undergone over the past few years.

I’m not talking about the big players like Santos [ASX:STO] or Origin Energy [ASX:ORG], who were involved in building some of the huge LNG plants in Gladstone, Queensland.

I’m talking about smaller players that will ride on the coattails of these guys.

The establishment of a huge LNG export industry means Australia has to find more gas to send to the export terminals in Gladstone. It’s squeezing domestic supply as we speak. And I’ve identified three small companies that are in the box seat to benefit from it.

The share prices of all three are up strongly today. But I think this is just the start.

Is it just the start? If it is, Greg says he has just the way to play it. Go here.

Climate change update

Quick, call the papers. We spy an increase in temperatures above the 80th parallel. Cue the hysterical headlines…

chart image

Source: Danish Meteorological Institute
Click to enlarge