When house prices fall…

  • Buy Australia!
  • Export boom
  • Flashback

Here comes trouble. From Bloomberg:

The Reserve Bank of Australia frequently seeks feedback on the health of the economy. It might want to call the debt counsellors soon.

Homeowners, consumers and property investors around Australia are making more calls to financial helplines as three warning signs back up the spike in demand: mortgage arrears are creeping up, lenders’ bad debt provisions have increased and personal insolvencies are near an all-time high.

We’ve banged on about high house prices for so many years that we’ve almost lost count of when we started.

We think it was back in 2005, when we started writing The Daily Reckoning eletter. That was when the average Aussie home was about 70% cheaper than it is today!

But it seems hard to us to deny that the Aussie housing market is finally starting to crack.

Remember that one of the big spurs for the housing market is negative gearing. Negative gearing only works when investors believe house prices will keep climbing.

If investors start to feel bearish about house prices, they’ll hold back…they won’t borrow hundreds of thousands of dollars knowing that there isn’t the capital growth to pay off the loan.

That’s the other thing. Many property investors take out interest only loans, which may last three or five years. In many cases, the aim is to give the place a lick of paint and a facelift, and then on-sell it without ever paying off a dollar of principal.

But nobody is going to do that if house prices aren’t going to rise. And that even makes buy-to-renovate deals uneconomical. The reality is that during a boom, an investor could just buy an un-renovated place, do nothing to it, and then on-sell it at a profit after six months or a year.

The rising market would take the price higher. But if house prices aren’t rising, the only ‘profit’ that a renovator is adding to the price of a house is the cost of labour.

And seeing as that labour cost is the renovator’s own labour, or labour they’ve had to pay for, the ‘profit’ is likely no more than they would make from doing comparable labouring work elsewhere.

This is a long way of saying that everything most folks think they know about the dynamics of the Aussie housing market is only applicable as long as house prices keep rising.

When they stop rising, everyone (including the so-called experts) will suddenly realise that when house prices fall, a whole new dynamic enters the frame.

Of course, we’ve been saying that for 12 years. One day, we’re bound to get it right…

Markets

Overnight, the Dow Jones Industrial Average gained 37.87 points, or 0.19%.

The S&P 500 added 0.52 points, or 0.02%.

In Europe, the Euro Stoxx 50 index closed down 2.6 points, for a 0.08% fall. Meanwhile, the FTSE 100 gained 0.2%, and Germany’s DAX index added 0.34%.

In Asian markets, Japan’s Nikkei 225 index is up 6.18 points, or 0.03%. China’s CSI 300 is down 0.33%.

In Australia, the S&P/ASX 200 index is up 28.78 points, or 0.51%.

On the commodities markets, West Texas Intermediate crude oil is US$51.51 per barrel. Brent crude is US$54.55 per barrel.

Gold is trading for US$1,234.32 (AU$1,616.31) per troy ounce. Silver is US$17.73 (AU$23.21) per troy ounce.

The Aussie dollar is worth 76.36 US cents.

Buy Australia!

How’s this for a deal? From the Financial Times:

Moelis & Co has been chosen as the sole independent adviser for the planned initial public offering of Saudi Aramco, according to three people familiar with the process, scoring the New York boutique investment bank the biggest equity advisory mandate to date.

Winning the hotly contested mandate represents a coup for the independent firm, which was founded by veteran dealmaker Ken Moelis in the midst of the financial crisis in 2007. Other banks are still in the race to underwrite the offering.

Saudi officials hope to turn the state-owned oil group into the world’s most valuable publicly traded company, which they believe could carry a valuation of about $2tn.

To put that in perspective, at the end of November 2016, the entire market capitalisation of the Australian stock market was $1.69 trillion (US$1.28 trillion).

The Saudis could sell Aramco and buy Australia! Imagine that.

Export boom

Despite the thrill, excitement and hype about new and renewable energy sources, it’s still fossil fuels that keep the world’s economy turning.

The valuation on Saudi Aramco, of US$2 trillion, is evidence of that.

Fossil fuels such as oil and natural gas are in huge demand. Check out the chart below, showing world crude oil demand for the past two years:



chart image

Source: Bloomberg
Click to enlarge


At the end of December, demand was at 96.45 million barrels of oil per day. That’s up from 95.18 million barrels of oil per day in early 2015.

But it’s not just oil where you’ll find a lot of demand. That’s true of natural gas too. And it’s the huge demand for Aussie natural gas by offshore buyers that’s opening up a huge opportunity…while at the same time creating a massive problem.

What is it all about? Colleague, Greg Canavan explains:

Over the last decade, Australia’s three dominant liquefied natural gas (LNG) producers, Santos, Origin Energy and BG Group have poured more than $60 billion into three enormous LNG terminals, which now occupy the southern end of Curtis Island.

All three gas terminals were built with a single purpose: To export millions of tonnes of freshly produced Aussie coal seam gas from Queensland’s Surat Basin to international export markets.

You see, at the time these massive LNG plants were approved, international gas prices were much higher than Australia’s domestic gas price.

The east coast domestic market was awash with gas supply, so it was much more profitable to sell Australian gas to international markets.

As I’ll explain in a moment, that’s no longer the case.

It’s why I see such an incredible investment opportunity today.

The thing is, hardly anyone knows what’s going on. They’re too busy focusing on the problem to see the huge — and potentially lucrative — opportunity staring them in the face.

Let me show you the problem first. Then I’ll reveal how you can take advantage of the coming ‘crunch point’ with three little known Aussie energy plays.

OK, here’s the problem:

The LNG plants on Curtis Island were built to access Queensland’s massive coal seam gas reserves.

The idea was to monetise Queensland’s reserves by selling gas into international markets (and getting much higher international gas prices for it).

But the flow of gas from these coal seams has underperformed expectations big time. As a result, the Curtis Island plants need MORE gas.

This is where the story takes an interesting turn…

Gas that was formerly destined for domestic markets in Sydney and Melbourne is now heading north for Curtis Island.

The three giant LNG plants are sucking all the excess supply out of the market.

Gas from the Cooper Basin on the South Australian border…and even as far away as Victoria’s offshore gas fields, is heading to international markets to take advantage of higher prices.

That means less gas available for Aussie households and businesses. Which means higher gas prices are on their way.

You can read the rest of Greg’s explanation, including the solution, here.

This is a big deal for Australia. The hype around renewable fuels, and the neglect of investment in fossil fuels, is starting to tell.

As ABC News reported last year:

In May, Alinta’s Northern power station at Port Augusta closed, which means coal has been cut out of South Australia’s electricity production equation.

At the time, Australian Energy Council chief executive Matthew Warren said the power station’s closure meant the state would have less back-up energy available on days of peak demand.

He also said the state would have a greater reliance on renewable energy and on the interconnector from Victoria for base-load power.

“The reality for South Australians is that we’re in uncharted waters,” he said in May.

“There’s an increased level of risk that we really haven’t seen before anywhere in the world, so it doesn’t mean we’ll have more blackouts, hopefully if we’re smart we can sort out solutions so power supply can be the same as usual, but it’s an increased risk.”

And it’s not just in South Australia. In Victoria too. From the Australian Financial Review:

Legislation enacting Victoria’s unprecedented bans on onshore petroleum exploration has arrived with the added but necessary insult of protections that explicitly protect the government from financial liability for the damage caused to drillers by this reactive, retrograde and unscientific decision.

Not only is Australia exporting existing gas and oil resources, state governments have legislated to make it illegal to replenish what Australia is losing.

It seems the fanatical green movement can’t help themselves.

That means there are only two outcomes: severe power shortages, or significantly higher energy bills…or both!

It’s not difficult to understand. It’s the simple laws of supply and demand. If hopeless state governments arbitrarily cut off major supply sources, it’s not always that easy to replace them with another source.

Or even if the market can cover the supply gap, you’re still left with a situation where a government has rendered millions of square acres of land as off limits to energy exploration.

And with demand increasing worldwide, the story can only get worse for consumers. The chart below shows the five-year price chart for natural gas. You can see the price has rebounded since the beginning of last year.



chart image

Source: Bloomberg
Click to enlarge


Expect that gas price to get higher. Bad news. But not for everyone.

Greg says that as the ‘crunch’ in the gas market starts to take effect, it will result in a handful of key investment opportunities for those prepared to take a risk.

You can find the details here, along with Greg’s full analysis.

As far as I’m concerned, Greg is our firm’s finest analyst. It’s why I made him the Head of Research last year. Greg has a knack for studiously scanning the market to find key contrarian plays.

He did that with his ‘China’s Bust’ thesis in 2012, and he was one of the first analysts to get on board with the gold stock bull market last year.

Now he’s found another opportunity. This time in the natural gas market. Check it out. I’m certain you’ll be glad you did. Details here.

Flashback

I won’t deny my fondness for the natural gas sector. Back in 2008 and 2009, I identified a similar trend in the market for natural gas.

On that occasion, it scored what until recently was Port Phillip Publishing’s best stock pick, Bow Energy, which gained 458% in nine months.

If Greg’s right about what’s in store, similar gains could be on the agenda again.

Cheers,
Kris