18/02/2009 - 22:00

A fair day’s pay for a fair day’s work

18/02/2009 - 22:00


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ast year, the world changed in a meaningful and substantial way, but most of us have not yet begun to grasp the nature of changes now in store.

A fair day’s pay for a fair day’s work

WELCOME to the new economy. Last year, the world changed in a meaningful and substantial way, but most of us have not yet begun to grasp the nature of changes now in store.

Briefcase believes that the new economy will be focused on payment of a wage for work completed. Paper shufflers and financial engineers, so discredited by the collapse of companies such as Allco Finance and Babcock & Brown, will be consigned to the history books, at least until the next asset price boom.

Rather than working to the very 1990s style of bonus payment culture, an employee will be expected to put in a day's effort to actually produce something and add value somewhere. Workers will receive a wage for doing their job, but no bonus for simply completing their allocated tasks. Don't you love the way Americans talk about wages and salary in terms of compensation? Recent history has shown that it is the shareholders who should be seeking compensation from those same employees for destroying their companies.

During 2009, Briefcase sees economic power swinging back towards shareholders at the expense of the debt providers. It is, after all, shareholders who take the bulk of the business risk and will want to be exposed to the upside for value adding, as a business grows.

Bankers who have been torched while lending on inflated asset values will go through a period of several years where extreme caution is applied when awarding new loans. Over the next five to 10 years, Briefcase believes that shareholders, the people who provide ultimate risk capital, can expect a higher tax effective rate of return on their investments than bankers, but target rates might initially fall towards 5 per cent per annum, from a more traditional 8 per cent to 12 per cent a year.

In response to heightened risk awareness, recent loan arrangements have begun to resemble equity in their structure. Gold developer Apex Minerals was obliged to offer convertible debt at usurious rates, while also giving away much of the upside associated with gold price appreciation.

Briefcase believes that this sort of deal may have been an aberration in a difficult and transitional market. Most companies will prefer to seek pure equity under these tough conditions, rather than give away half the company to their bankers, at the expense of their shareholders. This is why we have recently seen a spate of deeply discounted new equity issues from listed companies. Ultimately the lessons learned in the global financial crisis of 2008 will fade, but its legacy could live on in market behaviour for a decade or more.

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Interest rates look set to remain low during 2009. Eventually, cash will begin to trickle back into the equity market looking for return at manageable risks. While unemployment has risen towards 5 per cent and looks likely to rise towards 8 per cent by year's end, it is worth remembering that at present, 95.3 per cent of Australia's workforce is gainfully employed. Superannuation payments continue to pile up at a rate of around $48 billion/year, or about $4 billion per month. A large chunk of this money presently sits in cash or bonds, but recapitalisation by several companies is already attracting a fair share of this cash.

Deeply discounted primary issues by Transfield, Wesfarmers, Suncorp Metway, Macquarie Office and several others have attracted funding from institutional investors, weakening the secondary market for shares.

Meanwhile, the gold sector has begun to bounce. Newcrest came to the market for $500 million and took an extra $250 million in overbids. The company could easily have raised four times as much, given the strength of market demand. Most encouragingly, smaller development companies in the sector, such as Integra, have entered the market at a critical stage. Briefcase sees strong potential for speculative investors in this market to reap rewards, with some gold stocks likely to experience a ten-fold increase as the gold price continues to perform strongly and new projects come into production during 2009-10. At the current gold price, Briefcase calculates that Newcrest will more than double its profit level during the coming six months, compared with the six months to December 31 2008.

Gold is responding to financial uncertainty as it so often has in the past. So far, the US dollar has remained remarkably firm, despite the US treasury's printing presses working overtime to keep up with government spending. On the other side of this equation, gold coin makers cannot mint enough coins to keep up with demand. It may seem strange to contemplate inflation while asset and commodity prices are tumbling.

Other asset prices, such as shares and property, are falling because over-leveraged owners are being forced to sell at any price to repay debt, while commodity prices are falling in response to weaker end-user demand, as global industrial production slumps, again as a reaction to the freezing of both debt and equity markets.

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In 2007, Australia's Reserve Bank was worried about inflation. At that time, buoyant demand pushed up prices for everything from a cup of coffee and a tonne of steel, to a riverside mansion. By the end of 2009, it will be a different story. Too many US dollars, euros or Aussie dollars pumped into economies that have shown no fundamental growth in their underlying wealth or pool of assets will result in a supply-side boost to prices as these torrents of new currency actually devalue paper money and push up the prices of hard assets.

Early signs of this trend can be seen with the gold price. It might be argued that gold is the hardest of all assets. All this extra cash floating around the globe has begun to move into gold, inflating its price as the value of currencies decline. When gold reaches 'fair value', money will move onto the next best asset class and then the next and so on. Briefcase imagines that the price of other precious metals, such as silver and platinum, will ultimately be caught up in gold's wake.

The more paper currencies are devalued by issuing additional money into the economy with nothing to back up its value, the more people will want to exchange that paper for hard assets. Investors are going to continue to buy gold as a hedge against falling currency values and ultimately, when the price is right, they will want to buy property and equity in real businesses, to protect themselves from crumbling currencies, which will ultimately be subject to inflationary pressures.

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During December 2008, a total of 38.3 per cent of subprime homeowners in the US were 30 or more days behind on the loans on their primary residences, up 23.9 per cent year on year. Briefcase believes this situation is close to the nadir for that housing market. Houses are now being cleared at rock bottom prices in the US. A tidal wave of forced house sales in the US is coming to its peak and should show signs of retreating when the numbers are out in April.

If we are looking at the factors to watch which will impact on our market in the short term, there are a few key issues to follow. US housing activity, including sales numbers, should be a key as this will indicate if the market is beginning to clear inventories of unsold stock and show when money is coming back into the housing sector. Chinese steel production is another key ingredient, since this will indicate if the Chinese economy is recovering. The Baltic Dry Index is a bellwether for trade activity in bulk commodities and its recent improvement could be an early sign of recovery. Food prices locally look set to rise after the impact of drought fire and heat wave devastation on Australian horticulture.

n Peter Strachan is the author of subscription-based analyst brief StockAnalysis, further information can be found at Stockanalysis.com.au


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