17/08/2015 - 13:11

WA convalesces as fever spreads

17/08/2015 - 13:11


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Having already struggled through the fallout of the commodities price slump, WA could find itself emerging from its slump before other states.

WA convalesces as fever spreads
BOTTON: The period of falling commodities prices may be coming to an end.

Having already struggled through the fallout of the commodities price slump, WA could find itself emerging from its slump before other states.

Western Australia is well known for its fly-in, fly-out, or Fifo, culture, but if a recent change in sentiment among some investors is a guide, the acronym could soon stand for first-in, first-out.

The change relates to commodities, the world’s worst performing investment category over the past few years, which are also the lifeblood of the WA economy – and the reason why the state’s economic performance has been so anaemic recently.

Iron ore, gold and oil have been leaders in the commodity crash, which has switched the once popular slogan of ‘stronger for longer’, based on Chinese demand for raw materials, into a parody slogan of ‘lower for longer’ as China’s growth rate slows.

That new catchphrase might prove to be correct because the recovery will be a slow-moving affair, but the real importance in the change is that it signals that the period of falling prices might be coming to an end.

What comes next is a phase of price stability, albeit at a considerably lower level than the boom years; and that will be when the WA economy starts its recovery, with the start date sooner rather than later.

In other words, WA has had its commodity crash, which is hurting the local economy while also triggering a perverse sense of satisfaction in non-resources states, particularly regarding the GST carve-up.

However the stage of slow recovery, aided by a depreciated currency, could transfer some of WA’s recent pain to other parts of the Australian economy.

In other words as WA starts a recuperation phase, the rest of the country will continue to slow.

Two events lie at the heart of these observations about the commodity sector and the sharing of economic pressures being felt in WA with the rest of the country.

The first occurred in New York, where highly regarded investment magazine Barron’s last week put commodities on its cover, not to advise its readers to get out of the worst-performing sector of the global economy, but to start looking for ways into a recovery.

‘Time to buy commodities’ was the headline on the cover of the August 10 edition of Barron’s in what was perhaps the first positive report in several years on the industries that are of critical importance to WA.

“While calling a bottom is dangerous, we think it’s prudent to start adding commodities to your core portfolio at these (low) prices, and we’re not alone in saying it’s time to lean against the wind,” is how Barron’s summed up its revised view of raw materials.

Whether the new-found optimism is premature will be judged over the next six to 12 months, because plenty of economists still believe there are further price falls to come, especially for oil, and it takes time for higher commodity prices to flow through to capital raising and project development.

But because commodity prices (on average) are already back to levels last seen in 2002, the chances of a continuation of the widespread falls seems unlikely; and that’s why a change in sentiment towards commodities can be detected.

As good as that news is for WA, which will be first to benefit from an end to the crash and the start of a recovery, the effects on the rest of the country will be slower to arrive because the full blast of the downturn has yet to be felt in other states.

Investment bank Goldman Sachs identified the spreading damage of the commodity slump to the wider Australian economy in a recent comment about how the commodity crunch is reaching further than expected.

Share price weakness in the financial sector, especially for leading banks, caused Goldman Sachs to say that: “A number of resource-related profit downgrades sparked concern that the commodity correction was having a greater than expected spill-over into the rest of the economy”.

The “spill-over” Goldman Sachs refers to is likely to be reflected in falling profits for a wide range of industrial companies and banks “with a heightened risk of impairments” – or asset value write-downs.

Nothing that has happened in recent few weeks indicates WA’s economy will improve quickly, but there are signs the downturn is finding a bottom; and that the state that was first to feel the effects of the crash will be the first to feel the recovery.

Fifo – first-in, first-out.

Currency crunch

CHANGING currency values could be another reason for WA to feel better than the rest of the country sooner rather than later, with the falling dollar boosting mineral exports but having a potentially perverse effect on other parts of the national economy.

Because WA is so heavily exposed to commodities sold in US dollars, every slip in the exchange rate adds to the competitive position of local miners.

Gold is the best example of the currency effect, with local producers enjoying near-boom conditions as the price sticks close to the $A1500 per ounce mark.

There are, however, two problems with the currency change.

Firstly, other commodity exporters with falling currencies get the same benefit, which means overall production continues to rise even as the global economy struggles to grow at more than a snail’s pace.

Secondly, a cheaper domestic currency is bad news for anyone who has used the international debt market to borrow US dollars, and that includes Australian banks and a number of local manufacturers who couldn’t resist the super-low interest rates on offer in the US.

For companies with US dollar income (iron ore, gold and oil producers for example), it is relatively easy to offset income against US dollar denominated debt.

But not everyone will be able to achieve that simple like-for-like balance; and that’s when problems can occur, which they probably will as the Australian currency heads into the US60 cents range, and perhaps lower.

For WA, a lower dollar is an unequivocal boost, though that’s not the case of every other part of the country.

Fifo ditto.



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