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RBS – Round Up – 071209

Origin Energy Limited (ORG) said its share of the purchase price of Woodside Energy Limited’s (WPL) 51.55% interest in the Otway Gas Project is to be reduced from $712.5 million to $507.2 million. The company said the reduction was a result of Benaris International Pty Ltd advising that it would exercise its pre-emption right in relation to some of its interests. Origin said the sale remains subject to satisfaction of a number of conditions and it is expected that completion would occur by the end of 2009.

Felix Resources Limited (FLX) said it has been notified that Yanzhou Coal Mining Company Limited has received regulatory consent from the National Development and Reform Commission for the acquisition of 100% of the issued shares of Felix. Felix said the remaining Chinese regulatory consent is required from the China Securities Regulatory Commission, which is expected shortly.

Uran Limited (URA) said it has entered into an agreement with Canadian company Summit Point Uranium Corp. to earn up to an 85% equity in the Uravan Project on the Utah and Colorado border. The company said the project consists of registered mineral claims covering about 4,080 hectares and lies at the junction of two of the largest uranium production areas in the USA between 1945 and the early 1980s. Uran said it can earn a 65% interest in the project by expending US$300,000 on exploration within two years and issuing 2 million shares to Summit upon confirmation of the joint venture following completion of the due diligence, and a further 3 million shares on the earlier of grant of an exploration permit to allow drilling, or the first anniversary. The company is entitled to increase its equity to 85% by expenditure of a further $1.2 million within a further three years and issuing 3 million shares to Summit upon completion of earning the 85% equity.  

Tox Free Solutions Limited (TOX) said it has been advised by Rio Tinto Iron Ore Operations that it is the preferred vendor for the supply of Industrial and Waste Management Services to Rio’s iron ore operations in the Pilbara. Tox said the award of the contract is subject to signing which it hopes to complete within the next few weeks.

Clough Limited (CLO) said Clough AMEC, a 50/50 joint venture between Clough and AMEC, has been awarded a new contract by Woodside Petroleum Limited to provide offshore maintenance services for their Australian oil and gas assets, predominantly located on the North West Shelf off Western Australia. Clough said the JV would provide maintenance services for the supply of offshore core crew and routine/campaign maintenance. The JV has provided asset support services to Woodside for the last five years.

Economists at Goldman Sachs published a framework to assess economic growth and share market performances throughout the various stages of the economic cycle. Understanding their work is understanding the cycle and -possibly- understanding what is happening in financial markets today.

First, let's go back one step, and concentrate on what's happening in commodity markets.

Once upon a time the size and trend in global inventories would provide investors with a fairly good indication where prices for commodities, base metals in particular, were heading to. That script was thrown out of the window this year. I have included two charts from a Calyon presentation that show the build up in inventories for aluminium and nickel since mid-last year. As clearly shown on these charts, prices for both metals moved higher from early 2009 onwards, while inventories simply kept rising.

I could include charts for other base metals, or for crude oil, but they pretty much all look similar, except for copper, which is why anyone would be hard pressed to find a medium-term copper bear with conviction these days. Copper inventories are equally on the rise but they're still lower than earlier in the year.

It is this de-coupling between commodities and their traditional link with registered inventories that fuels widespread doubts whether current prices are anything other than a liquidity (or: speculator) driven bubble that might prove unsustainable in the twelve to eighteen months ahead. Add the growing realisation that "apparent Chinese demand" means actual demand plus stocking of massive inventories in the country and it is not difficult to see why some marketwatchers feel commodity markets are treading water.

Strictly taken, prices for the likes of copper, oil and nickel should be heading lower. Not only is such the usual seasonal pattern, but Chinese inventories are now believed to be filled and actual demand in the country is traditionally weak this time around. Recent import data from China have indicated as much.

Yet the majority of investors and market commentators appears convinced we will see higher prices, and higher share prices, before moving into 2010. How to explain this dichotomy?

One word: hope.

Prices for commodities continue to track global risk appetite, and global risk appetite is now built on the premise that global economies, including those in the US and Europe, will gradually recover from their trough in the quarters ahead. Many an economist will tell you: this seems but a reasonable assumption to make. After all, economic data and indicators continue showing improvement from Beijing to New York and from Tokyo to Berlin.

Don't forget also: economies are cycling relatively weak points of reference. It'll only get tougher as we move further into 2010.

The overall expectation is thus that apparent market demand for commodities will drop between now and February next year. From then onwards expectations start diverging. Chinese imports should pick up again, though likely not with the same strength as we've seen this year (would that be possible?) But demand in Europe and the US should pick up too because of the re-stocking cycle.

This is why current views about the outlook for 2010 are so diverse. If Chinese demand proves strong and Europe and the US jump on board this could give commodity prices a big boost next year. This is what makes some market experts quite excited about what might happen in the year ahead. (I already received emails with questions what I thought about predictions that crude oil prices might be back at US$147/bbl in a year from now).

There are, however, plenty of other scenarios possible. Many of these should still turn out a net positive for commodity prices next year -such as weaker Chinese demand compensated by re-stocking elsewhere- but some won't be positive at all.

In essence, the story for commodities in 2010 looks pretty similar as for equities in general. Both are being supported by investor hope that economies are now on the road to sustainable recovery. If correct, this means stocks priced on elevated FY10 multiples are not expensive and FY11 valuations will become "de rigeur".

Similarly, prices for copper and crude oil and nickel won't turn out expensive at current heights, and they all should be higher by the end of next year.

This is also why investing in the share market, and in commodities, at this point in the cycle continues to require a leap of faith. As shown last week when a tiny Muslim state on the big Arab peninsula asked for a temporary moratorium on billions in debt, investor confidence in positive scenarios next year remains low, vulnerable and fragile. Back in the previous bear market of 2000-2003 all it took was one relapse in one quarterly US GDP release and risk appetite instantly took a significant step back.

There are no guarantees the present recovery will develop smoothly and without encountering any barriers.

According to research conducted by economists at Goldman Sachs we are now in the transformation phase when "hope" will start materialising through increased earnings and returns for companies worldwide. This should confirm that asset prices have not run up too high thus far.

Let's take a closer look into the framework devised by these economists, who are based in Europe and whose work is based on historical analysis of economic cycli since 1970. Specifically they zoomed in on earnings momentum and share market multiples throughout the various stages.

The worst stage of the cycle is the one we experienced from late 2007 onwards: the economy is weakening and equity markets fall into despair in response. This is the worst stage, when both earnings and multiples take a dive, and share prices follow suit.

Then comes "Hope" – the stage we've experienced since March this year. This is when share prices move up because multiples rise (on hope) but earnings have yet to follow. Ironically, this is, from an investment return point of view, the best stage in the cycle. Uncertainty is highest, but so are the returns that can be achieved.

After "Hope" comes the actual "Growth" stage when economies do post positive numbers and companies can finally start releasing growing profits. This is the stage we should be moving into right now. Mind you, this is the second least profitable stage of the cycle as far as share market returns are concerned, because now company earnings have to play catch up with expectations. Multiples no longer expand in spectacular fashion.

After the Growth stage comes "Optimism", which other people would refer to as "Exuberance". I think we all know very well what that stage looks like. It's the second most profitable stage in the cycle. Of course, after that we go back to the beginning and things start all over again.

Goldman Sachs believes the transformation into the next stage will take place in 2010.

Market strategists at GSJB Were in Australia have adopted the work done by Goldman Sachs economists in Europe and put it to work in Australia. Their conclusion: the Australian share market is likely to gain some 24% between now and December next year (ASX200 index at 5700). One year later the index is projected to reach 6100 (implying a return of 33% over two years).

In terms of earnings growth projections, the minus 15% for industrial companies in FY09 should be followed by a mildly positive 5% average gain in earnings per share this year (FY10). After that we should see 17.5% growth in FY11, followed by 10% in FY12.

For resources companies the numbers look a bit different: minus 40% (FY09), minus 10% (FY10), to be followed by a positive 45% growth in FY11.

In terms of duration, stage "Despair" lasts on average 26 months, stage "Hope" 10 months, stage "Growth" 33 months and stage "Optimism" 14 months.

It turns out we left stage one sooner, but what does this tell us about the duration of the second stage?

In stage three, argues Goldman Sachs, commodities will outperform both equities and bonds, and individual stock picking will become key, instead of the all-encompassing sector rotations we witnessed over the past nine months.

Stocks likely to do well are those likely to gain most from the economic upturn: think transport, media (through advertising), employment and inventories (re-stocking), plus building and mining. GSJBW still likes the banks (as does the R-Factor on our website) and has started to look for more exposure to USD leverage. The reasoning is that if the US economy surprises to the upside, the USD will do so too and this will reverse the current one-way relationship between the Australian dollar and the greenback.Commodity experts at Citi, on the other hand, warned this week that investors are likely to overlook the fact that costs continue rising for mining companies. This would suggest earnings disappointments will follow during the upcoming results season.

With these thoughts I leave you all this week,

Till next week!

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by the Ab Fab team at FNArena)

P.S. I – Adopting the Goldman Sachs framework in Australia has led to some changes in GSJBW's Model Portfolio. The strategists still like Downer EDI (DOW) and Boral ((BLD)) but they have now added Amcor ((AMC)) while getting rid of OneSteel ((OST)). Exposures to REITs and consumer staples champion Woolworths ((WOW)) have been reduced. Instead came Computershare ((CPU)) and Macquarie Group ((MQG)).

P.S. II – To stay with the theme: GSJBW also updated its Conviction List this week. No changes were made, but it was noted the list once again outperformed the market in November. Current Conviction Buys are Aquarius Platinum ((AQP)), Bradken ((BKN)), Downer EDI, National Australia Bank ((NAB)), News Corp ((NWS)), Seek ((SEK)), Ten Network ((TEN)) and Wesfarmers ((WES)) while Macquarie Infrastructure ((MIG)) and Paladin Energy ((PDN)) are the only ones on the Conviction Sell list.
 

By Andrew Nelson

It is certainly a different oil market this December than it was the last. By December last year crude oil was trading down in the US$30s/bl and investment markets around the world were dressed out in funeral attire. This was just scant months after crude prices scaled to all time highs close to US$150/bl back in July 2008, with many predicting US$200/bl was just around the corner.

But by last December the GFC was in full swing, with havoc having been wreaked on financial markets the world over in the preceding three months. The questions investors were asking about oil last December were: How long will the global recession last and how deep will it be? How far will demand fall as a result? And will the damage being done to the global economy and its financial institutions be permanent?

In such a market, liquidity became the holy grail sought by investors. Risk in any form was avoided like an infectious disease and long-cycle dynamics carried little weight in a world that had quickly become afraid of sharp discontinuities and institutional fragilities.

Yet 12 months on and the price is back above US$70/bl, and instead of discussions being focused on how far can oil fall, the predominance of current commentary is speculating on: How soon will the current recovery be consolidated? How fast will demand rise as a result? When will sub-optimal investment levels translate into supply-side crunches? When will crude oil break out of its US$70s range?

The main reason for this shift is that having more liquidity and less risk is no longer the goal of your average or even institutional investor. At the same time, the longer cycle concerns about underinvestment have also helped place a solid floor under crude prices.

Commodities analysts at Barclays Capital note that one of the key lessons learned in 2009 was exactly what happens to the international oil industry at prices below US$70/bl. Deep cuts emerged early in the down cycle for prices. Significant investments were first questioned, scaled back and then cancelled, while those companies most reliant on cash flow quickly hit the wall in an environment where there was no longer credit.

It's this lesson that has the team from Barclays thinking that recent prices are not too high for current "fundamentals" because a main feature of the "fundamentals" is that the oil industry simply cannot operate sustainably at prices much lower than current levels. In fact, Barclays ponders whether the last year will go down in the history books as the year in which the world discovered how high the floor for oil prices needs to be in order to maintain a sustainable, balanced market over the longer term.

The bank's current forecasts have crude oil pushing up to an US$85/bl average in 2010 then to US$87/bl by 2011.

Analysts at RBS also expect oil demand to recover over the next two to three years, as world GDP turns positive. However, the broker believes the growth in demand will be mainly in Asia/Pacific ex Japan and in the rest of world areas. In the more mature industrial regions the broker expects little or no growth in oil demand in the period 2009-2012. As such, RBS predicts flat prices over the next 12-18 months as economic recovery helps demand begin to rise.

"There will definitely be a risk of short-term pull-backs if economic data disappoints," says RBS. However, from mid-2011 onwards, the broker expects to see consistently rising demand, which in turn will push prices over US$80/bbl and towards US$90/bbl. There is however, admits the broker, a chance that prices could spike over US$100/bbl at any time in the next three years.

Commonwealth Bank has also lifted its oil price forecasts for the coming year, noting crude prices have proven more resilient than anticipated over recent months.

While the bank doesn't expect any strong gains in the oil price in the coming year given current prices already seem to be factoring in an international economic recovery, CBA now expects prices to start edging slightly higher over 2010 after a few flat months early in the year. CBA then sees the price moving higher again over 2011 as the international economic recovery gains more traction and markets become more concerned with medium-term oil supply-demand fundamentals.

There are some risks that the data flow from developed economies will fall short of market expectations, which could see intermittent dips in the oil price, notes CBA. But ultimately, the bank thinks that any dip in the oil price towards US$70/bl would likely just attract fresh buying, thus putting a floor under any sort of sustained pull-back.

BHP Billiton Limited (BHP) and Rio Tinto Limited (RIO) have signed a binding agreement to create a production JV with their Pilbara iron ore operations in Western Australia. The signing of the agreement comes exactly six months after the joint venture was first announced to the market and amid speculation Rio Tinto was getting cold feet on the deal.

The companies acknowledged the deal still requires regulatory approval both in the US and Europe, with the deal hoped to be completed by the second half of 2010.

The two mining giants have previously said the potential savings could top $10 billion after adjacent mines are combined into one operation and combing administration overheads and rail and port facilities into one operation.

Unlike the June 5 announcement the current arrangement would not include joint marketing activities.

Meanwhile, Rio Tinto said it would use the majority of its investment in carbon capture and storage on a Californian hydrogen energy project it is working on.

Group executive, Technology & Innovation, Preston Chiaro, said that the California project is an excellent strategic fit for Rio Tinto as it would use coal or petcoke as a feedstock.

Rio Tinto said that it had sold its 50 per cent interest in Hydrogen Energy International, which owns an interest in the Hydrogen Power Abu Dhabi project, to BP for an undisclosed sum.

“We look forward to continuing to work with our partner BP, the US Department of Energy and other key stakeholders to deliver the California project, which we regard as a critical project in the development of CCS technology,” Mr Chiaro said.

At the close Friday, BHP shares were trading at $41.40 and Rio Tinto shares were $71.85.

Wall Street closed higher Friday after the release of better than anticipated jobs data spurred a morning rally. Despite a sell-off the market managed to remain above the gain line.

In employment news, the Labor Department reported that a 23-month low 11,000 jobs were cut in November, well below the 125,000 forecast.

Meanwhile in a separate report, it was revealed the unemployment rate dropped from 10.2% the previous month to 10% in November. Forecasts were for the rate to remain steady.

The Dow Jones gained 22.75 points, or 0.22%, to 10,388.90, the S&P 500 added 6.06 points, or 0.55%, to 1,105.98 and the NASDAQ put on 21.21 points, or 0.98%, to 2,194.35. 

Among the major banks, Bank of America rallied 3.3% as investors reacted positively to the $15 pricing of its new shares.

Wells Fargo and Goldman Sachs put on 1.8% each.

Solid gains within the tech sector sent the NASDAQ 1% into the black. Hewlett-Packard rose 1.7%, while Oracle and Yahoo! advanced 0.8% and 0.5%.

Apple lost 1.6%.

A stronger greenback placed pressure on commodity prices, resulting in a slide among related stocks. The dollar strengthend the most in a single session since June on the back of the positive jobs report.

Aluminium producer Alcoa lost 2.1%.

du Pont sank 7.2% after the chemical company said the release of several products in its seed business would be postponed.

Energy companies Exxon Mobil and ConocoPhillips shed 1% each as NYMEX light crude oil for January delivery fell US99c to settle at US$75.47 a barrel.

A slump in the price of the gold saw Barrick Gold and Newmont mining drop 8.9% and 4.5%.

COMEX gold for February delivery fell US$48.80 to settle at US$1,169.50 an ounce.

European Markets

European markets were buoyed by the US jobs report, sending stocksd higher. Banks and energy stocks gained ground, while miners dragged.

The UK benchmark FTSE 100 added 9.36 points, or 0.18% to 5,322.36. The French CAC40 gained 47.51 points, or 1.25% to 3,846.62, while the German DAX put on 47.30 points, or 0.82% to 5,871.65.

Financials were among the top gainers. Societe Generale and BNP Paribas rose 1.1% and 1%.

Deutsche Bank closed 1.4% higher.

UK banks were mixed. Lloyds and HSBC added 1% and 0.2%, while Standard Chartered and Royal Bank of Scotland fell 3.6% and 1.4%.

Energy majors Total and Royal Dutch Shell advanced 1.2% and 1%. BP added 0.4%, while BG Group lost 0.8%.

Xstrata led the miners lower with a 3.4% fall. All metals prices other than aluminium fell on the London Metals Exchange Friday.

Antofagasta and Anglo American shed 2.3% and 1.6%, while Aussie miners BHP Billiton and Rio Tinto lost 2.1% and 1.8%.

Pharmaceuticals made ground. AstraZeneca and GlaxoSmithKline added 2.6% and 2.2%.

Cadbury weakened 1.5% as the British business minister said Kraft’s takeover offer might face opposition from the British government.

Japanese Markets

Japan’s Nikkei closed above the 10,000 mark for the first time in five weeks on a mixed day. The market finished 10.4% higher for the week, the largest gain in 12 months.

The Nikkei 225 added 44.92, or 0.45% to 10,022.59.

Canon and Sony gained 2.8% and 1.4% as the yen weakened against the greenback. Industrial robots maker Fanuc put on 2%.

Automaker Honda advanced 1.5%, while rival Toyota slid 0.8%.

Takefuji Corp sank 9.4% on reports the lender is short of funds.

Inpex and Japan Petroleum Exploration Co. fell 2.1% and 1.7% due to a falling oil price.

Japan Tobacco climbed 2.7% following a broker upgrade.

Japan Airlines spiked 8.7% after an alliance said it was prepared to invest over US$1 billion in the company to prevent it defecting to Delta Air Lines and a rival group.

Hong Kong Markets

The Hang Seng dipped lower Friday after posting gains for the other four days of the week. The banks and consumer stocks lost ground on perceived weakness in the US service sector, while property stocks capped losses.

The Hang Seng dipped 55.72, or 0.25% to 22,498.15.

Bank of China lost 1.6%, while Bank of Communications was flat. HSBC lost 0.4%.

Clothing manufacturer for Wal-Mart, Li & Fung shed 3.8%.

China Overseas Land gained 2.4%, and R&F Properties rallied 2.8%. The property sector as a whole showed strength as many companies reached sales targets ahead of schedule.

Brilliance China Automotive slumped 7.4% as a key stakeholder sold a stake in the company, while rival BYD, backed by Warren Buffett, climbed 2.6% after receiving US$2.2 billion in credit from the Bank of China.

Directors' Interest Notices
04 December 09

* Excercise of options

Substantial Shareholder Changes 
04 December 09

All movements are percentage changes.