KEY POINTS:
The Australian stockmarket has, like just about every other stockmarket around the world, been particularly weak of late. In the past 12 months, shares from the lucky country are down by almost 10 per cent with the big banks like Westpac and CBA particularly hard hit.
One sector, however, stands out in all this gloom - resource stocks like BHP and Rio Tinto have confounded the cynics and are still very much in demand with investors, rising 23 per cent and 60 per cent respectively since March 2007.
While the strength in resource stocks is good news for their shareholders, it is potentially bad news for the rest of us, in more ways than one, says Tim Bond, writing in the 2008 version of the Barclays Capital Equity Gilt Study (BCEGS).
First some background: the BCEGS is produced by the top-rated global asset allocation team at Barclays Capital, the investment banking arm of Barclays bank in London. It has been published each year since 1956, producing data and commentary on the long-term returns from shares, bonds and cash in the UK and the US since 1899 and 1925 respectively.
The BCEGS focuses on the big issues for long-term investors and, in 2008, the Barcap team examine the increasingly visible topic of natural resource scarcity and speculate that rising prosperity in the developing world has altered the relationship between inflation and growth, potentially ending the long disinflationary trend that has been in place since the early 1980s.
Barcap then questions whether high levels of borrowings, particularly in the household and financial sectors, can persist in a more volatile and inflation-prone economic environment. All in all, it is sobering stuff, putting the current credit crisis in the context of a u-turn in the long-term repricing of risk.
According to Barclays, the fact that essential commodities like oil and copper are running out at an increasing pace is the single most important social, political and economic factor of our lifetime. As we all know, much of this increase in resource depletion is due to the explosion in demand by China and India and the fact that the human population has skyrocketed - from 2.5 billion people in 1950 to 6.7 billion now and an estimated 9.2 billion in 2038.
The unsustainability of the China/India effect alone can be appreciated if we look at demand for oil. Per capita, Chinese consumption of oil has grown from less than one barrel per person per year in 1990 to more than six barrels today.
If per capita consumption of oil in China and India were to grow to be equivalent to the present per capita consumption in the US, the International Energy Association estimates that this rate of demand would exhaust proven oil reserves in just 15 years and, ultimately, recoverable reserves in 26 years.
The situation is equally dire in many other vital commodities - if China and India's per capita copper consumption rose to the same level as that of developed Asian countries like Japan and Taiwan, global copper reserves would be exhausted in around 15 years.
This reality is the reason that commodity prices have surged during the past few years, with oil more than US$100 ($126.19) a barrel just the most visible. What the commodity and stockmarkets are signalling is that an increase in resource supplies to meet forecast needs is unlikely, so higher prices are needed to ration what's left.
For investors, this implies "a lasting secular rally in real natural resource prices". So that's why BHP is doing so well. But Bond draws several less obvious conclusions that mum and dad in New Zealand might incorporate into their investment strategy:
* The developed world's increased use of resources will mean higher inflation down the line and/or lower global economic growth rates. For investors over time this means higher interest rates and that companies will trade at lower multiples of earnings; that is, lower share prices. During the past 20 years, shares have done so well in large part due to their becoming more expensive, rather than profits increasing. That trend is at an end. In a lower return world, management fees become more relevant than ever.
* Similarly, during the past 20 years or so, the volatility of world economic growth and inflation has been trending lower - people call it the Great Moderation. This has allowed higher share prices and lower interest rates but it looks like the Great Moderation is over - Bond predicts that inflation from the resource markets will mean greater fluctuations in output, growth and employment in the future. The Goldilocks economy (not too hot and not too cold), as it has been called, is at an end because central banks like the Federal Reserve in the US will have less room to lower interest rates when the economy stalls due to higher inflation.
* A key feature of the world economy in recent years has been a persistent rise in debt to income levels due to falling interest rates. More volatile and possible higher interest rates mean that individuals in the Western economies in particular are likely to reduce debt rather than spend.
* Lastly there will be a number of big losers from the increased cost of resources. Carmakers in the US, in particular, have not adapted to higher oil prices and their industries are in decline. Bond suggests that air travel might also be affected in the future.
* Brent Sheather is an Auckland stockbroker/financial adviser and his adviser/disclosure statement is available on request and free of charge.
