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Saturday, September 29, 2007

Dont ride off the NZ economy

I dont see an increase in the NZ overnight cash rate. Dont see 50bp rise, more likely they will hold, with a 15% chance of a 0.25% increase. On the negative side (in favour of rate increase):
1. New Zealanders dont save
2. Need to rein in credit creation in an inflationary setting (ie. real rates are lower)
3. Growing inflationary outcomes worldwide - but not recognised by the Fed
4. Central banks are generally not inclined to make big steps unless they want their impact to resonate. A 0.5% would kill off the economy when there are strengths emerging.
5. New Zealand farmers are already being punished by a strong dollar and rising costs

On the positive side:
1. Previous rate rises are already having an impact
2. The outlook for NZ exports (food in particular) is very good
3. NZ is principally a food exporterYou watch food prices take off over the next few years.
4. The carry trade remains in place
5. Softer global ecoonomy

The good news is that this will restore earnings to farmers who have until now been struggling under low prices, high fuel/fertiliser costs and rising interest rates. I think we will increasingly see the corporatisation of farms globally in this period. The consequence of this will be:
1. Acquisition or merging of farm interests around the world by corporate players for subsequent listing on the stock exchange.
2. Amalgamation of farm holdings under a few very large companies with interests that integrate farming, processing and retailingHopefully farmers will see what is happening and not sell off the farm too cheaply. Fortunately they are already benefiting from an oversupply of credit. But you can expect corporates will pay even more for properties IF they can generate an income.

Why will this happen?
1. Because farm prices have lagged the increases in other commodity prices. Just look at the components of the CRB Index. See
2. Because its a global trend - towards greater global integration - and it makes particular sense in agriculture because farms are under-capitalised, often lacking the benefits of skilled technical resources, climates are shifting around the world because of the 'natural' heating and redistribution of rainfall.
3. Because where there is money there are investment bankers
4. Because farming is no longer a lifestyle - its a business and deregulation has globalised the agri-market
5. Because the use of farm produce in biofuels will lift demand, along with growing demand for agri-products in emerging markets (eg. China, India) as diets change.
6. Corporate entities want to increase market share
7. Corporate entities are comfortable operating in multiple jurisdictions
8. Corporate entities want to diversify operations to preserve stable earnings as well as offering segmental market focal advantages

The leaders in this process are likely to be:
1. Investment bankers, eg. Rand Merchant Bank, Macquarie Bank, Elders
2. Resource-retailers, eg. Wesfarmers, Woolworths looking for vertical integration
3. Some more wealthy and commrcially astute farmers
4. Existing listed agricuktural companies, eg. Australian Agricultural Co (ASX.AAC), Australian Wheat Board (ASX.AWB), etc.

Its actually interesting to see how events transpire because currently farmers are being squeezed by rising costs, stronger currencies, low prices, and even droughts in some markets. This is why I think we are starting to see take overs of agricultural assets, eg. Namoi Cotton in Australia. Who is next? Dont forget the baby boomers sitting on productive (but small) farms are likely to be considering selling off in preparation for retirement. They will be looking at the relatively high prices for land and saying its too hard, my kids are not interested in farming, its time to sell-up and move to the coast and retire on a waterfront. Farmers looking to expand their interests will be in acquisition mode. Other targets are likely to be farmers reeling from drought, low prices or hedge contracts that went wrong. This is all fertile ground for the investment banker.

So looking at the NZ dollar....we need to consider:
1. Central banks need to control inflation
2. Loss of competitiveness of a strong NZD
3. Weakness of NZD due to a subdued global economy (USD)
4. The seeming intent of the Fed to push for lower interest rates - forcing the hand of the European Central Bank (ECB) to follow suit, or again sustaining the unhealthy US economy
5. Weakness of the NZD if the Japanese carry trade unwinds

I dont see the Reserve Bank of NZ increasing rates at this time....I see it holding current rates. If the ECB follows the Fed, and there is another cycle of easing rates, the NZ will remain strong, undermining any need for a rate rise and the NZD will anyway be supported by stronger exports. If the ECB doesnt follow the Fed, and the Fed waits (as I expect), then we can expect the status quo (thats short term trading needing to sell into rallies). Eventually of course inflaiton will unwind the carry trade.

- Andrew Sheldon

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