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 www.crbtrader.com.
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 conditions...you needing to sell into rallies). Eventually of course inflaiton will unwind the carry trade.

- Andrew Sheldon www.sheldonthinks.com

The $AUD looking at parity with the USD by Jun'08

The AUD has been one of the strongest performing currencies this year, and there is no evidence of that changing soon. In fact there are good reasons why we can expect the AUD (currently at 0.86USD) to reach parity in the next 12 months. This is likely to occur on the back of strong export price settlements next year, which will likely coincide with a rise in the Reserve Bank's rate.
The $A is performing well because of the very favourable terms of trade, as the economy continues to benefit from strong export prices for mineral commodities, as well as an improving outlook for the farm sector. We can expect a breaking in the drought as well as higher global food commodity prices. On the domestic front, production capacity and labour markets are very tight, so there is every likelihood of strong business investment to lift productivity. A number of businesses and state governments have flagged the need for greater infrastructure spending. The long (100 bulk carriers) queues off Newcastle port are a testimony to the shortage of export capacity at Australian coal ports. Housing vacancy rates are also very tight, and whilst interest rate increases can be expected, there are several reasons why a strong AUD will be prompted by positive developments:
1. The stronger AUD will help reduce inflationary pressures - since imported items will be cheaper in AUD terms
2. The stronger will support alot of portfolio investment - particularly in mining and agriculture
3. The high levels of debt will discourage government from lifting interest rates significantly
4. Growth in incomes will fuel a 2nd rally in the property market

- Andrew Sheldon www.sheldonthinks.com

Aussie dollar - looking weaker

The Australian dollar is likely to fall off in the coming months as a softer Chinese and US economies tranlates into lower commodity prices. The highly indebted household sector will prevent the government from raising interest rates, though a weaker $A and tight labour markets suggests some upward move in interest rates will be required to quell inflation. There are already signs that retail sales and business confidence is weaker in the retail sector, so consumer spending should fall, but $A dominated mineral revenues will offer a sound buffer until inflation needs to be addressed. The 'staunchly independent' Reserve Bank (central bank) will have a chance to prove its meddle. We have already seen food prices moving up 7-15%, so that will eventually lead to wage pressures.

Strong commodity prices was recently the reason for a strong $A, but it appears to have been a speculative commodities play rather than reflecting real demand. Economic activity just was not that strong.

This set of affairs means that Australian gold stocks will out-perform.

Japanese Yen - subdued for now

The Japanese yen is a side-show compared to the $US as the US economy powers ahead and the Fed fight inflation fears with higher interest rates. The Yen will however out-perform the Euro since its economy is growing stronger. There is also considerable interest in the Japanese equity market as it benefits from a property-inspired boom.
- Andrew Sheldon www.sheldonthinks.com

Euro - nothing happening

The Eurozone remains a disappointment - given the slow growth and lack of resolve to establish a unified monetary policy framework. Progress with labour reform is also slow.

The Euro will be weak as the US and Japanese economy strengthen, particularly since the Eurozone will not want to raise interest rates.

- Andrew Sheldon www.sheldonthinks.com

US Dollar - range bound

The $US has broken out of its long term downtrend, though its likely to test its lows as oil prices and Asia`s mercantilist policies conspire to boost the US deficit. In the short to medium term however the US economy is growing strongly and the Fed is raising rates, so with the Eurozone recording subdued growth - except a stronger $US. The Japanese economy is looking stronger, however the Yen will look weaker as long as the rate differentials with the US remains substantial.
Higher deficits or lower interest rates could eventually bring the $US back to its Y86 low. For the meantime, the US remains a growth story. Nevermind that the bulk of the jobs created are in the service sector and will disappear with the forthcoming collapse in household consumption.

- Andrew Sheldon www.sheldonthinks.com

Indonesian Rupiah - up on growth

Ever since the current president of Indonesia was elected, I have been very excited by Indonesia`s prospects. The reasons are thus:

1. Leadership: The values and leadership style of PM Dr Susilo Bambang Yudhoyono are conducive to stable government. The PM is US-educated so there is some hope that he will embrace western values. He has also been concillatory with US and Australian governments.
2. Tourism: The tourism industry was hit by terrorism, and less so by the tsunami. It appears that Indonesian police have had greater success rooting out terrorism than the Philippines.
3. Values: Indonesia has long been divided by different values (religions) and ethnic groups that have fought over control of resources > mining revenues. This and corruption has undermined the rule of law.
4. Infrastructure: there is some hope that Indonesia will be able to develop basic infrastructure to service industry.
5. Industry: Certainly the Indonesian coal & minerals industries will benefit from renewed investment. Oil & gas exploration and development also will boost national income since indonesia is a net energy exporter.
6. Civil Unrest: The government is close to negotiating a peace agreement with the Free Aceh Movement in North Sumatra. This region controls a significant share of the country`s oil production capacity, so will aid further investment.
7. Trade: Exports are up 30% in the last year since Dr Y`s election.

There is every reason to believe that Indonesians will be less prone to embracing terrorism if their prospects for employment are raised. but it only takes 1 to set a bomb. Given the stronger terms of trade of Indonesia (from net energy exports) and its stronger leadership, it seems to have less upside than the Philippines peso, but represents a safer bet.

- Andrew Sheldon www.sheldonthinks.com

Philippines Peso - down on reform uncertainty

The Philippines peso is not one of the easist currencies to trade, but having visited the country in recent weeks, the country strikes me as an emerging good story. There are a number of dynamics shaping up to propel this country:

1. Constitutional crisis: The Arroyo government was close to impeachment in recent weeks, and though it looks like she will have a reprieve, a strong consensus emerged for reform. The Philippines is considered the 2nd most conrrupt country after Indonesia in Asia.
2. New cabinet: During the crisis, Arroyo moved to appoint several ministers who were well received by the Makati Business Club. eg. New finance minister, etc
3. High oil prices: The Philippines is strongly dependent on imported oil. This dependence has eroded government activity.
4. Expat income: The Philippines has the good fortune of having some 5mil expats working overseas, mostly in the USA, Japan and the Middle East. In times of crisis these Filipinos repatriate more funds to the Philippines.
5. Terrorism: The Philippines comprises 3 island groups. The southern island group of Mindanao/Sulu hosts a large number of Muslims, some of whom engender extremist views - the Abu Sayef - and resort to kidnap and ransom demands, assasinations and bombings of key infrastructure. Their activities have impacted on investment in the Philippines and the southern islands in particular.
6. Values: The Philippines has embraced the worst elements of western thinking - populist democracy, Catholicism and the hypocrisy that accompanies such subjective values. This aspect of the Philippines remains the most enduring and the most scary. Chile proved that it can be done - though it did not have the same democratic foundation given that Pinochet maintained control of the military.
7. Investment potential: The Philippines remains (along with Indonesia) the poor bed-fellow in Asia. There are 3 sectors of the Philippines economy that hold particular promise:

a. Mining: The Philippines is very rich, so is likely to benefit from a future mining boom. It will be greatly advantaged by expat miners returning home.

b. Tourism: More than most countries in Asia, the Philippines offers an attractive archipelago for developing tourist resorts for Asians. Part of the appeal is the allure of the Filipino, though improvements in diet, infrastructure, service, security and safety are needed.

c. Property: There are currently significant constraints on foreign investment in property in the Philippines. Foreigners are for pure investment purposes are only allowed to invest in condominiums starting from $US40,000.

In recent weeks the Peso has fallen to P42 against the $A and $56 against the $US. Uncertainty over the constitutional process and higher oil prices and the collapse of Asian exports can be expected to see the peso trade lower in future, but that will present an attractive buy opportunity.

- Andrew Sheldon www.sheldonthinks.com