Kevan Sangster

Persistently high inflation has forced the Reserve Bank to raise the base rate interest at the fastest on record in the last twelve months, from 0.1% in May 2022 to the 4.1% it reached on Tuesday. 

The speed and severity of the interest rate rises, along with the ‘stickiness’ of inflation, has caught many stock market investors by surprise. 

So what can we expect in the coming months? 

History as a guide

Firstly, a look at the facts. The ASX has largely flatlined since the turn of the year, up just over 1%, with the technology and healthcare sectors showing the biggest gains. 

However, a glance back at history may provide a more insightful view on what we should expect stock markets to do when inflation is high and interest rates are rising. 

Way back in 2003, Australia had an inflation rate of under 3% and a base interest rate of 4.25%. Over the next 5 years, inflation rose to 4.35% and interest rates followed the rise, peaking at 7.5% in early 2008 in the run up to the GFC. 

Sound familiar?

What is interesting is what happened to the stock market once interest rates started climbing. 

The ASX peaked at 6754 in October 2007, and by the time interest rates had peaked 5 months later, the Aussie stock market had fallen more than 20%.

Some more than others

The ASX is a broad combination made up of several sectors, and as you would expect, some fell more than others during early 2008.

Shares in retailer JB Hi-Fi (ASX: JBH) for example fell a massive 45% from November 2007 to March 2008. 

The reason? The company sells discretionary items such as televisions and other tech gadgets – things that consumers shun when they have less money due to higher interest rates on their mortgages.  

Contrast that with the resources sector, and Australia’s biggest miner BHP (ASX: BHP), for example. 

Its shares fell during the same period back in 2007/8, but at a much lower rate – just 15%. 

That’s less than the stock market as a whole, and three times less than JB Hi-Fi.

What this shows us is that the resources sector tends to suffer less in a high interest rate environment than those companies which rely on discretionary spending, as the demand for their products is not driven by consumers but broader economic trends.   

So, is this happening again? The ASX is down 2% in the last month as the most recent interest rate hikes sparks fears of a recession. 

And sure enough, retail stocks are down further, while some resources stocks have actually risen. 

Check out the chart below for more info. 

While it’s too early to say the current cycle of interest rate rises is at its peak, predictions are that they are likely close to the summit. 

Retail stockholders will be watching anxiously.

 

Company	Sector	9th May	9th June	% Change
BHP	Resources	$44.47	$44.70	+0.5%
Rio Tinto	Resources	$111.44	$114.70	+2.9%
FMG	Resources	$20.58	$20.76	+0.8%
Breville	Retail	$21.28	$19.34	-9.12%
JB Hi-Fi	Retail	$46.22	$42.36	-8.4%
Harvey Norman	Retail	$3.66	$3.22	-12.0%
Kogan	Retail	$4.48	$4.33	- 3.35%
Myer	Retail	$0.82c	$0.64c	-21.6%
Nick Scali	Retail	$9.57	$8.32	-13.06%
ASX 200		7,264	7,124	-1.9%

They can fetch higher prices than gold or diamonds.

Rare earth elements or REEs are in hot demand with reports that global market revenue could double over the next few years.

Tech gadgets such as smart phones and wireless headphones, and decarbonisation technology including wind turbines and electric vehicles, are driving the charge.

But just as demand is predicted to skyrocket, supplies could be about to hit a snag.

Supply chain woes

Despite their name, rare earth elements are actually relatively common.

What makes them ‘rare’ is that it is not common for them to occur in concentrations which are supportive of commercial mining operations.

China has cornered the market in REEs for years, mainly due to the fact they have an estimated 35% of the world’s rare earth reserves.

Last month, the country threatened to ban the export of rare earth minerals as part of their ongoing trade stoush with the US – interestingly the minerals are also used in the production of military equipment such as fighter planes.

Such a move would potentially cripple global supply chains, especially when one of the other major suppliers of REEs – Russia – is currently banned from trading practically anything with the West due to their invasion of Ukraine.

Together, China and Russia account for over 50% of global rare earth reserves. Limiting (or potentially eliminating) supply of these two REEs giants at a time of increasing demand could send prices skyrocketing.

Aussie opportunity

All of which could be good news for Australia – which has the sixth highest reserves of rare earths globally – and more importantly for investors, is home to the ASX-listed companies that mine them.

The big three Australian rare earth stocks listed on the ASX include Lynas (ASX: LYC), Iluka (ASX: ILU) and Alpha (ASX: A4N), and two of these three have outperformed the market significantly since China threatened to place an export ban back in April.

Even bigger gains have been seen in small cap rare earth mining stocks, with WA1 Resources (ASX: WA1) climbing an eye-watering 3500% in a touch over seven months, while Lindian Resources (ASX: LIN) is up 861% since May last year.

Spotlight on

WA1 Resources (ASX: WA1).

WA1 shareholders have seen the company’s share price rise from about 13c to $4.80 since late last year.

Their West Arunta Project in WA’s far east has unearthed niobium, an ingredient which has uses in smart glass, solar panels and 5G tech amongst others.

The final word

With demand driven by decarbonisation and the ongoing threat of a China export ban threatening supply, watch this space.

The world’s second biggest mining company, Rio Tinto, said recently that if the world is going to hit its Paris climate goals by 2050 we will need 700 million tonnes of copper.

That’s about the same amount of copper produced by Rio Tinto over its entire 150 year history.

Investors certainly understand the lithium opportunity - lithium is used in lithium batteries that power electric cars.

And China needs an estimated 10 million EVs a year by 2025, according to Just Auto.

But what about copper?

Renewable energy generation is up to five times more copper intensive than conventional power, as it requires multiple, smaller units to be connected to the main grid. 

A single onshore wind turbine requires more than four tons of copper, and a typical electric vehicle (EV) needs four times more than a comparable internal combustion vehicle. It's also essential for EV charging stations.

Yet ASX copper stocks haven’t been whipped into a frenzy in the same way as the lithium miners.

Copper stocks a takeover target?

Certainly at the big end of town, copper is king.

The world’s biggest miner, BHP’s (ASX: BHP) $9.6 billion takeover of OZ Minerals (ASX: OZL) is a case-in-point.

BHP COO Edgar Basto said the deal “strengthens BHP’s portfolio in copper and nickel, in line with our strategy to meet increasing demand for the critical minerals.”

Glencore recently bid for Canadian mining firm Teck Resources, although their $34 billion offer was rejected. 

Teck is on a transformation path from being a middle-sized copper producer to becoming one of the world’s top 10. 

Clearly Glencore clearly wants a piece of the action, and it’s easy to see why considering recent events. 

ASX-listed copper-gold explorer Celsius Resources (ASX: CLA) this week was an acquisition target of Canadian-based miner Silvercorp Metals. 

Maybe we’re looking at copper all wrong?

Copper has long been a ‘bellwether’ of economic stability, used as a leading indicator of economic health, hence the term “Dr.Copper”.

Its ubiquitous use throughout the global economy means that when economic activity picks up, copper demand tends to follow suit.

No doubt that’s part of the reason why the copper price is failing to catch fire right now.

The global economy is trying to find an equilibrium, and copper in particular is waiting on positive signals from China.

But with a seismic decarbonisation shift underway, could the metal be about to decouple with tradition?

For a long time it has been attached to general economic activity, but should it now be considered in the same way lithium is part of the electrification story?

As we know, that market is exploding right now and with copper supplies not expected to meet forecast demand over the coming years, is the commodity set for a breakout?

If predictions for the take up of electric vehicles and renewable energy growth are correct, the importance of copper will undoubtedly rise. 

And investors might start viewing it as a significant growth opportunity, rather than the bellwether commodity it has long been.

Company	Market cap	YTD price change
Celsius Resources (ASX: CLA)	$51.77M	+20%
Noronex Limited (ASX: NRX)	$5.65M	-60%
Oz Minerals (ASX: OZL)	$9.51B	+1.04%
Sandfire Resources (ASX: SFR)	$2.67B	+7.73%
Hot Chili (ASX: HCH)	$121.24M	+11.54%
Peel Mining (ASX: PEX)	$75.50M	-13.33%
NT Minerals (ASX: NTM)	$5.12M	-20%
Castillo Copper (ASX: CCZ)	$14.29M	-50%

 

The banking industry has been in the spotlight in recent months, with several regional banks in the US going under amidst a mini banking crisis stateside. 

Investors have traditionally seen banking stocks as a ‘safe bet’ on the Australian market due to their high dividends and strong balance sheets. But could a crisis of confidence in the US banking system change this view?

Profits boom 

At first glance it would seem the big 4 Aussie banks are in a very healthy position, with all four (Commonwealth Bank of Australia ASX: CBA, Westpac Banking Corp ASX: WBC, National Australia Bank ASX: NAB, and ANZ Group Holdings ASX: ANZ) reporting massive profits over the last few weeks.  

CBA was the latest of the big four Aussie banks to announce their results, with a A$2.8bn profit for the March quarter (yes, that’s in just 3 months!). 

Westpac also reported a booming bottom line this week (A$4bn in the last 6 months) and ANZ recorded the best result of all recently with a 23% rise in half year profits to $3.82bn.

So, what’s to worry about? Well, for investors it's mainly about their share price performance – and three of the big four are showing share price falls since the start of the year (the exception being ANZ, up 6%). 

The reason? Bank shares took a hit when Silicon Valley Bank collapsed back in March. Though they have since recovered, the more worrisome long term view is the potential economic downturn coming to Australian shores. 

An uncertain economic future

In his address to investors this week, Westpac chief executive Peter King spelled out why the big banks are hanging on to their surplus capital right now - they’re waiting to see how their business and home loan customers will cope with rising unemployment and slower growth if storm clouds start gathering for the Australian economy. 

During times of economic uncertainty, investors tend to favour so-called ‘defensive stocks’, which are those companies that provide stable earnings and consistent returns. Typical examples would be well-established companies in the consumer staples, utilities, and healthcare sectors, as those industries are seen as recession proof. 

Although the big Aussie banks offer great dividend returns for investors, they are very exposed to falling property prices and higher interest rates, which increase the risk of home lending defaults. 

What is the US banking crisis?

The problems in the US began when the Federal Reserve began raising interest rates in 2022. Bond prices declined, decreasing the market value of bank capital reserves. Many regional US banks struggled to have enough cash to cover their positions as a result – and a few didn’t survive. 

The good news for investors in Australia is that our banking market is a lot more top heavy than the US – meaning there are fewer regional banks. As highlighted above, the big 4 have ample cash reserves to cover short term losses on the money markets, making them much less likely to get into trouble, even in a falling economy.

As a result, Australian banks may be seen in a positive light in the medium term, unless the banking crisis in the US gets significantly worse. 

For investors, the dividends their shares provide may be welcome in the coming months, but don’t expect share prices to shoot up any time soon.

Bank	Market cap	YTD price change
Commonwealth Bank (ASX: CBA)	$166.89B	-2.07%
Westpac (ASX: WBC)	$74.01B	-7.22%
ANZ (ASX: ANZ)	$73.58B	+6.48%
National Australia Bank (ASX: NAB)	$82.89B	-10.23%
Bendigo and Adelaide Bank (ASX: BEN)	$4.98B	-8.36%

 

Property prices in Australia have started to rise, at least that was before the RBA raised rates by another quarter percent. 

Just before the rate rise, data showed property prices jumped by 1%, and while that might not seem like much to write home about, it's quite a shift given property prices in Australia fell 9% between May 2022 and February this year.

So, now that real estate investors can finally see an end to their gloom, are house prices set to take off? 

Interest Rates are key 

Every property investor knows of the inverse correlation between interest rates and housing prices – if rates are low then borrowing to buy a house is cheaper and prices tend to rise as a result. 

The same is true in reverse, as we’ve just experienced. The Reserve Bank’s eleven (yes, 11!) interest rate rises from May last year have driven real estate values lower across the board in the last twelve months. 

Higher value markets such as Sydney and Melbourne have copped the brunt of the falls, down 10.7% and 8.9% respectively since this time last year.

Now prices are starting to move the other way, its Sydney – usually the bell weather for Australian property - that is leading the pack. Prices in the harbour city have climbed 3% in the three months, triple the national average. 

The key to what happens next will be interest rates, and after the RBA’s shock rate rise last week they remain on an upward trend. 

Inflation is still way too high for the RBA’s liking, although the signs are that this is slowing. Interest rates are expected to fall with inflation, probably from early next year, which will be good news for property investors.  

The immigration factor 

Another factor worth bearing in mind is immigration, which is a major driver of increased demand for property. 

The number of new migrants to Australia is set to reach 400,000 this financial year, more than double last year’s figure. The return of international students and working holidaymakers after the pandemic is behind the rise.

More people means more demand for housing, which puts upward pressure on property prices. The catch is where they are all going to live, with supply of new housing dwindling – recent figures show construction of new dwellings fell 6.7% according to the latest ABS figures. 

With increasing demand and falling supply, it’s not difficult to see why house prices are starting to rise again. If interest rates start falling in early 2024, property could be back to being the Australian investor’s favourite market. 

Then again, with the building sector awash with insolvencies, the question remains: who is going to build the houses?

 

With next month’s Budget starting to dominate investors' thoughts, one possible outcome when Treasurer Jim Chalmers steps up to deliver his speech on May 9 is a tax increase on resource profits. 

Chalmers confirmed earlier this month that Treasury officials were working on options to reform the Petroleum Resource Rent Tax (PRRT). He suggested it could be the next revenue measure to help repair the budget deficit, estimated to be A$49.6bn back in October.  

The PRRT applies to profits from marketable petroleum commodities such as oil and gas, and more specifically for Australia, Liquefied Natural Gas (LNG). 

The tax is currently due to raise A$2.6bn this financial year, but this figure is projected to fall to A$2bn by 2025-26 due to concessions given to resources companies, which allow them to offset their exploration expenses. 

Restructuring the PRRT to eliminate these concessions could net an additional A$94.5bn over the next decade according to the Greens, although Chalmers is unlikely to go as far as they would wish. 

So what does this mean for Investors?

For investors, the problem with raising taxes on the profits of LNG producers is simple – more tax means less profit, and less profit could mean falling share prices for LNG stocks.

Sales of Australian LNG brought in revenue of A$92.8bn last year, making it Australia’s second biggest export market behind iron ore. Taking more tax from one of our nation’s biggest earners is a risky business, as the resources lobby is quick to point out. 

The flipside is that the budget deficit clearly needs reducing and the cash needs to come from somewhere. 

What are the alternatives?

One of the biggest drains on the Australian budget in coming years is the proposed tax cuts due to come into effect in July.

The so-called “stage 3 tax cuts” will cost the Government an estimated A$243bn over the next decade, and the challenge is to find the cash to fund these cuts in a budget already seriously in the red. 

One option would be to reduce these tax cuts, or scrap them altogether. The problem is that many Aussies are already feeling the pinch due to cost-of-living rises. Pulling back on already scheduled tax cuts could seriously damage consumer confidence. 

When you consider that consumer spending has historically accounted for over 50% of GDP in Australia, that’s a big chunk of the economy at risk if consumers close their wallets (which scrapping tax cuts make them more likely to do).

Investors in retail stocks might suffer as a result, as less spending will affect profits (and share prices) of companies in this sector (and beyond most likely). 

It’s a tough choice for the Treasurer to make, and not as straightforward as the resources sector would have you believe. 

The bottom line: investors are likely between a rock and a hard place until that Budget deficit is reduced.   

Investors have been falling in love with Bitcoin again, with the leading crypto recently announced as the best performing asset in the first quarter of 2023, up an impressive 72% since early January.  

Other cryptocurrencies have been rallying too, with the second biggest coin Ethereum showing a 63% gain this year. 

But it’s Bitcoin that is leading the way right now, much as it did during the crypto bull run during Covid, before falling off a cliff in late 2021. 

The notoriously volatile asset fell out of favour with investors after losing more than 70% of its value over the subsequent twelve-month period, with the high-profile collapse of crypto trading platform FTX in November last year marking a low point. 

Golden correlation?

Recent economic uncertainty and a mini crisis in the US banking system has resulted in a jump in the gold price, which this month broke the US$2,000 per ounce mark for the first time since March 2022.

Investors have traditionally bought gold as a hedge against an economic downturn, as its limited supply means the precious metal tends to hold its value when other asset classes fall. 

But could it be that Bitcoin is being viewed in the same vein, given it also has a limited supply?

The recent crypto rally has meant the digital currency’s traditional tendency to move in line with US stocks – which have remained largely flat this year – has reduced, while its correlation with gold (up 10% YTD) has strengthened.

For much of the past year, the Bitcoin price has mirrored gold’s trajectory except for the period surrounding the aforementioned FTX collapse.

The Halving effect

Another factor contributing to the rise of BitCoin is linked to its availability. 

Programming in the source code of the cryptocurrency ensures there is a limit of 21 million tokens of Bitcoin at any one time. 

This supply is reduced further during so called ‘halving events’, when the reward for mining Bitcoin transactions is cut in half.  
These ‘halvings’ reduce the rate at which new coins are created, lowering the available amount of new supply by 50%.

The next one is projected for March 2024, and it’s worth noting that after the last Bitcoin halving in May 2020 its value soared 500% in the subsequent 18 months.

Investors may be betting on a repeat performance, but given Bitcoin’s history of volatility, it's sure to be a wild ride. 

The national unemployment rate remained at 3.5% in March according to data from the Australian Bureau of Statistics this week, with a net increase of 53,000 jobs created last month. 

Despite headwinds in the global economy such as persistently high inflation and concerns over banking stability in the US, our local job market is still firing on all cylinders, with unemployment remaining at near record lows. 

So, what does this mean for Australian investors?

On the plus side, the fact that Aussie businesses are continuing to hire is a sign that business confidence is still strong, which bodes well for the economy as a whole.  

Some sectors are continuing to experience skills shortages, with a recent report by recruitment industry leader Hays indicating that firms in the Mining, Construction, IT, Education and Healthcare industries can’t get enough staff to service demand. 

While it can be problematic for businesses looking to grow, it does signal that their services are in demand, which is good news for investors in these sectors. 

So why did the ASX fall on release of such strong jobs data?

The problem for investors in the current climate is that the unemployment rate is one of three key indicators (along with inflation and wage growth) that the RBA is currently using to inform its decision on interest rates. 

The argument goes that if unemployment is low – and it’s currently at the second lowest rate in a decade – this will lead to increased wages and ultimately higher inflation. 

And given the RBA is already battling an inflation rate of 6.8% - way above its target range of 2-3% - you can bet that any sign of inflationary pressures in the economy will see them rushing to hike interest rates again. 

Aussies are already feeling the pinch after a record TEN successive interest rate rises since May last year – increasing the average mortgage repayment by almost $1000 a month. 

Another interest rate rise is the last thing homeowners want, and if it happens, the fear is that consumer spending – which makes up over 50% of GDP in Australia – will also fall off a cliff. 

For investors, any drop in consumer spending could finally hit company profits, and in turn their share prices. 

As a result, investors will be keeping a close eye on whether unemployment rises in coming months –  it might not be a bad thing in the long run, however crazy that seems.