ASX Weekly Wrap 03/12 - 07/12

The Australian markets made modest gains last week despite some heavy selling from Tuesday-Friday. All of our gains were made on Monday on optimism from an agreed 90 day truce between the US & China and tariffs. For the week the XJO rose 14.30 points or 0.25%. Our high was 5,771.20 on Tuesday and our low was 5,610.00 on Wednesday.

Selling accelerated over the week as comments from Trump weren’t too conducive to getting a deal done between the US/China. Then we had US equity and bond markets shut for the mourning of the passing of former President George Bush Snr, which saw investors jump out of the market just in case something happened whilst markets were closed. Finally late during the week we saw the CFO of Huawei, and daughter of their founder, arrested in Canada on claims she has broken sanctions implemented on Iran by doing business with them. This made markets sell off as Huawei are one of China’s largest electronics providers and have a lot of state ownership. Investors are worried the impact this will have on trade negotiations between the US & China as the US ordered the arrest. At this stage it doesn’t look like it will affect the relationship, but markets are nervous regardless.

As I pointed out last week there was a deluge of economic data released globally last week in the last real big dump before the year ends. In Australia we saw some very important data released, which on the whole was a little softer than expected. The most important data came the way of our Q3 GDP print which saw us grow +0.3% during the quarter. This was lower than the +0.6% expected with weakness coming from construction and consumer spending. The year on year print also came in much weaker at +2.8% vs +3.3% expected. We also saw ANZ Job Ads fall -0.3%, retail spending came in at +0.3% for October beating +0.2% forecasts and building permits came in at -1.5% vs +3.0% expected. On the positive side we saw our trade balance come in at a surplus of $2.3bill. Although this is weaker than expected it still shows a very robust exporting economy. We also saw services exported hit a surplus for the first time.

Overseas the major news come in on Friday night via the US jobs report which was mixed. It saw +155k jobs added for November when +194k were expected, however the unemployment rate remained unchanged at 3.7%. Hourly wages also saw a +3.1% increase year on year as expected. It still shows a very strong labor market in the US, but also maybe with some potential weakness slipping in. It also strengthened the theory the Fed is closer to pausing its rate hikes this cycle, something I have been saying they would do for a few months. Given the weakness in emerging markets and potential for slowing in the US the Fed will have no choice but to ease up on hikes. Whether they hike in December or not, no one knows but them, but we will find out next week when the Fed meet on Wednesday/Thursday our time.

Finally we saw manufacturing and services PMI data released by Caixin in China. These PMI reads are independent of the Chinese Government but focus more on small-medium business whereas the NBS data focuses on medium-large business. Regardless we saw two beats on this data for November with manufacturing coming in at 50.2 vs 50.0 forecasts and a 50.1 read last month. Services also came in better than expected with a big jump to 53.8 from 50.8 last month and 50.8 forecasts. Overall it was some welcome relief to see some stronger numbers come in regarding the Chinese economy. Obviously one data set does not signal a trend but it’s definitely a start. Will be interesting to see what their figures are for December come this time in January.

IOOF Holdings (IFL) has had a very tough time of it lately. The wealth management and product provider has been brought in front of the Royal Commission to have some pretty bad oversights on their behalf revealed to everyone. So much so that last Friday APRA demanded up to five directors stand down, including the CEO. This saw the share price fall 35% in one day and it has fallen 61% since its peak in November 2017. The problem has been that in order to keep increasing its earnings and funds under management IFL has been acquiring bolt on financial services business to do this. In turn proper due diligence has not been done and these business’ have not been properly monitored and kept compliant by IFL so it has resulted in inappropriate advice given to clients among other things. IFL have also been found guilty of pushing their own financial products where it may not have been in the best interest of the client to own these products. This is similar to what happened with AMP, which has forced them to sell off their wealth management arm.

In news just today APRA has got half its wish with the managing director and chairman stepping down from the board immediately. I doubt APRA will be content with that and I have no doubt we will see further directors stepping down plus legal action against them and the company. Where does this leave the sector? Well my thoughts are it will be illegal for a company to provide both financial products plus also financial services at the same time. There are just too many conflicts of interest and clients can’t be assured of receiving the best possible advice. The big banks saw this in advance and hence why they have been slowly selling off their wealth management arms the last two years. It’s definitely a sector I don’t want to touch at the moment and have not got any clients exposed to at this point.

One financial asset that has been performing well off late is Gold. Since its sell off to around $US1,080oz in late 2016 we have seen a steady and bullish recovery for it now sit around $US1,250oz. Once again it has been seen as a safe haven during more volatile times that we have seen this year. In my opinion gold looks set to run into old highs of $US1,360oz (purple line). If it is to go higher then it will need to break these levels to then potentially see $US1,560oz.

In better news for Australian gold producers the gold price is trading around $1,715 AUD. This means they are seeing fatter margins than their overseas counterparts all due to a low Australian Dollar. I said over 12 months ago that if you wanted to have exposure to Gold in your portfolio to stick with Australian producers as a falling AUD meant margins would improve. Whilst personally I and clients don’t have huge exposure to Aussie gold producers what we have got has played out well. Most are now seeing breakouts in their charts which could see news highs over the next few months. Gold also seems to perform well over the Christmas period as financial asset markets turn to low liquidity and Gold is seen as that safe haven play.

So when I talk about Australian gold producers who do I mean? Well there are probably four mid-caps that fit this bill well and they are Northern Start (NST), Evolution Mining (EVN), St Barbara (SBM) and Saracen (SAR). All are decent size producers going at 100,000oz+ per annum at AISC of $900-$1,200oz. Thus like BHP/RIO/WPL all trade with heavy free operating cash flow which should come back to shareholders via dividends and share price performance. What we will also see is some corporate activity. You may see one or two of these merge to create a bigger gold producer to safe guard them in the future or see them take over some well positioned micro-caps for extra resources and production facilities. There are a trio of micro-caps sitting close to the four companies I have written about above that could be taken over for strategic reasons. The three I speak of are Bellevue Gold (BGL), Red 5 (RED) and Echo Resources (EAR). These three are all located close to operating mines of the for mentioned producers and all have 1mill ounce+ resources with old production facilities to boot that could be brought online for sub $100mill and within the next two years. To me it makes logical sense that if you were a current gold producer with cash to burn and ready to go resources just down the road you would make a play. This is of course all general advice and you should speak with your financial advisor before making an investment decision.

Technically it’s looking ugly for the XJO at this stage. Including today’s action, not shown on the chart, we are trading well below that longer term trend line (green) at around 5,550. If we can’t hold these levels then 5,050 is a real possibility, which would give us a 20% correction from a recent highs of approx. 6,350. However during the end of 2015 and start of 2016 we also traded below the trend line for 2-3 months before making a large recovery. Funnily enough back then it was also fears over China slowing and emerging markets that had us sell off. We certainly need some decent upside moves in the US over the next few weeks to help us out, but keep your wits about you.

I will note that this does not feel like a major GFC style crash in my opinion for a few reasons:

a.) There has been no black swan event triggering a sudden sell off in markets

b.) Inflation is contained/low

c.) Oil prices are historically low

d.) Global asset prices have remained moderate

e.) Interest rates are still low

f.) Declining GDP growth

\Throughout history, most times when markets have crashed, we have seen high assets prices (equities, housing, commodities), rampant inflation, high oil and rising rates all coinciding before an eventual ‘black swan’ event triggers a major sell off. During the GFC it was all these factors coinciding before S&P and Moody’s downgraded Sub-Prime mortgage bonds to Junk status (the black swan event) that caused the GFC event. At this point in time asset prices (outside US markets) are moderate, inflation is not to be spoken of, oil is low, interest rates are low and GDP has been accelerating. Granted we will probably see a couple of quarters of slowing growth it’s not accompanied by any of the other factors, so to me it’s of no concern. To me this smells of late 2015/early 2016 again when we saw a correction of 20%. At this stage we are 12% off our recent highs so have a little way to go if that’s true. It would line up with the 5,050 level I spoke of above. To me this is a market adjusting itself for some slower growth which it had been for warned of via Trump and his threats and eventual implementation of tariffs. It may have been different if Trump had not spoken of these tariffs and dumped them on markets overnight but markets have been well aware of these for some time. Also rates in the US are well below where they were in 2008. As you can see from the chart below they got to 5.25% with core inflation above 3% to boot. They are currently at 2.25% with core inflation around 2% at this point. Also the rate increases by the Fed back then were much more aggressive as you can see. This time around it has been more measured and calculated. Approach. Of course I could be wrong and this could be the prelude to something much bigger, but remember that the XJO on average declines 5% three times per year and 10%+ once every 12 months. We have just had a period of 2-3 years without this so it could be markets adjusting for that very reason. I feel once this sell off is over we will look back and ponder what excellent buying opportunities it presented just as it did in 2015/16. Outside of market crashes these corrections provide us unique opportunities to buy quality companies at discounted prices. I feel by the time we start seeing economic numbers improving markets will already be turning up and factoring in better growth ahead. Remember Trump’s tariffs are not written into legislation and are mere executive orders so can be over turned in an instance. \

Looking ahead to this week there is not much to speak of scheduled on an economic or corporate front. The US releases its monthly CPI figures on Wednesday night and the XJO announces its quarterly rebalance on Friday so expect some weird trading to happen surrounding that. It’s getting to that time of the year when news get real thin so expect next week’s wrap to be short and sweet. It will also be my last wrap for 2018 as we head into the festive season the week after. I normally return mid to late January with a summary of the past year and look ahead into the next, so look out for that. I hope you all have a wonderful week and keep safe. I will speak to you all soon. Go Crows!

heath@hlminvestments.com.au

0413 799 315

Important Notice

Any advice in this article should be considered General Advice only and does not take into account your personal needs and objectives or your financial circumstances. You should therefore consider these matters yourself before deciding whether the advice is appropriate to you and whether you should act upon it. I am happy to assist you in this process. To do so, I will need to collect personal and financial details from you before providing my recommendations. Please note the author may own shares in the companies mentioned in the above blog.