The first shot of a new war has been fired. This morning markets are scrambling in reaction to the rate decision by the Reserve Bank of Australia. In a surprise move, the country’s overnight rate has been raised from 3.0% to 3.25% in the apparent first inflation fighting move among leading nations.
In early pre-market trading, the S&P 500 looks to open higher by about 1% while commodities are adding to their gains. Silver futures contracts for December are currently crossing above $17.00 per ounce with the corresponding SLV trading at $16.70. Similarly, gold futures are up about 1% to 1,026 per ounce and the GLD fund is now in triple digits at $100.71.
Commodity prices are heavily linked to the Australian economy because the country is very rich in natural resources. Australia was able to avoid recession due to its strong banking system, quick stimulus programs, and most importantly a strong commodities base which is coveted by China. The surprise rate change not only bolsters the price of many commodities, but also provides further strength to the Australian dollar. Currencies which pay a higher rate of interest become more attractive, and today’s move causes further pressure on the US dollar.
Australia was expected to be one of the first of the G-20 countries to raise rates, but economists had not expected the move to come until the end of 2009 if not early 2010. According to the statement which was released along with the rate hike, Glenn Stevens explained that economic growth was strong, fueled by demand from China.
Prospects for Australia’s Asian trading partners appear to be noticeably better. Growth in China has been very strong, which is having a significant impact on other economies in the region and on commodity markets. For Australia’s trading partner group, growth in 2010 is likely to be close to trend. ~Glenn Stevens, Governor, Reserve Bank of Australia
Australia may be seeing strength due to its unique cache of natural resources and healthy trade balance with China. But the global recession continues to be difficult to fight with the US struggling to post economic growth. The third quarter GDP data will likely show an increase in activity, but that is only due to government spending which has propped up the statistics. True healthy economic growth must exist outside the bounds of government spending. It is interesting to note that the last six recessions all included a quarter of positive GDP growth before reverting to contraction in the following quarter.
The move by Australia will likely put pressure on other nations to tighten policy. Countries who continue to pursue a loose monetary policy will see their currencies hurt, and likely deal with inflation. The Australian statement appeared to indicate that the rate hike was the first in a series of moves which could put even more pressure on the US dollar, the Japanese Yen, and other competing currencies.
As US equities begin to rise, it is important to consider whether the market is rising because more value is being created, or if the higher prices are simply a function of a lower-value dollar. If equities rise another 15% over the next year, but the dollar loses 20% of its purchasing power, the gains are simply paper gains and do not equate to true wealth generation. Investors will need to adjust their model for investment success to account for the purchasing power of their portfolio instead of simply looking at the percentage return.
Investments in hard assets including precious metals, grains, energy assets, etc. will have a good chance of maintaining if not expanding their purchasing power. The commodities markets certainly have their share of volatility, but the long-term returns are likely to be very attractive over the coming several quarters. A good investment approach should be well diversified into different asset classes, but today’s allocation to “stuff” should likely be overweighted.
FD: Author has a long position in GLD and SLV in the ZachStocks Growth Model
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November 3rd, 2009 at 11:26 am
Although it is true that the Australian economy is basically sounder than the U.S. economy at the moment, do not forget that their presumed insulation from the mortgage crisis in the U.S. is paralleled by their own real estate bubble that continues to grow. Housing prices in Australia continue to rise, encouraged by the government for the increased taxes they get, and could cause them trouble in the future. Increasing the interest rate by a quarter of a point may help alleviate the situation somewhat but they are not out of the woods yet. And the word is they plan to increase the rate further very shortly. Also, as a commodity exporter to Asia, their rising currency and prices will have a negative effect on exports at a time when everyone’s economies are in a precarious balance.