The Floor under the Aussie

By David Dittman • April 4, 2013 • Pacific Digest

The Australian dollar has held up a lot better than the Reserve Bank of Australia (RBA) would like in recent months.

Although recent data suggest the Australian housing market is getting healthier due to lower mortgage rates and that consumers Down Under are spending more freely as a result of recent RBA rate cuts, another desired effect of the central bank’s easing policy–a softer currency that would help manufacturers, other exporters and the tourism trade–has not transpired.

Recent data from the International Monetary Fund indicates foreign central banks continue to diversify their currency holdings beyond the traditional US dollar, Japanese yen, Swiss franc, British pound sterling and euro mix.

The March 29, 2013, IMF report on its database of global reserves, the Composition of Foreign Exchange Reserves (COFER), showed that the share of central bank reserves tied up in dollars and yen declined during the fourth quarter of 2012, while the share devoted to the euro was unchanged.

Meanwhile, the share invested in the category labeled “other”–which includes non-traditional currencies such as the Australian dollar as well as the Canadian dollar–surged to an all-time high of 6.12 percent.

In other words, demand from central banks is propping up the aussie, despite a series of cuts that’s taken the RBA’s overnight cash rate from 4.75 percent in October 2011 to 3 percent today.

Forecasters have predicted a slide below parity with the US dollar as Australia’s non-mining sectors struggle. Although the aussie has dipped below USD1.02 in recent weeks it’s consistently bounced back. This suggests central banks are stepping in on weakness, providing a floor for the currency.

The “big five” still command the lion’s share of central bank foreign currency holdings. But the trend toward the aussie and the loonie–which share in common underlying economies focused on resource production and export as well as supporting governments with relatively low levels of debt–is clear.

“Other” surpassed the Japanese yen to take fourth place during the fourth quarter of 2009 and leapt over the British pound for third place in the third quarter of 2010.

The US dollar and the euro remain in first and second place, respectively, but “other’s” share has grown substantially in the 21st century, from 1.49 percent of allocated reserves at the end of 2000 to 5.49 percent in 2011 to the present accounting above 6 percent as of Dec. 31, 2012.

We noted in the Nov. 28, 2012, Down Under Digest that an August 2012 IMF report had found that the aussie, along with the loonie, should be broken out from the group of currencies reported as “other.” A March report in The Wall Street Journal indicates this will happen by June 30, 2013.

“The IMF is expanding the list of currencies separately identified in the COFER template,” an IMF spokeswoman told the WSJ. “The implementation of the revised COFER Report Form, with separate identification of the Australian dollar and Canadian dollar, is scheduled for the first half of 2013.”

It’s important to note that the IMF is simply breaking out data for the aussie and the loonie. This alone should have no substantive impact, as it’s an after-the-fact accounting of actions central banks have already taken.

A new line-item doesn’t make these currencies any more or less fundamentally attractive. But it does acknowledge the fact that the Australian dollar and the Canadian dollar have achieved a certain critical point in the eyes of central banks around the world.

RBA Keeps Cash Rate Steady

RBA Governor Glenn Stevens, noting that “a number of indications that the substantial easing of monetary policy during late 2011 and 2012 is having an expansionary effect on the economy,” kept Australia’s cash rate at 3 percent following the central bank’s April 2 monetary policy meeting.

The RBA’s benchmark has been at a half-century low–a level previously matched during the aftermath of the Great Financial Crisis in mid-2009–since Dec. 4, 2012.

Mr. Stevens, who was recently appointed by Australian Treasurer Wayne Swan to serve an additional three years to September 2016, pointed out in his statement that “recent information suggests that moderate growth in private consumption spending is occurring,” though he noted as well that “with inflation likely to be consistent with the target, and with growth likely to be a little below trend over the coming year, an accommodative stance of monetary policy is appropriate.”

Since the RBA’s March meeting government and private data showed rate cuts are beginning to have an impact. Australian gross domestic product (GDP) grew by 3.6 percent in 2012, and employers added 71,500 jobs in February, the most since 2000. And consumer confidence rose in March to the highest level since December 2010.

Australia has now been recession free for 21 straight years.

This week the Australian Bureau of Statistics reported that retail sales were up 1.3 percent to AUD21.95 billion in February, beating economists’ forecast on strength in household goods and department stores. January sales were up a revised 1.2 percent from December 2012, making for the biggest back-to-back gains in nearly four years.

The RBA’s preliminary estimate for its Index of Commodity Prices for March indicates a 0.2 percent increase in Special Drawing Rights (SDR) terms. The index was up a revised 2.6 percent in February.

(“SDR” refers to “special drawing rights, the IMF’s unit of account. The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is based on a basket of four key international currencies, those of the eurozone, Japan, the UK and the US.)

The largest contributors to last month’s increase were higher prices for iron ore and coking coal. The prices of rural commodities overall also increased, while the prices of crude oil and base metals declined.

Over the past year the index has declined by 7.5 percent in SDR terms, much of the slide due to softer prices for coking coal and thermal coal.

Meanwhile, China’s official purchasing managers’ index rose to 50.9 in March from 50.1 in February, while the HSBC PMI, which is weighted toward small and medium-sized companies as opposed to the larger, state-owned entities that generally comprise the government survey, rose to 51.6 in March from 50.4 in February. A PMI reading above 50 indicates an expansion in manufacturing activity, while reading below 50 signals contraction.

The official reading was below a consensus forecast of 51.2, though weakness may have been somewhat exaggerated by the seasonal volatility around Lunar New Year holiday. Expansion was apparent across a broad base of sub-indexes, suggesting growth momentum continues.

Economists expect China to grow by more than 8 percent in 2013 and 2014, supported by investment growth and a rebounding property market. Efforts by the new Chinese government to crack down on corruption may, however, have a short-term negative impact on consumption.

China’s moderate but steady recovery, coupled with mild inflationary pressures that will encourage more official pro-growth measures from the new government–particularly in infrastructure investment–is good news for Australia.

The Roundup

AE Portfolio Aggressive Holding Newcrest Mining Corp (ASX: NCM, OTC: NCMGF, ADR: NCMGY) cut is fiscal 2013 gold production guidance due to restricted production capacity at its Lihir mine and “continuing challenges” with ground conditions at its Gosowong operation.

Management reduced its gold output forecast to 2 million to 2.15 million ounces, the midpoint of which is around 10 percent below the original minimum guidance.

Production across Newcrest’s six operating gold mines was supposed to be between 2.3 million ounces and 2.5 million ounces.

Annual copper production guidance of 75,000 to 85,000 metric tons remains unchanged, as is full-year site-cost guidance and full-year capital expenditure guidance.

Newcrest shares have slumped dramatically in the aftermath of this latest production disappointment, closing at AUD18.49 on the Australian Securities Exchange (ASX) on Thursday, April 4, 2013, a four-and-a-half-year low.

Management noted in a statement that the production ramp-up at Cadia East and the million-ounce plant upgrade at Lihir had progressed in line with expectations. But Lihir operations were running at a reduced production capacity after a routine thermal scanning program detected a hot spot in autoclave 1. An autoclave is a roaster used in refractory mining processes to recover gold from sulfide concentrates.

Following an inspection, management confirmed that the internal brickwork of the autoclave had been damaged.

Newcrest decided to “undertake a complete and permanent repair to ensure a long-term solution to this issue,” which means between five and seven weeks of down time. The three other autoclaves at the site, as well as the rest of the Lihir processing plant, continued to operate to capacity. Lihir is now on track to deliver between 620,000 and 680,000 ounces of gold in fiscal 2013.

Newcrest also noted that it continued to face difficult ground conditions at the Gosowong operation, as it went in search of high-grade ore in the Kencana mine. The Gosowong operation is now expected to deliver between 300,000 and 325,000 ounces during fiscal 2013.

This is the fourth production guidance cut in less than two years at Newcrest, one that, despite the recent track record, seemed unlikely given the wide range management previously outlined for Lihir of “between 700,000 and 900,000” ounces. In July 2013 CEO Greg Robinson specifically stated the range was “deliberately very broad” to allow for possible hitches at Lihir as the final machinery of the upgraded processing plant were installed.

Management has consistently defended the decision to buy Lihir for AUD9.5 billion in 2010, noting that its due diligence revealed that there would be obstacles to overcome at the Papua New Guinea mine.

An 11 percent decline in the price of gold over the past six months will make it even harder for Newcrest to even approximate its record fiscal 2012 profit of AUD1.12 billion.

Newcrest has been a consistent disappointment since our initial Oct. 14, 2011, recommendation. The stock has generated a negative total return–capital loss plus dividends paid–in US dollar terms of 47.6 percent. Without dividends the loss would be 48.8 percent.

Newcrest’s potential remains huge: Its mines in Australia, Papua New Guinea, Ivory Coast, Fiji and Indonesia are expected to be producing as much as 3.5 million ounces of gold by 2017. At the same time, however, it’s reasonable to question management’s ability to execute plans that will bridge the gulf between “potential” and “production.”

Newcrest Mining–far and away the biggest loser among our Portfolio recommendations–is now a hold.

Here’s where to find discussion of earnings for AE Portfolio companies, most of which just reported fiscal 2013 first-half results. Some posted results for 2012, while others report on completely different schedules. We’ve included the next reporting dates for those companies. Please consult the Portfolio tables at www.AussieEdge.com for current advice.

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