A Subtle Shift in Bias for the Reserve Bank of Australia

By David Dittman • September 18, 2012 • Pacific Digest

On Sept. 4, 2012, the Reserve Bank of Australia (RBA) held its benchmark overnight cash rate steady for the second straight month after cutting a total of 75 basis points (0.75 percent) in May and June. RBA Governor Glenn Stevens noted in his statement announcing the most recent decision that the full impact of the May and June cuts has yet to be felt.

“The board judged that, with inflation expected to be consistent with the target and growth close to trend, but with a more subdued international outlook than was the case a few months ago, the stance of monetary policy remained appropriate,” read Mr. Stevens’ official statement.

He also noted that the Australian dollar-US dollar exchange rate had declined over the past month or two, “though it has remained higher than might have been expected, given the observed decline in export prices and the weaker global outlook.”

But minutes of the Sept. 4 meeting, released Tuesday morning, Sept. 18, in Sydney, reveal a central bank moving toward easing but at the same time offering no definitive signals about its intentions for its next meeting on Oct. 2. The RBA meets to set the cash rate, the term is uses to describe its benchmark interest rate, 11 times a year, or every month except January.

The Australian dollar is slightly softer today at USD1.0434 as of this writing and has come off its QE3 closing high, reached Friday, Sept. 14, of USD1.0551. The aussie hit a 2012 low of USD0.9701 on Jun. 1 but rallied hard through the summer as hopes for a final solution to the eurozone problem rose and economic data in the US, contrariwise, weakened to the point where more intervention by the Federal Reserve became a fait accompli.

Notes from the RBA’s most recent discussion suggest the central bank is growing more concerned about the impact a persistently high Australian dollar, declining commodity prices and weakening conditions in other major economies will have on the domestic situation.

Its assessment of the aussie began with the observation that though it had come back in the month leading up the meeting “it remained near its recent highs, despite significant falls in some commodity prices and a weaker outlook for the global economy.” Relevant terms-of-trade models, however, suggested at the time that “the Australian dollar may have been somewhat overvalued, but not substantially so.”

At the same time, members of the RBA board “also noted the significant uncertainty that surrounded this assessment.”

The RBA’s commodity focus, appropriately, as it’s the country’s largest export, was on iron ore, though coal also figured. But its assessment of what the precipitous decline in prices for the commodity is conditional, and the impact, in the central bank’s view, could be ameliorated by the rise of other significant commodity exports, one in particular.

“If the fall in the iron ore and coking coal prices were to be sustained, it could lead to somewhat lower mining investment,” read the RBA minutes, “but given the large LNG and other mining investment projects already under way, the staff still expected there to be a substantial increase in resource investment over the next year or so.”

Since mid-June spot prices for iron ore had declined by about 35 percent, coking coal nearly 25 percent. But other commodity prices had been relatively flat; the RBA index of commodity prices had declined by 7 percent over the previous month.

It was also pointed out that iron producers set records for output in the first half of the year, with forecast pointing to rising production “over the coming year” as well. It was also noted that thermal coal shipments from New South Wales were up “sharply” in July on rising capacity and that “temporary factors” hemmed in coking coal exports from Queensland.

Again, however, RBA board members also appreciated the downside view, noting “reports of a slowing in demand as well.” As for mining investment, activity cooled during the June quarter from the March quarter.

Although the latest Australian Bureau of Statistics (ABS) capital expenditure survey, conducted in July and August, indicated the outlook for investment during fiscal 2013 “remained very strong,” resource companies in more recent days are reassessing projects to which they haven’t yet committed.

Looking abroad, the RBA, meeting before the European Central Bank (ECB) announced its intention to make new purchases of government debt and ahead of the German Constitutional Court’s refusal to grant injunctions against the European Stability Mechanism, pointed to improved sentiment during August in anticipation of positive news on these fronts.

It also noted “upcoming” policy decisions in the US, which clearly alluded to anticipation what became the Sept. 13 announcement by the Federal Open Market Committee that it would undertake another round of quantitative easing through the purchase of mortgage-backed securities, continue its program of buying of long-dated Treasuries and selling shorter-term paper already on its balance sheet and extend its promise to keep rates low until 2015.

The RBA concluded:

Overall, risks to global financial stability remained elevated, mainly reflecting the ongoing economic and financial problems in Europe. Although fears of a liquidity crisis in the euro area had eased earlier in the year following the ECB’s large-scale lending to banks, concerns about the resilience of sovereign and bank balance sheets in the euro area persisted. Outside the euro area, the major banking systems had generally continued on a slow path to recovery in recent quarters, while the Australian banking system remained in a relatively strong position.

Economic data reviewed by the RBA “pointed to a slight weakening in the global outlook.” China was “softer overall, after having appeared somewhat more positive in the previous month. The rest of Asia and the US, meanwhile, “appeared to have expanded at a modest pace,” though “economic conditions remained weak in Europe.”  In sum this global picture translated to “sharp falls in the prices of iron ore and coking coal more recently.”

Despite a murkier picture developing over the summer, the RBA anticipated June quarter national accounts data, which were released Sept. 5, “to show the pace of output growth had been around trend, following strong growth in the March quarter.”

The ABS reported the day after the RBA meeting that the Australian economy grew by 0.6 percent in the June quarter, less than half the 1.4 percent rate posted for the three months to Mar. 31, 2012. But annual growth at a seasonally adjusted 3.7 percent was comfortably above a long-term trend of 3.25 percent.

In early August the RBA raised its 2012 gross domestic product (GDP) growth forecast for Australia to 3.5 percent from 3 percent. The annual figure is in line with this assessment.

Resource investment and a pick-up in household consumption were behind the GDP upgrade. The pick-up in growth is expected to be temporary, with growth likely to fall back to around trend pace in the second half of 2012, amid moderating domestic demand, according to RBA forecasts. By contrast “current assessments are that global GDP will grow at no more than average pace in 2012, with risks to the outlook still on the downside,” said Mr. Stevens in his cash rate statement on Sept. 4.

Ultimately the RBA cited close-to-trend growth as a key factor for keeping the cash rate unchanged for a third straight month at its Sept. 4 board meeting on Tuesday. It also identified an inflation rate consistent with its 2 percent to 3 percent target. But the RBA also noted that the international outlook was more subdued than it had been a few months ago.

The RBA’s bias seems to have shifted, if only slightly, toward a cut. We’ll know more about its assessment of what had to be a surprisingly aggressive Fed reaction to continuing US employment weakness and its long-term impact on the Australian dollar in early October.

The Roundup

AE Portfolio Aggressive Holding New Hope Corp Ltd (ASX: NHC, OTC: NHPEF) leapt AUD0.37 on the Australian Securities Exchange (ASX) Tuesday in Sydney, or 8.8 percent, and is now back, ever so slightly, in the green since the Sept. 26, 2011, debut of Australian Edge.

New Hope, which produces mostly thermal coal used in electricity generation, is one of the “Eight Income Wonders from Down Under” that comprised the original AE Portfolio.

The company reported fiscal 2012 (ended Jul. 31, 2012) final results today, meeting production estimates and beating sales expectations. The board approved and management declared a final dividend of AUD0.05 per share, in line with the final dividend paid for fiscal 2011, as well as a special dividend of AUD0.20 per share. Both will be paid on Nov. 6, 2012, to shareholders of record as of Oct. 22, 2012.

Total dividends paid in respect of fiscal 2011, including a special dividend of AUD0.15 per share, were AUD0.2525. For fiscal 2012 New Hope will have paid AUD0.31 per share, up 22.8 percent.

Revenue from ordinary activities rose 15.9 percent to AUD767.5 million, as coal production was up 11.5 percent to 6.29 million metric tons and sales grew 10.6 percent to 6.25 million metric tons. Of this total 5.83 million metric tons were exported and 0.42 million metric tons were for domestic usage. On-site operating costs increased by 0.5 percent from the previous year, reflecting New Hope’s ongoing and successful focus on cost management.

New Hope’s 100 percent-owned Queensland Bulk Handling (QBH) facility exported 8.67 million metric tons of coal on 120 vessels during the 12 months ended Jul. 31, 2012, a 33 percent increase on the 6.52 million metric tons shipped in fiscal 2011.

New Hope posted net profit after tax (NPAT) of AUD167.1  million, 66.8 percent lower than fiscal 2011, as last year’s result benefitted from a AUD369.7 million non-recurring gain from the sale of interests in Arrow Energy and its Lenton project. NPAT before non-recurring items was up 16.5 percent to AUD171.1 million from AUD146.9 million a year ago.

Management forecast that total production from New Hope’s West Moretonin project in fiscal 2013 will be similar to fiscal 2012 output. It expects the planned January 2013 closure of the New Oakleigh operation to be offset by increased production from its Jeebropilly mine.

The company said in a statement that the current market is under significant negative pricing pressure, which it sees as a normal cyclical feature of the industry.  It also noted that “New Hope is well-placed to ride out this phase of the cycle being a comparative low-cost producer.”

Management is reviewing its suite of development projects in light of recent and projected coal prices. New Hope is sitting on a large cash reserve of AUD1.5 billion, which allows for development of these projects when economic conditions improve. And the company “continues to review the industry for further acquisition opportunities which are becoming more prevalent in the current depressed market.”

New Hope’s energy business continues to provide diversification and also a number of opportunities to add new cash flow to its existing coal assets. Its carbon-to-energy and coal-to-liquids programs continue to progress well, with the “proof of concept” indirect coal conversion plant expected to be delivered to the Jeebropilly mine site by the end of the 2012 calendar year.

Work on the direct coal liquefaction process also continues to progress well, with the commissioning of a 1 metric ton per day “proof of concept” plant underway in the US. Diesel production from the liquids will be evaluated over the next six months. New Hope’s research and development program into carbon-to-energy and coal-to-liquids remains on-budget, despite some delays caused by design modifications and equipment availability.

In addition, New Hope recently acquired the shares it didn’t already own in Bridgeport Energy, which has operations in the Eromanga and Otway Basins. These assets, which include three operated fields, are currently being integrated to the portfolio, following which New Hope plans to develop and implement a strategy to significantly increase production, both from the existing fields and potentially from acquisitions.

As for fiscal 2013, management noted in its earnings-release statement that “New Hope is poised to deliver another year of solid operational performance.”

New Acland “is well-placed to achieve similar levels of production in the current year,” while production from West Moreton “will be similar in 2013 to levels achieved in 2012.” The closure of New Oakleigh in January 2013 should be offset by increased production from Jeebropilly. QR National continues to perform rail services at or above contract levels, while the QBH port facility has the capacity and demonstrated monthly performance to handle up to 10 million metric tons in 2013.

All of New Hope’s budgeted fiscal 2013 production is contracted under multiyear, long-term contracts. And production from the newly acquired Bridgeport Energy assets will add to revenue, with the potential for an increase in earnings in coming years. New Hope is a buy under USD6.

Following are links to our discussion and analysis of the most recently announced financial and operating results for Portfolio Holdings.

Conservative Holdings

Aggressive Holdings

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