rob zdravevski's blog

Big Declines in Coffee, Cocoa, Cotton & Sugar.

Since their 2011 highs, Coffee & Sugar prices have fallen 43%, Cocoa has declined 37%, Orange Juice Concentrate is 48% lower and Cotton prices have retreated 62%.

Obviously it’s now cheaper to buy these commodities than it was last year and some are even hitting the same levels seen 10 years ago.

I’m always interested investigating how far the pendulum has swung when I see such price moves when compared to the changes in the supply and demand story. Although seasonal changes have great effect, I still remain bullish on the direction of prices of commodity prices, especially the soft and grain commodities. An old blog post that I wrote about Cotton may be interesting for readers to re-visit.

The FINVIZ website is also a wonderful resource where you can quickly check the prices and retrieve charts on various commodities.

Cash is expensive

Whether it’s property, equities, bonds, jewellery, art or even rare coins – there is often an opinion forthcoming whether it’s consider to be cheap, fairly valued or expensive..

Cash seems to miss out on falling into these categories. Cash is referred to as “king” in times of worry and “lazy” when everything is booming. You’re can be either “cash rich”, “cash poor”, “cashed-up”, “strapped for cash” or it can be “burning a hole in your pocket”.

The cost of money can be cheap or expensive when you are borrowing it but why can’t cash be expensive or cheap when valuing it as an investment?

Today, I think cash is expensive!

Notwithstanding the ebbs and flows of investment markets in the near-term, when compared to other asset classes, it’s probably very expensive.

The Earnings Yield

When scanning for what I refer to as a “Fertile Investing Habitat”, I take the Earnings Yield of an equity  index (which is the inverse of the Price/Earnings Ratio) and compare it to the government 10 year bond yield and the interest earned on bank cash deposits in that particular country when trying to initially determine whether that “habitat” is potentially cheap.

For example, the P/E ratio estimate for the current fiscal year of the ASX 200 Index is 12, the inverse of this figure and thus its earnings yield is 8.3%. The yield for the Australian government  10 year bond is 4% and a generous at-call bank deposit would earn 5%.

From this I may deduce that the ASX 200 equity index might offer a better return proposition over nest few years versus the return prospects of cash?

To figure out if my investment in cash is actually expensive, simply invert the 5% bank deposit interest and your conclusion is a Price/Earnings (P/E) Ratio of 25. This is twice as expensive as the ASX 200 equity index!

What about the United States?

The S&P 500 has a P/E of 12.5 which equals an earnings yield of 8%. The 10 year govn’t bond’s yield to maturity is 2.1% (P/E of 47) and the Fed Fund rate is 0.25%, giving you a P/E of 400.

What if interest rates double?

Over the past few months I have been asked whether the Reserve Bank of Australia (RBA) will lower interest rates by 25 basis points in the coming months.

My answer: Who cares?

With a RBA cash rate so low, does it matter that much if we see a rate cut of 25 basis points? Oh sorry, it might save borrowers $25 more per month. If your hoping for such a rate cut to save you $300 per year, perhaps you are too leveraged in the first place and didn’t do anything about it over the past three years?

The real damage will be done if rates were to double or triple over the next 8-12 years, of which I am placing a greater probability towards occurring.

The Australian inflation rate was last reported as 3.5% and the RBA’s “Cash Rate” is 4.25%, which equals a real interest rate of 0.75%.

Investors in Australia, today, need to re-educate themselves about the differences between a nominal interest rate and a real interest rate.

Earning 4.8% at-call in the bank, isn’t REALLY maintaining your purchasing power when you include the inflation rate, let alone adjusting for taxes!

What if……due to various global capital forces, the real interest rate rose 1.5%, which would be closer a 30 year average and when combining my view of prolonged energy and food inflation AND the economic effect of expanded money circulation, inflation rates could themselves rise a further 2%.

Hey presto! You would then have an inflation rate of 5.5% plus a real rate of 2.25% for a nominal rate total of 7.75%.

Add the spread that a lending bank would charge and you are suddenly borrowing money at 10.2%!!!

The 1970’s thesis continued – Fashion and Politics

I’m no fashionista but to continue a previous blog where I discussed an analogy covering the 1970’s, I am now seeing bellbottom jeans making a comeback to the stores along with specifically poorly styled shorts, slim tiny skateboards and even tennis-type sun visors.

So, if the current stock market, economic, social and union situation mimics the early 70’s, it won’t be too long before tartan (Bay City Rollers, remember them?) and crocheted bikini’s soon appear. It’s all quite worrying but at least there was Farrah!

Politically, the early 70’s saw an American 2-term President Nixon give way (albeit resigning due to scandal) to a succession of 1-termers in Ford & Carter. “Stability” in policy returned when Reagan took office in 1981.

In the United Kingdom, Harold Wilson’s two-term rule came to an end in 1970 and was followed by single election winners in Edward Heath (conservative) who lost after calling an early election in reaction to striking miners to see Labour’s Wilson return for a shortened term followed James Callaghan’s tenure. Then in 1979, Thatcher took over.

Australia’s government didn’t have any more luck with stability nor scandal.

Liberal PM, John Gorton was deposed mid-term by Billy McMahon who was defeated at election after serving 20 months. In 1972, Whitlam’s (Labor) government was elected with a 9 seat house majority (but didn’t control the senate) and following the ’74 election he lost a further 5 seats in the House of Representatives.

He did also have his share of drama aided by Minerals and Energy minister, Rex Connor who wanted to control the mining industry.

Although installed into office by the Governor-General, Malcolm Fraser’s (Liberal) 7 years as Prime Minister (until 1983) morphed into the relative sensible Hawke/Keating years.

It didn’t seem to matter which political party was in power, the requisite for social and economic happiness was stability in government and a majority in the house.

History does’t seem to bode well for Gillard and Obama!

An “early call” to sell Gold – Aussie Dollar is the key

Extract from my November 16th, 2011 newsletter

The Trade: 

Short Sell Gold on break below ~ $1,760 spot price.

Stop at $1,806 or $1,796 (to be determined/refined)

BUT the key to watch is AUD breaking below 1.0050.

Today’s fall in the EUR below 1.3480 along with declines in Copper, Silver and Platinum are providing early and minor confirmations for the Short Gold trade.

Further confirmation of market weakness, especially in equities would be confirmed if the SPX broke below 1,226.

If (once) gold’s decline commences, we’d look for it to test and break levels such as $1,630, $1,540 and $1,450 onto its way down to $1,340.

At a premium to Platinum..

Gold continues to trade at a premium to its more expensive cousin, Platinum. The spread between the two hasn’t been this wide for at least 30 years.

For past 20 years, the price of platinum has traded at an average of $250 higher than gold while the past 10 years has seen it trade at a mean of $405 above gold.

Today, gold is $145 higher that platinum. This is $550 “off” the 10 year average and a $300 deviation from its 3 year average.