Pete Wargent blogspot

CEO AllenWargent Property Buyers, & WargentAdvisory (institutional). 6 x finance author.

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Friday, 28 November 2014

Mining's a Hole But Intentions are Good (Capex!)

Prawn Sandwiches, Anyone?

Had to laugh this week when an Arsenal football fan was arrested for spraying the Manchester United bench with red wine.

In the very same footballing week, a waiter had already caused a kerfuffle at the glistening new Wembley Stadium by serving food during the game, thus blocking fans from watching the match. 

Ha - modern football, eh! Nothing could make me sound much older than saying that it's all a far cry from "them olden days" when we paid 50 pence to stand on the terraces at Blackpool!

No frills or prawn sandwiches back then, of course, but disposable incomes are generally a bit higher today than they were in the 1980s, and Premier League football in particular has become hugely commercialised.

Traditionally a working man's sport it was once de rigeur for fans of southern teams to come up our way (Yorkshire) and berate northern football supporters with the then-popular chant "what's it like to lose your job?" - 'humorously' crooned in a similar strain to that of the Welsh hymn Cwm Rhonnda (basically "Bread of Heaven").

Were the goading chants taken with a cheerful bon homie? No, not particularly, but then as I recall rival football fans didn't take anything at all with much good humour back then.

The thrust of the old football chant was that Britain, then as now, suffered from a noteworthy north-south economic divide.

Manufacture, Resources and Service Industries

Roll back through enough decades and the north of England was once the industrial powerhouse of Britain - leading the world through an Industrial Revolution - with the south of the country being viewed by many northerners as a place for soft wastrels and a general drain on the country. 

However, in our neck of the woods, industries such as steel fell into decline and dramatically cut its workforce. The coal industry in South Yorkshire died too. And as with many developed countries. manufacturing fell into a steady decline, today accounting for only around 8 percent of the workforce.

Some of Britain's success stories since have included a fortuitous discovery of North Sea Oil (it was Scotland's oil really, but was deftly massaged into UK national revenues) and the City - financial services and banking. 

Britain has had another stroke of good fortune since the John Major years, that being that it did not enter the European Monetary Union (EMU) and did not adopt the Euro as its currency, and as such the Bank of England (BoE) has retained control over its own interest rates.

Different Rates for Different States

The BoE has dropped British interest rates to rock bottom for the past half decade and engaged in quantitative easing (QE), but even with your own currency monetary policy can still be quite a blunt tool.

The BoE is the central bank of the United Kingdom, and as such sets its base rate of interest for a diverse range of regions which incorporates 86 traditional counties as well as several different countries (though I still haven't worked out if Wales is actually a country or a principality).

It's a seemingly impossible task when you think about it. 

How does one go about setting interest rates simultaneously appropriate for a region which had been devastated from the halving of its shipyard industries, such as the north-east was in the early 1980s, yet a London housing market which went on triple in value in a decade during the "Lawson boom" as UK economic growth hit a rollicking quarterly growth rate of 2 percent?

Today, London may once again benefit from a few rate hikes, but hikes for Northern Ireland could mean 1 in 6 people at risk mortgage of mortgage stress by 2018.

Short answer - it can't be managed easily.

Capex Not Crapex

Hey hey, anyway, on to today's capex results, and whaddya know, some brighter news for the Aussie economy!

As implied by its full definition "capital investment", capex refers to when a business or enterprise invests in an asset such as a factory, warehouse, equipment, plant or machinery for the purposes of furthering its objectives or deriving a future economic benefit.

Capex is a good thing for economic activity now, and it is expected to be of more benefit to the economy down the track as the asset is put to use. Rising capex is thus a good sign, falling capex is more likely to be a pre-cursor to a dollop of economic malaise. 

It's long been feared that total capex in Australia would drop off a cliff as the mining construction boom unwinds, but although total new capex is down by 5. 9 percent over the past year, total capex actually increased fractionally in Q3, albeit only by a seasonally adjusted smidgeon.

The ABS has been having a bit of a 'mare with a few of its seasonal adjustments of late, so I've charted the original figures for total capex in red too. 

Jolly good. But how so have we recorded an increase given falling mining investment? The answer is that other industries - though notably not manufacturing - are responding to low interest rates and stepping up to the plate.

So while mining investment slipped by a further $640 million in the quarter, transport, postal and warehousing investment, for example, increased by $713 million. 

In other words, the economy is rebalancing away from mining construction, which is what most people who don't hate on the Australian economy would rather like to see happening.

One would expect the mining states to bear the brunt of any capex collapse.

In the event Western Australian mining capital expenditure produce a very robust result in Q3 - likely a combination of project overruns and yet more construction, though state level quarterly data is volatile - with other industries picking up nicely too, while Queensland's decline has not been quite as sharp as feared, at least when viewed over a three year time horizon.

New South Wales recorded an increase in the quarter.

Intentions Are Good

Perhaps the most important part of the capex release is the expected expenditure, which is derived from the management accounts of a sample of thousands of key companies:

"Estimate 4 for 2014-15 is $153,210m. This is 7.5% lower than Estimate 4 for 2013-14. Estimate 4 is 2.2% higher than Estimate 3 for 2014-15."

That's a very good result in the circumstances, and way better than the ~$145,000 million that many had expected. Notably, expected 2014-15 expenditure is now improving quarter on quarter (circled below) as other industries pick up their game.

The "capex cliff" may be taking on more the shape of a capex...camber? Off-ramp? Need to have a think on that one. Potentially a shallower rate of decline, anyway, which would be welcome news.

Some industries do look set to roll over and die, though.

State Versus State...

To finish up for today, I'd just like to come back briefly to my original point on monetary policy and the difficulties facing a central bank with its blunt interest rate tool. 

While much if not most of regional Australia is suffering from soft labour market conditions and rising unemployment (as I considered here), current monetary policy settings are at the same time too easy for Sydney.

I've been building my case over the years that in many respects Sydney may have the best placed economy - and strongest housing market - in Australia.

With a city population exploding higher by ~90,000 per annum, boom-like retail trade conditions, a Greater Sydney unemployment rate declining to just 5.1 percent and house prices continuing to rise at close to a 17 percent annualised clip (Residex), interest rates are too low for the harbour city at their current setting.

It was first mooted a couple of years that the Reserve Bank may be forced to wear a Sydney housing boom, and thus it is proving.

Although it is true that New South Wales has a well-diversified range of industries, it nevertheless remains the case that NSW capital investment growth has also been very heavily reliant on mining, although other industries are now gradually responding to low rates by deploying capital investment.

NSW has an ace up its sleeve, though. After a dismal lack of dwelling and infrastructure construction over the past decade, there is now multi-faceted building boom underway, showing up to some extent in the capex prints together with a twin boom in residential and non-residential construction (which is now up by a massive 54 percent since Q1 2012, a huge increase in activity).

Across the Queensland border, mining construction is now in near freefall, putting pressure on other industries, which have responded just a little to date. Watch out for soft rental markets in regional Queensland

The mining construction boom never really made it to South Australia with the cancellation or delay of a raft of projects, and as such SA has a few tricks held in reserve from a resources perspective, such as Woomera and a possible Olympic Dam expansion. 

It's just a shame for the state's economy that commodity prices have now tanked, which will keep an effective lid on mining capex for the remainder of this cycle.

One of the challenges for SA has been that manufacturing traditionally made up around half of its total capex spend, but so much manufacture is now dying with the automobile industry set to be the next to wind up.

The Wrap

The capex data set is a dream for nerds such as myself to analyse with alnost limitless scope for charting trends, but let's leave it there for today.

Summarily, challenges remain with mining investment still set to fall sharply, but this was a really good release with some promising signs of rebalancing and a solid pipeline of investment planned for the year ahead.