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

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Friday, 14 October 2016

Surprise, surprise...a coal-fired recovery

Deficit to narrow

Following a string of trade deficits, Australia recorded a somewhat narrower trade deficit of $2 billion in August.

Unfortunately, over the past year only gold has performed strongly in terms of merchandise export values, while iron ore and coal have recovered modestly.

Supply squeeze

However, this dynamic is about to change, at least for a while, and for a rather unexpected reason.

The coal spot price has essentially exploded, to US$213/tonne (the average Australian export price back in the March quarter was just $81/tonne).

Peter Ker of the AFR reported that the prices for coking coal exports to Japan would rip 117 per cent higher in just three months, potentially increasing national income by 2 per cent and delivering a rip-snorting $7 billion budget revenue windfall if prevailing prices were to persist for a year.

Note here that budget documents were previously projecting a deficit of only $5.9 billion in 2019/20, so that deficit could feasibly be completely seen off in the forthcoming mid-year forecasts.

It was reported today that FOB values for Australian coking coal have now tripled since the beginning of the year from $76.45/mt to an outlandish $231/mt on perennial Chinese coal shortages.

As noted here previously a number of Australian coal mining companies have seen their share prices multi-bagged in 2016.

As you can see in the chart below, coal export FOB values were just $2.8 billion August, while services exports appear to be rising solidly again after a bit of a wobble.

Piecing it together

In the event of a doubling of coal export values - and assuming the LNG price holds up as export volumes increase by 40 per cent over the next year - other things being equal, there's a fair chance that the trade deficit could flip back to surplus, at least temporarily.

I wouldn't necessarily expect to see this confirmed in the trade figures any time soon, with export values initially reported based upon estimates that are unlikely to be as high as those quoted above.

Perhaps the most obvious risk to this scenario - apart from the coal price being smashed back down again as China relaxes its policies - is the iron ore price.

Iron ore remains Australia's most valuable export commodity, with exports of $4.7 billion in August. 

China has imported one billion tonnes of red dirt over the year to September, up by 9 per cent from one year ago, but most analysts believe that there is a prevailing glut of the commodity.

New highs for national income

Although we had recessions in the 1970s, 1980s, and 1990s, Australia has now gone for a remarkable 25 years since its last recession (see the red line below), and in fact GDP growth has stormed ahead of that of other developed nations over the past decade.

The chart shows that while Australia narrowly avoided a technical recession through the global financial crisis, conditions were far from smooth sailing at that time.

Businesses struggled, and unemployment increased. Rudd deserves credit for his timely stimulus packages.

For a whole range of different reasons quite a lot of people don't seem to like this narrative, so they instead like to highlight that national income (green line) growth has slowed.

I guess the thing with figures about the economy is that you can always and everywhere find a weak point to highlight, even when the economy has held up much better than almost everyone expected.

It's all in the marketing and spin, really.

After all, steadying national income isn't all that surprising when you look at the preceding boom which ran for fully 17 years from 1991 to 2008 and saw real national income doubling. 

Anyway, while national income growth did slow, but then it rebounded again in the June quarter to all-time highs, in real terms.

The national accounts also show that gross household income increased by more than 3 per cent in FY2016, well ahead of the rate of inflation. 

In summary, a tripling in coking coal FOB values combined with a surge in LNG export volumes could see national income rise further in 2017 too, with iron ore as usual being the major downside risk.