In order to talk about cycles, and how they can help your understanding of world markets, brings me to an idea I want to share with you. It’s also an idea that describes and predicts great change in the world.

 

The idea is that the world’s financial markets might be subject to the same kind of polarity reversal our own planet has periodically experienced. This reversal amounts to an enormous change in asset allocation models and even the way people think about risk. And according to PIMCO’s Ramin Toloui, the way to start preparing for this rebalancing of growth is to buy more government bonds in emerging markets.

A rebalancing of the world’s available pool of investable cash, based on a fundamental shift in attitudes toward risk, is basically the end of the world for the US dollar standard. PIMCO doesn’t say that. But it’s telling investors to plan for it and to profit from it.

But let me back up a second and explain what I mean about reverse polarity in scientific terms. For the planet, I’m talking about an event where the magnetic poles of the Earth reverse. North becomes South and South becomes North. It’s actually happened quite often, according to scientists And it will certainly happen again.

As you might expect, this kind of change can be pretty disruptive, especially if you’re eating your lunch at your desk on a Tuesday. It probably won’t be good for real estate values…anywhere. In fact, some scientists speculate that reverse polarity is what allowed the solar wind to blow away the atmosphere on Mars and make that planet less hospitable to life.

A Sudden Change of Direction for World Markets

 

I thought of reverse polarity because it’s one of the only metaphors that could describe a sudden change in the way the world’s large money managers and investors perceive risk. The current distinction is between the developing world and the developed world, between emerging markets and emerged markets, or between the US/Europe/Australia/ Japan and Brazil/China/Russia/South Africa/India/Indonesia/Korea etc.

Up until 2007, the idea is that one category of countries (the developed world) is “safe” while the other countries are “risky.” Thus, “risk on” trades saw investors buy emerging markets and commodities while “risk off” trades saw rallies in the US dollar, yen, euro (generally) and blue chip developed world stocks.

It’s a pretty simple way of thinking about the world markets and where to put your money at the right time. The only trouble is this description of the world no longer matches the world. The description needs to change. And like any change in investment markets, being ahead of it is better than getting run over by it.

Besides, after two years of constant crisis, the government bonds of developed world countries like the US, Spain, the UK, and Italy can hardly be described as “safe.” And in any event, their yields (on the shorter-term debt) are all nearing zero in nominal terms and below zero in real terms. The news about various bond auctions is a giant distraction.

Meanwhile, in the so-called developing world, government debt ratios as a percentage of GDP tend to be lower, savings rates higher, and GDP per/capita growing (rather than shrinking). Yet investments in the so-called developing world are still considered “risky” while US debt is considered “safe.”

This general attitude toward risk is subject to a pole reversal. It occurred to me that attitudes toward risk can change quickly too, with huge investment consequences. Attitudes at the margin are already changing. The fact that it’s showing up in PIMCOs advice to clients is another sign that the idea could reach a “tipping point.”

But a “tipping point” is another way of saying an event needs a catalyst to initiate what chemists would call a “phase change.” Solids don’t turn to liquids without a phase change. Liquids don’t turn into gasses without a phase change. And investors don’t suddenly change their attitude toward the world without a similar phase change.

Dan Denning

Editor, Australian Wealth Gameplan

 

I always preach caution to investors lured by mining towns.

They’re the ultimate risk-return conundrum for the mum-and-dad investor.

The considerable appeal of high rental yields and fast capital growth needs to be weighed against the risk of all that collapsing amid a GFC or a reversal of fortunes for a key employer.

The typical package for an investor buying a capital city suburban house in the past 10 years is rental yields around 4 per cent (which means a loss-making investment or, as the industry likes to term it, a negatively-geared one) and capital growth averaging 10 per cent a year.

Outside of the capital cities there are regional locations where capital growth has averaged better than 20 per cent a year over the past decade.

There are also places where you can get double-digit rental returns, delivering an investment that provides weekly income.

Here’s the thing: those high-capital-growth places and those high-rental-return places are the same places.

They’re all mining towns or regional centres which service mining towns.

One of them has averaged 33 per cent in annual growth in its median house price. It also can provide rental returns around 15 per cent.

This extraordinary place is Moranbah. It’s in the Bowen Basin, Australia’s greatest coal province, in central Queensland.

No one can say for sure what its population is, because so many people who work there don’t live there – or live there temporarily as fly-in-fly-out or drive-in-drive-out workers.

The permanent residential population is around 8,000 but there could be double that number in the town at any point in the working week.

Ten years ago you could have bought the typical Moranbah house for under $50,000. Today you pay twelve times as much.

As the town’s importance as a mining hub expanded, there was exponential price growth from 2003 to 2007. Growth stopped around the onset of the GFC, which put a dampener on the resources sector for a couple of years.

Unlike other mining towns, however, Moranbah did not suffer any noticeable loss of values – just a short-term pause in the growth. It resumed strongly last year and now appears headed for the stratosphere again.

Australian Property Monitors records a long-term growth average of 33 per cent a year, which means values doubling every two years or so.

The only other markets in Australia that come close to that performance are Dysart, another coal mining town in the Bowen Basin, and Port Hedland in Western Australia.

The other extraordinary thing about Moranbah is that rents have grown recently at an even faster pace than prices.

The Real Estate Institute of Queensland records a median rental yield for the Isaac Region (of which Moranbah is the key mining town) of 15.3 per cent. In 30 years of writing about Australian residential property I haven’t seen a number like that.

Properties currently for sale in Moranbah include a three-bedroom house tenanted at $2,000 per week and with an asking price of $820,000, which equates to a 13 per cent yield. Another rented at $1,900 per week had an asking price of $789,000, which equates to 12.5 per cent.

A four-bedroom house with an asking price of $920,000 has a two-year company lease in place at $3,100 per week. That’s $161,200 in annual rent and a yield of 17.5 per cent.

There are many others with similar numbers.

While the median price for Moranbah is now around $600,000, I can’t find anything for sale at the moment for less than $750,000 – and we’re not talking about palatial modern homes, in most cases.

This is why such investments are so risky. When you’re paying $800,000 in a small country town for a house that might fetch $350,000 in an outer Brisbane suburb, you known the values are at best tenuous.

They depend on the resources sector continuing to grow and also depend on the current lack of housing supply in Moranbah. Both situations could change in the future.

I do believe the current upturn in the resources sector has long-term horizons because the industrialization of new growth nations like India and China is only just beginning. And that’s where the demand for Bowen Basin coal originates.

Certainly BHP Billiton thinks so, moving forward with the $4 billion Caval Ridge project, while Anglo American is tipping $1.7 billion into the Grosvenor project.

These and other projects are forecast to bring another 10,000 FIFO workers into Moranbah, effectively doubling its population.

But be aware of the risks. BHP showed at Ravensthorpe in Western Australia, where it closed a $2 billion mine only months after completing its construction at a cost of 1,800 jobs, that it’s prepared to take ruthless action if the world economic climate turns south.