If there is one obvious short in the global economy for 2011, it has to be Australia. They have developed a leveraged relationship to growth in China, with an internal currency that has appreciated to parity with the US dollar. This sets their equity markets up for a serious beating if any of the following happens. I personally would not be shocked if all 4 of these happen at or near the same time.
Any slow down in real Chinese growth is going to show up in Australia first. A sure sign of this will be when ships dedicated to the bulk raw commodity market start to slow steam from Australia to China, or worse start to show up as idle along the Australian or Chinese coast.
The following source is great for tracking global commerce at sea, in real time.
The land down under has not seen its housing bubble pop yet. The bubble has continued to grow, with the mining industry, and mining services industry’s providing a vehicle of growth during the economic bleak years of 2008-2010 in the rest of the western economy.
”Safe as houses” is a well-worn expression, but the MLC Investments strategist Brian Parker says the notion that Australian real estate prices can move in only one direction could go out the window. ”Residential property looks absolutely obscenely overvalued and seems to offer very, very poor investment prospects,” he says.
The central bank in Australia is in the position where it will need to raise rates by at least 100 basis points in the next year, to fight inflation expectations. If the Chinese experience a real case of destocking of raw commodities, while the US slows down again, Australia is going find itself raising rates into the second round of the global economic storm.
When the rate shock hits the housing market in Australia, with any real slow down in China, you will have a MAJOR deflating of the Australian equity and housing markets at the same time. It is just a matter of when, not if. Just ask the IMF, which has a way of pointing out crisis with out pointing fingers.
"From a financial stability perspective, stress tests suggest that a correction in house prices is not expected to take a toll on banks because of the low level of high-risk mortgages," the report said. "The current historically high terms of trade are expected to be long lasting. Strong population growth and high real income growth in the wake of record-high commodity prices this year will continue to support house prices."
While house price-to-income and house price-to-rent ratios suggest homes are overvalued, interest rates have fallen since 2000, making these higher ratios sustainable, the IMF said.
Average home prices in Australia are 6.8 times annual median household income, more than double the U.S. ratio of 2.9 times, according to the annual Demographia International Housing Affordability Survey.
So according to the IMF, the new higher ratios are perfectly normal as long as China never slows down. I mean, it is not like China is fighting inflation expectations and needs to cool off its own economy in the near term.
Disclosure: Pondering some Australian equity shorts…
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Steve December 27, 2010 at 9:29 AMThe more I think about it, the best way to play this would be to buy deep out-of-the-money puts on the Aussie. You will probably get zeroed out a few times, but keep rolling them every 3 months. If China goes, the Aussie could drop 20 handles in a couple of months. The payoff would be staggering.
Reply Jack H Barnes December 27, 2010 at 9:37 AMSteve,
When I was driving a couple of funds, during the 06-08 period specifically, I bought what we called WTFOOTM (way the fuck out of the money) puts on investment banks.
Best example, we had ridden Bear up and down during its crash… I remember we had 65 puts or so on it, when all of a sudden you could buy seriously cheap puts around 20 and below. We bought even more on that Friday, and washed out the position at 3 dollars and change.
WTFOOTM can seriously pay off. If the risk premium is low, I love LEAPs on them.
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yo December 27, 2010 at 2:45 PMnot sure aussie is going to be fighting inflation if china tanks
ReplyPingback: Shorting China via Australian Markets | Jack H Barnes..via Abnormal Returns | leroygardner.com
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The more I think about it, the best way to play this would be to buy deep out-of-the-money puts on the Aussie. You will probably get zeroed out a few times, but keep rolling them every 3 months. If China goes, the Aussie could drop 20 handles in a couple of months. The payoff would be staggering.
Steve,
When I was driving a couple of funds, during the 06-08 period specifically, I bought what we called WTFOOTM (way the fuck out of the money) puts on investment banks.
Best example, we had ridden Bear up and down during its crash… I remember we had 65 puts or so on it, when all of a sudden you could buy seriously cheap puts around 20 and below. We bought even more on that Friday, and washed out the position at 3 dollars and change.
WTFOOTM can seriously pay off. If the risk premium is low, I love LEAPs on them.
Pingback: Monday links: learn and attack Abnormal Returns
not sure aussie is going to be fighting inflation if china tanks
Pingback: Shorting China via Australian Markets | Jack H Barnes..via Abnormal Returns | leroygardner.com
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