Market Matters Morning Report Tuesday 5th July 2016

Morning Report 05/07/2016

Market Matters Morning Report Tuesday 5th July 2016

Does strength in resources & falling interest rates make sense?

Global interest rates continue to fall with 75% of global interest rates below 1% and an amazing 35% below zero. Hard to imagine but Australia is a high-interest rate country even with the official RBA rate at 1.75%. We could actually see rates head towards 1%, or lower , if the $A continues to rally higher from this mornings' AUDUSD 0.7535.

This afternoon the RBA will announce its July decision on rates, we expect no change maintaining the tradition of only one change from the July meeting in 20 years and of course there is the uncertainty that we still have no government. With around 95% of economists forecasting a cut to 1.5%inAugust the market risk is no cut but we are with the majority on Australian rates, a cut to 1.5% in August and then watch the $A / inflation for future direction.

Yesterday, just like the UK after BREXIT, the local share market shook off a disappointing election result and surprised many by closing up 35 points, with gains led by resource stocks. No surprise to us as we remain bullish with the driving force the massive piles of cash on the sidelines - markets rarely fall when investors are not long shares.

The RBA Official Cash Rate Monthly Chart

What is standing out to us is that investors are currently buying resource stocks and avoiding banks, since the start of 2016 we have seen: BHP +9.3%, FMG +108% and NCM +94% BUT CBA -14.2%.

A stockbroker who had advised their clients to sell banks and buy resources at Christmas would probably have been searching for new clients, however, today they would look like a hero. We are glad to have participated in a proportion of this rally in resources but have underestimated its strength e.g. Regis Resources and Fortescue Metals, two stocks we bought near their lows.

We would reiterate here that we regard the resources space as a trading / aggressive investment sector as the companies cannot determine their profitability being dictated to by the respective underlying commodities prices.

What comes next is clearly what matters to investors portfolio performance and the question we ask ourselves is "if interest rates are plummeting on the back of weak economic growth why are resource stocks rallying? Theory suggests they benefit from strong economic growth – not weak".

We believe there are two answers to this question:

1. The $US has weakened over 3% in 2016 because the anticipated interest rate rises in the US are not materialising due to weak global growth. Commodities are priced in $US hence a weaker $US supports the price of commodities.

2. Funds who are sitting on "piles of cash on the sidelines" that we mention often are occasionally forced to invest some money in stocks. Resource stocks have been savaged since 2010/11 and hence value is simply perceived in these sectors.

Our view is split in two very clear opinions between resource stocks and gold. Firstly we remain negative resource stocks medium term and still believe a break of Januarys panic lows is a strong possibility.

Hence we are happily long Origin Energy (ORG) with a target in the low $6 area BUT we are not generally buying into this current strength.

Fundamentally weak economic growth is bad for resource stocks and technically the upside looks limited at best. Our view is this current strength will dissipate in time but our preferred stock in the sector is Fortescue (FMG).

BHP Billiton (BHP) Weekly Chart

However, secondly, we are bullish the Gold Sector medium term and are now looking for good risk / reward entry after taking profits on Regis Resources (RRL) pre-BREXIT which was now clearly premature.

Fortunately, the sector is volatile and the opportunity to purchase Newcrest into $2.50 retracement is likely to present itself .

Newcrest Mining (NCM) Monthly Chart

Summary

While we remain bullish equities over coming months, we are not keen on the resources sector at current levels. Conversely, we are very bullish gold and are keen buyers of the next decent retracement.

Watch out for VOC which we may purchase today under $8.20.

Overnight Market Matters Wrap

A quiet session was experienced overnight, with the US markets closed in celebration of Independence Day
and lower than average volume traded in Europe.
Oil, however, closed marginally lower, down 0.5% tot US $48.76/bbl.
The September SPI Futures is indicating the ASX 200 to open with little change, hovering above the 5,285 level. Expect to experience a quiet start to the session, leading up towards the RBA July Interest Rate meet at 2.30pm.
The European markets closed lower, with EuroStoxx off 0.7%, ending the day at 2,862, while London’s FTSE closed 0.8% lower at 6,522.
The Commodities sector is expected to outperform the domestic market today, with Gold futures up 1.1% to US$1,353.50/oz and Iron Ore up 3.5% to US$56.22/t.

Regards,
The Market Matters Team
28-34 O'Connell St
Sydney, NSW 2000

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