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Business OutlookBusiness OutlookCEDA’s Economic & Political Overview 2006

Perth16 February 2006

Executive Summary

Economic overview: this time last year

iChina’s insatiable demand for raw materials had led to a favourable commodity supply/demand d i i i ifi t i ti i t ditidynamic causing a significant appreciation in most commodities.

i This fuelled strong growth in the Australian economy and stock market.

– The Australian stock market had risen 55% in Australian Dollar terms and over 100% in US dollar terms from 2003-2005.

– WA in particular was highly leveraged to the Chinese boom.p g y g

iRobust balance sheets led to corporate activity, particularly in the resource sector.

– The biggest of which was BHP’s circa A$9b takeover of WMC.The biggest of which was BHP s circa A$9b takeover of WMC.

iHowever, we did warn of certain storm clouds emerging…

– Economy was approaching full capacityEconomy was approaching full capacity.

– Input costs were rising, impacting margins.

– Interest rates were poised to rise– Interest rates were poised to rise.

Executive Summary

Global growth has been strong, largely fuelled by the US and China.

US & China Rest of the world

i US– Housing Bubble

i Japan– Recovering stronglyHousing Bubble

– Wealth effect consumption– Inflationary concerns– High energy prices

i China

Recovering stronglyi Rest of Asia

– Buoyanti Europe

– Continues to disappointi China– Strong performance but:

Growth slowingOvercapacityN f i l

Continues to disappointi South America

– Signs of recovery although underinvestment is a concern

i AfricaNon performing loansPolitical dissent

Africa– Good growth potential but relies on

political stability

Globally

i Clash of ideologies and the risk of a pandemic are a threat to global stability

Executive Summary

Buoyant commodity and energy prices have driven much of Australia’s recent strong economic performance. However, Australia can be seen as two distinct economies:

WA & QLD Rest of Australia

St dit d d h l d t F t d th t i GSP 2 5% ii Strong commodity demand has led to forecasted GSP growth rates of 5% in WA and 4.5% in QLD for 2006.

i Strong balance sheets have enabled

i Forecasted growth rates in GSP are 2.5% in SA, 1.5% in ACT, 2.75% in NSW and 3% in Vic.

i Housing markets in NSW and Victoria areincreased business investment, with dramatic investment in the resource sector and allied support industries.

i High demand for new dwellings is persisting,

i Housing markets in NSW and Victoria are well off their peak, reducing debt based consumption.

i Moderation in growth of household spending.g g p g,increasing consumption but distorting resources.

i Economies are at full capacity with constraints starting to bite:

Australia wideconstraints starting to bite:

– Public sector capital works are competing for labour

– Other input costs are rising

i Signs that Australia’s long expansionary period is vulnerable to external shocks.

US

Recent housing boom significantly contributed to solid economic performance.

iUS has defied many critics with strong economic growth.

iEconomic growth has been largely driven by consumer spending. However, a large proportion of this spending has been financed from borrowing against capital gains on homes.

iChief Economist at Merrill Lynch, David Rosenberg, believes that housing accounted for 50% of US GDP growth in the first half of 2005.

iHowever, continued high energy prices are likely to undermine consumer confidence as , g gy p yinflationary concerns lead to fears that interest rates will rise.

iNot only is the US economy exposed if housing prices cool off, but housing booms negatively affect productivity by diverting resources into consumer spending away from more productiveaffect productivity by diverting resources into consumer spending, away from more productive uses.

iHope is that business investment will take up the slack.

US housing market has soared

The share price of the US’s largest home builder reflects the recent housing boom.

ce $) 45

50

Pulte Homes Share Price

Shar

e Pr

ic

(US$

35

40

45

20

25

30

5

10

15

0

5

1991 1993 1995 1997 1999 2001 2003 2005Time

Source: Bloomberg

Time

High oil prices are balanced by soaring housing prices

But how long can the housing bubble last? Real Oil Price

US House Price Ratio

5.0 70to

me

Housing price ratio to average income vs real oil prices

S$)1

4.6

50

60

Pric

e R

atio

ter

age

Inco

m

il Pr

ice

(US“Measured by increase in asset values over

the past five years, the global housing boom is the biggest financial bubble in history”

3.8

4.2

30

40

US

Hou

se P

Ave

Rea

l O

3.4

3.8

10

20

U

3.02000 2001 2002 2003 2004 2005

0

YearYear

Source: The Economist

1 Adjusted to 2005 Prices

US twin deficit

Due to a lack of domestic saving, America relies on increasingly large inflows of foreign capital.

General-government fiscal balance

Current account

1.3

United States’ Twin Deficit

DP

Current-account balance

0.1

0.6

0 7

% o

f GD

-1.1-0.7

-1.7

-2.4

-4.0

-4 6

-4.0-3.7

-3.9

-3.2

-4.2-3.8

-4.54 74.6 -4.7

-5.7

-6.5 -6.66.6

Financial Year

China

China’s economy has been the driver of the world economy.

i The World Bank has forecast China’s economy to grow by 9.2% in 2006.

iBy some measures China’s economic expansion has contributed fully a third of global economic growth in recent years.growth in recent years.

i This “China Boom” is responsible for much of the Australian share market’s amazing run. This is d t A t li ’ l t th i i tdue to Australia’s leverage to the mining sector.

i The effect on growth has been particularly pronounced in WA and QLD, causing fullThe effect on growth has been particularly pronounced in WA and QLD, causing full employment and fuelling rising housing prices.

Chinese commodity imports and exports

China’s imports and exports of commodities has exploded since 1999.

S$ 00)

Chinese Imports Chinese Exports

400400

S$ 0) Steel Exports

US

ndex

(Bas

e 10

300

350

300

350

US

dex

(Bas

e 10

Petroleum Imports

In

150

200

250

150

200

250 InIron Ore Imports

50

100

1999 2000 2001 2002 2003 2004 200550

100

1999 2000 2001 2002 2003 2004 2005

Year Year

1999 2000 2001 2002 2003 2004 20051999 2000 2001 2002 2003 2004 2005

Source : Bloomberg

China’s importance to WA exports

ChinaJapanKoreaOther

China’s share of WA exports has increased since 1997.

1997 – Exports by destination 2005 – Exports by destination

17%7%

25%

22%53%

57%

8%

11%

0%0% 8%

Source : Australian Bureau of Statistics, WA Department of Treasury and Finance

Chinese warning signs

There are signs that this “China Boom” may be slowing…

i In only 3 years, Chinese steel production has increased 3 fold to 360 million tonnes per annum. This is significantly larger than either the US or EU production of 93 and bi ne

)

HRC Steel PricesChina

7,000either the US or EU production of 93 and 186 million tonnes respectively.

i This phenomenal growth has flowed into

Ren

mim

(per

tonn

5,000

6,000

the development of iron ore and coal mines as well as a plethora of related infrastructure. 3,000

4,000

iHowever, as capacity has increased, Chinese steel prices have fallen.

1,000

2,000

2001 2002 2003 2004 2005

Year

2001 2002 2003 2004 2005

Source: Bloomberg


Shipping rates, which are another leading indicator of the Chinese economy, have also slumped over the last year.

7,080

Baltic Dry Index of Shipping Rates

5,080

6,080

3,080

4,080

1,080

2,080

80

,

2001 2002 2003 2004 2005 2006Year

Source: Bloomberg

Year


Other indicators that the Chinese dragon is slowing include:

– Year-on-year growth in China’s crude oil imports dropped from over 35% in 2003-2004 to j t 3 5% i 2004 2005just 3.5% in 2004-2005.

– Property prices in some of the big Chinese cities have fallen.

iWhat does this mean?What does this mean?

– Chinese companies continue to target output over profit.

– Expansion has been funded through the availability of cheap money.

– Has led to problems in the banking sector, with some estimates of underperforming loans at 40%.

iOversupply!Oversupply!

– It is likely that when the boom in China subsides, there will be serious excess supply in the economy.

Thi d t b d ll f th t f th ld Chi ’ d i i th f t– This does not bode well for the rest of the world, as China’s dominance in the manufacture of electrical and textile goods, coupled with its excess supply, could see cheap Chinese goods flooding the international markets…trade wars?

Rest of world

If China and the US begin to slow we must look elsewhere for increased aggregate demand.

Western EuropeStagnant High unemployment

Eastern EuropePoised for rapid growth butStagnant. High unemployment

reflects region’s lack of competitiveness. Euro zone zeal turning into malaise.

Poised for rapid growth, but hard not to doubt growth’s effectiveness in a region plagued by large income disparity and graft.

JapanReformist Koizumi recently elected amidst a new phase of potentially sustainable economic growth. Recovery well under way.

Rest of AsiaSouth America

I di

Buoyant, yet higher energy prices could have destabilizing effect.

South AmericaInflation remains low.Signs of a recovery.Underinvestment a concern.Inter and Intra Continental trade agreements are

IndiaFull of promise but yet to deliver.Buoyed by continued demand for textiles and growing i t t

AfricaExpected to produce overall

gpromising.

investment. Excessive birth rates, inefficient bureaucracy and threat of war are barriers to long run growth.

p pgrowth rates in excess of 6%. However growth is segmented and reliant on political stability.

Energy: oil, gas and uranium

iCurrent supply and demand equation is being driven by low supply of Sweet Light Oil, and high d d

Energy prices are crucial to Australia’s economic performance.

demand.

i Large investment being made to develop capacity to refine Heavy Crude Oil.

A i d l ki k i d th i d d f Chi f ll i h ld b i t f lliAs increased supply kicks in and growth in demand from China falls prices should begin to fall: China accounted for 38% of the growth in world oil demand over the past four years.

iBut we can be very optimistic that there will continue to be strong demand for natural gas as a cleaner and more environmentally friendly alternative.

iUranium could emerge as a major new source of export revenue if the State Government changes its stance.changes its stance.

iSo far higher energy prices haven’t lead to higher inflation and interest rates, but have:

– Dampened consumer sentiment and changed US car buying habitsDampened consumer sentiment and changed US car buying habits

– Led to policy changes relating to renewable energy sources

Commodities

A key factor affecting commodity prices is the substantial growth in hedge funds …

Hedge Fund Assets

men

tlio

ns 934

900

1000

Hedge Fund Assets

r Man

agem

US

$ B

il

592650

795

700

800

900

sets

Und

er

324

408

564592

400

500

600

Ass

99 76 97130

210 221

324

200

300

35 5076

0

100

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

YearYear

Commodities

… this has led to a marked increase in hedge fund speculation in commodities, ‘artificially’ pushing prices higher, even as fundamentals start to weaken.

ue 0)

USD Prices of Key Global Commodities

6 Years


1 Year

300

ue 0)

150

Inde

x Va

lu(B

ase=

10

200

250

Inde

x Va

lu(B

ase=

100

Aluminium

100150

200

Aluminium

50Jan-05 Apr-05 Jul-05 Oct-05 Jan-06

50

100

2000 2001 2002 2003 2004 2005 2006 Jan 05 Apr 05 Jul 05 Oct 05 Jan 06

Year Year

2000 2001 2002 2003 2004 2005 2006

Source : Bloomberg

Commodities


ue 0)


6 Years


1 Year

300

ue 0)

Inde

x Va

lu(B

ase=

10

150

200

250

Inde

x Va

lu(B

ase=

100

Aluminium

100150

200Nickel

Aluminium Nickel


50

100

2000 2001 2002 2003 2004 2005 2006

Year Year

Jan 05 Apr 05 Jul 05 Oct 05 Jan 062000 2001 2002 2003 2004 2005 2006

Source : Bloomberg

Commodities


ue 0)


6 Years


1 Year

300

ue 0)

Inde

x Va

lu(B

ase=

10

150

200

250

Inde

x Va

lu(B

ase=

100

Gold

GoldAluminium

100150

200 GoldNickel

Aluminium Nickel


50

100

2000 2001 2002 2003 2004 2005 2006

Year Year


Source : Bloomberg

Commodities


ue 0)


6 Years


1 Year

300

ue 0)

Inde

x Va

lu(B

ase=

10

150

200

250

Inde

x Va

lu(B

ase=

100

Lead

Gold

GoldAluminium

100150

200 GoldNickel

Aluminium

Lead

Nickel


50

100

2000 2001 2002 2003 2004 2005 2006

Year Year


Source : Bloomberg

Commodities


ue 0)


6 Years


1 Year

300

ue 0)

Inde

x Va

lu(B

ase=

10

150

200

250

Inde

x Va

lu(B

ase=

100

CopperLead

Gold

Copper

GoldAluminium

100150

200 GoldNickel

Aluminium

Lead

Nickel


50

100

2000 2001 2002 2003 2004 2005 2006

Year Year


Source : Bloomberg

Commodities


ue 0)


6 Years


1 Year

300

ue 0)Crude Oil

150

Inde

x Va

lu(B

ase=

10

200

250

Inde

x Va

lu(B

ase=

100Crude Oil

CopperLead

Gold

Crude OilCopper

GoldAluminium

100150

200 GoldNickel

Aluminium

Lead

Nickel


50

100

2000 2001 2002 2003 2004 2005 2006 Jan 05 Apr 05 Jul 05 Oct 05 Jan 06

Year Year

2000 2001 2002 2003 2004 2005 2006

Source : Bloomberg

Australia

Economic Overview

iAustralia’s current run of economic growth has been impressive, surpassing any previous run i f d tisince federation.

i Improved terms of trade has translated to gains of over $2,000pa per Australian since 1999.

With th ti f WA d QLD th h i b t biWith the exception of WA and QLD the housing boom appears to be over.

i The end of the housing boom has substantially lowered borrowing against actual/expected increases in housing prices. As a result consumer spending is slowing.

iCommodity demand from China is partially offsetting the slowing consumer demand especially in WA and QLD.

iCosts are experiencing upward pressure as the economy continues to operate near full capacity.

i Inflationary concerns may lead the RBA to raise the cash rate further.Inflationary concerns may lead the RBA to raise the cash rate further.

iNarrow interest rate spreads and weakening commodity prices could see the A$ fall further in 2006.

Australia’s relative stock market performance

The Australian stock market has performed exceptionally well against its peers over the last 2 years.

ue 00)

Global Indices3 Years

200

ue 0)

Global Indices1 Year S&P

120

Inde

x Va

lu(B

ase

10

160

180

Inde

x Va

lu(B

ase

10

100120

140

802005 2006

80

100

2003 2004 2005 2006

Year

2003 2004 2005 2006

Year

Source : Bloomberg



FTSE

ue 00)


200

ue 0)


FTSE

120

Inde

x Va

lu(B

ase

10

160

180

Inde

x Va

lu(B

ase

10

100120

140

802005 2006

80

100

2003 2004 2005 2006

Year

2003 2004 2005 2006

Year

Source : Bloomberg



FTSEWorld

ue 00)


200

ue 0)


FTSE

120

Inde

x Va

lu(B

ase

10

160

180

Inde

x Va

lu(B

ase

10

100120

140

802005 2006

80

100

2003 2004 2005 2006

Year

2003 2004 2005 2006

Year

Source : Bloomberg



FTSEWorld

ue 00)


200

ue 0)

Global Indices1 Year Nikkei S&P

FTSE

120

Inde

x Va

lu(B

ase

10

160

180

Inde

x Va

lu(B

ase

10

100120

140

802005 2006

80

100

2003 2004 2005 2006

Year

2003 2004 2005 2006

Year

Source : Bloomberg



ASX FTSEWorld

ue 00)


200

ue 0)

Global Indices1 Year

ASXNikkei S&P

FTSE

120

Inde

x Va

lu(B

ase

10

160

180

Inde

x Va

lu(B

ase

10

100120

140

802005 2006

80

100

2003 2004 2005 2006

Year

2003 2004 2005 2006

Year

Source : Bloomberg

Currency trends

Strong commodity prices and a positive interest rate differential led to a marked appreciation of the Australian dollar against the US$ and Japanese Yen over the last 6 years. However, this trend has slowed over the past year.

Trends of Key Global Currencies6 Years

140

Trends of Key Global Currencies1 Year

120

Inde

x Va

lue

(Bas

e 10

0)

120

140

Inde

x Va

lue

(Bas

e 10

0)

JPY/AUD

100100

JPY/AUD

8060

80

2005 2006

Year

2000 2001 2002 2003 2004 2005 2006

Year

Source : Bloomberg

Currency trends



140


120

Inde

x Va

lue

(Bas

e 10

0)

120

140

Inde

x Va

lue

(Bas

e 10

0)

JPY/AUD

USD/AUD

100100

USD/AUD

USD/AUDJPY/AUD

8060

80

2005 2006

Year

2000 2001 2002 2003 2004 2005 2006

Year

Source : Bloomberg

Currency trends



140


120

Inde

x Va

lue

(Bas

e 10

0)

120

140

Inde

x Va

lue

(Bas

e 10

0)

JPY/AUD

USD/AUD

100100 EUR/AUD

USD/AUDEUR/AUD

USD/AUDJPY/AUD

8060

80

2005 2006

Year

2000 2001 2002 2003 2004 2005 2006

Year

Source : Bloomberg

Company profits

In particular, the share price performance of Australia’s commodity and energy players has been strong, but experienced recent buffeting.

A t li d h i

300

ue 00)

Australian resource and energy company share pricesIndex

200

250

Inde

x Va

lu(B

ase=

10

Woodside

150

200

100

50 Jan 05 Apr 05 Jul 05 Oct 05 Jan 06

Time

Source : Bloomberg

Company profits


A t li d h i

300

ue 00)


200

250

Inde

x Va

lu(B

ase=

10

WoodsideOil Search

150

200 Oil Search

100


Time

Source : Bloomberg

Company profits


A t li d h i

300

ue 00)


200

250

Inde

x Va

lu(B

ase=

10

WoodsideOil Search

150

200RIOOil Search

100


Time

Source : Bloomberg

Company profits


A t li d h i

300

ue 00)


200

250

Inde

x Va

lu(B

ase=

10

WoodsideOil Search

150

200RIOEnergy Resources

Oil Search

100


Time

Source : Bloomberg

Company profits


A t li d h i

300

ue 00)


200

250

Inde

x Va

lu(B

ase=

10

WoodsideOil Search

150

200

BHP

RIOEnergy Resources

Oil Search

100


Time

Source : Bloomberg

Company profits


A t li d h i

300

ue 00)


200

250

Inde

x Va

lu(B

ase=

10

WoodsideOil Search

150

200

BHP

RIOEnergy Resources

Oil Search

Newcrest

100


Time

Source : Bloomberg

Individual company performances

WA’s most significant energy/resource players have experienced a similar trend.

300

D$

00)

2 Years

600

D$ 0)

1 Years

Paladin

200

250AU

Dnd

ex (B

ase

10

350400450500550

Paladin AU

Dnd

ex (B

ase

10

100

150

In

150200250300350 In

0

50

2005 20060

50100150

2004 2005 2006

Year

2004 2005 2006

Year

Source : Bloomberg



300

D$

00)

2 Years

600

D$ 0)

1 Years

Paladin

200

250AU

Dnd

ex (B

ase

10

350400450500550

Paladin AU

Dnd

ex (B

ase

10

RCR Tomlinson RCR Tomlinson

100

150

In

150200250300350 In

0

50

2005 20060

50100150

2004 2005 2006

Year

2004 2005 2006

Year

Source : Bloomberg



300

D$

00)

2 Years

600

D$ 0)

1 Years

Paladin

200

250AU

Dnd

ex (B

ase

10

350400450500550

Paladin AU

Dnd

ex (B

ase

10

SummitRCR Tomlinson RCR Tomlinson

100

150

In

150200250300350 Summit In

0

50

2005 20060

50100150

2004 2005 2006

Year

2004 2005 2006

Year

Source : Bloomberg



300

D$

00)

2 Years

600

D$ 0)

1 Years

Paladin

200

250AU

Dnd

ex (B

ase

10

350400450500550

Paladin AU

Dnd

ex (B

ase

10

RCR Tomlinson

Fortescue

Summit

RCR Tomlinson

100

150

In

150200250300350 Summit

Fortescue

In Fortescue

0

50

2005 20060

50100150

2004 2005 2006

Year

2004 2005 2006

Year

Source : Bloomberg



300

D$

00)

2 Years

600

D$ 0)

1 Years

Paladin

200

250AU

Dnd

ex (B

ase

10

350400450500550

Paladin AU

Dnd

ex (B

ase

10

RCR Tomlinson

Fortescue

SummitCazaly

RCR Tomlinson

100

150

In

150200250300350 Summit

Fortescue

In

Cazaly

Fortescue

0

50

2005 20060

50100150

2004 2005 2006

Year

2004 2005 2006

Year

Source : Bloomberg



300

D$

00)

2 Years

600

D$ 0)

1 Years

Paladin

200

250AU

Dnd

ex (B

ase

10

350400450500550

Paladin AU

Dnd

ex (B

ase

10

RCR Tomlinson

Fortescue

SummitKagara

Cazaly

RCR Tomlinson

100

150

In

150200250300350 Summit

Fortescue

Kagara

In

Cazaly

Fortescue

0

50

2005 20060

50100150

2004 2005 2006

Year

2004 2005 2006

Year

Source : Bloomberg



300

D$

00)

2 Years

600

D$ 0)

1 Years

Paladin

200

250AU

Dnd

ex (B

ase

10

350400450500550

Paladin AU

Dnd

ex (B

ase

10

Fortescue

SummitKagara

Cazaly

RCR TomlinsonRCR Tomlinson

100

150

In

150200250300350 Summit

Fortescue

W tKagara

In Fortescue

Western AreasCazaly

0

50

2005 20060

50100150

2004 2005 2006

Western Areas

Year

2004 2005 2006

Year

Source : Bloomberg


National Performers

300

D$

00)

2 Years

600

D$ 0)

1 Years

Monadelphous

200

250AU

Dnd

ex (B

ase

10

350400450500550

AU

Dnd

ex (B

ase

10

Monadelphous

100

150

In

150200250300350 In

0

50

2005 20060

50100150

2004 2005 2006

Year

2004 2005 2006

Year

Source : Bloomberg


National Performers

300

D$

00)

2 Years

600

D$ 0)

1 Years

Monadelphous

200

250AU

Dnd

ex (B

ase

10

350400450500550

AU

Dnd

ex (B

ase

10

Worley

Monadelphous

100

150

In

150200250300350 In

Worley

0

50

2005 20060

50100150

2004 2005 2006

Year

2004 2005 2006

Year

Source : Bloomberg


National Performers

300

D$

00)

2 Years

600

D$ 0)

1 Years

Monadelphous

200

250AU

Dnd

ex (B

ase

10

350400450500550

AU

Dnd

ex (B

ase

10

Worley

Monadelphous

100

150

In

150200250300350 In United

WorleyUnited

0

50

2005 20060

50100150

2004 2005 2006

Year

2004 2005 2006

Year

Source : Bloomberg

WA unemployment

The unemployment rate in WA has fallen as a result and labour availability is an issue.te %

)

Unemployment rateWestern Australia v Australia

6.0

ploy

men

t rat (%

Australia

4.0

Une

mp

WA

2.0

0.0Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06

TimeTime

Source : Bloomberg, Australian Bureau of Statistics

WA economic growth

WA’s leverage to Asia provides a favourable economic growth outlook.

10.0%th %)

WA Gross State Product Growth

Forecast

8.0%Gro

wt (%

4.0%

6.0%

0 0%

2.0%

-2.0%

0.0%1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

TimeTime

Source: Bloomberg, Western Australian Department of Treasury and Finance

To recap…

iAustralia (particularly WA) still basking in the China effect glow.

i Stock and property markets (particularly in WA) have been exceptional f t thperformers over recent months.

iFuture performance will be driven by global, not domestic, factors.

iCracks appearing in macro/global environment.

iWill see financial markets react first, then property.

iSheer amount of real and committed money being spent in WA means time to prepare.

Pty Ltd ACN 107 416 106

PO Box Z5340Perth Western Australia 6831

Level 33 Exchange PlazaLevel 33 Exchange Plaza2 The Esplanade Perth Western Australia 6000

Phone: +61 8 6263 0888Fax: +61 8 6263 0878

business outlookbusiness outlook · – the australian stock market had risen 55% in australian...

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