RBS Morgans sees commodity price recovery


Transcription of Finance News Network Interview with RBS Morgans Chief Economist and Director of Strategy Michael Knox

Lelde Smits: Hello I’m Lelde Smits for the Finance News Network and joining me today from RBS Morgans is Chief Economist and Director of Strategy, Michael Knox. Michael, good to have you back again.
Michael Knox: It’s good to see you again.
Lelde Smits: Now there’s been a lot of talk of the impact the strong Australian dollar is having on our economy. What’s your outlook Michael?
Michael Knox: We think fair value of the Australian dollar in terms of our model is about $US1.05 at the moment, that’s a little bit higher than it was about two months ago. Our model peaked out last year at about $US1.10, came off a bit, now it’s drifting up a bit. The reason it’s drifting up a bit is because our long term interest rates are moving up relative to foreign long term interest rates. And, the reason that’s happening in turn is we’re getting a lot of capital inflow because of the mining investment boom.
Lelde Smits: Now Michael you mention the mining boom: There’s been a lot of talk commodity prices have now peaked, would you agree with that?
Michael Knox: I think we had a short term peak last year. And, the experience we’ve been through with the European Banking Crisis, is very similar to the experience that we had in the Global Crisis, just smaller. In the Global Financial Crisis banks, instead of lending it for trade finance, put their money in their socks. And, the result of that is commodity prices fell. Then, after the Global Financial Crisis banks started lending again to trade finance and commodity prices recovered again.
So, what you saw during the European Banking Crisis, which is now fundamentally finished, because of all of the actions of the ECB [European Central Bank] and European Banking Authority, we saw banks put their money in their socks again and commodity prices fall. But now, banks are starting to lend again for international trade finance. And, you’ve seen that most markedly in the recovery in oil prices that’s happened since May. You’ve seen a significant recovery, particularly in Brent oil. And, you’ve also seen the beginning of a turnaround in gold prices. So, both of those signal that actually we’re going to see a significant recovery in commodity prices over the next 4-6 months. So, I think there has been a sell-off in commodity prices but it’s now pretty much finished.
Lelde Smits: Generally speaking if commodity prices fall so should the dollar, but it hasn’t. Why do you think this is?

Michael Knox: Well we did have a sell-off in the Australian dollar, again because of the European Banking panic, and then we had a recovery, just as we had with oil. So I think the recovering Australian dollar is successfully forecasting the general recovery in commodity prices, which is about to happen in the next quarter or two. 
What’s recovering the Australian dollar is the capital inflow. There was the short-term capital inflow from banks lending again for trade finance. But, what we’re seeing is that our long term interest rates are rising relative to foreign long term interest rates. And, the reason that’s happening is because of the capital inflow into Australia for mining construction. 
Lelde Smits: Do you believe that investment will continue to support the mining industry?
Michael Knox: Sure, what we’ve got is we’ve gone through the period of high mining prices and mining prices are maybe topping out. They’re not falling, but they’re topping out, say. But, what we’re now seeing is the second stage in the mining industry is the enormous expansion of our mining capacity. So, having gone through a mining price boom we’re now going through a mining construction boom which we enormously expand our capacity. And that lasts for, another four or five years, that’ll keep going on that way. And, after that finishes then what we’ll have is a sustained period of high mining production but with a lower number of people currently employed in mining that are currently employed in mining.
Lelde Smits: Finally Michael, do you believe a strong Australian dollar is a good or bad thing for the Australian economy?
Michael Knox: What’s your experience when you go shopping? Your experience when you go shopping is that the high Australian dollar is giving you cheaper prices at the shops. It’s cheaper prices at the supermarket, cheaper prices at K-Mart of Big-W. Things are much lower than they otherwise would be. Imported car prices are lower than they would otherwise be. And, that actually improves the general Australian standard of living. The fact that your Australian dollar goes further to buy more imported goods. So, it does actually improve the Australian standard of living, having a higher Australian dollar. It’s better for us to have a higher dollar than would otherwise be the case. Now, there will come a time when the Australian dollar will go down again, when the mining boom instead of just being rumored that it’s ending, it will eventually end, as these things always do, but not yet. And, for right now we have the benefits of a higher living standard and lower import prices.
Lelde Smits: Michael Knox, thank you for your insights.
Michael Knox: Thank you.

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