Macro Tsimmis

intelligently hedged investment

BUY iShares MSCI Australia Index (EWA)

Posted by intelledgement on Tue, 02 Jan 07

Australia has lots going for it: bountiful resources, well-educated and healthy population, established capitalist economy, good government…but to us, what puts Australia over the top as an investment play is her relationship with China.

For all the reasons listed in the write-up of our FXI long position, we consider the buildout currently underway in Asia in general and in China in particular to be a huge investment opportunity. But with rapid growth on a vast scale inevitably come disruptive change and the potential for significant volatility. There are any number of pitfalls which may cause temporary but dramatic declines in the fortunes of China’s bourses…and likely codas for some specific enterprises who bet on the wrong horse, or have the right horse but in the wrong race. So investing directly in Chinese enterprises is risky.

Obviously with FXI, we are willing to take the risk, but another less risky way to play the buildout is to buy what China wants/needs. Clearly whenever there is a slowdown of the buildout, then suppliers will cool down, as well, but if you can find suppliers who have a good thing going on their own, the downside is likely to be muted. This is where Australia comes in.

Australia is a huge country; only Russia, Canada, the USA, China, and Brazil are larger. It is also very dry (6% arable land) and thinly populated (20.3 million). From China’s perspective, Australia is a notable speck on the radar screen, accounting for 1.7% of imports and 1.8% of exports, but for Australia, China is momentous: currently their second largest trading partner after Japan, and growing faster than the other top dogs. Unfortunately for both countries, Australia is not self-sufficient with respect to oil—and therefore not prepared to export significant quantities—but she does have a lot of other stuff that China craves for the buildout: natural gas (annual surplus of 10 billion cubic meters), iron ore, alumina, machinery and transport equipment, and quality coking coal, as well as other useful commodities such as wool for the Chinese clothing industry, gold for the jewelry industry (and potentially for government reserves). and high-end meat products for the growing upper middle class.

Politically, Australia’s relations with China are strong. There is some awkwardness over Taiwan, principally related to Australia’s decades-old commitment to the ANZUS treaty, which presumably obligates her to go to the aid of the USN should it come under assault from mainland forces attempting a cross-Formosa Straights invasion. Most likely, Beijing will eschew attempting a military solution to the problem of effecting reunification; if so this remains only a minor irritant.

Australia’s economy has been conservatively managed for decades and is in excellent shape. GDP growth is running around 3% with an unemployment rate south of 5%. While they do have an aging population in line with most advanced Western nations, public debt as a percentage of GDP is just 14% (compared to 65% for the USA) and Australia’s Gini index (a measure of wealth distribution) is 35…considerably lower/better than that of the China (44) or the USA (45). And the country is popular: the migration rate is higher than that of the USA (+3.9/1000 as opposed to +3.2/1000).

Thus we believe that Australia is well-positioned not just to weather the emergence of China as a dominant economic force but to prosper thereby, and overall is likely to outperform the USA market over the next decade or so. Certainly that has been the case of late:

Year Australia USA
2006 25% 14%
2005 18% 6%
2004 32% 11%
2003 51% 29%
2002 0% -23%

Our investment vehicle of choice, iShares’ MSCI Australia Index ETF, does a good job of tracking the performance of the Australian stock market, with more than 95% of the fund’s assets typically invested in public Australian companies. It has over $1B of assets and a modest expense ratio of around 0.5%…and is yielding 4% to boot.


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