MACROBUSINESS MEMBERS APRIL UPDATE 1. THE ECONOMY AND ASSETS 2.

READERSHIP STATS
1. THE ECONOMY AND ASSETS Mining The key theme for 2013 is the upcoming peak of the mining investment boom and what it means for the Australian economy, in particular employment, incomes and growth. Mining investment matters because it has been the strongest driver of GDP growth since the GFC. As it falls, it must be replaced with something else or jobs disappear. Mining capital expenditure (capex) has more than doubled over the past two years, from 3.1% of GDP in December 2010 to 6.5% currently. In addition to underpinning GDP growth, the boom in mining capex has also strongly supported Australian employment, with recent research from the Reserve Bank of Australia (RBA) showing mining-related activity (including activities associated with mining capex) accounting for around 6.5% of total jobs across the Australian economy. Earlier in April, we received further confirmation that the peak in mining investment is approaching, via the release of engineering construction data by the Australian Bureau of Statistics (ABS) for the December quarter of 2012. According to the ABS, total engineering construction recorded a -1.7% fall over the quarter, but was up by 18.6% over the year, driven entirely by the private sector. There are dark clouds developing on the horizon, however, with the pipeline of construction projects continuing to shrink. After peaking at $161 billion in September 2011, the pipeline of construction projects both commenced and yet to begin fell to $138 billion as at December 2012, consistent with the view that Australian mining investment will peak sometime over the next 6 months:

The prospects facing Australias key commodity exports iron ore (25% share), coal (15% share), and gas (6% share) - have also worsened. Chinas central government recently moved to tighten curbs on property lending, including implementing a 20% capital gains tax, and the central bank also tightening lending criteria, which has led to big cut-backs in property-related lending by Australias banks. The China International Capital Corporation (CICC) has forecast that Chinese property investment would lull later in the year on the tightening measures, which could significantly dampen imports of iron ore (Australias premier export), whose prices have already retraced significantly since the beginning of the year. Whether or not these measures have yet had an effect, Chinas first quarter growth figures missed market expectations by a wide margin. First quarter growth was 1.6%, annualised to 6.4% and looking dangerously like it might fall well below the 7% threshold so many optimists defend. It is no surprise then that Morgan Stanley made headlines with its reiterated call of a looming bear market in iron ore, which is heading toward its first surplus in at least a decade as output expands and Chinese steel mills, the biggest buyers, boost production at the slowest pace in five years: Seaborne supply will advance 9.1 percent and demand 8.3 percent in 2013, led by exporters from Perth-based Fortescue Metals Group Ltd. (FMG) to Vale SA (VALE5), Morgan Stanley forecasts. A surplus will emerge in 2014 and keep widening until at least 2018, the bank predicts. Prices will slump as much as 34 percent to $90 a ton by the end of December, according to the median of seven analyst estimates compiled by Bloomberg. Our own view is that the surplus will arrive earlier and will be larger than MS is forecasting:

Australias second biggest commodity export coal is also coming under increasing pressure. As noted in numerous MacroBusiness posts, coal-to-gas switching in the US following the shale gas boom is pushing large volumes of US thermal coal into the international seaborne market, just as Indonesian production also surges. It was revealed this week that Japanese utilities have forced thermal coal contract prices lower by 17% to $US95 a tonne. Such a price level could put at risk up to one-quarter of Australian coal mines. Finally, Australias liquefied natural gas (LNG) exports continue to come under increasing threat from the shale gas boom in the US, where there are currently 15 projects seeking approval to export US LNG to non-free trade agreement (FTA) countries, equivalent to around one-third of domestic US gas consumption, or roughly 30 billion cu ft of gas per day. Woodsides confirmation that it will shelve the $43 billion Browse project should be interpreted as a signal that no new large scale LNG projects will be approved in Australia for the foreseeable future. Housing is still poorly placed to fill the mining void The RBA is trying hard to engineer a transition away from a mining-led economy towards one based on increased housing-related investment. Since November 2011, it has cut -1.75% from the official cash rate (OCR), bringing it down to record low levels (3.0%) experienced only once before in the wake of the Global Financial Crisis (GFC). The sharp cuts in the OCR have seen mortgage rates fall significantly, with average discount variable mortgage rates (comprising the majority of mortgages) falling to just 5.7%, and average three-year fixed rates falling to only 5.5%. To date, the impact of the rate cuts on the housing market has been positive on prices, but muted in relation to actual housing-related activity. The Housing Industry Association (HIA) new home sales data for the month of February registered an overall -5.3% fall in new home sales over the month, with detached house sales falling by -4.0% and unit sales falling by -11.0%. It was a disappointing result that reversed some of the modest gains experienced over the prior four months and on a rolling annual basis, the

results were even worse, with overall new home sales recording the second lowest result in the series history. As shown below, the detached house segment is particularly weak, with all mainland states, except Western Australia, registering record low annual house sales in February:

Dwelling approvals data also suggests ongoing weakness in the housing sector, with overall approvals tracking just below their 30-year average level, but activity in the employment-intensive detached house segment at recessionary levels (see next chart).

The ongoing weakness in new home sales and approvals data comes despite new government subsidies provided in New South Wales, Queensland, and South Australia, as well as generous incentives on offer from developers of new house and land packages.

Although apartment construction is running at elevated levels, there are two reasons to discount this as sustainable. First, apartment investment remains driven by the bubble in Melbourne where rents and capital prices are already falling owing to existing glut. Another 25,000 apartments are set to hit the market in under construction developments. Second, standalone houses are far more labour intensive than apartments to build and both the RBA and Treasury are on the record aiming to stimulate this segment of the market for this very reason in an effort to soak up construction labour returning from the completed mining projects. So far, they have failed. Overall, the latest data confirms our view that the pick-up in housing construction will be insufficient to offset the loss of jobs and income that will be caused when the mining investment boom begins to unwind. Meanwhile, other domestic data remain mixed Residual economic data released over the past month has been mixed. On the positive side, retail sales data for February revealed strong growth, with sales jumping by a seasonally-adjusted 1.3% over the month, which followed Januarys 1.2% increase. The result took annual sales growth to 4.6% (3.4% trend), which is the strongest result since late2010 in trend terms (see next chart).

Sales growth was also broad-based by category and state. Clearly a post-Christmas bounce is in effect after three consecutive monthly declines were recorded in the lead-up to Christmas. The result also suggests that the recent interest rate cuts and house price rises are finally working to stimulate the retail sector. Having said that, Westpacs April consumer confidence survey retrenched -5.1% and is now virtually unchanged since the beginning of the interest rate cycle. The trend remains promising:

Recent partial data also suggests the employment market remains tepid. The ANZ job ads series resumed falls this month, down -1.5% after two months of stabilisation. This followed ABS job vacancies data for the February quarter, which fell by -6% to their lowest level in three years. The NAB Business Survey also showed ongoing weak employment intentions. The ABS Labour Force data for February has also begun to catch-up with these partial measures. In the year to February 2013, the official unemployment rate has increased by 0.4% to 5.6% - a result that would have been worse had the participation rate not fallen by -0.2% over thE period. Jobs growth has also been weak, rising by only 0.9% over the year, with no growth in the aggregate number of hours worked, reflecting the increasing trend towards part-time work:

Fiscally hawkish conservatives positioned to take power in September We do not generally cover politics in this update but there is a macro-economically important story developing. Owing to recent (and long term) bumbling by the incumbent Labor government, recent mainstream political polling about the upcoming Federal election is painting a clear picture that Australia will see a change of government in its September federal election in a landslide. The opposition conservatives who will take power have a long track record of fiscal hawkishness, owing to a combination of ideology and the success of their last stint in power in which they ran consistent surpluses of around 1% of GDP. All senior figures in the conservatives have maintained a strong argument that Labor wasted money in its GFC stimulus program and that it was too slow to return the budget to surplus. Recent statements by the shadow Finance Minister have suggested the Coalition might return the budget to structural surplus (that is, match spending to an assumption of revenues based upon below current market commodity prices). This would mean cutting government spending by some 1-1.5% of GDP. While this is no doubt pre-election bluster in some measure, the conservatives have painted themselves very much into a corner vis--vis the budget and will be compelled to run materially tighter fiscal policy than Labor even if not so severe as a structural surplus. This risks pro-cyclical fiscal settings as mining investment and commodity prices fall. Conclusion Overall, recent dataflow suggests that the risk of a material Australian adjustment to both employment and incomes remains real as the year deepens. The big risk is that a fall in commodity prices later in the year occurs simultaneously with the peak and long correction in mining investment. To date, housing construction has responded very modestly to RBA stimulus and is not well placed to fill the resulting gap in private investment. And with a fiscally hawkish conservative government assured of power in the September election, public investment will also be tightened from already restrictive settings. At this stage we see the likelihood of further interest rate cuts later this year and again next year. To the extent that this holds the Australian dollar in check, it will aid the levitation of the share market (although it already appears fully valued) and there is a distinct possibility of a mid-year correction as global growth repeats its winter swoon. We do not expect the dollar to fall materially until the cash rate drops to 2.5%. For the time being, property prices can continue to rise on the chase for yield by investors, but we expect appreciation to slow as economic pressure grows through the second half.

2. READERSHIP STATS
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