Weekly Market Update

Robert Davies, Patersons Securities

Follow me on Twitter @davies_robert

3/09/2012 11:54:16 AM Page 1 of 4

Weekly Overview
Week ending 31 August 2012

End 2011
All Ords Index S&P 500 Shanghai RBA Cash Rate US Treasury Bond (10yr) Spot Gold Price Copper, spot Oil WTI Oil/Gold Ratio USD Index AUDUSD EURUSD USDCNY 4,111 1,258 2,199 4.25% 1.88% 1,563 344 99 6.3% 80.23 1.022 1.294 6.299

31 Aug 2012
4,339 1,406 2,047 3.50% 1.55% 1,691 346 96 5.7% 81.22 1.032 1.257 6.350

Chg (week)
-0.8% -0.4% -2.2% 0.0% -8.1% 1.3% -0.8% 0.3% -0.9% -0.5% -0.8% 0.6% -0.1%

Chg (ytd)
5.5% 11.8% -6.9% -17.6% -17.4% 8.2% 0.6% -2.4% -9.8% 1.2% 1.0% -2.9% 0.8%
Peaked at 4400 again Rally has been on low volume (weak) Not a good signal for Chinese economy

Rally in equties not confirmed by bonds Breakout from 12 month consolidation Consolidating

Steady, despite QE, but watch Gold High dollar hurting Australian industry Despite problems, currency doing OK Weak Renmimbi, Fed not happy

Chinese PMI came in at 49.2 over the weekend, signalling contraction in manufacturing (under 50). This confirms a string of other data and anecdotal information that the Chinese economy is substantially weakening. Now the catalyst for this may be largely a result of the political uncertainty going into the power changeover at the Politburo in October. While its known who will be chosen at the highest level, its largely unknown who acquires the next 2-4 levels of power. Therefore, without this political certainty, projects are not commenced, some projects are halted, business doesnt make decisions until they know where they stand in the power heirarchy. The price of Iron Ore has collapsed due to lack of demand from China (as projects are cancelled). Thirty percent of world production comes in at over $100/ ton and most of that is from China. With the price now $90/ton most of the Chinese production is sub-economic. However as it is 50% state owned, its likely they will keep producing. For the Aussie producers, Rio holds the lowest costs (under $50/ton) and will be the last man standing if the price drops from here. The Aussie producers will survive this price collapse, but the long term price is likely to now stay between $80-$100, squeezing margins and making growth and investment strategies unrealistic. Im hoping to see a bottoming out of this market in September. More on this thematic below. Ben Bernanke gave his much anticipated speech at the Central Bankers conference in Jackson Hole on Friday. He basically rehashed the history of cerntral bank interventions over the post 2008 period without commiting himself to more Quantitative Easing (also not saying he wouldnt do it). So the market is basically left to wander without direction, until the election in November. Gold spiked up following the speech and has now broken out of the 12m consolidation zone. The Republican National Convention in Tampa, Florida came to an end. Obama still appears to have a slight lead in the polls with the Democratic convention coming up where they will have a turn at picking apart their opponents (as the Republicans just did). One of the interesting platform positions the Republicans took was the establishment of a Gold Commission to look into returning the US monetary system to a hard currency or sound money basis. When they look at the numbers Im sure if will scare them off, the US Gold reserves vs M1 money supply would be well over $5000 per oz, a level which no politician would want to deliver the bad news to holders of US Dollars, although the Gold bugs would be very happy. Europe is inching towards its next catalyst, the German constitutional court ruling (12 September) on the validity of German participation in the Eurozone bailouts and bank restructurings. Bond yields and Credit Default swaps are in a holding pattern at the moment. I cant see anything happending before the 12 of September in Europe. I expect the plans to go forward. Im hearing the Italians have already threatened to exit the Euro and devalue the Lira if they dont get debt relief. This would cause a significant problem for German industry (more competitition) and a nasty outcome for European solidarity.

Weekly Market Update

Robert Davies, Patersons Securities
Follow me on Twitter @davies_robert

3/09/2012 11:54:16 AM Page 2 of 4

France nationalised its second largest home lender over the weekend, Credit Immobilier, as the European banking system continues its problems. While I believe the Euro will survive the current problems in Europe, the banks, stuck with billions of government bonds, are another story. Angela Merkel was in China this week sealing a deal for the German and Chinese financial systems to work directly without utilising the US Dollar in trade transactions. This is another nail in the coffin for the US Dollar as worlds reserve currency. We now have most of Asia, Germany, Japan, Brazil, and many other countries well on their way to fortifying alternative arrangements without the US$.

Economy
From Markit Economics US Factory orders for July rise 2.8% Chicago area PMI at 53.2, growing Japan Manufacturing PMI down to 16-month low in August, at 47.7 German Unemployment steady at 6.8% US second quarter economic growth revised higher to 1.7% from 1.5% US PMI came in at 51.9 continuing to show weak expansion of the US economy. From Dow Jones China Non-Mfg PMI at 56.3 vs 55.6 in July. Non mfg economy growing, mfg slowing Japanese July industrial output down -1.2% on prior month Korean Industrial Output -1.6% on prior month, July industrial output +0.3% on year Other US Case Shiller house price index prints with a annual gain of 0.5%, the first monthly yearon-year gain in two years Spanish GDP falls 0.4% in Quarter 2 from the previous quarter. (Sky news) US Weekly jobless claims rise to 372,000 (reuters). Stagnant labor market

All Ords Charting

Last week I wrote We pushed up to the 4400 level and failed (once again) to push through. Valuations in some sectors are now stretched (banks) while resource stocks are under pressure due to economic stagnation around the world. The catalyst to push through 4400 would be a favourable ruling from the German Constitutional Court on 12 September in support of the bailout bonanza. A negative ruling would see a selloff from here. Expect a ranging market until the ruling. Resources stocks continue to get belted by the collapsing Iron Ore price while banks are drifting lower. Weve now fallen well off the 4400 resistance level and look to be going lower this week as the bad news about the Australian economy persists.

Weekly Market Update

Robert Davies, Patersons Securities
Follow me on Twitter @davies_robert

3/09/2012 11:54:16 AM Page 3 of 4

Weekly Stockwatch
As noted above and in previous newsletters, the Iron Ore price has collapsed below the $100 mark which had been seen as the floor price due to 30% of world production which has a higher costs base. The below chart (from Atlas Iron) shows the iron ore cost curve. Rio Tinto occupies the large green area at the left side of the curve. The Chinese and Indian producers are to the right.

Here is the Iron Ore price chart, which now has the spot price at $90

So is it time to buy yet? Considering the collapse in commodity prices and the high Australian dollar, positions in iron ore stocks can now be considered. However, in the short term, its likely stocks go lower. Heres the 5 year chart of Rio Tinto below. Long term investors should be getting ready.

Weekly Market Update

Robert Davies, Patersons Securities
Follow me on Twitter @davies_robert

3/09/2012 11:54:16 AM Page 4 of 4

Chart of the Week AUSTRALIAN DOLLAR LOOKS OVERVALUED

The Australian dollar continues to look overvalued against the US dollar held in place by foreign fund inflow chasing higher yields in our Bond and other markets. Foreign ownership of Australian Government Bonds is approximately 79%. Generally, the Australian dollar has a reasonable correlation with the Industrial metals market (the chart below shows this - Industrial Metals against the A$). With coal and iron ore prices under pressure, and Residential construction off 1.9% in the June QTR back to 2002 levels, high household debt and housing prices, generally trending lower, scope exists for the Australian dollar to trade lower as the RBA is pressured to move rates down from 3.5% into 2013. Likewise the All Ordinaries (XAO) is up against the ten times tested 4400 level, while global financial risks remain considerable. I see scope for stimulatory expectations from foreign central banks to disappoint. Ways to partially cover Australian exposure and global debt risk include an allocation to Gold Bullion through either a purchase of phyiscal bullion or through and Exchange trades fund. The ETFs: GOLD.ASX, PMGOLD.AXW, ETPMAG.AXW, and USD.AXW.