Research: NZ will benefit from rising commodity prices

• Oil prices have risen, helping Fletcher Energy
• Forestry log prices have also recovered somewhat helping Carter Holt and Fletcher Forests. US dollar log prices in the Korean market for instance are up 16 per cent since September (although they are still down 13 per cent on a year ago).
• However, it is not clear that the majority of NZ commodity prices are improving.
• International agricultural price indices are still falling in US dollar terms. The Goldman Sachs USD Agricultural Price Index is down 20 per cent on a year ago.
• The ANZ commodity price index in February fell by 1.3 per cent in world prices, and is still 6.6per cent down on February last year.

Looking at a range of recent commodity prices we see:

• NBSK USD pulp prices have not changed in the past three months, and are down 14 per cent on a year ago. These will rise in the June quarter due to low producer stocks.
• UK Lamb prices are slightly up in early April, but have remained essentially unchanged for five months, and are still down on the same time last year. Part of the price rise in recent months is lower New Zealand supply due to drought.
• US manufacturing beef prices are up about 12 per cent in the past four months driven by stronger US fast food demand and weaker supply.
• New Zealand dollar butter prices are down 7 per cent on three months ago, and are only marginally up on the 1998/99 low.

The New Zealand economy is still basically a commodity exporter. It is worth listing the key revenue generators (excluding tourism). About two-thirds of New Zealand's goods exports are primary commodities with another 15 per cent basic manufacturing commodities. If an investor wants a fairly pure commodity play, New Zealand fits that bill, but note that rather eclectic list of commodities. The outlook for many of New Zealand's big revenue generators is more in the hands of the US and European legislators than in the markets. We are also a pretty big player in some of these markets.

The New Zealand dollar is rising - up around 10 per cent from its low in August 1998. The NZ dollar is seen as a commodity play. Movements, or perceptions of movements, in commodity prices can therefore drive the NZ dollar. While the reality is that New Zealand commodity prices on average are falling, the perception is that they are set to increase. This is pushing up the NZ dollar.
Using commodity prices to work out currencies seems a little technical. The reason it probably works for the New Zealand dollar is that commodity price movements are a key driver of New Zealand's net trade income, and hence our current account and economy.
Will New Zealand's commodity prices improve? My rule of thumb is that I want to see two of the three big players (US, Japan and Euroland) doing well for commodity prices to improve strongly. While the consensus view on Asia is brightening, I am not convinced. This region has deep-seated structural problems the will take time to address.
Even though we are seeing an improved outlook for global industrial production, the world economy will still be pretty weak next year. For instance growth weighted by New Zealand's export markets will rise from 0.7 per cent in calendar 1998 to 1.5 per cent in calendar 1999. This is still considerably below the growth seen in the mid-90s.
Our story therefore remains the same. Until the New Zealand current account significantly improves we see the NZ dollar under pressure, with the possibility it can test US$0.50 this year. The current account deficit should improve significantly next year.
However, in the short term New Zealand will publish some large current account deficits. Each of these will be a test for the New Zealand dollar. At the same time the Australian dollar will also face a trial by ordeal as the Australian current account deficit moves back towards the banana republic levels.
For the moment the commodity price story is dominant. While the commodities are the latest hot thing the New Zealand dollar is likely to continue to appreciate.
If the anticipated commodity price recovery occurs relatively soon, it will have significant implications for the New Zealand and global outlook.

• New Zealand exports will be much stronger than expected
• The New Zealand economy will grow faster than forecast
• The current account deficit will improve quickly
• The New Zealand dollar will appreciate.
• Inflation will re-emerge as a threat. Commodity price deflation has been a significant part of New Zealand's surprisingly low inflation outcomes (as with most countries). To take that out and add a stronger economy and inflation can easily start to move towards the top of the target band.

Such an outcome will push the New Zealand recovery profile more towards those seen in 1977, 1983 and 1991. Comparing the current recovery with past recoveries is not accurate as it is unusual for New Zealand to recover in the face of falling commodity prices.
What does this mean for New Zealand stocks? The pure commodity plays on the New Zealand market will win further in this environment. The forestry/energy stocks will benefit. Remember Carter Holt, Fletcher Energy, Fletcher Forests and Fletcher Paper make up 22 per cent of the NZSE40 in September 1997, but got down to 12 per cent in early April. Companies servicing these commodity companies (for instance ports) will also benefit.
More widely, a stronger New Zealand economy will help most companies. However, rising interest rates means selectivity will be required. This would take us back to the domestic franchises, Telecom, Warehouse, Progressive Enterprises and SKC.

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