How to profit as Australia's economy runs out of luck

Unless you've been living under a rock, you'll know that China has been having a few problems recently.

Slowdown, hard landing or crash – we don't know yet, but the point is China has been slowing for a while. And it will keep growing more slowly in the future – that's an inevitable result of its desire to move to a more consumer-led economy.

This, of course, is having an impact on China. But it might be an even bigger problem for any economy whose business model is based on selling stuff to China.

There's one developed economy that's so dependent on China that it's been jokingly referred to as an overseas Chinese province.

I am, of course, talking about Australia.

The lucky country runs out of luck

Australia is sometimes described as the 'lucky' country. The nickname fitted it well during the '00s.

Australia has vast amounts of commodities. So China's desire for raw materials served it well. Meanwhile, rising wages along with soaring credit growth fuelled a massive housing boom. Australia even escaped recession during the worst of the financial crisis, one of the very few global economies to do so.

But now, its luck has run out. Miners are getting clobbered as the Chinese boom turns to bust.

Take iron ore, Australia's largest export. The price fell by more than a third over the past year. It's now at its lowest levels since 2009. Coal prices have dropped by a similar amount.

As a result, miners are cutting back on both output and investment. In fact, spending by miners is down 37% on this time last year, and dropped by a full 15% in the three months to June alone. Nearly 40,000 jobs have been lost in the last three years, and 80% of mining companies plan more layoffs in the coming year.

And if mines aren't closing, they're being sold off. Vale and Sumitomo recently sold a mining project in Queensland that had once been valued at $629m to Stanmore Coal for just $1.

The end of the housing market bubble

This is all having a knock-on effect, of course. The Australian dollar has collapsed. At its peak, an Aussie dollar would have bought you US $1.10. Now it's only going to fetch you about US $0.70.

Then there's the legendary housing market bubble. Australia is one of those few markets – like Canada – that just kept going up, even through the financial crisis. Sydney and Melbourne – both charming cities, of course – regularly pop up in lists of the world's highest property prices.

Those who like to clutch at straws to justify property valuations argue that properties in Sydney tend to be a bit bigger than their global peers. But even if you take this into account, Sydney prices are still on a par with Geneva and Singapore.

That's hard to accept. Australia is one of the least densely populated places on the planet. Space is not an issue. And while there is some foreign investment, mostly from China, even Sydney isn't as attractive to the average oligarch as a genuinely global city like Paris or Los Angeles, both of which are cheaper on a per square metre basis.

The reality is that – like all other housing bubbles – it's been driven by the availability of easy credit. Australian household debt now stands at a total of more than A$1.9trn.

But with the economy turning down, banks are closing the credit taps, fearful they've already lent too much. As a result, house prices are starting to fall. LF Economics expects a "bloodbath" in the housing market.

The commodity collapse and the bursting of the housing bubble point to one thing: recession. In fact, investment bank UBS now thinks the fall in commodity exports, and falling wages and profits mean that Australia is probably already in recession.

The government has been hoping to save the economy by boosting gas exports. Liquefied natural gas terminals will allow Australia's natural gas to be sold across the globe. Trouble is, if energy prices remain low this may not be economically viable.

How to play the downturn in the Australian economy

Some time ago, when the Aussie dollar was near its peak, we suggested shorting it against the US dollar. But how can you profit from the downturn now?

You could stick with shorting the Aussie. The Australian central bank is probably going to cut rates further, while the US is (maybe) thinking about raising rates. However, bear in mind that it's already fallen a lot. And playing the currency market is risky at the best of times, never mind some of the wild moves we've seen in the past week.

An alternative – more long-term – option, would be to pick up a cheap mining stock. One with deep enough pockets to pick up all the mines that are currently going cheap. BHP Billiton (LSE: BLT) isn't a pure play on the Australian mining industry, but a large proportion of its revenue comes from Australia, so it should benefit from any drop in the Aussie (labour costs will go down, while the resources it sells are still priced in US dollars).

BHP currently has a very attractive yield of 7.5% and trades at 12.3 times 2017 earnings. It has adopted an aggressive cost-cutting programme that should help the bottom line and preserve cash.

Our commodities specialist Alex Williams wrote about some of his favourite mining stocks in a recent issue of MoneyWeek magazine. If you're not already a subscriber, sign up now.

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