Your money - Market snapshot

Over the past six months a shadow has been placed over the future profitability of the mining sector. The initial announcement of a mining tax and the subsequent uncertainty around its implementation could have been expected to significantly dampen investor enthusiasm for the shares of mining companies.

However, in the six months to the end of August, there has been no net change in the average share price level in the mining sector.

Resource stocks have actually out-performed the overall Australian share market, which has fallen by 3 per cent over this six month period.

Despite the mining tax uncertainties and the somewhat fragile position of the global economy, investors are gradually coming to the realisation that something big is going on in the Australian mining sector.

Large liquefied natural gas projects, such as Gorgon and Pluto, headline a massive expansion planned in productive capacity.

Official data is now starting to the show the expected magnitude of this growth. The Australian Bureau of Statistic's Capital Expenditure Survey suggests that investment spending in the mining industry will grow from $35 billion in the 2010 financial year to $55 billion in 2011. This level of investment is more than five times the level that was taking place as recently as 2005.

Mining sector investment involves the development of new mines and supporting infrastructure to service the mining industry.

This growth in investment spending is coming at an opportune time for the Australian economy. Projects associated with the government's economic stimulus program are now gradually being completed so the pick-up in mining sector investment activity will reduce the risk that the withdrawal of Government stimulus will leave a growth and employment hole.

According to the Reserve Bank's May 2010 Statement on Monetary Policy, mining investment is "at historically high levels" and well above the peaks of previous mining booms in the early 1980s and the late 1960s and early 1970s.

It is estimated that exports from the Gorgon and Pluto projects alone will add 1 per cent to the size of the Australian economy.

Hence the next mining boom has positive implications for economic growth, exports, foreign debt reduction and employment. It will, however, leave the Australian economy more dependent than ever on the mining sector.

IMPLICATIONS FOR INVESTORS

The magnitude of expected growth in the mining sector output creates opportunities for a considerable rise in earnings of not only mining companies, but a myriad of mining support and service industries.

While the profitability of companies involved in mining activity will ultimately be heavily influenced by commodity prices, other companies supporting the industry will benefit directly from the expansion in mining infrastructure - regardless of the ultimate profitability of those mining ventures. Identifying and investing in companies that will receive most benefit from this mining boom is not easy and may be a job best left to fund managers who have the research resources to assess these specialised opportunities.

As with any boom, while there are undoubtedly opportunities there are also risks. The mining industry has a history of over investing in capacity in good times only to create excess supply and price weakness when demand weakens.

A POLICY CHALLENGE

There is the potential that labour shortages in certain industries will contribute to inflationary pressures in the economy.

There is also a danger that the significant growth in exports resulting from the mining industry expansion will push the value of the Australian dollar higher, making it difficult for non-mining industries to compete.

Using policy to manage the inflation and exchange rate risks of the mining boom may prove challenging for authorities. While higher interest rates may be effective at neutralising any inflationary impact, they would only magnify any upward pressure on the $A that may result from the mining boom.

More industry specific measures may be required. Hence, while the mining tax is initially being seen as a mechanism to restore balance to government finances, its relevance may grow to increasingly being used as a tool for industry and economic policy management.

Market snapshot

AUSTRALIAN EQUITIES: OVERWEIGHT

The growth outlook for the Australian economy remains solid with strong exports and significant mining sector investment activity likely to be strong catalysts for growth over the next year. Manageable inflation, low unemployment and some reduction in household and government debt make this pattern of growth sustainable over the long term. Share market valuations and earnings forecasts are not excessive given this favourable economic backdrop.

INTERNATIONAL EQUITIES: NEUTRAL

While there remains some prospect that share market values will adjust upwards from current cheap valuations, ongoing uncertainty over the impact of high government debt is likely to cut-short any rally. Risks to the sustainability of the global economic recovery are greater than the risks ahead of the Australian economy.

PROPERTY: UNDERWEIGHT

Prospective returns from global property securities appear less attractive on a valuation basis than global equities, with much of the risk premium being eroded by price rallies over the past year. Australian listed property looks more solid on a valuation basis.

FIXED INTEREST: UNDERWEIGHT

The fall in government bond yields over August has pushed values further below long-term fair value. Current yields provide no compensation for medium term inflation risks. Opportunities remain in credit, which appears superior to sovereign debt on a risk adjusted basis.

ALTERNATIVES: NEUTRAL

Given the fine balance between inflationary and deflationary forces, a neutral exposure to inflation sensitive assets is warranted. With ongoing disparity in valuations, higher than normal returns may be available.

AUSTRALIAN CASH: OVERWEIGHT

Recent interest rate fluctuations and a likelihood higher overnight cash interest rates this year have increased the relative attractiveness of cash and other short dated investments.