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Week Commencing June 9, 2014

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This week we look at the following topics:* Why Draghi’s move might be dangerousWe predicted the move, now we think the desperation should be cautioned.* RBA still unsure about economic paceNothing really new this month, becoming a bit of a trend for the RBA.* Energy stocks in play as M&A heats upWe continue to look for anecdotes indicating higher energy markets coming.* Small cap corner – AppLabs looking interestingSomething different this week, a small exposure on the market with a difference.

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Why Draghi’s move might be dangerous

The fact that the European Central Bank (ECB) has now moved to further ease its monetary stance

comes at no real surprise. You are not going to make money in markets by responding to what central banks have done. You are going to make money instead by looking forward. Invast Insights is about positioning you for future trading ideas. We are focused on future opportunities, not about past movements. In terms of the Euro, we have been writing and expressing our view that the ECB must act over the past few months.

Since the beginning of April, readers of this report have heard our reasons for why Draghi needed to act – the first was to restore credibility as a central bank must with the market after months of talking the talk and the second was pressure from the corporate lobby which has seen its earnings erode as the Euro rallied against the US dollar. If you weren’t taken out by a tight stop loss, the trade since our initial call to short the Euro would now be in profit by around 300 pips.

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So what now? The major global central banks are now in a deep currency war, nobody wants to be caught behind. There is no short-term incentive to be prudent and it now feels as though all central banks are in a race to the bottom.

The Euro hit our target against the US dollar, perhaps even exceeding our wildest forecast as the EURUSD flirted with 1.35 before bouncing back strongly and closing in the mid 1.36 range where we think it will now sit and consolidate for a while. Our focus is now not on what the ECB will do but what this all means! The method of Draghi’s easing policy, the tone and the overall impression to us suggests a large layer of desperation. We think that the Draghi move to push the Euro lower and flood the system with cash is dangerous and these dangers are what every single trader out there now needs to keep in mind.

In the short term there will be a honeymoon. We have already seen the DAX break though the 10,000 barrier following the news. German multinational companies can now basically binge on money, which is free when adjusting for inflation. The banks are pressured to lend, if they hold cash they will be penalized. Corporate CEOS and executive are the biggest winners, for the time being. Some of you who read this report might be somewhat surprised by our tone, have we become bearish? Possibly, read on below if you have an interest in what has changed our mind.

We think this ECB move is the roll of the last dice. There won’t be any second chances following Draghi’s June action. There is a growing sense of fear among many in the market that the fragile structure of Europe and the inability of governments to reduce unemployment towards levels seen in the UK and USA might lead to an all-out flight away from the Euro as a currency and the flow on effects of rising government bond yields. If there is anything that keeps us up at night it is the prospect of European sovereign debt issues returning to the market again. This time the impact will be worse because the ECB’s debt burden and the member state’s balance sheets have been put to use several times in order to get to where we are.

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The fragility of the whole situation reminds us of Nassim Taleb’s book The Black Swan which we have previously written about. Its worthwhile reading again, even if you have already read it several times, like us. The whole situation around Europe and Japan is starting to feel like desperation. The central

banks have created a situation, which is extremely fragile to shocks. We don’t know where these shocks will come from – Black Swans in their very nature are unpredictable – but the sense of desperation from Draghi and the BOJ cannot be ignored. We think the US Fed is in a more comfortable relative position but the US economy is not immune from the shocks that might come from the ECB and BOJ fallout. The next major financial crisis could start out in Europe and Asia and work its way back to the United States, which will be ironic given the way the last crisis flowed the other way.

It’s always difficult to be a bear when markets are rallying. Being a bear is not about being a hero, you cannot fight the market when global stocks are rising and interest rates are near zero. Being a bear is about being patient, about being prudent and about preserving your capital. It is about being able to withstand pressure out there from people telling you that you need to be in the market and that not taking part will see you miss out.

Every single billionaire investor has made their money by being contrarians, by doing the opposite of what the market was thinking. The trend might be your friend BUT your you want to make sure your friend sticks around when times get tough. You don’t want to make friends that are with you when times are good and then disappear when something goes wrong. In the business of trading and investing, there are no friends. Your best friend is your mind, your way of thinking – something we spoke about last week.

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In summary, we feel very uncomfortable with the way that the ECB has had to act. We don’t like the sense of desperation and we see huge fragility in the whole system. We are looking for huge wealth generation opportunities – we want to bet pennies to make dollars and not bet our hard earned dollars to make pennies, or in the case of the ECB – hard earned dollars being lent out now at zero interest rates. The word bet is probably not the right word, we are investors and traders and what we look for is risk to reward.

We are not shooting blindly here, what we are doing is looking at the huge risk the ECB and BOJ are creating and not seeing much reward on the way up. In the next few weeks, we will start to release our forecasts for the new financial year – at this stage we continue to think the VIX index is the best way to be positioned for possible fallout from the ECB and BOJ and we will maintain our negative view on the Euro. The ECB has moved, we have adjusted our way of thinking and we want you to be prepared for our trading calls when they are published. Stay tuned; he market is about to get very exciting in the not too distant future.

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RBA still unsure about economic pace

There was nothing really new from the RBA in its monthly statement. We don’t see much value in copying and pasting certain parts, by now if you are trading the markets you would have probably already figured out what the RBA is trying to achieve – a balancing out of the economy. We think interest rates are on holding until there is a blow out of inflation.

That is the only real consideration that will see the RBA move. The RBA is on hold for as long as the rate of inflation remains within the target band range of 2-3%. The GDP numbers show that the rise in mining and energy volumes – a function of the mining and investment boom, which is now coming to an end – has so far offset the falls in pricing. But this is likely to reverse in the coming quarters.

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We still think that the AUDUSD is heading down towards the 0.9000 range where it will probably struggle to hold ground. Like many other global central banks, the RBA knows very well the cost of a high currency. The non-mining part of the economy continues to post below average economic data like consumer confidence, which printed below expectations last week. We’ll go through our complete view on why the AUDUSD is heading lower in the new financial year in a webinar to be hosted by Peter Esho on 24 June 2014.

If you haven’t already registered, this is another reminder to get onboard. Peter will run through the fundamental drivers behind the terms of trade and wealth impacts on the Australian economy. He will discuss the financial impact of lower iron ore prices in recent months and the flow on effect this will have on the RBA and AUD when the data starts working its way through official economic numbers. Click here to register for the webinar.

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Energy stocks in play as M&A heats up

We have been writing about the potential for oil prices to break out to the upside over the past few weeks. We have made clear our bullish position on energy markets and the looming geopolitical movements, which constrain oil supply. The greatest risk to our bullish oil thesis is a large slowdown in the global economy. This is always a possibility, but we feel that even if the consumption side of the equation is to fall or moderate, in a worst case scenario, the supply side is looking very fragile.

One of the things that caught our eye this week was a deal by Australian listed energy giant Origin Energy. The deal sees Origin Energy join PetroChina in one of the most attractive global energy regions. The price tag caught our eye. Let’s explain further.

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Under the deal, Origin has acquired a 40% interest from Karoon Gas in Australia for access to natural gas prospects offshore in northwestern Australia. This is in the same backyard of Woodside Petroleum, which for us is the premier oil and gas exposure in the whole Asia Pacific region. Woodside is a key holding in our wealth preservation portfolio.

The deal includes an upfront payment to Karoon of US$600m and additional payments, which are based on development success. Origin clearly sees the importance of diversifying into the northwest region, outside of its traditional key stronghold in eastern Australia. Natural gas prices have already started to skyrocket and they need to continue growing, if businesses like Origin, are to make any reasonable investment returns from deals like this. Keep in mind Origin is not acquiring a production assets, instead merely a prospect with the potential to be a key gas hub!

The deal underscores our thinking that the energy industry insiders know that prices are heading higher and key assumptions around supply from OPEC etc. are probably incorrect. Origin has been a prudent investor, it is not known for throwing money at deals without doing its homework. The price tag to us suggests natural gas prices are going up. They have traditionally been closely correlated to oil prices, although not exactly in the same proportion. If Origin thinks it can make a return on an US$800m deal for a share in a prospect, then other energy companies around the world will start to re-evaluate other assumptions.

There is a common connection in the deal for Origin. ConocoPhillips is the project operator in the new deal, a partner with Origin in its other liquefied natural gas projects. We will continue to spell out more reasons around our bullish energy thesis in coming weeks as promised last week. For the time being, we continue to watch the Brent crude price very closely and would be inclined to start accumulating again if we are afforded the opportunity of some short term price weakening.

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Small cap corner – AppLabs looks interesting

We’ve spent a fair bit of time talking about the big picture this week. We also constantly screen for smaller company ideas for Invast clients to trade shares through our online trading platform. A business which caught our eye this week was AppLabs, stock code ALA.

Applabs Technologies Ltd is the first ASX-listed app development company and app venture fund with the unique ability to offer app development, app financing and a full range of services to clients of all descriptions. Its focus is on taking mobile and web projects efficiently from A-to-Z and has a specialist team of creative professionals who can fulfil those requirements.

Experienced UX/UI and visual designers; experts in marketing, launch, and innovation strategies; investment advisors; and world-class programmers; provide customers with a service that’s second to none. Whether an app is a promotion, a business tool, a game, a solution or a revenue-generator, its customers are only limited by their imagination.

The business is very small and probably not right for every investor. Market capilisation is tiny at less than $10m as of the last calculation. The reason why we like the stock is because of its unique product offering on the Australian market which tends to be very over represented by mining and energy prospects. We are finally starting to see a larger presence in tech names, albeit from a very small basis. We haven’t seen any real tech exposure on the Australian market emerge since the tech boom more than ten years ago now. That didn’t end too well so many investors are still very wary – and so they should be.

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AppLabs isn’t likely to evolve into the next Google or Apple. But it should be on your watch list because of its ability to hit a winner. We stress the fact that this is only a remote chance but the payoff can be large. We all know the silly valuations certain tech businesses can attract when the market is hot and at the moment, there is a growing appetite for tech winners. Take Seek.com for example, stock code SEK, a company which is trading at a price to earnings multiple of 26x and one which has returned to shareholders are 45% per annum for the past 10 years. Yes that’s right, read that sentence over a few times to completely take in the vast shareholder returns. We haven’t misprinted it!

AppLabs has two potential apps in development, which we think look interesting – Property Toolbox and Snappy Recruit. They are in the employment and real estate, coincidently the same space that Seek.com and Realestate.com trade in. The latter are multi billion dollar companies. We don’t think either of these two apps developed by AppLabs will ever reach those types of valuations, BUT, there is always the potential to surprise. The business provides a breath of fresh air on the Australian market and we wouldn’t be endorsing it at the moment, just pointing it out for your watch list. Keep an eye on this one!

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