2023 UNIT Finance Guide

UNIT 2023 FINANCE GUIDE

MENT

EDITOR IN CHIEF:

Anthea Trang

EXECUTIVE CONTENT

EDITORS:

Amante Abela

Mingxi Shen

EXECUTIVE DESIGN

EDITORS:

Alec Lu

Alice Guan

Tiffany Tang

DESIGNERS:

Grace Lee

Alysha Airey

Sarah Chan

AUTHORS:

Will Tsui

Laryssa Latt

Yash Samant

Rohan Wahan

Belinda Chien

Belinda Chien

Maya Guden

Laryssa Latt

Grace Lee

Jacob Magallanes

James Hui

Sarah Chan

Alysha Airey

UNIT CHAPTERS: ACKNOWLEDGE

DISCLAIMER

1 The information in this free guide is provided for the purpose of education and intended to be of a factual and objective nature only The University Network for Investing and Trading (“UNIT”) makes no recommendations or opinions about any particular financial product or class thereof

2 UNIT has monitored the quality of the information provided in this guide However UNIT does not make any representations or warranty about the accuracy, reliability, currency or completeness of any material contained in this guide

3 Whilst UNIT has made the effort to ensure the information in this guide was accurate and up-to-date at the time of the publication of this guide, you should exercise your own independent skill, judgement and research before relying on it This guide is not a substitute for independent professional advice and you should obtain any appropriate professional advice relevant to your particular circumstances

4 References to other organisations are provided for your convenience UNIT makes no endorsements of those organisations or any other associated organisation product or service

5 In some cases, the information in this guide may incorporate or summarise views, standards or recommendations of third parties or comprise material contributed by third parties (“third party material”) Such third party material is assembled in good faith, but does not necessarily reflect the views of UNIT, or indicate a commitment to a particular course of action UNIT makes no representations or warranties about the accuracy, reliability, currency or completeness of any third party material

6 UNIT takes no responsibility for any loss resulting from any action taken or reliance made by you on any information in this guide (including without limitation third party material)

EQUITIES

1

Equities (commonly known as shares or stocks) refer to an ownership interest in a particular company. This chapter will provide an overview of the different ways of thinking about equities, as well as the current trends within various markets.

COMMON VERSUS PREFERRED

Common shares represent partial ownership of a company and provide shareholders with the right to vote on major company decisions. Common shareholders may also receive dividends, however, this is dependent on company performance and managerial discretion. While preferred shares do not have voting rights, they have a set dividend payment on a regular schedule and higher priority in the event of liquidation.

GROWTH VERSUS VALUE

Growth or value stocks are distinct categories of shares used to build equity portfolios. Typically, growth stocks are characterised by above market revenue growth, and tend to perform well in low interest rate environments. On the other hand, value stocks generally pay a dividend and are believed to trade cheap relative to their fundamentals.

CYCLICAL VERSUS

Cyclical shares are shares in companies rising when it expands and falling typically industries dependent on discretionary spending such as car manufacturers, airlines and hotels.

underlying business is not disrupted provide necessities such as consumer outperform during a recession, cyclical shares tend to do better during an economic expansion.

ETFS, MUTUAL FUNDS AND INDEX FUNDS

Exchange-traded funds (ETFs), mutual funds and index funds are investment vehicles commonly used for creating a diversified portfolio.

Mutual funds pool assets from shareholders and invest it in securities such as stocks, bonds or other securities. Investors purchase shares in mutual funds, where each share represents their ownership in the income generated by the fund.

ETFs are a type of pooled investment security, but are different from mutual funds because they are traded on stock exchanges similar to individual stocks. They track the performance of an index, sector, commodity or asset, with their price fluctuating throughout the day unlike mutual funds.

An index fund is a type of mutual fund or ETF that tracks the returns of a market index, for example the S&P 500. Index funds offer low operating expenses, low portfolio turnover and broad market exposure at low costs by tracking specific market indices.

AUSTRALIA

An uncertain global macroeconomic outlook, rapid tightening cycle, supply chain constraints and labour shortages have driven down Australian equity markets this year, with the All Ordinaries Index and S&P/ASX 200 down by around 1.15% by the end of June.

The RBA has continued to hike up the cash rate to 4.1% as of 5 July, the highest level in 11 years. Nevertheless, the relative strength of the Australian economy and low unemployment will enable the Reserve Bank to keep interest rates higher for longer. Notably, CBA predicts interest rate hikes to 4.35% in the second half of 2023, with ANZ predicting hikes reaching 4.6%.

However, as the tightening cycle approaches a possible pause, investors have gradually returned to equity markets. CommSec predicts that the Australian equities market will rebound by 4-7% over the next financial year, depending on the level of interest rates and inflation at the time.

ASIA

While facing similar circumstances from the unfavourable global macroeconomic conditions and global economy, Asia is expected to rebound and outperform global markets. Despite the downturn in the global economy, the MSCI International All Country Asia Pacific index has been up 4.71% year to date. Owing to their lengthy resurgence following the pandemic, the direction and pace of Asian markets has been out of sync with the rest of the global economy.

China’s gradual re-opening followed by the return of the tourism sector will mean steady growth in business activities and economic performance over the next couple years. While interest rates may rise beyond 2023, inflation in Asia has likely peaked, with most Asian central banks having taken a pause in their rate-hiking activity. Most Asian economies have begun to experience disinflation, with an expectation that inflation rates will return within target ranges for 80% of the Asia-Pacific Region.

Despite high inflation, a debt ceiling crisis, a brief yet troubling banking crisis, and persistent rate hikes, investors have been ‘pleasantly surprised’ with the 12.89% rally in the S&P 500 in the first half of 2023. While analysts at the start of the year forecasted disaster for US markets, the economy stands on much stronger footing than expected.

Inflation has been flattening out for several months now, with June reporting a CPI number of 3%, the smallest year-on-year increase since March 2021. This ‘all-important core number’ signifies to investors that the central bank is nearing or has reached the conclusion of its aggressive rate hike cycle which began in March 2022, when it hiked the Fed Funds rate from 0.25% - 0.50%. In line with these speculations, the Federal Reserve maintained the funds rate at 5.25% in June, suspending further increases beyond the 25 basis point jump from March to May. Despite strongly contractionary monetary policy, the US economy reportedly grew 2% in Q1 this year, making it clear that the worst fear of economic collapse is likely not on the horizon. At the same time, corporate mammoths in the tech sector produced exceptional financial results which exceeded investor expectations, further bolstering their share price.

The forecast for the latter half of 2023 is only mildly bullish despite the surge thus far. The situation could darken quickly with expectations of another 25 basis point rise in the Fed Funds rate likely on the way. This has the potential to erode investor confidence and undo the work done by major tech stocks and the wider economy.

EUROPE

European investors will be in good spirits throughout the holiday season in the northern hemisphere as they celebrate a surprisingly sound first half of 2023 despite worrying GDP data, with the MSCI Europe Index reporting a 14.2% return over this period.

This march further into the green has been largely underpinned by resilient macroeconomic tailwinds. The Eurozone did enter a technical recession following the -0.1% contractions in the consecutive quarters Q4 2022 and Q1 2023. Since 2022, the ECB has hiked the official interest rate from 0% to 4%, with a recent 25 basis point hike implemented in June. Despite the bleak GDP data, the tightening cycle has led to inflationary pressures easing across the continent, with the Euro Area consumer price inflation rate being 5.5% in June this year, compared to its 10.6% peak in October last year. It was this inflationary success which bolstered stock prices amidst a stagnantly growing economy.

Specific movers included mining companies which rallied 2.2%, as well as oil and gas stocks which increased by 1.6%. The Euro zone inflation data for June of 5.5% was lower than expected, but underlying inflation still continued to increase. Further, this price growth number is still more than double the European Central Bank’s 2% target, and the technical recession from Q1 should not be overlooked. As such, many are cautious about this year’s rally in European stocks.

FIXED INCOME

OVERVIEW

A bond is a loan that an investor makes to a borrower, such as a government, corporation, or municipality In return for the loan, the borrower agrees to pay the investor a fixed interest rate over a specified period of time, known as the bond's maturity. At the end of the maturity period, the borrower also agrees to repay the investor the principal amount of the loan.

This chapter will detail the key drivers of fixed income and trends in both Australian and US government and corporate bonds

HOW DOES A BOND WORK?

The interest rate paid by bond issuers and received by bondholders on the face value of the bond is known as a coupon rate. A bond’s yield to maturity (YTM) can be used to determine the price of a bond by considering the expected total return on the investment. The level of coupons can be influenced by factors such as economic conditions, investment timeframe and risk premium.

KEY DRIVERS

There is clearly an inverse relationship between bonds and interest rates. Inflation causes interest rates to rise, leading to a decrease in value of existing bonds. During times of high inflation, bonds yielding fixed interest rates tend to be less attractive. Bonds with a longer maturity are more sensitive to changes in interest rates, and therefore, more affected by inflation. This is something that we have largely observed in the past year, as inflation reduces the purchasing power of income generated from a fixed-income investment. After the bond is issued, it may trade at a premium or

YIELD CURVE

The yield curve represents the yield on bonds over different to maturity, it is also called the risk-free yield curve for government bonds. The curve is grapphed with the duration on the yield rate on the y-axis. The ‘normal’ shape of the yield curve upwards, where short-term yields are lower than long-term This makes intuitive sense as the longer the maturity of the higher the interest rate, as there is a higher level associated with giving up money for a longer period of time.

An inverted yield curve depicts a state in which longer term have a lower yield than short-term debt instruments. discuss later, there is an inverted yield curve in many economies an aftermath of prolonged monetary policy expansion, economists to anticipate a potential recession later in leading nations, particularly the US.

DEFAULT RISK

Default risk in bond investing refers to the possibility that the bondissuing company would fail to make its debt and interest payments. It is possible for bond investors to lose 100% of their investment, alongside uncollected interest. Bonds are rated based on their relative probability of default, with several indices and credit rating services providing a scale and rating on bonds, assessing the financial health of a company and the likelihood of a potential default occurring.

LIQUIDITY RISK

Liquidity refers to the investor’s ability to sell a bond quickly and at not all bonds are liquid, and are thus which can present an issue when investors are trying to sell before maturity.

TYPES OF BONDS

On the ASX, there are two main types of fixed income securities: government bonds and corporate bonds.

WHAT ARE GOVERNMENT BONDS?

Government bonds are bonds issued by a national government, denominated in the country's own currency, for example Australian Commonwealth Government Bonds and US Treasuries. These are debt securities that carry an annual rate of interest fixed over the life of the security, payable semiannually.

The money that is lent to the government is used to support public spending and government spending obligations, such as infrastructure development and repaying sovereign debt. While all investment incurs a level of risk, government issued bonds are regarded to be low-risk investments and thus will generally tend to pay a lower rate of interest than corporate bonds. This is attributed to the low likelihood of a government defaulting on its loan payment.

AU GOVERNMENT US GOVERNMENT

Following the economic bounce-back post-pandemic, the growth trails significant hikes over the previous year as the RBA combats rising inflation.

During the RBA policy meeting on July 4, the Reserve Bank left the cash rate at 4.1% as they needed more time to review the economic outlook, still a record high since March 2012. However, bond futures traders are pricing in a 63% chance that the RBA will increase interest rates in August to 4.35%.

Australia’s 10-year government bond yield has fallen below 4.1% while the 3-year bond yield was 3.95%, reflecting a normal yield curve, suggesting continued positive economic growth. According to economists, the 10-year Australian government bond is anticipated to be trading at 4.4% by the end of this quarter, and 4.79% by the end of the next 12 months.

US government bond investors have racked up positive returns of 2.4% in 2023, compared with a negative return of 13% from 2022.

Government bond markets have started to perform strongly due to growing speculation that central banks might be nearing an end to their tightening cycle. Additionally, with the phenomenon of an inverted yield curve, there are growing speculations about a US recession.

As of June 30, 2023, the yield for a ten year US government bond was recorded at 3.86%, while the yield for a two year bond was 4.94%. This reflects an inverted yield curve, demonstrating that investors are highly uncertain about the market conditions in the future as an inverted yield curve has historically been associated with preceding an economic contraction.

WHAT ARE CORPORATE BONDS?

Corporate bond are issued by companies, and is a form of debt financing sold to investors that enables companies to receive required capital, raising money for their business activities. Companies can use these proceeds for purposes such as purchasing new equipment, investing in R&D, share buybacks, paying dividends, refinancing debt, financing mergers and acquisitions etc. Purchasing corporate bonds can be thought of as providing a loan to a company seeking to borrow money for expansion.

Compared to government bonds, corporate bonds are considered higher risk securities, and thus tend to offer higher yields. The largest risk factor is the aforementioned default risk. However, in the event that a company goes bankrupt, corporate bonds are generally considered to be safer than shares, as they take priority above shareholders in a company’s capital structure.

AU CORPORATE US CORPORATE

In contrast to a rise in global debt by almost USD $8 trillion in 2022, Australian corporate debt has fallen by one sixth in 2023. Australian investors have faced challenges in accessing corporate bonds. They are often traded between large institutions without ever being offered to everyday investors, although ETFs are helping democratise investing in the Australian fixed income market.

Due to higher borrowing costs and slower economic activity, it is likely that Australian businesses will continue to repay their debt obligations, further decreasing Australia’s net debt and expanding corporate bonds. Economists also argue that fixed income is becoming more attractive to local investors as a secure source of yield due to the high quality of companies in the economic environment.

Corporate bonds make up one of the largest components of the U.S. bond market, which is considered the largest securities market in the world. US corporate debt issuance rose sharply in the first half of 2023, up from 36% from the first half of 2022. The reason for bonds being back in 2023 was a result of more attractive yields and lower rate volatility. Investment grade bond yields are now at 13 year highs hovering around 5%, which has provided investors with a significant level of confidence.

In particular, investment-grade corporate bonds are attractive for investors seeking to earn higher yields without taking too much additional risk The current spreads, which are above their long-term average, provides a high possibility of a recession occurring later this year. Economists continue to expect good performance of corporate bonds during the second half of 2023, however they anticipate that the volatility may increase, in particular for high yield bonds.

OVERVIEW

An abbreviated name for currency investments, FX involves buying a particular currency (the quote currency) by selling another currency (the base currency). These transactions occur based on currency exchange rates, which display the value of one unit of a currency relative to the value of another.

Serving as the largest financial market globally (average daily turnover of US$7.5tn), the foreign exchange market (FOREX) facilitates the exchange of national currencies. This chapter will detail the key drivers of Australia’s exchange rate and trends in notable exchange rates with the global reserve currency: the USD.

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KEY DRIVERS

Having adopted a floating exchange rate, the value of the Australian dollar (AUD) is determined by the forces of supply and demand in the FOREX. Thus, an appreciation (increase in value relative to another currency) occurs when there is more demand for, or less supply of, the AUD (vice versa for a depreciation). As supply and demand for the AUD is constantly influenced by various factors, the value of the AUD relative to other currencies also constantly fluctuates.

Interest Rate Differentials and Capital Flows

Interest rate differentials refer to the difference between interest rates in Australia and other economies. Thus, this influences capital flows between economies as investors seek to capitalise on assets yielding higher interest. For example, if Australia’s interest rates are lower compared to other economies, there would be increased supply (i.e more AUD being sold to buy other currencies and invest in their respective economies) and reduced demand , leading to a depreciation of the AUD.

International trade

To facilitate the international trade of goods and services, AUD is also bought and sold. For example, when Australian firms export, the overseas buyer purchases AUD to pay the Australian firm. Thus, this increases demand, leading to an appreciation of the AUD. Notably, the ToT measures the ratio of export prices to import prices. An increase in the terms of trade implies an increase in export prices relative to import prices.

Commodity Prices

Given a large proportion of Australian exports consist of commodities, commodity prices have a large influence over the ToT. Notably, rising commodity prices would increase the ToT, further increasing demand for, and appreciating the AUD.

KEY DRIVERS (CONTINUED)

Prices

Inflation refers to an increase in the prices of goods and services over a period of time. If Australia experiences a higher rate of inflation relative to other economies, the prices of Australian goods and services become more expensive. Therefore, this would decrease demand for Australian goods and services, hence, decreasing demand for and depreciating the AUD.

Speculation

Investors often speculate about the future movements in exchange rates. Thus, if speculative investors expect the AUD to appreciate in the future, they will purchase more, and increase demand for the AUD in the short term. As such, this speculative investment results in the expected appreciation of the AUD.

Intervention

Despite the floating AUD, the Reserve Bank can still intervene in the FOREX should the AUD experience major distortions. For example, the AUD experienced large, rapid depreciations during the GFC, incentivising the RBA to intervene in the FOREX to purchase more AUD. Thus, this increased demand for, and appreciated the AUD to offset the depreciation.

USD / AUD

With the US sustaining an interest rate differential against Australia, the USD/AUD exchange rate remains slightly appreciated, fluctuating around $1.50.

At the time of writing, the target Fed Funds rate is 5.0 - 5.25%, remaining almost a whole percentage point ahead of Australia’s target cash rate of 4.1%. Thus, as asset returns remain higher in the US, this leads to higher demand for the USD, leading to its appreciation. Simultaneously, supply of the AUD would increase as Australian investors may also seek to invest within the US, reinforcing a depreciation of the AUD against the USD. Moreover, as the global economy continues to suffer from high inflation and a tight monetary policy environment, demand for Australian commodities remains weaker. Therefore, coupled with falling commodity prices, demand for the AUD has also significantly weakened, further sustaining a depreciation against the USD.

Looking ahead, Westpac and NAB economists predict the USD/AUD exchange rate will depreciate towards $1.30 by June 2024, perhaps in line with projections that the Fed will lower interest rates in 2024. However, with China’s slower than expected recovery, this only reinforces the recent decline in demand for Australian commodities. Therefore, this justifies CBA economists’ conservative estimates that the USD/AUD exchange rate will only lower slightly, towards $1.45.

USD / EUR

Ever since the USD moved beyond parity with the EUR in late 2022, the USD/EUR exchange rate has gradually depreciated towards 0.90 euro.

This movement has occurred by virtue of multiple factors causing the EUR to strengthen against the USD since the beginning of 2023. Primarily, as Europe is a net importer of energy, declining energy costs have resulted in less supply of EUR for energy imports. Simultaneously, Europe continues to maintain their high services exports (i.e tourism), thus sustaining demand for the EUR. Hence, both of these factors contribute to an appreciation of the EUR. Furthermore, as the ECB began raising interest rates to combat high inflation, their interest rate differential with the US has begun narrowing. Fuelled by expectations that the Federal Reserve is approaching the end of its tightening cycle, whilst the ECB continues to raise rates, this has stimulated demand for the EUR, further appreciating it against the USD.

Looking forward, despite inflation declining, the ECB still has impetus to implement rate hikes. This largely stems from record unemployment figures and rising wage growth, which may induce inflationary pressures if unregulated. As this will further narrow their interest rate differential with the US, the EUR will likely experience increased demand, driving an appreciation. Thus, the USD/EUR exchange rate is expected to further depreciate.

USD / JPY

Demonstrating signs of high volatility, the USD/JPY exchange rate peaked at 150 yen in October 2022, before sinking below 130 yen at the start of 2023. Since then, the exchange rate has seen an appreciating trend, continuing to heavily fluctuate around 140 yen.

Having depreciated over the first quarter of 2023, this occurred by virtue of the JPY experiencing an appreciation. This stemmed from expectations that Japan’s interest rates would rise after the Bank of Japan (BOJ) raised the upper limit of its long term interest rates from 0.25% to 0.5%. Furthermore, in tandem with subsiding energy costs, vehicle and electronics exports began to recover, leading to Japan experiencing a 2.6% rise in exports and 2.3% decline in imports in April 2023. Thus, this simultaneously stimulated demand for, and decreased supply of the JPY, aiding an appreciation against the USD. However, as Japan’s interest rate differential with the US continued to widen over the past few months (BOJ has maintained a short term interest rate target of -0.1%), this has resumed an appreciation of the USD against the JPY.

Looking ahead, Japan is slowly becoming a new investment outlet as multinational companies seek to diversify supply chains after experiencing various constraints amidst the pandemic. This will likely attract large capital inflow, increasing demand for the JPY and ultimately, depreciating the USD/JPY exchange rate.

USD / GBP

Much like the USD/EUR, the USD/GBP exchange rate experienced an appreciation late 2022, but has since depreciated to around 0.80 GBP.

In conjunction with the USD appreciating due to the Fed’s rate hike cycle, the GBP also performed weakly across the entirety of 2022. This is owed to various reasons such as weak economic growth, sustained costs from Brexit, high inflationary pressures and the infamous Truss Budget. Thus, this heavily discouraged investors from making any inbound investments into the UK. Nonetheless, as Truss’ budget was eventually reversed, the UK economy has exceeded expectations by being able to avoid the IMF’s prediction of a mild recession. Paired with expectations of interest rate hikes due to the UK’s inflationary pressures being higher than the US and EU, this has fueled capital inflows into the UK. Moreover, as a net importer of energy like the EU, falling energy prices have also resulted in less supply of GBP for energy imports, hence further strengthening the GBP’s appreciation.

Having bridged their interest rate differential with the US, and sustaining inbound investment for new foreign direct investment projects, the GBP will likely continue to appreciate in the near future. Thus, the USD/GBP exchange rate will likely depreciate.

COMMODITIES

4 INTRODUCTION

Commodities refer to raw, naturally occurring materials that are bought and sold for consumption or to produce another good. There are 4 main types of commodities: energy, metals, agricultural products and livestock.

In terms of financial markets, commodities are physical goods that are bought, sold and traded in markets. While the risk is high, the cyclical nature of commodity pricing offers investors a unique opportunity, virtually guaranteeing a boom bust cycle.

This chapter will detail the various instruments used to invest in commodities, and trends in specific commodities over the past year.

KEY INSTRUMENTS FUTURES

The most common way to trade commodities is to buy and sell contracts on a futures exchange A commodities futures contract is an agreement to buy or sell a predetermined amount of a commodity at a specific price and date in the future The futures market allows ‘hedging’, enabling commodities producers and consumers to limit their risk of losing wealth in response to commodity price changes

Futures are typically traded on organised exchanges, which set standardised contract terms including factors like the size of the contract, contract length, delivery time period, trading day and locations. When you trade futures contracts, you’re not buying or selling the physical commodity itself, but rather betting on price changes only When a futures contract is bought or sold, it is done through a ‘clearing house’ - an electronic trading platform responsible for executing these transactions.

OPTIONS

Commodity options provide the options holder with the right, but not the obligation, to buy or sell commodities at a specific price and date in the future. These contracts are traded either on a public stock exchange or implicit agreement between two parties, respectively called Exchange Traded Options and Over the Counter contracts Options contracts can be distinguished into a call option to buy the commodity, or put option to sell.

A commodity call option establishes the maximum price of a future commodity purchase. For a put option, a minimum price of a future commodity sale is established Option holders are protected from unfavourable price movements, but retain the right to capitalise on favourable movements

EQUITIES

Commodities’ investors can also buy and sell shares of companies involved with growing, harvesting and/or extracting particular commodities These can include mining stocks, energy companies, dairy producers, commercial farming companies. These equities are generally bought and sold on stock exchanges or via OTC markets, which is a private exchange between two parties without the use of a central exchange or broker

Australia is one of the world’s biggest commodity producers, with some of the world’s biggest players in the commodities equity market such as Rio Tinto (ASX:RIO) and BHP (ASX:BHP). Investors commonly use this to minimise risk in their portfolios as commodity prices often move in opposition to shares.

ETFs

Regarding commodities, ETFs involve investing in a single commodity or a particular commodity index, which tracks the performance of a group of commodities If the prices of a particular commodity or commodity index rises, investors in the ETF benefit. Commodity ETFs can be physically backed, futures-based or equities-based and are generally traded on a stock exchange.

COMMONLY TRADED COMMODITIES IRONORE

Iron ore prices experienced a strong rebound in 2023, after a ‘v-shaped’ movement and heightened volatility in the past year. The price of iron ore has fluctuated from a peak of US$160 per tonne in early 2022, dropping more than 50% to a trough of approximately US$80 per tonne in late 2022, before recovering to around US$110 per tonne this year

2022 saw the resurgence of the pandemic and China’s implementation of its ‘zero-covid’ policy, with demand for iron ore faltering as the country temporarily suspended construction in the property and manufacturing sectors Coupled with weakening global demand for the commodity upon central banks tightening interest rates, iron ore prices declined towards US$80 per tonne Nonetheless, by virtue of a seasonal increase in steel production, the higher prices seen in recent months also can be attributed to the recovery in Chinese steel production, as the country reopens following the end of the zero-covid policy

Looking forward, the sustained weakening of global economic growth and slower than expected recovery of China have sparked concerns of iron ore prices falling in the near future. Notably, Goldman Sachs forecasts iron ore prices to average US$93 a tonne in 2024, expecting price recovery to ease and plateau in the short term as supply and demand rebalance Australia is the top 1 exporter of iron ore and the

COMMONLY TRADED COMMODITIES GOLD

To combat severe inflationary pressures, the Federal Reserve’s aggressive interest rate hike cycle has served as the largest catalyst for an increase in gold prices Amidst expectations that the Fed will pause rate hikes, gold prices rallied to new highs as demand for the commodity soared Experiencing a drastic increase since late 2022, gold prices peaked in May 2023 at over US$2,000/oz, and have since stabilised around US$1,900/oz This is largely attributed to the commodity being considered an alternative universal currency that does not generate returns, and thus, the price tends to be inversely correlated with interest rates. Gold has historically maintained its value over time, serving as a form of insurance against adverse economic events, categorised as a safe haven asset

Moreover, the faltered confidence in the USD after the collapse of Silicon Valley Bank and other US financial institutions also fuelled demand for gold

Nonetheless, with consumer confidence continuing to rise, the US has

OIL

Global oil prices faced great volatility in the past year, peaking halfway through 2022, amidst rising concerns upon a decrease in global oil supply from Russia, as it commenced its invasion of Ukraine. Oil prices have gradually declined from a high of approximately US$120/barrel to US$75/barrel, as of June 2023 – down 37.3% on the year.

Further reinforcing this have been consecutive reductions in oil production by OPEC members (a group of nations who produce 30% of the world’s crude oil) Beginning with a reduction in oil production by 2 million barrels a day in October 2022, this figure has since risen to over 4 million barrels a day, with the most recent reduction being Saudi Arabia, aiming to voluntarily decrease oil production by 1 million barrels per day in June 2023 Nonetheless, oil prices have gradually declined across 2023, as oil supply continues to expand via nations such as Russia, Iran and Venezuela. Coupling this, concerns of a recession in the US and a slow recovery by China, have led to decreased demand for oil. Looking forward, financial institutions expect growth in global oil supply to exceed the rise in oil demand, maintaining downward pressure on oil prices.

LITHIUM

As a key component of batteries in electric vehicles (EVs) and electronic devices, lithium was among the best-performing commodities over the past couple of years amidst the EV boom However, lithium prices have experienced a drastic fall over the course of 2023, through a combination of supply and demand factors Peaking late 2022 at over US$80/kg, lithium prices have experienced a steep decline to around US$25/kg, and have since moderated around US$40/kg

Primarily, with declining sentiment for EVs in China due to EV subsidies expiring and low household confidence postpandemic, demand for lithium has significantly decreased. Simultaneously, global supply of lithium has continued to increase, with China, Australia and Chile being significant contributors Lithium prices are still expected to recover as uptake of EVs worldwide sustains in attempts to meet carbon emission targets, with many countries still largely lagging behind in this transition

CRYPTO

5 INTRODUCTION

Developed by a small number of computer scientists following the Global Financial Crisis, cryptocurrency has grown from a niche subject among tech enthusiasts to an entirely new asset class. While crypto prices have currently pulled back, with a market capitalisation at an impressive US$1.1tn, cryptocurrency has a bright outlook.

Cryptocurrency is a form of digital currency, in which transactions are verified and records maintained by a decentralised system using cryptography, rather than by a centralised authority. The currency is powered by blockchain technology, with a ledger of transactions maintained by a decentralised network of participants

Many proponents of crypto argue that it can remake our financial system with less frictions, inefficiencies and costs While the decentralised nature of crypto addresses the perceived vulnerability of centralised financial institutions, the lack of regulatory frameworks, use of crypto in criminal activities and its high energy consumption should not be ignored

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YEAR IN REVIEW

2022 was a ‘crypto winter’ year, with the price of Bitcoin failing almost 65% amid the Terra Luna crash, bankruptcy of major crypto exchange FTX, and the rapid tightening cycle in response to sticky inflation.

After FTX founder Sam Bankman-Fried was charged with securities fraud and money laundering, US regulators were galvanised into a wide cryptocurrency legal cleanup. Kraken, Genesis and Gemini Trust were targeted by the US Securities and Exchange Commission (SEC), charged with selling unregistered securities to investors. Such regulatory actions placed downward pressures on crypto prices, causing Bitcoin to fall to around US$20,200 in the second week of March, from a high of almost US$24,000 in Mid-January. However, the short lived banking crisis provided support for ‘alternative money’, with Bitcoin rising 21% in March.

In line with the crackdown on the crypto industry by US regulators, on June 5 the SEC brought 13 charges against the world’s largest cryptocurrency exchange Binance, as well as its founder and CEO, Changpeng Zhao, for their violation of securities laws. The firm was accused of creating separate legal business entities to evade US securities laws, and Zhao was alleged to have founded another firm to artificially increase the trading volume of assets listed on the Binance US platform. It was unsurprising when Bitcoin subsequently fell 5.5% to a threemonth low and Ether 5.1% considering the size of the crypto exchange. This only briefly interrupted the crypto ascent of Q1 2023, as BlackRock filed for a Bitcoin ETF with the SEC on June 15. The support from the world’s largest asset manager proved bullish for crypto markets, with Bitcoin rallying above US$30,000 on June 21, and Ether climbing 11% in the latter half of the month.

Despite the remarkable 2023 turnaround, price growth stalled yet again in July, leaving investors uncertain and skeptical of the longevity of the March surge. Some analysts anticipate a bearish correction for both Bitcoin and Ether over the next few months. In any case, investors will keep a close eye on inflation data,

TETHER

While Tether USD is the third largest cryptocurrency in circulation and the largest asset-backed cryptocurrency stablecoin linked to the underlying USD currency, it is also one of the most controversial cryptocurrencies.

Tether is called a stablecoin – theoretically, backed by the USD However, Tether Limited has long faced concerns that its tokens are not completely backed by the equivalent value of a US dollar This is despite claiming that it holds all US dollars in reserve to allow customer withdrawals to be met upon demand, sparking debate over the coin’s credibility Tether Limited was previously fined by regulators over the inaccuracy of such claims, as well as the failure to present audits proving sufficient asset reserves.

However, while the US banking crisis affected rivals, the Tether stablecoin experienced fast growth this year Tether reported $1.48 billion profit in Q1 of 2023, doubling the result of the previous quarter On 1 June 2023, the Tether coin hit a new all-time-high market capitalisation of over $83 billion, with its market capitalisation higher than its close competitors’ combined value as it continues to hold market dominance.

NFTs

While Tether USD is the third largest cryptocurrency in circulation and the largest asset-backed cryptocurrency stablecoin linked to the underlying USD currency, it is also one of the most controversial cryptocurrencies Tether is called a stablecoin – theoretically, backed by the USD. However, Tether Limited has long faced concerns that its tokens are not completely backed by the equivalent value of a US dollar. This is despite claiming that it holds all US dollars in reserve to allow customer withdrawals to be met upon demand, sparking debate over the coin’s credibility

Tether Limited was previously fined by regulators over the inaccuracy of such claims, as well as the failure to present audits proving sufficient asset reserves. However, while the US banking crisis affected rivals, the Tether stablecoin experienced fast growth this year. Tether reported $1.48 billion profit in Q1 of 2023, doubling the result of the previous quarter On 1 June 2023, the Tether coin hit a new all-time-high market capitalisation of over $83 billion, with its market capitalisation higher than its close competitors’ combined value as it continues to hold market dominance

REAL ESTATE

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INTRODUCTION

A Real Estate Investment Trust (REIT) is a company which invests directly in real estate through the purchase of properties or by buying up mortgages. REITs issue shares which are publicly traded on major securities exchanges, meaning that they can be easily exchanged between investors, presenting them as highly liquid instruments

This chapter will define and classify the different types of investment vehicles available as REITs, detail the key drivers of its underlying assets and uncover global trends in the real estate space

HOW DO REITS WORK?

Investment vehicles classified as REITs can include a range of incomeproducing property types such as commercial buildings, apartments complexes, data centres, hotels, medical facilities, offices, retail centres and warehouses – although most REITs specialise in a specific real estate sector.

Investing in REITs provides investors the advantage of diversification to their portfolio and the ability to earn dividends from real-estate investments without having to buy, manage or finance the properties themselves. Depending on the investment and the economic environment, they can potentially offer an attractive yield compared to residential properties or some other income-oriented investments. Investors gain the benefit of any increase in value in the underlying asset and from regular rental income generated from the properties owned.

Like shares, REITs can generate two kinds of return - capital growth and income, in the form of regular distributions. A key requirement for a company to qualify as a REIT is that it must pay a minimum of 90% of taxable income in the form of shareholder dividends each year, meaning investors can be assured of a stable cash flow.

OFFICE

Office REITs own, operate and finance office real estate, which refers to commercial office properties such as buildings used primarily for business purposes. They receive income through rent from tenants, often signed on long-term leases. Some common markets include central business districts or suburban areas.

Residential

Residential REITs invest in a portfolio of rental properties for non-professional purposes. This includes family homes, apartments, townhouses, unit developments, and other living arrangements. Residential REITs differ as financial contributions from investors are only used to purchase residential properties. Investors are therefore able to earn returns from rent income through dividend payments.

RESIDENTIAL

Residential REITs invest in a portfolio of rental properties for non-professional purposes. This includes family homes, apartments, townhouses, unit developments, and other living arrangements. Residential REITs differ as financial contributions from investors are only used to purchase residential properties. Investors are therefore able to earn returns from rent income through dividend payments.

INDUSTRIAL

Industrial REITs function in the industrial real estate sector which involves warehouses, logistic centres and other buildings used for manufacturing and distribution. Properties which are owned and managed by REITs are leased to tenants under long-term contracts, often under a triple net lease structure which leaves them liable for building insurance, real estate taxes and maintenance.

RETAIL

Retail REITs own and manage properties within the retail real estate sector which refers to properties used exclusively to market and sell consumer goods and services. This includes properties such as large shopping centres, outlet centres, grocery-anchored shopping centres and other big-box retailers.

TRENDS

Rising rates coupled with inflationary pressures over 2022 saw property valuations and consumer confidence plummet - a major headwind propelling the A-REIT Index delivering a -15.4% return over FY22.

INTEREST RATES

Despite the Australian property market facing the largest interest rate rise campaign in the past 30 years, property prices have subverted the regular inverse relationship between interest rates, with prices only momentarily falling before bouncing back since May 2022.

Regarding the initial price plummet, property prices were reportedly more responsive to cash rate hikes. Property prices began their descent the same month as the first hike in May 2022, with the month-on-month change in value at -0.1%. Meanwhile historically, in 1994, when Australian markets last saw rates rise this quickly - by 275 basis points over 5 months - the property market responded 4 months later, reflecting the traditional assumption of monetary policy’s lagging effect and medium to long term impact. According to leading economists, the unusual hyper-responsiveness to rate hikes is largely due to increased consumer attentiveness to the recent hiking cycle and the increased forward guidance provided by the RBA. This likely accelerated the price decrease, with the greatest month-on-month decrease in property prices of -1.6% occurring in August.

The possibility of continued higher interest rates, along with the ongoing housing affordability constraints reduced the house prices more than expected.

As of December 2022 property prices were still declining, contradicting the significantly abovetarget inflation of 7.8%. In fact, when considering inflation-adjusted data, house prices were on such a steep descent that they had reached 2017 levels. Although the 12 month tightening cycle softened demand for properties and placed downward pressure on prices, investor speculation that the hiking cycle would be nearing its end revitalised property market demand prior to the cycle’s conclusion, contributing to this bounce.

UNEMPLOYMENT AND INTERNATIONAL MIGRATION

Market Economics managing director posited that the impact of the hiking cycle on property prices was being overstated, with other labour market variables such as unemployment and international migration proving unexpectedly resilient amidst the hiking cycle. Usually, economic theory tells us that higher interest rates transmit to declining migration and employment. However, the jobless rate fluctuated between 3.4 and 3.7% during the past year, well below NAIRU as well as the 1990s rate of 7-8%, a period which somewhat parallels Australia’s current cash rate tightening cycle. Further, the rate of migration is approximately 3 times larger than that of the 1990 period. These standout factors have contributed strongly to the Australian property market’s unusual bounceback in the past few months, rallying 2.3% from March to May.

SUPPLY OF HOUSING

On the supply side, low residential listing levels and limited household size relative to population growth has culminated in an immense undersupply of residential property and inflated prices for prospective homeowners. The value of the dollar has been “obliterated” in the property market, with the cost of purchasing a property being up to 10 times greater than average household income.

The current median annual Australian salary is $79,800, while the average loan value in NSW is $726,902 and the median dwelling value is $1.01 million, reflecting the dire price situation in the residential property market. In the industrial and office property markets, low rates of construction approval and high vacancy rates post-pandemic have further heightened prices despite the tightening cycle.

Nevertheless, with high employment, migration, and property undersupply, both supply and demand factors are contributing to upward price tailwinds ahead.

The Australian commercial property market has been dragged down by negative sentiment in both retail and office markets amidst the tightening cycle, with speculation that consumer demand for goods and services will contract as credit becomes less accessible. Some REITs also worry that the quasi-stagflation state of the Australian economy renders rate hikes ineffective in addressing both low economic growth and high inflation, leading the economy into a downswing. As such, the NAB Commercial Property Index reported a 6 point loss in the first quarter of this year. Notably, the CBD Hotels sector reported strong 33 point gains due to positive capital growth and increased revenue per available room.

In the aftermath of the COVID-19 pandemic this year, there have been several structural shifts amongst commercial asset classes. For example, CBD retail prices have suffered with the transition to online shopping. Meanwhile, industrial assets have significantly outperformed retail properties since warehouse buildings for storage and manufacturing facilities are more demanded by consumers in light of this booming ecommerce. This change in pricing has led to industrial yields dropping far lower than retail yields. Further, the lease structure of retail assets makes them more effective at leveraging high inflation into income growth. These factors will likely decrease the price dispersion between retail and industrial properties.

OFFICE REAL ESTATE

Even with lockdowns having been lifted long ago now, office vacancy rates have not downwardly rebounded as much as office property investors hoped. The forced remote working has now evolved into an opportunity for increased flexibility in the labour market, weighing down office prices. Colliers’ valuation services managing director posited that the total peak to trough decline in Australian property prices might reach up to 20%. However this is not the case nationwide, with areas such as Gold Coast and Perth seeing price growth due to population gains.

Beyond technical implications from rates impacting valuations and leveraging concerns for property, there are a few general thematics set to drive performance in the sector.

OPPORTUNIITIES BUILD-TO-RENT HOUSING

Tailwinds from a growing middle class, increasing urbanisation and a push for land efficiency (particularly in Sydney) is propelling the rise of Build-to-Rent platforms. Build-to-rent housing is large-scale, purpose-built rental housing, held in single ownership and professionally managed. Build-to-rent housing can provide more rental housing choices and support construction jobs to drive economic recovery, post COVID. Alongside its heavy institutional backing, it is forecasted that 70% of Local Government Areas in Sydney alone are in need of new rental supply.

SELF-STORAGE REITS

The push for land efficiency amidst urbanisation boom behind its rapidly growing demand in self-storage REITs, high occupancy and thereby stable cash flows which attractive to investors. Over 3 years, to March 31 2023, storage rent rose from $350 to $425 per square Sydney.=, reflective of a trend of ‘condensed’ living.

'NEW ECONOMY' OFFICES

Post-COVID change in living conditions is similarly reflected in new working environments, causing a surge in what are coined ‘new economy’ offices. These office environments, like WeWork, are