The commodity investment setting Australia up for the next 40 years

Treasury released its latest Intergenerational Report (IGR) in August this year. Taking a 30-year perspective, it firstly makes some assumptions and projections about the Australian economy, then considers the forces that will shape the outcomes. 

Mark Knight, CEO at Ausbil Investment Management has taken an in-depth look at the report. Here is his overall view:

"The Intergenerational Report highlights some long trends that call for a critical response from policymakers to address the core problem of falling productivity in Australia...

While we wait for policymakers to respond, the trends like decarbonisation, support for an ageing population, increased participation and an expanded workforce for more productive output, a growing services sector, the adoption and leverage of new technologies, and any actions that can be made to make it easier for business to invest, and for consumers to participate more in the productivity equation, all offers compelling opportunities for investors with a long-term focus." 

Slower growth 

Treasury's view of the Australian economy for the next 40 years is a picture of slow growth, with the economy projected to grow by an average of 2.2% per year in real terms, lower than the 3.1% over the past 40 years as shown in the chart below. 

Over that same period, our population is projected to grow at a rate of 1% per annum over that 40 year period. It will also shift towards an ageing population which Knight interprets as:

"A falling share in the productive younger labour market years, and a population swelling in the post-retirement years which is helping to drive an increasingly services orientated economy."

The IGR also documents the shift in the industrial base away from goods and towards services. Knight comments:

"While Australia has benefited from extensive natural resources over the last 200-years, over the last 40 years the country has evolved towards a higher share of services to goods output, as shown in Chart 4. 

Given the level of wages and the cost of land and services, Australia has long lost any competitive advantage it may have had in the production of goods and, apart from natural resources production and export, continues to pivot more towards a services economy."

Labour productivity challenge 

A key challenge for the next 40 years is how to reinvigorate labour productivity across the economy, with Treasury's assuming growth of around 1.2% per year, down from its 30-year average of around 1.5%. The IGR report notes:

"Placing more weight on recent history better reflects headwinds to productivity growth, such as continued structural change towards service industries, the costs of climate change, and diminishing returns from past reforms."

And while this downgrade in productivity rate "is consistent with forecasts in other advanced economies such as Canada, New Zealand, the United Kingdom, and the United States", it brings unique challenges for the Australian economy that require policy solutions, according to Knight:

"Of course, in Australia, there is a spectrum of views on each of these reform issues and how to address the declining productivity of Australia’s economy. What is undebatable is the pressing need for governments and other policymakers and regulators to look at a coordinated approach to helping address the productivity problem that is outlined in the Intergenerational Report, and by the Business Council of Australia and the Productivity Commission in their work to promote greater productivity for Australia."

The five forces shaping the economy 

The IGR identifies five forces that will shape the economy are the key to understanding not only Treasury's modelling, but also the risks and opportunities for investment. The five forces are 

1. population ageing
2. technological and digital transformation 
3. climate change and the net zero transformation 
4. rising demand for care and support services 
5. geopolitical risk 

There is an obvious link between an ageing population (force 1) and the rising demand for care and support services (force 4). 

Investment opportunities 

Knight sees investment opportunities in the long secular thematics outlined in the IGR:

"we believe these would be magnified with improved conditions for productivity like a review of the tax system, and more pro-productivity policies that are harmonised between federal and state governments."

While he sees there are multiple themes that could be used, he focused his commentary on the investment opportunity found in the outlook for the commodities and natural resources. Noting Australia is resource rich, and we have experience of cycles in which different commodities have made significant contributions to Australia's economic growth, Knight sees the commodity opportunities around the need to decarbonise. Specifically, he calls out the major underinvestment in supply of  the commodities that support decarbonisation over the last 10 years, as illustrated in the chart below

Knight indicates this has "positive ramifications for the metals and mining, and energy sectors", focusing on those key thematics driving long-term earnings growth, with a particular interest in those areas "where imbalances see demand exceeding supply on a fundamental basis for some time." With this in mind, Ausbil likes critical metals and commodities to shift from fossil fuels to renewables, "with the steady switch from combustion and fossil fuel power to renewable electricity generation."

As he notes,

"This is a long game which requires a significant amount of investment. Service companies associated with the CapEx investment needed for this energy transition are also attractive."