Another hung parliment!

Having seen May's UK election result in a hung Parliament, last weekend it was the turn of the Australian electorate to leave its nation in a state of political limbo. Given Australia's position as a key player in the world of natural resources, the election result down under is of significant importance to global equity markets.

Having begun on an uncertain note thanks to the inconclusive election down under, equity markets have taken their lead this week from negative US economic data as well as a "double dip" warning from the Bank of England.

The main event though arrived on Tuesday. The expiry of the popular home buyer tax credit in the US was always expected to dent home sales however a fall to the slowest pace in 15 years was not expected. July's numbers were a stark reminder that the recovery owes much to government aid and that plenty of ups and downs remain before equity markets are allowed to embark on a protracted ascent.

Political uncertainty in Australia is not helping matters. The main theme in the run up to last weekend's election has been the Mineral Resources Rent Tax or MRRT and the implications for Australia's economic health and for the big producers of iron ore and coal such as BHP Billiton and Rio Tinto.

So controversial the issue it saw the ousting of Labor Prime Minister Kevin Rudd, who was replaced by Julia Gillard whose first move was to tone down the tax.

Now though the plot thickens. The non-outcome of the Federal election has added to significant uncertainty for global equity markets during the same weak that housing data from the US provided a catalyst for a significant move to the downside. The balance of power now rests with a small handful of independent MPs who will horse-trade their way to extracting a major rural dividend for their individual electorates.

For UK investors, the MRRT is of significant importance given the dominant position of the mining sector on the FTSE 100. To reiterate, the MRRT is the brainchild of Australia's Labor party, projected to raise US$9.3 billion over two years from 2012. The Liberal-National Coalition has pledged to kill the tax.

The mining giants have been quick to point out that the tax would threaten investment in the resource sector, the main reason why Australia has been able to sidestep the worst of the global financial crisis. Rio Tinto CEO Tom Albanese this week stated Australia's international competitiveness is very much at stake.

Earnings for the likes of BHP Billiton, Rio Tinto, Anglo American and Xstrata are also at stake. BHP's move for Potash Corp reflects the financial well being across the sector however the respective management teams would all have been hoping for a definitive election result so that plans to maintain the prevailing levels of earnings growth can be drawn up as soon as possible.

So how soon will CEO's Albanese, Kloppers, Carroll and Davis know the outcome?

For now, we are assuming that another election will not have to be held. This implies that either the Labour Party or the Liberal-National Coalition will be able to successfully woo the independent MPs with sufficient candy-bar politics to form a minority government. It is certainly not in the interests of the independents to return to the ballot as they already have the aces they need.

In our view, the negotiations with the independents will boil down to offering sufficient enticements to each MP's electorate to draw support to form a government. If the cost of winning the Treasury benches means pork-barrelling a handful of rural electorates, then the country could probably afford to tolerate such tactics.

Adding to the difficulty of garnering support from this collection of MPs is the fact that each has his own agenda. There is likely to be some commonality among them, but their differences are what will tangle the process.

Making matters even more delicate is the fact that each of these MPs as the above graphic illustrates is a disaffected former Member of one or more of the larger parties. There will be grievances and grudges flowing underneath the discussions that could easily de-rail talks and send the process backwards or worse, in the direction of the other major party.

Australia's broadband roll out, tax reform and the MRRT are set be the deciding factors for the independents. Focussing on the MRRT, the Liberal-National Coalition's stance may be more appealing to the independents. Labor's policy of using the MRRT proceeds to fund company tax cuts would be scuppered if the MRRT was not enacted. Following a path of encouragement for corporate investment might not only create more direct jobs but also support the rural communities that co-exist with the mining industry.

In the Senate, it becomes even trickier for whichever party can form the government. From 1 July 2011, the Green Party will have 9 seats with which to play kingmaker to any proposed legislation. This platform will become a powerful antidote to the governmentÕs agenda unless it can incorporate the Green's agenda at the same time. The Greens, for example, are demanding an increase of around $2 billion to the MRRT and an increase in the company tax rate to 33% to fund various projects of their own.

It would not surprise us to see a very limited range of legislation being passed once this change occurs, unless it gets through in a highly diluted manner.

This consensus politics is becoming a feature of several governments but unfortunately does not always deliver the best outcomes. Equity markets do not like uncertainty and at present an uncertain economic outlook is being managed by administrations with compromised modus operandi.

The Dow Jones Industrial Average failed to break above the 200 period moving average (red line) and has since pulled back below the 50 period moving average (green line). The Dow penetrated the key psychologically significant 10,000 level but found good buying interest at this level finishing back above the intraday low of 9,937.98 on August 25th.

We expect there will be another test of this key level in the coming sessions. A break of the 10,000 mark would likely lead to a retest of the July 21 low of 9,614. However, as long as this level holds we would target a move back towards the 200 day moving average at 10,454 and beyond.



We have been discussing two potential scenarios in recent weeks; a bullish inverse head and shoulder reversal pattern that suggests a retest of the 2010 highs and a bearish rising wedge pattern that would give us a downside target that suggests a retest of the 5,000 level. With the move below the 50 day moving average last week it looks as though the near term rising wedge pattern has prevailed as the index has put in an intraday low of 5,070 on the 25th of August.

However it is worth noting that this move does not negate the potential bullish inverse head and shoulders pattern. At present the current weakness could be interpreted as the formation of the right shoulder of this pattern. However, if the FTSE 100 breaks below the psychologically significant 5,000 level and retests the July low of 4,790 the potential inverse head and shoulder pattern would be void. How the index behaves over the next few trading sessions could determine the trend for the next few weeks and months.




Gold successfully broke out from the bullish continuation flag pattern to reach a recent high of US$1,244.3 on August 26. We have also seen a break of the RSI downtrend and a positive MACD crossover which has now been confirmed with the bullish move back above the zero signal line.

The almost vertical appreciation in price should now lead to a period of consolidation. We would expect support to hold at the 50 period moving average (green line) at US$1,209. Once the short term corrective phase is complete, we would anticipate a move higher in line with the broader term uptrend. The upside target is towards the June 21 high of US$1,265.