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If there is one obvious short in the global economy for 2011, it has to be Australia.  They have developed a leveraged relationship to growth in China, with an internal currency that has appreciated to parity with the US dollar.  This sets their equity markets up for a serious beating if any of the following happens.  I personally would not be shocked if all 4 of these happen at or near the same time.

  • Slowdown in Chinese demand for raw commodities
  • Housing Bubble Pops due to raising interest rates
  • Raising interest rates due to inflation expectations
  • Yuan ~ US Dollar volatility

Any slow down in real Chinese growth is going to show up in Australia first. A sure sign of this will be when ships dedicated to the bulk raw commodity market start to slow steam from Australia to China, or worse start to show up as idle along the Australian or Chinese coast.

The following source is great for tracking global commerce at sea, in real time.

The land down under has not seen its housing bubble pop yet.  The bubble has continued to grow, with the mining industry, and mining services industry’s providing a vehicle of growth during the economic bleak years of 2008-2010 in the rest of the western economy.

”Safe as houses” is a well-worn expression, but the MLC Investments strategist Brian Parker says the notion that Australian real estate prices can move in only one direction could go out the window. ”Residential property looks absolutely obscenely overvalued and seems to offer very, very poor investment prospects,” he says.

The central bank in Australia is in the position where it will need to raise rates by at least 100 basis points in the next year, to fight inflation expectations.   If the Chinese experience a real case of destocking of raw commodities, while the US slows down again, Australia is going find itself raising rates into the second round of the global economic storm.

When the rate shock hits the housing market in Australia, with any real slow down in China, you will have a MAJOR deflating of the Australian equity and housing markets at the same time.  It is just a matter of when, not if.   Just ask the IMF, which has a way of pointing out crisis with out pointing fingers.

“From a financial stability perspective, stress tests suggest that a correction in house prices is not expected to take a toll on banks because of the low level of high-risk mortgages,” the report said. “The current historically high terms of trade are expected to be long lasting. Strong population growth and high real income growth in the wake of record-high commodity prices this year will continue to support house prices.”

While house price-to-income and house price-to-rent ratios suggest homes are overvalued, interest rates have fallen since 2000, making these higher ratios sustainable, the IMF said.

Average home prices in Australia are 6.8 times annual median household income, more than double the U.S. ratio of 2.9 times, according to the annual Demographia International Housing Affordability Survey.

So according to the IMF, the new higher ratios are perfectly normal as long as China never slows down.   I mean, it is not like China is fighting inflation expectations and needs to cool off its own economy in the near term.

Disclosure: Pondering some Australian equity shorts…