Will Resource Tax Sink Australia ETF?

by on May 21, 2010 | ETFs Mentioned:

One of the many beneficiaries of the tremendous growth in China’s economy has been the resource-rich nation of Australia. The Aussies are one of China’s largest trading partners, and have thrived on the emerging market’s insatiable demand for raw materials over the last year. Australia was the first advanced economy to raise interest rates following the recent crisis, and has continued to distance itself from its economically-challenged developed market counterparts. Australia, which is currently the world’s largest exporter of coal, alumina and iron ore, has fueled much of China’s industrial expansion (also see Australia ETF: A Developed Market Play On China).

However, the booming Australian resources industry has come under attack from politicians who are threatening to impose huge new taxes. Prime Minister Kevin Rudd has proposed a ‘super tax’ on resource profits in order to pay for rising health care costs for an aging population. The tax which, would be equal to 40% of resource gathering firms’ profits, is proposed to begin in July 2012 and would raise an estimated $8 billion a year from 2013-14, which is about 0.7 per cent of national income.

The tax has not become law yet and is strongly opposed by many conservative politicians. The new tax would “eventually choke the goose that’s laid the golden egg for Australia,” said conservative Tony Abbott. “Australia’s future depends on the bulk carriers traveling to Asia.”

Others also worry about the impact of the tax and how it might change foreign perception of the country. “Australia’s hard-earned reputation as a stable investment environment will be dramatically undermined,” said Mitch Hooke, chief executive of the Minerals Council of Australia. Hooke went on to note that the tax would result in Australia having the highest taxed mining industry in the world (see Playing Precious Metals Through Mining Stocks).

Australia ETF In Focus

Although the most popular Australian ETF, iShares MSCI Australia Index Fund (EWA) allocates more than 40% of it assets to financial stocks, it also maintains a large allocation to industrial materials, which comprise about a quarter of assets. Top holding BHP Billition, the world’s largest mining company, makes up about 15% of the fund, while mining giant Rio Tinto accounts for another 3.5% of EWA (see more holdings of EWA). These two firms could be especially hard hit by the mining tax; some analysts are forecasting that Rio Tinto’s earnings could fall by as much as 30% while BHP could see a drop of more than 19% in its earnings. This suggests that if the tax gets put into place, it could have a devastating effect on EWA’s returns.

Small Cap Fund Also Impacted

Generally, small cap equities tend to shy away from capital intensive business ventures such as mining. But the IQ Australia Small Cap ETF (KROO), which invests in small cap Australian equities, also has significant exposure to materials companies;this sector accounts for more than a quarter of assets (see more information on KROO’s fact sheet). As such, KROO will also be in focus as debate over the proposed tax continues.

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Disclosure: Eric is long EWA.