A Bear Market Where You Least Expect.
While events in the US and Europe impact the Aussie market, events in China are far more important as they will affect our economy.
There are now two competing China narratives. One is that the decade long China led resources boom is over.
The other is that China is undergoing a managed slowdown and demand for Australia’s raw materials will soon pick back up. This being the case, the recent collapse in iron ore and coal prices will soon reverse.
But it’s not quite as simple as that.
There are two parts to the commodity story. Two very different parts.
What if I told you that many of the commodities Australia produces have been in a long bear market? You probably wouldn’t believe me.
Check out the following chart…
It shows the Reuters/Jefferies CRB index (a US dollar index) priced in Aussie dollars. The index includes all commodities including base metals, agriculture, energy and precious metals. It excludes bulk commodities like iron ore and coal.
There are a few points to note about this chart…
For many Aussie based commodity producers (who denominate revenues and costs in Aussie dollars) there has been no price boom. Making things worse, cost inflation over the decade, coupled with a price collapse since 2009, means profitability for many producers must be near all-time lows.
The other obvious conclusion to draw is that if other commodities are in the doldrums, the bulk commodities — coal and iron ore — must have been doing all the heavy lifting. In other words, the commodity boom, especially over the past few years, has been dangerously narrow.
That’s not a particularly huge revelation. But if the commodity and terms of trade boom are all about Chinese steel production and the coal and iron ore that feeds it, then you have to wonder about the fundamentals of the Aussie dollar.
In my view the iron ore and coal bubble is in the process of going bust. A bubble bust is a process where prices ALWAYS overshoot on their mean reversion journey.
Those hoping that bulk commodity prices will rebound strongly or that further Chinese stimulus will come to the rescue are unwittingly churning out that well-worn phrase…this time is different.
My conclusion? The Aussie dollar is way overvalued. It must fall to restore competitiveness and profitability to our ‘other’ commodity industries, not to mention to the benefit of other non-commodity sectors.
Editor, Sound Money. Sound Investments.
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