Why it’s Crisis Time for Aussie Stocks: Don’t Get Caught Out.
It can be a laugh a minute here in our office, squashed between the traffic and trams on Fitzroy Street at the front, and garbage bins and smoko breaks in Scoops Lane at the back.
For instance, this morning your editor, and our old pal, Sound Money.Sound Investments editor, Greg Canavan started off the morning by discussing inflation, what causes it, and why price inflation isn’t happening right now.
See, we told you…a laugh a minute.
That’s not all. Yesterday one of our other pals, Nick Hubble, told us a story of a 1,000 year-old fish trap. The story was so good he published it in the Daily Reckoning. And you can read about it later in today’s guest essay.
But before that, more trouble for Aussie resources stocks. What the mainstream analysts thought would happen hasn’t happened, which means what we thought would happen looks set to happen. Confused? We’ll explain more below…
According to Reuters:
‘Iron ore shipments to China from Port Hedland, a bellwether for Chinese industrial activity, fell by 9.5 per cent in September from the previous month to be flat on the year, port authority data showed.’
Unless you’ve been living under a rock you’ll know that the iron ore price has crashed this year. From the start of July to the end of August, the price fell from USD$135 per tonne, to USD$95 per tonne:
Since then the price went as low as USD$86 per tonne, and has now recovered to around USD$100 per tonne.
So, what’s the big deal?
Well, if you’d listened to the mainstream analysis, a falling iron ore price should have been good news for iron ore miners. Why? Here’s what Fairfax economics columnist Ross Gittins had to say in July:
‘A widespread fear – or maybe for some, a hope – is that the resources boom will evaporate someday soon. What will we do once it’s over, a lot of people ask. Well, this week we got an answer: export at least twice the minerals and energy we do today.’
The ‘resources boom will evaporate someday soon’? How about the fact that it has already evaporated?
They’re too busy looking at what’s happening today and assuming that the good times will last forever. That’s why when the mainstream cheered the US market higher in 2007, our old pal Dan Denning told his subscribers to sell US stocks before it was too late.
It’s why we told you to stop and think before you risked taking out a big mortgage from 2007 to 2010. While the mainstream insisted Australia was different, we warned that what caused the Aussie house price boom was the same thing that caused the US and European house price booms — easy credit.
That was despite the mainstream commentators claiming that the Aussie market was different because many Aussie houses had ‘marvellous water views’, were better built, and Australia had a chronic undersupply.
All of those arguments were false.
And it didn’t stop Aussie house prices falling. And if we’re right, despite the wishes of the housing bulls, Aussie house prices have plenty of room to fall…30-40% from here is our bet.
The fact is lower prices don’t always mean increased demand. The relationship between supply, demand and price isn’t always linear. In other words, cutting a price by 50% won’t always double the demand.
That’s especially true when a credit boom caused the initial high demand.
You’ve seen that with house prices. Aussie house prices have already dropped and yet volumes are near record lows.
And iron ore prices dropped 30% in two months and yet demand was the same.
But when the credit boom ends, businesses realise the boom wasn’t sustainable. So rather than spending more to take advantage of lower prices, businesses are more likely to get out while they can. They realise the error and decide to downsize and sell while they can.
It’s a basic human and market reaction. You see it in the stock market all the time.
If the mainstream was right, that falling prices simply double the demand, then share prices would never fall. Or if they did fall the price would quickly recover. Because you would always get twice as many buyers propping up the price.
But that doesn’t happen. When a share price falls, investors start to re-evaluate the investment. Investors question the value they’ve put on the shares.
Many investors — especially those who bought assuming the price will always go up — realise the error of their analysis and sell…even though the shares are cheaper than they were before. Based on mainstream analysis, this should cause investors to buy more shares rather than sell.
In short, it’s important to remember that share investing isn’t a zero sum game. There isn’t an automatic positive feedback loop where falling prices lead to rising demand, which leads to rising prices.
Yes, falling prices can increase demand, but it doesn’t always lead to a positive outcome for all businesses.
Business and economics isn’t that straight forward. Economics isn’t purely a numbers game. Economics is about human action and reaction. That’s not something you can easily put into a spreadsheet or calculator.
The Aussie economy is going through a big shift right now. Sitting back and assuming everything will be fine because it has been fine during 20 years of economic growth is a big mistake.
The Aussie resources boom is over. It’s time to move on and plan your investments for the next stage.
Cheers.
Kris Sayce.
This article is contributed by Money Morning. Click Here to Subscribe to their free newsletter.
