La Correction Nouvelle Est Arrive!

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

This story was first published two days ago in the form of an email sent to registered FNArena readers.

By Rudi Filapek-Vandyck, editor FNArena

Let’s go straight to business this week: if it feels like a correction, smells like one and certainly has the look of it, it probably is a correction. You are witnessing one right now.

The good news is that we are not about to see a repeat of the global sell-off from mid-August. On the flipside, better not to expect a swift rebound like we saw in the weeks post the August sell-down either.

For weeks I have been struggling with the question: could it be? Could it be possible that despite the prospects of slowing global growth, of downgrades to corporate earnings forecasts and of continuous ominous signals from global debt and credit markets,.. that equity markets can still hold their strength? Saved maybe by BHP Billiton’s ((BHP)) deal of the decade proposal to shareholders of Rio Tinto ((RIO))?

The answer is: of course not! Last week I wrote it was BHP-Rio against the world. Unfortunately, even with the two potentially creating a corporate giant (top five in the world), the weight of a slowing global economy still gained the upper hand – but then it always would. This was an unequal battle from the start.

Here’s some more good news: we’ve seen this all before. As a matter of fact, resources specialists at Citi reported this week that since the world woke up to the wonders of the Commodities Super Cycle in 2004 prices for base metals have “corrected” on average two to three times each year, and each time the cause was worries about global growth and demand.

This time is no different.

What is different is that we are three months further than where we were back in August and -with the exception of BHP-Rio- the news hasn’t become any better. There’s no need to dissect all the recent company announcements and economic data – the best proof any investor can see and understand is the fact that global equity markets are back at levels near or even below their levels at the time of the first Federal Reserve rate cut in September.

Allow me to rephrase the previous sentence: after 75 basis points in official US rate cuts (and not to mention the extra liquidity provided by global central banks) most equity markets around the world haven’t advanced at all – in net terms.

In fact, several major indices such as the S&P500 (US shares), CAC40 (French market) and the FTSE100 (UK market) appear to be heading towards a test of their mid-August lows, indicating that even the rapid recovery post the initial scare in August may soon have completely evaporated from these markets. And, it has to be emphasised: this despite 75 basis points of cuts in official US interest rates.

The world fears a US recession, regardless whether the US Fed follows through with another interest rate cut in December. And nowhere is this more obvious than in the base metals sector.

Most base metals prices have taken some severe beatings over the past few trading sessions. This in itself is not unusual as spot prices and futures markets can get very volatile. But after several weeks of gradually lower trending prices several metals have now fallen through key technical support levels.

Copper, widely regarded as the benchmark for global economic growth, even managed to sink through two key support levels on Monday (European time).

Gold has now fallen below its so-called rising trend line.

The good news, among all these negative omens, is that nobody believes this is where the Super Cycle ends. The story of China, India, BRIC economies and Emerging Asia is far from over -in fact that story still has many decades to run- it’s just that the switch in economic momentum is not mature enough yet. The US economy may no longer be as important as it was at the turn of the century, it still is the largest across the globe and if the US will experience a recession this will thus by default have an impact elsewhere.

Three more years.

According to economists at DBS Group that’s the time it will take for Emerging Asia, including China and India, to deliver a larger contribution to global economic growth than the US economy. After that, the gap will only widen and widen further.

Presently Asia’s domestic demand (excluding Japan) is 38% as large as the US. So if US domestic demand is $100, then Asia’s is $38. In terms of relative breakdowns, China accounts for about $16, the Asia eight for another $16 and India for $5. (With a little rounding error, it adds up to $38.)

If US domestic demand last year was $100 and it grows at a 3% rate -as it used to- it will generate $3 of fresh demand this year. Asia’s domestic demand, however, typically grows at a 7% rate. On a $38 base, that generates about $2.70 of fresh demand this year, or about 90 cents of fresh demand for every dollar generated by the US.

Even if the US economy will manage to recover relatively quickly from its US housing sector led economic slowdown, as the optimists are assuming, Emerging Asia will still take over as the main driver of global economic growth in three years from now.

Imagine for a second what that will do to the mindset of investors across the globe.

But right now what matters most is the fact that US consumers are being hit with higher gasoline bills and with higher food prices while they’ve lost the wealth support from rising house prices at a time that US lenders are still tightening their standards amidst indications that businesses have stopped spending.

There’s a fair chance that economic data from the US will be weak for weeks, if not months, to come. And the damage to global financial institutions from the subprime mortgages market is far from over still.

Investors might also want to take into account that prices for most commodities, including crude oil, are expected to trend lower next year, with the exception of bulk commodities such as iron ore and coal for which big price increases should be achieved by the main producers.

As such the current price correction is bound to open up bargains and opportunities, though the road ahead will remain winding and windy – possibly for longer than you and I are currently willing to contemplate.

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