FYI | Aug 13 2008
I am not seeking to be sensationalist just for the sake of it, but I am nevertheless making the following statement with an iron conviction: if the dust has settled post the current price correction across the commodities complex it will have turned out to be the most severe correction investors have seen for many, many years. It will certainly be much bigger than anything they have seen since 2002, when the initial beginnings surfaced of what later became a once-in-a-lifetime Super Boom for commodities.
The good news is that commodities and investors, both true to their inner nature, will casually overshoot in their current direction and thus prices for base materials, and for shares in companies related to those materials, will become much cheaper than can be justified on fundamental grounds. Thus a fertile base will have been created for the next leg of what we all have come to know as the Commodities Super Cycle.
Yes, and of course!, this story is far from over, if one takes a longer term view. From a shorter distance, however, this will look like a running train passing by at high speed. Better to take a step back and take your time.
Strictly taken this correction is already a few weeks old (and I happily refer to various stories I wrote on this matter already over the past months), as such the impact on prices of base materials, and of share prices of listed companies, has already been significant. I therefore must assume that many among you are getting ready to spot the first signals of a bottoming process, and then jump back in. Unfortunately, this correction won’t be over tomorrow, and prices are likely to fall much, much lower than where they are now.
It’s a brave man who dares to call an exact date when this correction will have run its course. Resources specialists at Citi believe a rally sometime in the final quarter of calendar 2008 is to be expected. Economists at Westpac predict prices for most commodities will be back at June’s lofty levels by the end of 2009. I can see an argument for both scenarios. Citi’s time schedule fits in with the fact that everything appears to take place at a much faster pace these days. There’s much more money flowing around, in and out of assets, and back in again. The speed and the magnitude of the correction since June/July can easily serve as a prime example of this.
But I can also come up with various scenarios that could delay any recovery for the sector until 2010 instead. It is this uncertainty that is currently pulling investors out of the sector. Better to return when a clearer picture has emerged. It is the latter sentence that will be key to any sustainable rebound for the sector: signs that demand-supply dynamics are improving instead of deteriorating.
Right now the overall context for commodities is deteriorating, and quite rapidly so. This is mainly because the global economy is having a hard time; the world is slowing down. This is probably best illustrated by the fact that I don’t seem to be able to open a research document on a given country these days -be it Germany, Italy, Japan, Estonia or Argentina- without a few chapters in it about the possibility of that particular economy facing a recession. Of course, the world will be in true dire straits if every single economy on the planet were experiencing a recession between now and mid-2009, but this does show the current overall mood inside the global financial sector. Also, while on an individual basis there is a certain chance for each country to suffer a recession, in reality some of them might, but most of them probably won’t.
Apart from all this, I believe the world is more often than not too focused on the exact semantics behind these particular events. Recession or no recession? And according to which rules and principles? Who cares, really? The core message behind all of the above paragraphs should be: the world is slowing. Pure logic tells us demand should slow as well. China may now be more important for various commodities than any other country in the world, but China simply cannot be more important than the world in its entirety.
What’s more: China’s economy is slowing too and since we’ve collectively put the country on a pedestal as the Immaculate God for all Commodities, this has really scared the bejezus out of many a financial speculator. To make matters worse: we are arguably only at the early stages of this process. This puts the odds in favour of 2009 marking a lower point for global economic growth than 2008.
Now re-read my opening paragraph. Does it make sense?
Help is onh the way, as governments and central banks will seek to prevent the worst scenarios from materialising. This also applies to China. As such, none of the above is set in stone. On the flipside, uncertainty about the resilience of global growth, and demand, could dominate until late this year, or even into 2009. History shows investors can move quickly in pricing in the coming upturn, but before this can happen, it first has to become feasible and visible. Hope can only last so long.
This is why the current correction for commodities won’t be over anytime soon. My gut feeling tells me that Citi’s prediction of a rally in the fourth quarter is probably the fastest possible scenario, and that the opening quarter of 2009 might subsequently still prove that investors have – once again – been a little too hopeful too fast. But we’ll only know this by the time we get there.
As far as interest rate cuts are concerned, it’s probably a fair assumption that investors are currently too hopeful on this matter as well. As a result, interest rates in Australia (as possibly elsewhere too) might not come down as quickly as currently anticipated – though the prospects for lower commodity prices certainly should help calm any fears about sustained high inflation across the globe.
Investors in Australia might want to take note from a recent analysis by economists at Macquarie who found that unemployment rates and consumer spending tend to reach their respective peak and bottom about nine months after the Reserve Bank of Australia starts cutting interest rates. If the same holds true this time around, and on the assumption that September will see the first RBA interest rate cut, economic indicators in Australia are likely to remain weak until at least mid-next year.
External factors such as the credit crunch and the direction of the US dollar aside, this will likely determine whether the next upswing for retailers, banks and other industrial companies might prove sustainable or not.
Bottomline: we seem to be at the beginning of everything, really (including the beginning of the end of the bear market).
With those thoughts I leave you this week. Till next week!
Your editor,
Rudi Filapek-Vandyck
(as always firmly supported by Andrew, Greg, Chris, Grahame, Joyce, George, Pat, Sarah, Todd and Paula)
P.S. I will be featuring as an expert guest on Sky Business’ Business View again this Saturday from 9-10am. And for those who have read my quotes in today’s Wealth section of the Australian newspaper: the above probably explains it all, I assume?
