While the RBA rate cut is good news for the Aussie share market, the utter collapse in global commodity prices is not. This week the CRB commodities index fell the most in over 50 years—the most ever in such a short period. What is going on and where will commodity prices go from here?
Three factors have contributed to the huge reversal in resource prices. First is the global rush to cash. Investors have voluntarily liquidated positions they've held for years in order to be in cash and out of the markets.
Second, there's a perception that the credit crunch is morphing into a synchronised global recession that will hit emerging markets especially hard. This is another reason for the fall on the CRB commodities index, as emerging market growth has been especially resource intensive.
Third, you have the collapse of leverage. This is crushing the hedge fund business, which thrived by borrowing huge amounts of money to invest in rising asset classes. Now that the money has dried up, the whole hedge fund business model (like the investment banking model) is collapsing. Leveraged bets on commodities and commodity stocks are being ferociously unwound as access to credit evaporates.
So is there a light at the end of the tunnel? Yes. But it could take longer than anyone expects. Global-deleveraging hits at the consumer as well as the corporate level. American consumers, who've kept the world turning with borrowed money and an economy geared to consumption, are spent. They'll have to start saving, paying down debts, and living beneath their means.
Love him or loathe him, it will not be easy to replace the American consumer as the engine of global growth. The new engine is in Asia. But it's still in the factory as well. Asian economies still have high savings rates and high rates of investment in fixed capital. They're still producing things instead of buying them.
Eventually, Asia will become the world's biggest consumer too. Resource investors should realise this big shift is in process, and that by virtue of its proximity to the next great markets, and by luck of its massive endowment of energy and industrial commodities, Australia's going to do just fine.
Between now and then, though, it's going to be tough, expect more volatility in the CRB commodities index. Lack of credit and falling commodity prices are going to wipe out a lot of the smaller explorers in Australia. So what should you be looking for? Which Aussie juniors are going to survive? More on that tomorrow from Diggers and Drillers editor Al Robinson. He says you want to favour cash...and sort out who's most exposed to leverage.
Dan Denning
The Daily Reckoning Australia
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Related Articles:
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- Commodity Inflation Causes Consumers to Cut Back on Spending
- The Aussie Dollar as a Measure of Global Risk Appetite
- Gold, Commodities and Markets
- Every Investor in Commodities Should Know China is their Biggest Buyer
About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by Curt on 9 October 2008:
But Gold is over 900 today, as investors begin to realize it is safer then cash.
Comment by Robert on 9 October 2008:
Gold is not much better than cash. If things really get bad you won't be able to make use of Gold either - do you want to throw it at somebody if they try to steal your rice or bread? A gun would be preferable. The problem is that you can't go to an extreme and buy either only gold, stick to cash....or buy guns and rice. The current volatile situation requires idividuals to deleverage if they can and find a mix of all of the above.
The ideal situation if things really get bad is a self-sustainable farm far away from civilisation, loads of antibiotics and medication stocked, solar sytem, water, rice etc. If things do not get that bad, you might lose your assets, jobs, go bankrupt etc...but things will stabilise eventually and in the long run you will be ok.
It's a simple lesson in history!!!!
Comment by john on 11 October 2008:
gold can be worse than cash if everyone starts dumping it...
but if you've got alot of excess cash thats not a bad thing-
it could reach record lows, buying at record lows could change your fortunes from being a junior to one of the major players in the industry.
what goes down, will eventually go back up.
i bet the price of gas will drop also, so as an investment
a mining operation could continue to stockpile assets.
if things really get bad, hiding in a farm won't be the way to go for the young though.
you should be ready to join the armed forces to stop foreigners from taking the rich lands away.