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.
The Daily Reckoning Australia