Warren Buffett is a master of aphorisms. He once said, ‘never ask a barber if you need a haircut’. I don’t know if he coined the phrase, but he certainly popularised it.
His point, of course, was that you should never solicit biased advice. Never ask a stock broker whether you should buy stocks…don’t ask a real estate agent whether now is a good time to buy property. (Of course it is!)
Or, for example, don’t ask Rio Tinto [ASX:RIO] whether iron ore is a buy.
In a major iron ore presentation given in September, Rio was still upbeat on its long term outlook. One of the dot points in the presentation was a long (and now grimly) held forecast that china’s crude steel production was expected to reach around 1 billion tonnes by 2030.
This forecast is behind Rio’s decision to invest hundreds of millions of dollars into expanding iron ore production in recent years. In fact, all the iron ore producers believed in rising Chinese steel production for many years. ‘Stronger for longer’, was the neat little slogan.
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Yesterday, China’s official forecaster finally put such pie-in-the-sky forecasts to rest. According to the Financial Review:
‘China’s steel production will not recover next year, according to its official government forecaster, which believes demand for iron ore will decline by 4.2 per cent.
‘The report released on Monday by the China Metallurgical Industry Planning and Research Institute predicts steel production will fall 3.1 per cent to 781 million tonnes in 2016, as economic growth continues to moderate.’
Further along in the article, there’s this:
‘Despite this consensus view, Australia’s two largest iron ore miners, BHP Billiton and Rio Tinto, refuse to believe China’s steel production has peaked.
‘Both are forecasting the peak to come the middle of next decade at or above 1 billion tonnes.’
Call me sceptical, but I think the barbers are wrong. The only haircuts on offer right now are for the shareholders of the iron ore miners. The iron ore price fell heavily again yesterday. The price is now into the US$30 per tonne range.
To be fair though, it’s not just iron ore under pressure. Oil is in all sorts of problems as well. From Bloomberg:
‘Oil fell to the lowest level in more than six years amid speculation that a record global glut will be prolonged after OPEC effectively abandoned its longtime strategy of limiting output to control prices.’
West Texas crude plunged nearly 6% overnight, while Brent crude wasn’t far behind, down 5.3%. Aussie energy stocks fell hard yesterday afternoon, and will probably do so again today.
Most other commodities were under pressure too.
Speculators are clearly using the Federal Reserve’s upcoming interest rate decision to milk existing trends. That is, to sell commodities and nearly all non US dollar assets, while pushing the greenback higher.
Financial markets have turned into a giant casino. It’s very difficult to separate real economic influences from the effect of speculative capital flows.
These days, speculative capital preys on central bank announcements. In effect, central bankers guide capital around the world. It is no longer driven by real economic activity. That’s why markets are so unstable. They aren’t ‘natural’.
Given this situation, don’t be surprised if you see a huge reversal of these bearish commodity trades following the Fed’s interest rate announcement next week.
There’s a well-known saying in markets — buy the rumour and sell the fact. That is, trade on the rumour of something happening (a US interest rate rise) and then reverse that trade when the news hits.
Given the trading extremes seen in recent months on the back of this long awaited interest rate rise, don’t be surprised to see a big ‘sell the fact’ trade unfold post announcement.
It’s not just commodities under pressure though. Even Aussie property is faltering. Yesterday, new real estate agency listing McGrath Limited sank 12% from its issue price. Markets have a knack of picking tops with new listings, so perhaps this is a bad omen for the Melbourne and Sydney property markets…at least for the time being.
The upshot of all this is that central bankers have created a very destabilising backdrop for investors. It’s a split market. Some asset prices are sky high and others just keep falling.
This is why I’ve long recommended investors hold plenty of cash. While there are definitely investment opportunities out there, there are major issues too. Overvalued stock markets combined with a challenging economic outlook are hardly conducive to going ‘all-in’ on stocks.
When cash seems useless to hold, that’s when it’s worth having some.
Having a big cash balance also allows you to take a punt on a potential big winner, without putting your portfolio at risk. I’ve just published a special report on a stock that has the potential to be a ‘10-bagger’.
It’s high risk, for sure. You don’t get the potential to make 10 times your money without taking on some risk. But I use a strategy that helps reduce your risk significantly while still giving you a potential upside.
It’s a simply strategy. It just requires a little discipline on your behalf to follow it. If you’re interested in how this is done, click here to read my free report.
The problem that most investors make when punting on high potential reward opportunities is that they put too much of their capital into it. They see the end result and don’t think about the potential for loss.
This is the wrong way of thinking about it. You need to first ask: what can I lose here? Setting a stop loss point (an exit point) is the first step to managing risk. But you must adhere to your stop loss.
I only ever recommend putting 1–2% of your capital into these high potential return situations. Even so, if you find a ’10-bagger’, it will still make a massive difference to your overall portfolio. Do the math.
To find out more about the next ASX potential 10-bagger stock, click here.
For The Daily Reckoning