Pete Wargent blogspot

CEO AllenWargent Property Buyers, & WargentAdvisory (institutional). 6 x finance author.

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Tuesday, 2 June 2015

Commodity prices cascade lower

Rates on hold

The Reserve Bank of Australia (RBA) kept interest rates on hold today as expected, but with every chance that interest rates could have further to fall yet through this easing cycle.

Nothing of too much excitement in today's release, in the event. 

Earlier this week, the Reserve Bank released its Index of Commodity Prices for the month of May 2015.

Let's take a look at, and particularly at what it means for investors...

Crunch continues

Australia's terms of trade were crunched in the first quarter of the year, and it doesn't look as though the second quarter is shaping up all that much better.

The Index of Commodity Prices has been whacked by an excruciating 19.5 per cent over the past year in SDR terms.

The drivers of yet further declines in May were once again falls in the prices of thermal coal and coking coal.



Given that the index is very heavily weighted towards Australia's most important export commodities  - iron ore and coal - it is unsurprising that the driver through this cycle has been the collapse in, um, iron ore and coal prices, effectively denoted by the "bulk commodities" red line in the chart below.

Wowsers.


In theory the chart should be a little flatter in Aussie dollar terms as the currency adjusts downwards.

Well, yeeees, but the index is still down by a gut-wrenching 13.5 per cent in Australian dollar terms over the past year.


Meaning?

What does this mean for investors, broadly speaking?

Firstly, and most obviously, on the share markets the resources index has under-performed the industrials and financials, as has indeed been the case for some years now.

In particular, the industrials with exposure to the declining Australian dollar seem likely to continue to outperform the wider market.

Secondly, as the Reserve Bank noted in its Media Release today, a lower dollar is "both likely and necessary" to support our export prices - so we might expect to see low interest rates for some time to come.

Thirdly, from a real estate market perspective, the pain for a number of mining towns and resources regions has no end yet in sight.

So many of our resources regions built extensively to accommodate new workers as the mining boom surged ahead.

Now we are coming down the other side of the investment boom, and as workers are relieved of employment and skip town vacancy rates are rising, while conversely rents and prices are declining. 

This is not a healthy dynamic for many regional towns.

Fourthly, and finally, if you have an investment strategy based around the hope that new mining projects will get up in order to dig rocks out of the ground...you might just want to double-check that you don't also have rocks in your noggin.

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National Accounts for the first quarter of 2015 to follow in the morning!