Economic e-News - November 2016

By Craig Turnbull
Chief Investment Officer


Is the commodity cycle on the way up again?

Over the last two years, commodity prices sunk to historic lows on the back of soft global growth and falling capital investment in many of the world’s advanced economies.

But since the beginning of this year, there has been a rebound in spot prices for a range of commodities including one of Australia’s key exports, iron ore.

enews aug graph

Source: YCharts

What is driving up the price of iron ore?

The spot price for iron ore slumped to just US$41 per tonne by the end of 2015. However, since the start of the year, the price has rallied, reaching US$59 by the end of October.

China has been a major factor. Annual GDP growth in China has stabilised at 6.7% and despite restrictions on property speculation, new construction remains at healthy levels

More building activity requires more steel which in turn requires more iron ore. However, the global supply is limited largely due to many higher-cost producers being squeezed out when prices tumbled.

But will the rally last?

The latest Chinese Manufacturing Purchasing Managers’ Index (PMI) paints a positive outlook. The October PMI figure of 51.2 is the highest since mid-2014 and suggests the manufacturing sector in China is set to grow.

Some commentators are also looking beyond China; arguing that there is also an enormous need for infrastructure throughout Asia, particularly in the expanding cities of Jakarta and Manila.

Nevertheless, commodities are inherently volatile and price movements can be difficult to predict over the medium to long term.

What does it mean for the Australian economy?

There’s no doubt that higher iron ore prices are good for the Australian economy. In fact, our terms of trade, which is the ratio of export prices to import prices, is finally on the rise after steadily falling for more than two years.

The price rise has fattened the export revenues of our two largest iron ore producers, BHP Billiton and Rio Tinto, and their share prices have rebounded strongly since the start of the year.

Job vacancies have also begun to rise across the mining and resources sector for the first time in almost three years, however; most of these vacancies have been for temporary, not permanent positions.

All this activity is expected to flow through to our GDP growth rate and into tax revenues which may help to reduce our Budget deficit over the medium term.

A rise in commodity prices usually means a higher dollar and although it has strengthened in recent months, expectation of a December interest rate rise in the US has kept the lid on the Australian dollar at around the US$0.77 level.

And this is currently making Australian commodities, particularly iron ore, even more competitive on world markets.

What does this mean for investors?

Many investors sold out of mining shares at the end of the mining boom when commodity prices tumbled. In the case of coal, many divested altogether due to concerns about the long-term viability of fossil fuels.

We may have seen the bottom of the commodity cycle but with global growth remaining below the long-term trend, it’s highly unlikely that commodity prices and mining shares will surge back to the peaks achieved during the mining boom.

However, stronger commodity prices will benefit the broader economy and may spell the end to further interest rate cuts in the short term.

 

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Markets at a glance

for the month ending 31 October 2016

downArrow Australian sharesdown by 2.15%
upArrow Australian Government Bonds yield2 up to 2.305%
downArrow Australian dollar down to US$0.7613
noArrow Cash ratesteady at 1.5%
downArrow International sharesdown by 2.01%

 

1 ASX 200 Accumulation Index
2 Yield on 10 year Australian Government Bonds
3 RBA cash rate
4 MSCI – World ex Australia (USD)

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