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Commodity rush: turnaround…or a dead cat?

Significant gains over the past few days may cloud judgement over commodity cycle turnaround.

Even though the JSE closed in the red, Tuesday was another good day for resource stocks with many companies boasting significant gains. Kumba Iron Ore was up 8.44%, Assore rose by 9.63%, while the platinum miners Anglo American Platinum and Impala Platinum gaining 7.42% and 7.55% respectively. The gold stocks also performed well, but to a lesser extent. Harmony Gold (4.27%) and AngloGold Ashanti (4.46%), among others, were also in the black.

This was the second run in as many (South African business) days. Kumba also rose by 11% on Friday in response to an increase in iron ore prices. BHP Billiton, though it lost some ground on Tuesday, also climbed by about 3.5% on the day.

So, could this be the beginning of the turnaround in commodity stocks that the industry has so desperately been waiting for? Ryan Wibberley, Investec Asset Management’s head of dealing for emerging and frontier markets, says it’s too early to tell but argues that it could be.

 “The majority of general equity portfolios in South Africa, at the moment, are significantly underweight when it comes to resources. That is, they are holding less than the benchmark of those stocks…and these massive funds now start thinking that it is the time to move money from yesterday’s winners, like the Naspers and banking counters, into resources,” says  Wibberley

Other reasons for this apparent spike in prices is a sense of anticipation that the Chinese government will again thrust money into the economy to stimulate growth – a move that will improve the fortunes of the commodities sector dramatically and strengthen the US dollar.

“There’s a bit of caution ahead of Wednesday’s decision by the Federal Reserve whether to increase interest rates, while US GDP performance figures for the first quarter will also be released. This, along with the close monitoring of what will happen in China, has created this bull run in commodities,” says Wibberly.   

Peter Major describes what is happening as “some kind of dead cat bounce”.

“I am worried that most of these commodity prices are still a bit too high compared to where we are in the world economic cycle and compared to where these commodities have traded historically for the past 120 years,” he says. 

Major thinks it would be naïve to believe that we are already at the beginning of a turning point for resources. He says share prices, unlike commodity prices, do not reflect today’s reality. Rather, they reflect what investors believe will happen to commodity prices in 12 to 18 months’ time, and are thus overly sensitive to the whims of immediate sentiment.

Says Major: “Oil and iron ore are clear examples of commodities that have remained too expensive for far too long. And we saw that with how quickly they fell last year. But by coming down too quickly, instead of gradually, they were bound to bounce. And that’s just how share prices work. Sentiment will always exaggerate the moves in commodity shares, much more than the commodity prices themselves, whether it is overly positive or overly negative. I think Kumba Iron Ore did fall too far. As did ARM and possibly Impala Platinum. But now the gains we are seeing are also look they are going beyond where they should.”

The key driver for such bounces, according to Major, is a common perception that after commodity prices fall drastically and then remain a certain level for a while, people start believing this is a safe and firm base and can now only move upwards. Many people do not consider that most commodities have now only come back down to their long-term averages and nothing more. People forget that in the 80s and 90s most commodities traded below their long-term means!”

“I worry that all of these commodities are still likely to come back down to the lows of where they were a week, or a month ago. They might not come down a lot lower, but they can certainly revisit recent lows and quite possibly fall more. 

“But to think reverting to the mean as the new low is wishful thinking in my book. In the 80s and 90s, oil was trading at $35 barrel for 15 years in today’s prices.  And gold averaged maybe $600 per ounce then. So how could we be at the bottom of the cycle now?” he asks.

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