Has the resources market reached its nadir?

Like all investors, StockAnalysis keeps asking whether the terrible market for resources has reached its nadir. We think that the bottom is very close indeed and that recovery during 2016 looks ever more certain.

The really confusing part of this strategy is to separate performance of the broader market, driven by a small number of large, high dividend paying income stocks like the large financial, retail and property companies from the other 97 per cent of stocks that have effectively been in down-trend for seven years.

The Bloomberg Commodity Price Index tells this story clearly. After a long and relatively flat period for commodity prices during the 1990s, commodity prices took off in 2001. Under the influence of an urbanising China and a decade of underinvestment in new productive capacity, prices for bulk commodities like coal, iron ore and oil took off.

Prices for bulks were variously followed up by prices for precious and industrial metals, reaching a crescendo during 2007/8 before plummeting during the Global Financial Crisis in 2008/9 and recovering into 2010/11.

The rot then set in with a gradual decline of prices into 2014, followed by capitulation from mid 2014 in the form of a collapse in commodity prices, well below marginal production costs for coal, iron ore and oil, accompanied by much weaker base metal prices.

StockAnalysis has highlighted the ASX 200 Resources Index which is now trading back at 2005 levels. However if we want to see a market in deep depression we need look no further than the ASX Small Resources Index.

The scale of this bubble is impressive. From a level of around 1,000 in October 2003, the Index peaked at around 7,170 in May 2008 and has recently traded intraday, back at 1,200.

While the Bloomberg Commodity Index rose 2.7 fold during the resources boom, the Small Resources Index increased seven fold, driven by cheap money, risk-on investing and a China driven, local mining boom the likes of which we may not see again for many a year.

One encouraging aspect of this study is the idea that both the underlying commodity prices and the price of shares that rely on commodities for their lifeblood financing, have now returned to historic levels from which further falls appear to be both unlikely and financially unsustainable over the medium to long term.

Also providing encouragement, sales of iron ore out of Port Hedland are running at record levels, about 30-40 MMt/a ahead of the same period last year. Meanwhile, the Baltic Dry Index of shipping costs for bulk commodities appears to be making a slight recovery. This may indicate an improvement in demand for ships transporting oil and other bulk commodities.

Peter Strachan is the author of StockAnalysis, a leading-edge, independent news source focused on stock market news, analysis and recommendations.

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