Limit up in commodities

There will be plenty of talk about 6000 points for the ASX this week as commodities, specifically iron ore, leg higher.

Iron Ore
Source: Bloomberg

I am all for championing a rally in commodities and all for a cyclical change to the commodities market for two reasons:

  1. It illustrates growth is returning – an uptick in commodities means confidence in major investment is returning and projects are being developed.
  2. It also means liquidity is flowing to places of investment rather than pilling into narrowing cash trades – that promotes employment and wealth.

Monies should be put to work – currently there is plenty of passive earnings. Good for the investor not for the collective – industrial commodities are a good indication of money at work.

So, it is nice to see things like iron ore bouncing and some global liquidity returning to this area after a two year decline. Last week’s trade saw iron ore entering ‘bull market’ after a 22% increase.

However, it is here that I caution the rise in the near term – the supply/demand fundamentals in iron ore and even oil have not changed in the past week – particularly iron ore. Oil has seen change to its supply side as the US dials down drill rigs in the south of the country, however, US crude inventories still remain at record highs which is likely to flow into the market over the coming month. Once the inventory levels return to historical norms then oil is likely to maintain a high price.

Iron ore, however, has seen no fundamental change to supply – in fact quite the opposite having seen quarterly reports from Rio and BHP last week. Both are on track to deliver record production numbers - BHP even lifted guidance by 2%. Supply gluts are still coming as China has not announced any major acceleration of infrastructure projects in the past few weeks.

It is this expectation coupled with China’s mass move on reserve requirement ratio that appears to be the reasoning for the rally in iron ore. The spot price and the futures have clearly reacted to the news and anyone short in iron ore today is going to wish they had closed out Friday having seen futures over the weekend legging up a further 5.5%.

But one week does not make a trend. Nor does it mean the down trend of the past two years is broken. If iron ore can sustain these prices for a month then we will know China is back in the game and is absorbing the supply glut and that yes iron ore will return to more sustainable levels. (Something I see happening at the back end of this calendar year just not yet). But, be aware the trend hasn’t been broken and a snap back is likely – the futures market has been a leading indicator of the spot price something to watch over the coming week if it becomes exhausted the spot price will follow just as quick.

Ahead of Australian open

We are calling the ASX 200 up 41 points to 5975 – back within striking distance of the 6000 point mark, however the resistance there is massively strong. I am not sure it will break without support from a rate cut and a further surge in the iron ore price.

What may help cross the resistance line is the banks all report early next week. History shows solid rallies the week before reporting - expectations of increased dividends over the past four years has been the main reason for this rally. However, the lowering of expectations around the RBA and the fact ANZ and NAB have some overhanging risk (Asia and the UK) in their numbers means the rally may not be as strong as previous years.

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