Tuesday, March 10, 2009

Commodities wait to bat a bouncer in long test series

While spending the weekend watching the reincarnation of Doug Walters (Phil Hughes is his name) carving out twin centuries against the arrogant Boks there was something bugging me – which I will come back to later. My infatuation with Doug Walters stems from him coming to speak at a sportsman night while I was at university. He arrived Friday night and left Sunday afternoon – he didn't unpack his bag or use his bed, and was not sighted without a smoke in one hand and a beer in the other. He is right up there with Boonie as one of my favourites. Oh, and by the way ProFarmer backed the Aussie to win the series in SA – not out of some misguided sense of loyalty but on the basis they were $11 and I thought they were not that far away in the series they lost in Australia. I was delighted to see Mitchell Johnson find his inswinger again, but someone needs to tell Graeme Smith that it works better if he hits the ball with his bat and not his thumb.

It was big weekend for cricket lovers....you can probably tell I enjoyed it. But the thing about my job is that you never totally switch off. Last week I went to some excellent presentations and flew to Sydney on Friday which gave me time to read the latest RBA statement on Monetary Policy (not for everyone but I found it a good read). So my subconscious was analysing these things over the weekend.

The thing that stuck me with the first presentation (from Luke Mathews a recently appointed Commodity Analyst with CBA – call him for a copy Luke.Mathews@cba.com.au 02 9312 4150) was that all the economic growth forecasts are V-shaped – low growth in the first half 2009 and then a big bounce and everyone lives happily every after. This is similar to our thinking about commodities – we believe demand for soft commodities and other commodities have to de-link at some stage. But do you know what, I think everyone is just guessing and that human nature is leading us to forecast a sharp recovery because that would be pleasant. Certainly this has been the experience in previous downturns, but I am increasingly getting the feeling that this is much more serious. The economic recovery after a financial crisis led recession (i.e., this recession) tends to be more drawn out compared to other recessions, therefore leading to a great risk of an L-shape recovery rather than a v-shape recovery.

The reason: the growth in the internet and the emergence of BRIC (Brazil, Russia, India and China) means that we are a much more truly global economy than ever before. The specialisation and division of labour has become so acute now that if one link of the chain breaks down it can cause dislocation right through the global economy.

The explosion in demand from China has taken us to great heights, which means the fall can be just as great if China doesn't manage its way through this appropriately. My Chinese friends tell me it is in disarray up there at the moment and it may take them a little while to work out how to manage things. They are currently drawing down stocks to help clear out their bulging warehouse inventories.

So, I have yet to see any evidence that supports any sort of nearby recovery and if anything the indicators are looking worse. If you read the RBA statement they are trying to talk things up but I don't believe the analysis really supports their proposition that our economy is on the road to recovery.

These stimulus packages will help, but from the AIG result it looks like that the US will need deep pockets to keep its financial sector afloat – and they still need to convince these guys to lend to each other (and businesses generally). The amount they spend to keep its banking sector afloat will limit the amount of real fiscal expenditure they have to play with.

So, as the facts change and evolve, so does our view. I am now thinking that we will not see a v-shaped bounce and that it could be more of a dead cat bounce. The interesting thing is – will the money be smart enough to recognise the difference between soft commodities and other commodities? The experience over the past month shows no indications of this. Without any significant production issues soft commodities turn to outside markets for direction.

We still reckon that commodities will bounce independently of everything else in the backend of 2009. I suspect that plantings will be lower and yields will fall because access to farm inputs will dry up. We are hearing reports that even Aussie farmers may find it difficult to get access to the required level of inputs, and if we are struggling how do you think the Eastern Europeans are going? (the Russian Rouble has turned to rubble).

We already have sold positions for 2009 and 2010. But for anyone who is bare naked and exposed to a prolonged global downturn you should look to take some risk off the table by using 2009 swaps at A$340/t. Given that we are already covered for some 20% at >$400/t we will look to be a bit cuter and wait for the $A to fall through US60c, a nth hemisphere spring weather scare, and a good general Autumn rain before extending our position.

Anyway, good luck and if you want to chat this through give me a buzz on 1300 302 143.

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