The B word has been bandied around a lot of the past couple of weeks – that is, Boom, when referring to commodities. However, will the B word transform into Bubble in the next few months?
As can happen with any investment class they tend to get overheated at times. They often start as simply a rally then gets justified as a new paradigm and then become normalised. This is what we have seen most particularly with commodities. The RBA Commodity Price Index was somewhat steady, even benigh up to about 2003 where it hovered around 40 which it had done since 1990. Since then it rocketed up to around 120 when the GFC hit and then rallied again up to around 160 before the recent decline.
With the index rallying along came the commodities “asset class”. Before this time commodities were rarely talked about as an asset class, gold being an anomaly. Of course all this was justified because of the urbanisation of China and much of the talk was about “stronger for longer” suggesting that this was a new growth area. Australia was, and is, at the forefront of this “boom” in commodities. Now that the price of commodities and in particular, iron ore, is falling the media are now referrring to the rise as a “boom”. Of course boom is often associated with that other word – bust. The media has latched on and can smell blood.
The word, Bubble hasn’t been used much too date. Especially not in Australia because it has such scary implications. However when you look at the Commodities Price Index chart that is what it looks like. Even though there will be plenty of punters saying that this time is different.
Whether or not it is a bubble or a temporary “pull back” the warning signs are there. Gina and Twiggy have lost over $4b between them in the last couple of months and Fortescue is looking exposed with a higher cost to dig iron ore out of the ground. Not to mention the brash young arrogant Tinkler who looks to be now teetering on the brink.
So if it turns out to be a bubble what should an investor do? Well firstly, check to see if you are heavily leveraged to the bubble. This happens by stealth, an Australian Equities index approach (heavily materials based), small junior mining stock portfolio, strong run up in values of resource stocks in your portfolio or heavy biasses towards the next big boom commodity. Have a close look and you may find yourself more highly concentrated than you thought you were.
As always, diversify your portfolio and rebalance. However, be careful to stay within the same risk class – moving to cash is punting that you know more than everyone else and will almost certainly guarantee a lower return over the medium to long term.