The great commodity bubble
It all started last Thursday when the US Federal Reserve unveiled 'Operation Twist'.
Operation Twist is the name given to the Fed's project to sell short-term bonds and buy 10 and 30-year Treasuries.
The aim of the operation is to allow households to renegotiate their mortgages at lower rates, which would help improve disposable income and potentially spark more demand for housing.
In the short-term it has backfired spectacularly, as what was meant to act as a stimulus to the US economy has resulted in the unwinding of the 'inflation hedge' trade, and sent a shudder through world commodity markets.
In what is a very simple version of events, Operation Twist effectively meant no QE3 (third stimulus package) for the US markets.
Since QE1 was announced in November 2008 the world markets have bought physical commodities such as gold, silver and copper as a hedge against inflation as the US dollar was devalued as a currency. This inflation hedge trade has pushed commodity prices to record highs and speculators have entered the markets.
The realisation that there is going to be no QE3 caused a surge in the US dollar, and with it the unwinding of the inflation hedge trade, which had become very crowded.
How do I know it's a crowded trade? Well, I had a call from a client just last week saying he had read how good exchange traded funds were in a men's health magazine.
Alarm bells were ringing, to put it nicely. At the weekend commodities were put to the sword, led by gold, with the rout continuing on Monday as investors and speculators alike raced to unwind their long commodity positions.
This has seen a rough couple of days for the ASX, with the large resource stocks bearing the brunt of the selling.
As of Monday, BHP is off more than 30 per cent from its April highs, Woodside finished below $30/share, Rio touched $60/share and Newcrest lost 9 per cent in a day. This has brought the Australian dollar back to below parity as money has flowed out of Australia at a rate of knots.
With the stocks that have for so long led the Australian market falling sharply, it brings the question where is value? Looking at Bloomberg consensus forward price-to-earnings ratios Rio Tinto at $60 has a forward P/E ratio of about 6.5, compared to a long-term market average on the ASX 200 Index of about 13.
Now that looks cheap in anyone's language, but before jumping in the deep end the first logical question you need to ask is have the analysts got the earnings part of the price-to-earnings ratio correct?
What I can say is the uncertainty on the market right now surrounding Europe, the US and commodity prices is damaging the market and at times like this we see the market trading on sentiment and not on fundamentals.
·For more information, contact Cameron Bartram at Sentinel Stockbroking on 9225 0028 or email firstname.lastname@example.org
_Information in this article does not consider your personal circumstances. You should consult a stockbroking professional before making any investment decisions. Sentinel may hold positions in stocks discussed from time to time. _
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