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Why The Commodity Crunch Could Be Worse Than Expected

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Why The Commodity Crunch Could Be Worse Than Expected
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A new report by Goldman Sachs analyst Matthew Ross discusses how weak earnings numbers from several Australian companies have influenced Goldman’s view of the commodities environment. Ross believes the latest news indicates commodity weakness may be having a bigger impact than the firm previously had feared.

The Numbers

The ASX 200 severely lagged global markets last week, falling 3.9 percent versus only a 1.0 percent loss in the U.S., a 1.3 percent decline in Asia, and gains of 1.3 percent in Europe and 1.2 percent in Japan.

Overall, 85 percent the ASX 200 traded down last week, a staggering percentage.

Commodity Spill-Over

According to Ross, much of the weakness in the Australian market is due to commodity prices weighing down the economy. Prior to last week, Goldman discusses three risks to the Australian market that the firm believed were “mispriced.”

The list included margin headwinds due to Australian dollar weakness, weakness in the housing market and “greater than expected spill-over from the commodity correction with a heightened risk of impairments.”

Ross believes the third concern has now become validated by the market.

Market Moves

Rio Tinto Plc (NYSE: RIO) reported numbers that were mostly in-line with Goldman’s estimates, but the company was able to reduce costs by 10 percent more than Goldman expected.

Orica released fiscal 2015 guidance that fell 10-15 percent below Goldman’s expectations.

Downer was never more appropriately named, as the company has demonstrated sustained pricing and volume pressure. Goldman reduced its fiscal 2016 EPS estimates by 16 percent.

Financial earnings headlines in Australia have been dominated by Australia & New Zealand Banking Group’s news of an unexpected $3 billion capital raise and a startling 17 percent increase in mortgage delinquencies reported by Genworth Mortgage Insurance Australia.

Commodities Are At 'Center Of Our Economic Universe'

In an email to Benzinga, Vice President of Grain Citizens Angie Setzer said the report highlights one universal truth: "The amount of effort that goes into physically producing, transporting and reselling goods has great and far reaching impacts on the surrounding economy."

These impacts, Setzer explained, are visible through employment and wage growth. "Just as a commodity market gets its direction from supply and demand the economy surrounding these markets does the same," she added.

Her full thoughts are worth a read:

The report released Friday indicates a lot of what I've been saying for quite some time: The amount of effort that goes into physically producing, transporting and reselling goods has great and far reaching impacts on the surrounding economy. These impacts in my opinion, are seen most specifically through employment and wage growth as the increased demand for a physical product results increased employment opportunities as well as an increase in the amount of wages paid. Just as a commodity market gets its direction from supply and demand the economy surrounding these markets does the same. A reduction in demand produces a subsequent need to reduce supply. This necessary supply reduction will result in contractions seen through layoffs, wage cuts and an overall slowdown in growth.

At the same time throughout the stretch of higher commodity prices from 2008 forward we have seen exponential growth in many sectors. This growth was of course backed by investments through not only private individuals but local, state and national governments. Many of these governments had anticipated continued growth, so of course the recent swoon in prices and subsequent economic contractions have caught many off guard--especially those who thought high commodity prices were here to stay. Just as in anything commodity-related we will see a cyclical development in return on investment, meaning that eventually supply and demand will find equilibrium before likely swinging in the opposite direction once again.

Overall it is important to realize that commodities in many ways are at the center of our economic universe. They are the engine that drives our economy, most times for the good, sometimes for the bad. In times of high prices, high demand and solid growth the surrounding impacts can be exponentially beneficial. Whereas the busts that we see after the booms can cause sharp and drastic moves with far reaching impacts. Luckily though, just as with anything else commodity related it tends to get darkest before dawn and intrinsic needs will again become apparent. At that point we will not only see a correction in the overall pricing outlook, but the surrounding economic indicators as well.

Latest Ratings for RIO

DateFirmActionFromTo
Dec 2016Credit SuisseUpgradesNeutralOutperform
Dec 2016CitigroupUpgradesSellNeutral
Dec 2016ArgusMaintainsBuy

View More Analyst Ratings for RIO
View the Latest Analyst Ratings

Posted-In: Analyst Color News Commodities Global Top Stories Economics Exclusives Markets Best of Benzinga

 

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