Have the miners dug themselves into a hole?

Commodity prices on average are close to their 2008 levels at the onset of the global financial crisis.

Unfortunately, the same reality isn’t shared for the materials index, which is home to Australia’s resource companies. BHP has edged back to prices reached in 2008 before the crash, but Rio Tinto still has a mountain to climb to get back to the same price levels.

The future of resources will largely be driven by the actions the Federal Reserve takes in regards to quantitative easing. We saw the material impact of a higher Treasury yield threaten a healthy global growth story, so Treasury yields will need to decline (which they have been) to protect and sustain the global growth we have almost come to demand.

If quantitative easing is wound down and it begins to strangle global growth, the outlook for commodities — with the probable exception of gold — is going to be bleak. The effect will almost be like a waterfall, with emerging markets spluttering followed by the outlook for commodities.

The nature of the global landscape and growth drivers suggests investors won’t be able to rely on the miners to pull the index along like they did in the wake of the global financial crisis. The miners have faced a wrath of investor criticism for dragging the ASX 200 index down, but their performance hasn’t been that miserable. 

Looking at the past 10 years, it has only been since the start of this year commodities, accounted for in the materials index (white line) have fallen out of favour in terms of performance as the rest of the market has raced away (green line).

A recent McKinsey report explains resource prices remain high by historical standards, even as the global economy is struggling to emerge from a period of slow growth.

But the major problem facing iron ore is the threat of oversupply. At the moment, the aluminium industry is carrying record levels of inventory, which has pushed down the price and kept it at four-year lows.

Jim Chanos has tipped the market will be in oversupply towards the end of this year or next year. If this is the case, it could prove costly for BHP and Rio Tinto, who have expanded their production capabilities.

In the near term, for iron ore there is the possibility there will be a season re-stock in China, pushing prices above their current levels of around $US130 per tonne. Beyond this, it appears monetary policy decisions will be the catalyst for moving prices.