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A commodity bubble forming, mining shares vulnerable

Posted by Adrian on June 25, 2008

With a volatile and at times confusing market and global economy, it is sometimes hard to focus on the determining issue within the global economic turmoil. But then again, if one was to assess the global market and economy, you could essentially lump it all into an interacting basket of problems. All reacting with each other in a nest of uncertain volatility.

There is now, thanks to a combination of factors, a commodity bubble forming. Disproportional currencies in regard to commodity markets, the artificially low Chinese currency Yuan and the declining value of the USD. Both causing inflationary problems, the USD’s fall against against all commodity markets, combined also with scarcity in rice, cocoa, wheat, oil. China with a raw material boom, that is showing no end; faces a problem with inflationary pressures that will either cause China to raise interest rates and strengthen the currency, or face a hyperinflation scenario that could lead to a harsh hard landing. As long as the market looks for a hedge against inflation, it will always turn to the commodity market

The problem with a Chinese and Indian raw material appetite, especially in regards to commodity export countries is the invertible slowing down in other aspects of their economies, namely housing, financing and general company profits. Two examples come to mind, as far as commodity export countries, is Brazil trying to contain inflation with an interest rate at 12.25% (exporting Iron Ore which is 15% of the Brazilian GDP). The other country is Australia, with a mining boom that is still persistent with forecasts for Iron Ore exports to grow into 2009.

Nevertheless, the commodity markets could still be in for a large correction. But in the meantime, prices will still rise (in the case of steel makers, passing on higher iron ore costs) and global growth will slow, or in some cases decline rapidly (consumer and business consumption). To what economic benefits booming commodity markets will have for emerging economies and developing economies will be disputable. Apart from leading to inflation, thus contributing to stagflation. The mining sector could be overvalued (stocks) and it would be worth noting that a correction in mining stocks could be imminent in the near future.

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