Investment update 4 June 2018

Last week in the markets

Over the past week Australian shares fell 0.7%, however small company shares were up 0.5%. Shares in developed countries declined 0.1% while the US market rose 0.5%. Shares in emerging markets declined by 0.6%. The Australian dollar increased by 0.3% to 75.69 US cents. The Australian 10 year bond yield fell to 2.7%, with the US 10 year bond yield also declining to 2.9%. The oil price fell 3.0% to 65.81 US dollars per barrel.

What impact does volatility in commodity markets have on the Australian economy?

The one certainty in commodity markets is volatility. Australia’s two largest exports, iron ore and coal, have been experiencing price falls, illustrated in the chart below. The most likely reasons for these recent falls include a large build-up of stock in Chinese steel inventories, the possible repercussions of trade protectionist measures and the impact of additional supply from Australia (increased supply, if not matched by increases in demand, results in lower prices).

RBA's Statement of Monetary Policy, May 2018

There are a range of flow-on impacts.

Firstly, at an industry level, variability in commodity prices directly affects the underlying businesses. Given the fixed costs of iron ore and coal production, a variability in commodity prices results in amplified variability in company profits. New projects become questionable and the viability of existing projects may be reassessed.

Secondly, a fall in prices of Australia’s two largest export items is clearly not good for national accounts. To maintain economic growth at a national level, other sectors of the economy will have to make larger contributions.

Finally, at a household level, the people who work in the mining sector may face greater uncertainty. They'd hesitate on spending decisions and this has flow-on effects on the regions in which they live.

While we consider commodity prices in forming our economic views, it’s one of the most difficult areas to forecast because of its volatility and therefore constant monitoring forms an important part of our process.

Signing off

David Bell | Chief Investment Officer

Past performance isn't necessarily an indicator of future performance.

Data sourced from Bloomberg. Graph from the Reserve Bank of Australia's Statement of Monetary Policy, May 2018.