Over the past couple of months, we are witnessing price deflation almost all asset class, including commodities. This huge falls in commodity prices is hardly surprising. As we explained back in March 2007 in Warning: gold price can still fall significantly,
When the inevitable liquidity contraction occurs, gold price will fall as well.
18 months had gone past since that article was written. Today, we are witnessing the deflation that we had been waiting for. In this deflation, commodity prices in general are falling. It is in this context of falling commodity prices that many Australian resource stocks are falling, especially the smaller cap ones. Many of them are even falling below their 12 month lows. The market’s logic is that falling commodity prices imply falling revenue and therefore profit will fall.
Is this logic correct?
First, commodities are priced in US dollars and they are falling in terms of US dollars. Next, the Australian dollar is perceived to be a commodity currency and tend to have some correlation with commodity prices. In that context, as commodity price falls, the Australian dollar tends to follow along to a certain degree. At this time of writing, the Australian dollar is worth of US$0.795. In just 1 ½ months, the Aussie dollar has fallen almost 20%!
Therefore, in terms of Aussie dollar, the fall in commodity prices is not as bad as it looks. However, some costs may rise may rise due to rising price of oil in terms of Aussie dollars. Everything else being equal, a falling Australian dollar is actually good for the bottom line of resource producers.
Thus, if you look at some of the massive falls in some of the smaller resource stocks, it looks that they are being oversold.
