Vexing or frustrating, it doesn’t really matter, the outcome is the same. I’m sure you all mirror my sentiments as we watch the so called soft economy stocks drive this market to 5 year highs while the resource sector, the very sector that drives our economy continues to languish.

The sheer weight of money flowing back into equities has ensured that some money must find its way into BHP and RIO, simply because they are the largest and sixth largest companies in the index. However, that’s as far as support for resources has gone. Any sign that investment dollars are prepared to move further down the resource sector food chain has so far been muted.

Even a grudging agreement in the broader market that China’s prospects are looking good and growth has been restored to the Middle Kingdom has done little to bring investors back.

I, for one, would have thought that iron ore holding $150 per tonne would have restored some level of confidence. After all, if you punch those numbers into the models of, say, Fortescue or Atlas, you’ll find that you end up with very low single digit earnings ratios as they ramp up production over the next couple of years.

The main question on resource junkies lips right now is this: will we go through this current rally without so much as a sigh from the sector; or are we simply in a traditional investment cycle, whereby commodities are a late cycle investment and hence resource stocks are late, but ultimately strong, performers.

I’m afraid I can’t answer that. The uncertainty in the world economy at present does not allow for that clarity. However, one thing I do know is that momentum is driving this market more strongly at present than possibly at any time since I’ve been involved in the market, with the exception of the Tech Boom and the last few months of madness that culminated in the GFC. I unfortunately missed the Poseiden Boom.

The momentum has now driven a handful of “blue chip” stocks into bubble territory. Around 70% of this current rally has been driven by just 10 stocks. Bubbles always burst, but of course they can get very big before they blow, and typically the larger the bubble, the bigger the bang. The 99 dollar question right now is when the money does come out of these companies, will it cause a whole sale sell-down across the market, or is there enough confidence/momentum to see those funds spreading themselves across those sectors that are yet to see any real gains. For this columnist, read resources.

What signs should we watch for before we can have some confidence of investing strongly in the sector? I see two indicators. Firstly, we need to see real support coming into the second line resource stocks like Oz Minerals, Pan Aust, Fortescue, and Atlas Iron as examples. If we can see these companies manage more than a two or three day rally, which to this point they have not been able to achieve, then sentiment might be changing. Secondly, if we see commodities break out on the upside from their very narrow trading ranges it might indicate that the investment clock is finally ticking on to the next stage of the cycle.

Until either of those events take place I’ll just sit banging my head against the desk, as I watch CBA continue its seemingly never ending upward spiral, with no concern as to whether earnings justify the company’s current valuation.

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Gordon Barratt is an authorised Representative and financial adviser with RBS Morgans. He is not a Director or Employee, of Market Cap and does not receive any fees or remuneration from the company. Any comments that are made are General Advice purposes only and do not take into account any persons personal circumstances. Any views expressed by the author do not necessarily represent the views of RBS Morgans

 

19 February 2013

586 words

19 February 2013 Markets