While bubbles are often associated with housing markets, they can be found in other guises too, from stocks to bonds or commodities.
Canadian scholar Dr. John-Paul Rodrigue produced a neat chart in order help us to understand how bubbles and manias are created and might unfold.
Rodrigue’s chart is not meant to be taken literally and is only intended to be indicative of possible outcomes, yet it does help to explain some of the emotions and events which can drive the phases of a mania.
While the Reserve Bank’s Commodities Index has not followed Rodrigue’s pattern perfectly over the past decade, it’s seemingly having a darned good crack at it, replete with its own “bull trap”!
Technically the bulk commodity prices – iron ore in particular – have experienced a collapse rather than a true capitulation to date.
But with the iron spot price now at just US$47.30/dry ton (China import – Fines 62% Fe) we can expect that a number of marginal producers might be suspending operations in due course.
Central Bank view
It is interesting to reflect on how the Reserve Bank has viewed Australia’s terms of trade boom over recent times.
Governor Stevens has discussed in his speeches how it had previously been expected that the terms of trade would peak in 2010, yet in the event the boom had a way longer to run, thus overshooting on the upside.
In the last quarter of 2014, Stevens noted that the Reserve’s “best guess” was that the terms of trade will fall further “but remain at a level well above the standard of the past century.”
The Reserve Bank notes that there are, however, many uncertainties, and the Reserve’s own chart above shows how every previous terms of trade boom over the past century in Australia has ended with an over-correction to the downside.
The final graphic below, which charts the volume of engineering construction activity, shows how although there are some still large projects under construction, particularly in the gas sector, the trajectory of mining investment is set to follow that of the commodities index.
With bulk commodity prices having consistently tested multi-year lows, it has become more and more difficult for new resources projects to pass feasibility or secure financing.
One of the few remaining mega-projects, Adani’s potential $21 million Carmichael project which would represent Australia’s largest coal mine, is struggling to secure financing, ostensibly for environmental reasons.
But with a depressed coal price, when financing costs are included it is difficult to see how the project is economically viable, let alone environmentally.
The latest Detailed Labour Force figures showed that although total construction employment has held up surprisingly well thanks to a boom in residential building, mining employment has tanked by nearly 50,000 in only 12 months.
Not only is mining construction employment in sharp decline, operational positions could now be lost too.
Terms of trade forecasts have a wide range of uncertainty.
We need stronger growth outside the resources sector.