Terms of trade taking a hammering

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As predicted, coking coal is now breaking down in sympathy with iron ore. From the ANZ commodity daily:

Newc September futures added 0.2% to USD87.8/t, while coking coal dropped sharply to USD202.1/t on reports of distressed cargos being offered at significant discounts. The sentiment surrounding coking coal has deteriorated in recent days due to continued concerns about weak demand, high inventories and declining iron ore prices.

That’s 10% in two weeks. Thermal coal is down 10% in two months. Ore is now down over 20% in two months. These three commodities make up 50% of the terms of trade. By my calculations that’s a roughly 8-10% hit to the TOT coming across the September and December quarters if prices stabilise here.

The TOT is kind of pro-cyclical in its construction. That is, as an export price rises it also increases its weight in the TOT basket, and the same in reverse. So the hit may be bigger than that.

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And yes, that’s another reason why the Treasury thesis of a pleasant easing down of the TOT over the next thousand years of Chinese bridges to nowhere is total poppycock.

Moreover, there doesn’t appear to be any immediate end in sight. China has stimulated already and is growing at 7.5% to 8% and iron ore isn’t really a monetary commodity so QE3 isn’t terribly useful. Having said that, as the infrastructure begins to roll through in the second half we can expect renewed support for the steel complex. At this point, though, we’re clearly seeking some new equilibrium point.

Moreover, on the charts, iron ore looks to have formed the mother of all head and shoulders topping patterns. For 12 month swap:

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And spot:

Let’s hope either those necklines hold or the technicals are wrong.

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Either way, the hit to income and the cancellation of mines that is coming means more rate cuts are most definitely coming down the pipe. The Australian dollar, which rises now on every data release regardless of what it says, has officially entered a bubble.

ANZ Commodity Daily 670 260712

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.