RBA Commodity Price Index -- Reflation Or Growth?

We all suffer from bias – it’s what makes interpreting the subtext fun. So how to read the RBA’s latest commodity price release (here)?

Preliminary estimates for March indicate that the index rose by 0.6 per cent (on a monthly average basis) in SDR terms, after rising by 1.4 per cent in February (revised). The largest contributors to the rise in March were increases in the price of crude oil and the estimated price of coking coal, while gold prices also rose notably. Most rural and base metals prices in the index fell in the month. In Australian dollar terms, the index rose by 1.6 per cent in March.

By my records the RBA’s A$ all-comers index was recorded in its last report as 101.9 for February – as against the current 101.6 reading in March. That would be a 0.3% fall not a 1.6% rise wouldn’t it?

It looks like the discrepancy arises as ‘preliminary estimates for iron ore, coking coal and thermal coal export prices are being used for recent months, based on market information.’ As these items are material to the calculation of the index, revisions in these estimates can give rise to ‘adjustments’ in previous reported levels. If March is higher than February, it seems it has as much to do with February being lower as March being higher.

All this implies that the RBA, based on intelligence from exporters, has ratcheted down its expectations for iron ore and coal price rises for the March quarter from just a month ago. Pity the RBA didn’t explain what is happening here.

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Still, there is no denying the strength of commodity prices and the Australian dollar – it’s as if the Japanese crisis gave the reflation trade a much needed fillip. Per the RBA’s latest numbers for March:

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Photo: Rohan Clarke

Note that base metals lagged gold in this latest shunt higher. Whether this is indicative of a growing belief that inflation is destined to take hold of the global throat is, at least to my mind, counter-intuitive given that we are heading into the tail of QE2. It seems more reasonable to expect rising uncertainty about continued loose money – with debates about interest rate rises in Europe, credit tightening in China and the impending pulling of the Fed’s bid.

Still if it’s the spectre of inflation haunting markets, think we can expect gold to continue to outperform its poorer cousins in the industrial metals complex – ultimately we revisit the relative lows of 2010 – much the same way that gold continued to thrash copper in the late 70′s and early 80′s.

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Photo: Rohan Clarke

Finally, the idea that this latest thrust higher is anything but monetary in origin is just fanciful. Granted the world economy has regained some of its poise, but the leading indicators are still turning over and suggest that the marginal user of commodities is fighting inflation by contracting credit (see latest global PMI data here). For valuations of metals and mining companies to be justified, we need the expansion to continue.  We need Chinese equities to signal a return to the good times. Now one might argue that the recent outperformance of EEM versus the S&P500 is signalling exactly this.

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Photo: Rohan Clarke

Heck, it isn’t convincing me. I’m happy to stick with the playbook – we’ll remain defensively positioned into the end of the stimulus. It’s a time tested strategy (see here for our test of the Albert Edwards playbook).

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