Seeking Beauties In This Ugly Market

About Latest Posts Bruce JacksonBruce co-founded The Motley Fool UK in 1997. Now back in his native Australia, Bruce is …

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It's just not fair.

These markets keep falling. Even yesterday, following a strong lead from Wall Street, our local market went into reverse.

Today is not pretty. Wall Street slumped over 1.7% on the fears of a Greek debt default, fears of a U.S. double-dip recession, and slumping commodity prices.

As of writing, the S&P/ASX 200 index is off 1.25%, flirting with 4,500, and within a bee's wing of an official 10% market correction. Oh what joy.

What would RBA governor Glenn Stevens make of all this? Just yesterday he made it plainly clear local interest rates are heading up – it's just a matter of when.

But as we suggested just last week, we think movements in the stock market influence the RBA's short-term decision making more than even Mr Stevens himself realises.

It makes sense, of course. The strength of our economy is totally built on the mining sector. When the future expectations for the mining sector are positive, the share market rises.

Who turned the lights off?

On days like today, future expectations for the mining sector suddenly don't look so bright. The U.S. economy is stuck, and China continues to touch the brakes, as witnessed by their government tightening bank lending requirements.

Weakening economies need less oil, iron ore, coal and copper, to name a few.

As a result, commodity prices fall. When commodity prices fall, and stay permanently lower, mining companies rein back their capital spending. Some projects may even become unfeasible.

Small-cap carnage

Check the recent carnage in the small-cap mining and resources sector as an example of what happens when commodity prices fall…

We recently mentioned former highflier and market darling Carnarvon Petroleum (ASX: CVN). They have the dubious distinction of being one of the worst performing stocks this year, down a painful 62%.

Another former market darling, Dart Energy (ASX: DTE) is also on the nose, their shares having fallen 50% in 2011. Dart call themselves "The First Global Coal Bed Methane Company", are cashed up and have a fully funded 12-18 month accelerated forward work program.

Finally, Western Australia based Galaxy Resources (ASX: GXY), is down 45% this year. The company is engaged in the production of battery grade lithium carbonate. It's an attractive market, especially given China is targeting twenty percent of its energy requirement by 2020 from renewable sources.

I'm not suggesting anyone goes out and buys shares in any of these companies, far from it. In any case, just because a company's share price has had a tumble, it doesn't mean the stock is a screaming buy.

And never forget the commodities sector is littered with hundreds of companies, some capitalised at well above $50m, that simply will never generate a single cent of revenue.

But there will be some gems in there. Stating the obvious, finding them, and sorting the wheat from the chaff, is the tricky bit. In the years ahead, The Motley Fool will be here to help.

If it looks like a recession…

Back to the economy. It's no mean feat, given unemployment is running at less than 5%, that outside the mining sector, we're close to being in recession. Adding fuel to the recessionary fire, as judged by the Westpac-Melbourne Institute survey, consumer sentiment fell 2.6% in June and is at its lowest level since June 2009.

Given that, and that the mining sector only directly employs around 200,000 people, how on earth can Glenn Stevens be thinking about raising interest rates?

The market doesn't believe interest rates are heading significantly higher.

First-home buyers, suckered into the housing market when interest rates were at rock bottom in 2009, are hoping like hell there are no more increases. For them, variable mortgage rates were never supposed to hit 8%, let alone potentially go even higher.

If Glenn Stevens were talking today, with the shadow of a Greek debt default, a stuck U.S. economy, a falling stock market, low consumer confidence, and plunging commodities prices, I think he'd be singing to a different tune – one where he might be suggesting interest rates are on hold for the time being, with just a hint of the next move being down.

Interest rates heading down?

Charlie Aitken of Southern Cross Equities thinks the next move in Australian cash rates will be lower, and is targeting a $US1.00 rate for the Aussie dollar.

I tend to agree, not that I'm into making predictions, although I have been warning for a while the Aussie dollar is at bubble proportions – and we all know how bubbles end.

If all that sounds a little too gloomy for these wintery days, it's worth remembering fear in the markets brings opportunities for the patient, long-term investor.

The uglier it gets, the bigger the potential profits. Be prepared. Be brave.

Bruce Jackson does not have an interest in any of the companies mentioned above. The Motley Fool's disclosure policy is a beauty.

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