Greed, the emotion which drove the market for the past five years, has flipped to fear. Essentially, the two are much the same – and both are irrational.
Just as the share prices of some companies rose without any visible means of support, so will companies fall for much the same lack of reason.
Before looking at what’s happening, a brief diversion into the world of definitions, and the core question: is this a crash?
The correct answer: it depends where you’re standing; if you own shares in rock solid businesses with recurrent cash flow, no. Companies such as BHP Billiton, Rio Tinto and Oxiana, are passing through a correction.
If, however, you own shares in exploration companies which are a long way from producing anything, and have not topped up their capital with a recent share issue, then you are watching a crash.
Overall, the mining market is close to crash territory. The metals and mining index on the Australian Stock Exchange (XMM) was down 19.4% this morning from its mid-July high.
Anything above 20% is technically a crash, and that’s where you’ll find some of the recent stock market darlings.
Fortescue Metals Group, for example, has fallen from its all-time high a few months ago of $41.75 to trade today at around $25.99, a fall of 37.7% - technically a crash.
Jubilee Mines is down 38.9% from $18.44 to $11.26.
Mincor is down 47.6% from $5.10 to $2.67.
And Independence is down 50% from $8.90 to $4.41.
What now?
Time is the only cure for the ills sweeping the market – and a belief that the fundamentals underpinning the resources boom have not gone away.
All that has been lost in the crash (or correction if you’re feeling a little shell-shocked) is the speculative hype which drove shares to ridiculous heights.
What’s causing the big sell-off is a combination of reality dawning, and a rush by gamblers (sorry, speculators) to unwind their positions ahead of margin calls which will come from their banks and friendly stockbroking firms which so liberally loaned money in the first place.
The real danger over the next few days is that the United States credit crunch could see some of that country’s over-geared hedge funds collapse under a wall of recall notices.
Last night was the time for US investors to lodge recall notices for September 30 payment.
Today is the time when those hedge funds should let the world know how much cash they are going to have to cough up – and whether they can.
The next few days is when a snowball effect could take hold, like this:
1. Hedge fund investors ask for their money back.
2. The hedge fund lacks the cash to repay (a classic ‘run on the bank’ scenario).
3. The hedge fund goes to the bank to borrow cash.
4. The bank says no.
5. The hedge fund closes, or is forced into a fire sale liquidation of its assets which could include commodities (gold, oil base metals), or equities.
Fear of what comes in the next few days, caused to some extent (quite remarkably) by a crisis in mortgage lending to bad borrowers, is why the Australian market is in crisis today.
The good news, and yes there is some, is that real demand in the global economy for metals, minerals and fuel, has not disappeared.
China has its problems, such as a ruined environment and dodgy exports, but they can be fixed.
In the 1950s, when Japan led the way, the quality of its exports was as bad as what’s coming out of China today. Over time, quality was improved, and today Japan is a world leader in quality.
China will do the same, and its demand for raw materials will continue to grow despite the odd speed bump along the way.
The problem for investors in speculative shares is that the repercussions from those speed bumps can be very unpleasant.
