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New Pricing Should Mean New PortfoliosA How To Book Of Self Managed Super FundsThe Power of Thought & Ageing. Part 2The Easiest way to do a Client NewsletterReally Caring - healthy confrontation about money issues with kidsWhy Warren Buffett won't buy a NewspaperThe Future of Financial AdviceEmail Marketing Business Opportunity - Helen Bairstow
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New Pricing Should Mean New Portfolios

Click here to buy - A How To Book of SMSF's by Tony Negline
John Robertson

Changes to the way some of Australia's major export commodities are priced should prompt a change to equity portfolio design. Having BHP Billiton viewed as an investment suited to the more conservative investor could need rethinking.

The emergence of China has shaken up the way business is being conducted in the iron ore industry. In the December quarter of 2003, Japan was Australia's largest iron ore export destination but, in the December quarter of 2009, it bought less iron ore than it did six years earlier.

Purchases by China, meanwhile, grew fourfold. China now accounts for two thirds of all Australian iron ore exports. The doubling in Australia's iron ore exports in six years is fully accounted for by China's increased offtake.

The growing prominence of China in the market has broken down the old negotiating structures in which the Japanese steel industry was the dominant buyer. China's emergence has given sellers the opportunity to look at alternative ways of setting prices.

In recent months, the major bulk commodity producers, including BHP Billiton and Rio Tinto, have been pushing customers to move away from annual contract prices in favour of sales based on shorter term or spot prices.

While Chinese raw material buyers, in particular, are fighting this radical shakeup in industry practice, the momentum for a pricing overhaul is strong with little to impede the change. Miners are being driven by perceptions of their own self interest but are also being urged on by financial institutions looking to cash in on newly developed derivative products that can add liquidity to day-to-day trading.

The new marketing arrangements being embraced by the miners will eventually result in daily prices for iron ore and coal being set in much the same way as they are for copper and gold across a trading pit in London or Chicago or, more anonymously, across an electronic screen.

Over the last two years, bulk commodity prices had already become more volatile than they had ever been. As the new pricing mechanisms take hold, the relative stability of short term bulk commodity prices evident over the past three decades will have been lost permanently.

Bulk commodity price patterns are likely to replicate historical base metal price patterns. To the extent this happens, we could also look forward to bulk commodity prices gravitating toward marginal production costs as prices have typically done in the non ferrous metals markets to bring about market balance when surpluses emerge.

Indeed, there is a long history of base metal prices falling below the production costs of many producers as prices are set by a high cost marginal seller satisfied to settle on a price that keeps him in business for another month or two.

The tendency for relatively high rates of return on iron ore and coal mine investments could be eroded as this happens. The putative change in pricing arrangements raises the risk that producers lose the monopoly power they typically exercised in face to face negotiations. In the new order of things, they will be at the mercy of the most desperate seller. They will no longer be able to squeeze him out of contention by trading off price concessions for volume gains at their annual gatherings in Tokyo.

Against the background of these changes, equity portfolio constructors will need to review what might constitute an optimal blend of output and price exposures in a resources equity portfolio. Needing to hold BHP Billiton in the same proportion as before would either be a massive coincidence or a sign of analytical inertia.

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