Politicians and central bankers have it all wrong.
They think the cure for too much debt is to issue more debt.
But we can’t entirely blame them for thinking that way.
Maybe they’ve gotten themselves in a muddle.
Because there is an instance in financial markets where going to excess is the cure to excess. It’s playing out right now, and it could help you build a fortune.
What are we talking about?
Here, we’ll explain…
More debt piled on top of existing debt isn’t a good move.
Anyone who’s tried to ‘pay off’ one credit card using another credit card can tell you that.
The interest bill just gets bigger and bigger.
However, when you’re dealing with prices, rather than debt, it’s a different story.
Prices are the ultimate signal
Perhaps you’ve heard the saying. It’s fairly well known.
It goes like this: the best cure for high prices is high prices.
If you haven’t heard that saying before, at first glance it may appear to be gibberish.
You may even think that it doesn’t make sense.
But, once you stop and think about it, and apply it to exactly how markets work, you’ll start to see what we’re getting at.
You may not realise it, but prices act as a signal to the market.
When the price of something is high, it catches peoples’ attention, especially entrepreneurs and capitalists.
They see the high prices and they see the demand for the goods or services at the higher price.
Their immediate thought is that they’d like to get a piece of that action — charging high prices, hopefully with a big profit margin.
But then something else happens. Other entrepreneurs and capitalists see the high prices and they say, ‘We can give the market something better and at a cheaper price.’
So they enter the market, with a lower priced product in order to attract sales from the higher priced products. Then others, and still others enter the market, all seeking to undercut the other by offering a better product at a cheaper price.
Even those that offered high prices eventually cut their prices too, in the interests of gaining back market share.
So you see, high prices attract competitors into the market. This drives down prices. The result is that the cure for high prices is in fact high prices.
This is something that’s playing out in the resources sector right now.
Patience beats war
For years the Chinese complained about high resources prices, especially iron ore.
But copper, aluminium, coal, oil and other resources hit record highs too.
The Chinese could have gotten into a resource war. And they did with some resources, such as rare earths.
But what they should have done (which they mostly did) was just remain patient and wait for the market signals and responses to play out.
Because eventually, the consequence of high resource prices played out in the market. High iron ore and oil prices caused a whole heap of investment in exploration and production.
The price of both commodities went so high that it drew in more capital than the market could possibly absorb into long-term viable projects.
Resource deposits that were previously too uneconomical to consider, became a proverbial gold mine…providing commodity prices stayed high.
But that was the problem. Commodity prices wouldn’t stay high for the long term, because the high prices would eventually lead to excess production driving down commodity prices.
It’s why the resources sector has been in a slump for the past three years. The cure for high prices? High prices.
So, that’s the end of it, right? Not quite…
This cycle is about to hit an uptrend
Now it’s time to think of the reverse. If the cure for high prices is high prices, what do you think is the cure for low prices?
You got it — low prices.
Just as high prices draws entrepreneurs and capitalists into the market, low prices drives entrepreneurs and capitalists out of the market.
They look at the low prices, the low margins, and even the lack of profits, and decide that they’d prefer to make money elsewhere.
For a time that’s fine. It takes time for the industry to work through excess capacity. After all, even in a low price environment, some of the lowest cost businesses are still making half-decent profits.
It’s in their interest to keep producing in order to keep out competitors.
But eventually the excess capacity dries up. And even the lowest cost producers can’t keep up with demand — they’re not likely to spend billions of dollars on increasing production facilities when prices are so low.
That drives up prices as investors and commodity users start to fear supply shortages. And remember, the supply shortage never has to actually eventuate. Like all investing, a big chunk of what goes into prices is investor psychology.
To put things simply: the resources sector has taken a beating over the past few years. No one (and we mean no one) is worried about a commodity shortage.
As far as most investors are concerned, there are plenty of resources to go around. That may be true for now. But it won’t be that way forever.
What’s happening to commodity and resource stock prices today is all part of the natural cycle. It’s not the end of the world, and there’s no need to panic.
In fact, this is precisely when investors should use the history of commodity price cycles to their advantage. If prices are low now, there can only be one way for them to go in the future.
That’s why we say resources stocks make such a great speculation today. Buy low and wait for the cycle to turn higher.
What could be easier? You should try it.
Publisher, Port Phillip Publishing