Low Finance Costs Not Enough for Higher Resource Sector Returns

Resource sector equity values have normally varied inversely with risk appetite measured by the cost of finance. The chart illustrates the historical link between the Australian small resources share price index (the red line) and the spread between CCC rated US corporate bond yields and US government 10 year bond yields (in blue). The yellow highlighted portion of the chart covers October 2011 to May 2013 when, unusually, falling yields coincided with falling equity market values as the effect of weaker growth outweighed the benefit of cheaper finance. Since then, the more usual relationship seems to have been restored. Initially, falling financing costs helped support market prices before another rise coincided with the downward plunge in equity prices during the second half of 2014. Very recently, slightly easier financial conditions have helped to stabilise prices again. With yields already so low, it is hard to foresee the financial market risk appetite changing enough to be the source of a strong upward move in equity prices of the sort which kicked off the last cycle in 2003.