Look out above, fellow investors!
The S&P/ASX 200 Index (ASX: XJO) is marching higher, and that looks set to continue today after another incredible lift in commodity prices overnight.
Iron ore experienced its biggest daily gain in history, while oil prices continued their strong run as well.
I'll have more on that shortly…
But first, let's take a look at how the market itself is tracking.
Yesterday saw the main bourse jump another 1%. That in itself isn't much to get too excited about, but when added to last week's gains it's certainly encouraging.
Australian shares had their best week since October last week. The main index climbed 4.3%, and it was sitting at 5,142 points overnight.
It's up 9.3% since it bottomed out nearly a month ago.
Indeed, there is a spring in the step of investors right now.
What exactly is behind the recent rally?
Really, there are a number of factors helping to reinvigorate the demand for Australian shares right now…
To begin with, the recently completed earnings season yielded better results than many investors had anticipated.
AMP Capital's chief economist, Shane Oliver, released some pretty interesting statistics that highlight this, including the fact that 47% of companies bettered expectations (versus a norm of 44%).
Likewise, 20% came in worse than expected against a norm of 25%, while 62% raised their dividends.
Of course, there were a few big misses, including the likes of Slater & Gordon Limited (ASX: SGH), but all in all, there was a lot to like from Australia's listed corporations.
In Australia, investors also cheered a better-than-expected set of economic growth figures.
According to the data released by the Australian Bureau of Statistics last week, the local economy was growing at 3% annually in the year to December – much quicker than either the United States or the Eurozone are growing.
That's sure to ease concerns regarding a pending Australian recession.
But above all else, it seems there is one area of the market that has investors particularly excited right now…
Soaring Resources
Iron ore rallied the most on record overnight.
In a surprising twist of fate, the metal rose an incredible 18.6% to US$63.75 a tonne! It's the commodity's highest level in almost eight months.
Based on the data from The Metal Bulletin, it has now surged an unbelievable 66% since mid-December, where it bottomed out at around US$38 a tonne…
According to The Australian Financial Review, the sudden surge was sparked by a strong policy lead out of China, which is committed to boosting spending and loosening monetary policy to support growth.
We already saw the country cut its Reserve Requirement Ratio (RRR) last week, allowing its banks to hold less capital and push more money into the economy. That should spur demand for new funds and hence, contribute to economic growth.
The government has committed to an economic growth target of 6.5% over the next few years, sparking plenty of excitement among steel producers and iron ore investors.
But iron ore isn't the only commodity benefiting…
Oil prices plunged violently at the beginning of the year, but it's been all uphill since then!
Brent crude oil hit a 12-year-low of US$27.10 in January this year, but in the time since it has gushed 48% higher!
It rose 5.4% overnight to US$40.81 a barrel, while US crude oil has also surged to US$37.79 from a low around US$28 a barrel less than a month ago.
The moves in both commodities have taken analysts and investors by complete surprise.
The share price of BHP Billiton Limited (ASX: BHP), for instance, has soared nearly 32% since it bottomed out in January.
Shares of BHP's spinoff South32 Ltd (ASX: S32) have jumped 66% as well…
While Fortescue Metals Group Limited (ASX: FMG) has more than doubled in roughly the same time.
Fortescue's shares gained 23.7% during Monday's session, alone…
But they weren't the only resources shares flying higher yesterday. Just take a look at some of these incredible figures from Monday:
- Atlas Iron Limited (ASX: AGO) shares, up 46.7%
- BC Iron Limited (ASX: BCI) shares, up 42%
- AWE Limited (ASX: AWE) shares, up 8.8%
- Senex Energy Ltd (ASX: SXY) shares, up 19.5%
- Sundance Energy Australia Ltd (ASX: SEA) shares, up 53.6%
The list could go on, and we could see further strong gains today as well…
With performances like that, you'd be crazy not to invest in the resources sector, right?
It's tough watching those kind of performances from the sidelines.
Indeed, it's perfectly reasonable to assume that investors want their money to be invested where it can achieve the greatest gains, and over the last month or so (and particularly overnight), it seems the resources industry ticks all the right boxes.
Really, investors have two options…
Firstly, they can listen to the roars of the market and follow the hot money into the resources sector.
Now, that strategy could work.
It's certainly worked for those investors who bought in a month or so ago, and it could continue to work if commodity prices do continue to rise.
After all, iron ore and oil prices are still well below their highs from previous years. Iron ore maxed out at around US$185 in 2011 while oil was fetching about US$110 a barrel in mid-2014.
For the record, I don't think we'll see those kind of prices for a long while, and that's why I'm sticking with the second option, for now…
The second option investors have is to ignore the noise and avoid the resources sector.
That strategy won't make sense to some investors…
As I said previously, investors should put their money where it can achieve the greatest returns, so avoiding the resources shares could seem counter-intuitive.
But the fact is, the supply of both iron ore and oil still far outweighs demand.
China's stimulatory measures could certainly help to balance that out in the near-term, but whether or not it lasts in the long-run is a different story.
Too good to be true?
The most recent rally can perhaps be explained by a report from Reuters.
The report says that Tangshan, a city located in the country's top steel producing region, is scheduled to host an international horticultural exposition between April 29 and October 16.
No doubt the country will want clear blue skies for that event, so don't be surprised if the authorities order steel mills in the region to slash their production to reduce air pollution during that time.
As a result, producers are expected to increase their output ahead of the event, which could explain the rally.
But when that slows, what happens to the iron ore price?
It's worth remembering that a similar rally occurred last year.
Iron ore prices exploded more than 30% as Chinese mills brought forward production before a military parade on 3 September 2015, and plunged again soon after as their production fell away.
It's clearly too early to tell whether this time will be different or not, but it's certainly worth keeping in mind before you dip both feet into the sector.
Foolish Takeaway
The recent commodities rally could have legs, but I have my doubts, and that's why I'm steering clear of the action – for now at least.
Based on the reports I've read, it seems to be 'hope' driving the iron ore price higher, which is a dangerous mix.
As such, avoiding the sector today could mean missing out on some attractive gains. But it could also mean avoiding some big losers if this rally doesn't hold.
All in all, I'm concerned that this could be short-lived.
Investors might pick up some quick gains, while others might be fooled into a temporary rally only to regret it shortly after.
Investing isn't about short-term gains. It's about buying high-quality businesses at reasonable prices, and then holding onto them for the long-run.
Ideally, the companies you should be looking for are those that can last the test of time…
Those with top quality management teams building sustainable competitive advantages for their businesses…
