Miners: More Pain Before Gain

The outlook for commodities remains negative, for now at least.

By Anthony Fensom, December 02, 2015

Asia’s resource sector has felt the pain of falling prices in 2015, forcing job cuts from Indonesia to Australia and destroying billions of dollars of market value. Fortunately for miners, the longer-term outlook appears brighter, although more pain is expected in 2016.

A recent report by BIS Shrapnel predicts Australia’s miners will shed another 20,000 jobs over the next three years, on top of the 40,000 jobs lost since the peak in investment during the mining boom as miners adjust to the post-boom hangover.

Meanwhile in Indonesia, the coal slump has reportedly caused “the majority of coal mining companies in Indonesia to stop operating,” with up to 80 percent estimated to have ceased production as of August 2015.

The pain has even been felt in resource-poor Japan, where the nation’s major trading houses have suffered falling profits after making aggressive investments during the mining boom. According to Reuters, top-ranked trader Mitsubishi recently postponed its forecast of a recovery in prices to 2018 from 2017, sparking a switch in focus to non-resource investments.

According to Thomson Reuters GFMS, the world’s top 10 miners have lost around half their market value over the past 12 months, wiping out an estimated $280 billion.

“The clock has turned back on commodity prices and revenue to levels last seen in 2008 and 2009, while over the same period debt on the combined balance sheets of the 10 miners is more than 50 percent higher,” GFMS was quoted saying by MiningNews.

Speaking at the Mining 2015 conference in Brisbane, Australia, Westpac economist Justin Smirk admitted that the Australian bank had got its forecasts wrong on China, the world’s biggest resource consumer and producer, which was now in a “cyclical slowdown with a structural overlay” as it struggled to rebalance its economy.

“This year is the first since the 1990s in which industrial production in China has actually declined,” he said in his November 11 presentation, noting falling steel output, a large property overhang in tier two and tier three cities outside the major centers, and faltering export growth.

“China is becoming more mature…we’re talking about a slowdown to 5 percent [GDP] growth over the next four years, leading to softer industrial demand. We still see Chinese steel production growing by around 2 to 3 percent, but it doesn’t suggest we’re about to see another boom.”

According to Smirk, the commodities super-cycle has changed from “investment at any cost to output maximization with a key eye on cost control,” with a modest upturn in prices tipped in 2016 before another potential downturn in 2017/18.

In the meantime, iron ore and coal are burdened by oversupply, while crude oil prices have reached a base around $50 a barrel, echoing similar recent forecasts by analysts.

Westpac expects the benchmark iron ore price for 62 percent iron fines to fall as low as $47 a ton in December 2016, before gradually improving to reach $66 a year later and $82 by June 2018. Coal, liquefied natural gas and oil prices are also expected to soften further and not start rising until late 2017.

Globally, Smirk said the United States was still not “completely healed” some seven years after the global financial crisis, with history indicating it might take another year to recover from the economic shock.

Meanwhile, Europe remains “essentially stalled,” while China is “relatively weak – if you call 6 percent growth weak, but it’s not about to collapse,” he said.

“In the medium term, China remains important [to commodity prices] but it’s now a bedrock, with volatility coming from elsewhere,” Smirk noted.

Japan had benefited from Abenomics, but “we’re not seeing the follow-through from profits to wages, and the economy is stagnant at the consumer level,” he said.

“India stands out as the fastest growing economy in the developing world…while other Asian economies have been hurt by weak global trade, falling commodity prices and political instability,” he added.

According to Westpac, world economic growth will improve to 3.6 percent next year and 3.8 percent in 2017, led by stronger growth in the United States, up 2.8 percent in 2016. India is seen expanding to 8.1 percent GDP growth in 2016, but China is expected to slow to 6.8 percent and then 6.6 percent in 2017, while Japan posts a steady 1.3 percent expansion.

Australia is forecast to grow more strongly though, posting a 2.7 percent gain in 2016 and 3.2 percent the following year, with miners benefiting from a weaker Australian dollar.

Fertilizer a Winner

CRU associate consultant Allan Trench told the conference that current commodity prices were around 20 to 40 percent below long-run costs, making them too low to justify investments in the “next generation” of projects. “Either prices have to rise, or the long run marginal costs have to come down,” he said.

According to the commodity researcher, this year’s hottest commodities have been sulphuric acid, potash and phosphate rock, with the coldest including coal, iron ore and nickel.

Trench said a stronger U.S. dollar was putting pressure on “commodity currencies” such as the Australian dollar along with emerging markets, with China’s supply response crucial to the immediate outlook.

“The big challenge in this stage of the commodity cycle is waiting for a supply-side response from China…where decisions to shut mines do not only depend on economics,” he noted citing CRU research.

“We may look back in a couple of months and see that we were shopping in the bargain basement,” he added.

Looking ahead, Trench said the current situation would reverse by 2019, with base metals leading the recovery while fertilizers lagged. CRU expects cobalt, sulphuric acid, thermal coal, tin and zinc to lead the pack with forecast price gains of more than 15 percent, while the losers with more than 15 percent price falls expected to include crude oil, iron ore and silver.

Trench was more bullish on gold, stating that while the consensus view said higher U.S. interest rates were a negative influence, demand from Chinese and Indian consumers could help drive the yellow metal’s price higher.

“China could do for the gold price what it did for iron ore and really get a roll on when the [Chinese] consumer gets going,” he said.

In the medium term, Trench said miners’ prospects were brighter in base and precious metals which were in limited oversupply compared to bulk commodities, although he also noted the potential for uranium and minor metals such as lithium.

However, Austex Mining’s Rob Murdoch suggested that the longer-term outlook remained positive, despite the industry’s current bearish sentiment.

“People forget that everything that we use that’s not grown has been mined…Commodity prices are cyclical: we go through a high-growth phase, we get lots of funds for exploration, we float lots of companies, we spend lots of money and now we find too much as our exploration today is too successful, so we have too much supply when the economic cycle peaks,” he said.

“But without new discoveries, reserves will decline, and people in the cities with their computers, cars and energy usage will make demands for these and we’ll need to get back into the field.”

Murdoch suggested the decline in share price of the world’s biggest miner, BHP Billiton, may have neared a bottom, indicating that the cycle may have reached its nadir ahead of a rebound in the next two to three years.

He noted lithium, gold, graphite and fertilizers had been the recent standouts, with gold remaining the most popular commodity among Australian miners despite the market interest in “new age” commodities.

Yet with some A$625 million ($451 million) raised by exploration companies in the September quarter, up for the second straight quarter, better times may lie ahead for the sector as sentiment further improved.

Thomson Reuters GMFS has also pointed to an eventual recovery, with the current cuts fueling future price growth.

“Project deferrals and capex [capital expenditure] cuts will dent future supply growth, and while sentiment remains firmly negative, we are sowing the seeds for the next mining boom, as supply, once again, falls out of sync with global demand growth, albeit at a slower pace this time around,” it said.

“We look forward to substantial price hikes in the medium term, but as for 2016, it will be a largely muted affair, as the rebalancing continues.”

For Asia’s emerging middle classes, cheaper energy and metals prices should fuel further consumption growth in 2016, while miners tighten their belts ahead of the promised upturn.