The com­ing year won’t be any eas­ier for com­modi­ties, writes An­dries Mahlangu

Financial Mail - Investors Monthly - - Front Page -

The slide in com­mod­ity prices has de­liv­ered a thun­der­ous blow to in­vestor sen­ti­ment and min­ing stocks in re­cent weeks.

As­sore, for one, is now out of the JSE’s Top 40 blue-chip in­dex after los­ing 40% of its mar­ket cap­i­tal­i­sa­tion this year.

The re­sources in­dex has slid 20% from re­cent highs. The de­te­ri­o­rat­ing sen­ti­ment to­wards re­sources raises ques­tions head­ing into 2015 about the di­rec­tion of the metal prices to which th­ese com­pa­nies are closely linked.

Rezco As­set Man­age­ment di­rec­tor Rob Span­jaard be­lieves that com­mod­ity prices will con­tinue to de­cline or re­main flat for a cou­ple of years be­cause the com­mod­ity su­per cy­cle is end­ing.

“From 2000 to 2011, the iron ore price in­creased from about $10 a ton to $170 a ton. So while iron ore prices have fallen pre­cip­i­tously to the cur­rent $75 a ton, they could grind around th­ese lev­els for a while,” says Span­jaard.

The spot price of iron ore, a raw ma­te­rial in steel, has fallen over 40% this year, in­flict­ing dam­age on the bot­tom lines and share prices of Kumba Iron Ore and As­sore.

Kumba, which com­mands the top spot in the pro­duc­tion of the metal in SA, ex­pects head­line earn­ings in the year to De­cem­ber to drop by at least R3bn from last year.

As­sore ex­pects earn­ings in the six months to De­cem­ber to de­cline by as much as 45%, cit­ing weaker prices.

FNB Se­cu­ri­ties in­vest­ment an­a­lyst Chan­tal Marx says the iron ore price is ex­pected to nor­malise over the long term, but risks of a de­cline re­main in the medium term. This is be­cause, Marx ar­gues, low-cost iron ore pro­duc­ers con­tinue to bring more sup­ply on­line while higher-cost pro­duc­ers are still in business — al­beit los­ing money.

Kumba and Exxaro Re­sources have lost 40% and 20% re­spec­tively since Jan­uary. The lat­ter has fallen off the Top 40 in­dex, high­light­ing the vi­cious­ness of the sell-off that gath­ered pace from Septem­ber.

The stronger dol­lar, which has an in­verse re­la­tion­ship to com­mod­ity prices, is partly

One needs to see gold price moves as long-term cy­cles: cur­rently the cy­cle is neg­a­tive and will re­main that way for a while

re­spon­si­ble for the rout in metal prices and com­mod­ity shares.

Absa Wealth & In­vest­ment Man­age­ment’s head of pri­vate clients as­set man­age­ment, Craig Pheif­fer, says the im­prov­ing global econ­omy, cou­pled with the ex­pected rise in US in­ter­est rates in 2015, presents down­side risks to the gold price.

The pre­cious metal, cur­rently hov­er­ing around $1,155.75/oz, is in full cor­rec­tion mode after slip­ping 16% from its highs in March. The con­se­quences for gold coun­ters are breath-tak­ing. Shares in AngloGold Ashanti have halved in just un­der nine months from R209/share in March to R100 at present, though this was also at­trib­uted to neg­a­tive sen­ti­ment to­wards its now canned plan to re­struc­ture its as­sets. Har­mony Gold is deep into bear-mar­ket ter­ri­tory and looks sets to be rel­e­gated to the small-cap mar­ket after drop­ping 55% to less than R20 from R40 early this year.

One needs to see gold price moves as long-term cy­cles, Span­jaard says, not­ing that cur­rently the cy­cle is neg­a­tive and will re­main that way for a while. The big­gest dif­fi­culty for gold is that there are such “huge above-ground stocks that dic­tate the price”.

Pheif­fer ex­pects slightly bet­ter prospects for plat­inum and pal­la­dium as the de­mand side of the equa­tion im­proves, mostly on greater au­to­cat­a­lyst de­mand from higher car sales.

But even so, the re­cent ca­pit­u­la­tion in the plat­inum price, a stronger dol­lar and ten­ta­tive global growth cre­ate un­cer­tainty. Plat­inum eq­ui­ties are still re­cov­er­ing from the five-month in­dus­trial ac­tion early this year that af­fected out­put, dent­ing in­vestor sen­ti­ment.

The stock price of Impala Plat­inum, the world’s sec­ond-largest pro­ducer of the metal after An­glo Amer­i­can Plat­inum, has de­clined more than 30% since the start of the year.

“China is in for a soft land­ing, but it’s still com­ing back down to earth. Ja­pan looks promis­ing, but the sheer im­men­sity of its debt bur­den re­mains wor­ry­ing,” Ob­sid­ian Cap­i­tal an­a­lyst War­ren Kelly says.

The Ja­panese econ­omy sur­pris­ingly fell into re­ces­sion ear­lier this month on weak pri­vate con­sump­tion.

“Europe is plagued by de­fla­tion that seems to be ig­nor­ing ev­ery mea­sure taken by the Euro­pean Cen­tral Bank so far. With­out the US as a growth en­gine, the global econ­omy will most likely stum­ble and stut­ter to medi­ocre growth.”

The pre­dom­i­nantly frag­ile mood in the re­source mar­ket has al­lowed the in­dus­trial and fi­nan­cial stocks to con­sol­i­date their in­flu­ence on the 165-mem­ber Jo­han­nes­burg Stock Ex­change.

The JSE’s fi­nan­cial 15 and in­dus­trial 25 in­dices are up in the year to date more than 21% and 13% re­spec­tively.

The sub­stan­tially weaker rand is a boon to in­dus­trial com­pa­nies such as Aspen, which ral­lied by nearly 50% this year.

Pheif­fer says the rand is likely to be weaker against the US dol­lar but this prob­a­bly won't be suf­fi­cient to over­come the lower com­mod­ity prices for a num­ber of com­mod­ity com­pa­nies and shares in terms of bot­tom-line earn­ings.

“For the di­ver­si­fied min­ers, the un­der­ly­ing com­mod­ity pro­duc­tion bas­kets are dif­fer­ent and this makes earn­ings prospects dif­fer­ent in each. BHP Bil­li­ton has sig­nif­i­cant ex­po­sure to iron ore and pe­tro­leum and could be the big­gest lag­gard in that space,” Pheif­fer says.

“Con­versely Glen­core, with no iron ore ex­po­sure and a strong mar­ket­ing arm, could be among the bet­ter per­form­ers.”

Ei­ther way, the con­sen­sus is build­ing among th­ese an­a­lysts that 2015 is still go­ing to be a chal­leng­ing one for the com­modi­ties mar­ket.

Kelly says com­modi­ties will be an as­set class for the brave and the US dol­lar is likely to re­main strong as a rate hike looms and global growth con­tin­ues to dis­ap­point.

Global gross do­mes­tic prod­uct (GDP) is un­likely to re­bound sig­nif­i­cantly in the next two years as a grad­ual slow­down in the Chi­nese econ­omy and struc­tural im­ped­i­ments to growth in the euro area, Brazil and SA con­tinue to weigh on eco­nomic ac­tiv­ity, ac­cord­ing to Moody’s In­vestors Ser­vice in its quar­terly global macro out­look re­port.

For the G20 economies as a whole, the rat­ing agency ex­pects GDP growth of around 3% in 2015 and 2016, after 2.8% in 2014.

Eco­nomic growth in the euro zone — which is one of SA’s main trad­ing part­ners — re­mained sub­par in the third quar­ter of 2014. The econ­omy in the 18-mem­ber cur­rency bloc grew just 0.2% quar­ter on quar­ter in the July to Septem­ber pe­riod, ac­cord­ing to fig­ures from the Euro­pean Union Statis­tics Of­fice.

The sub­stan­tially weaker rand is a boon to in­dus­trial com­pa­nies such as Aspen, which ral­lied by nearly 50% this year

“Our rel­a­tive pref­er­ence lies with the low­est-cost iron ore pro­duc­ers with a di­ver­si­fied re­source base, like BHP Bil­li­ton, and cop­per-geared di­ver­si­fied coun­ters with low iron ore ex­po­sure, like Glen­core,” Marx says. “Based on the short- to medium-term out­look for prices, we will be steer­ing clear of pre­cious metal pro­duc­ers for now.”

Pheif­fer says he will avoid pure plays in gold and iron ore for now. Plat­inum and pal­la­dium ex­po­sure is “still pre­ferred via ex­change-traded funds rather than the com­pa­nies them­selves”.

“Over the medium term we would ex­pect global growth to ad­vance and cre­ate ad­di­tional de­mand for com­modi­ties. This will help work through pro­duc­tion sur­pluses and im­prove prices. For now, though, it looks like spot prices will gen­er­ally re­main un­der pres­sure along with share prices. Mar­ket down­turns pro­vide op­por­tu­ni­ties to po­si­tion for a pick-up over the medium term,” Pheif­fer says.




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