Financial Mail - Investors Monthly
COMMODITIES NOT UPBEAT
The coming year won’t be any easier for commodities, writes Andries Mahlangu
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.