Financial Mail - Investors Monthly
Hard road to commodities recovery
Prices this year have all but confirmed a fundamental downside shift in demand, writes Barry Sergeant
What has happened to the commodities super-cycle? This time around, nothing looks good and investors continue to run for cover.
The time progress of the super-cycle, which commenced for most commodities during or around 2001, has been marked by bubbles and blow-offs in certain years, and severe degeneration in others, such as 2008.
The general, if not universal, price-collapse during 2008, triggered by the global credit markets crisis, was relatively short-lived and the recovery was surprisingly rapid.
But this time around it feels different: fundamentals indicate that the road to recovery will be arduous and long. Another major factor has been noted in idiosyncratic subperformances within the global resources sector.
Since 2001, there have only really been three superstars: seaborne iron ore; seaborne metallurgical coal (used to reduce iron ore); and copper, the price of which is seen by some as the single most accurate underlying reflection of the performance of the global economy.
And the profits generated by these three commodity subsectors have been truly astounding.
Seaborne iron ore is dominated by three super-groups — Vale, Rio Tinto and BHP Billiton. Other contenders, such as SA’s Kumba and Australia’s Fortescue Metals, are far behind. Despite its determination to diversify over the past decade and Andrew Mackenzie … CEO of BHP Billiton more, the stock price and value of Brazil’s Vale continues to represent its world-leading position in iron ore.
Measured on the NYSE, Vale was priced around $5/share in mid-October, giving it a market value of just over US$23bn.
At times during the super-cycle, like in 2004, Vale’s stock price traded around $60/share, providing a market value running into hundreds of billions of dollars. The big diversified resources stocks have at times ranked among the world’s most valuable companies, by market value.
The significance of the super-cycle was not lost on Swiss-based commodities trader Glencore, which merged with its former mining spinoff Xstrata and, during 2011, listed as Glencore in London. Glencore’s
debut was above £5/share, marking a peak-to-date. In mid-October, it fell to £1,20/share, putting its market value at just over £17bn.
At times there has been “fat” talk, such as that of a $100bn merger between Glencore and Vale, but everyone knew the Brazilian government would veto any such deal. The chatter has, nonetheless, charmed investors and been an essential driver of a commodities super-cycle unlike any other in history.
But the reality is something else entirely.
The Economist Base Metals Price Index has varied between about 90 (in round figures) and 250 points over the past decade, marking peaks in 2007-2008 and 2011, and a significant trough in 2008. Today, that index is priced around 140, well above the oversold levels seen during 2008.
However, the MSCI Mining Index, a broader measure of global mining profitability (and losses) paints a different picture.
Over the past decade or so, the index has moved from lows of about 160 points, to highs — just ahead of the 2008 crisis — well above 600 points. The index is currently priced around its lowest levels in more than a decade.
What this shows is that, like their profits, sentiment for resources companies is rotten.
Commodity prices this year have all but confirmed a fundamental downside shift in demand.
Just ahead of the 2008 collapse, seaborne iron ore prices were trading around $200/t. Prices collapsed, within months, to about $50/t. But changes in supply and demand were such that seaborne iron ore was once again changing hands at around $200/t during 2011. Since then prices have oscillated, downwards generally, to the point where the commodity is now again trading at under $50/t. These are truly multiyear lows.
Of course, the gorilla in the global commodities super-cycle was always Chinese demand.
The industrialisation of the world’s most populous economy, during an era of unprecedented population levels, has been a boon for all kinds of companies. It defied many metrics, defied predictions and left many aghast.
It’s been a tough world. But the big diversified resources groups — wedged between insatiable speculators and investors on the one hand, and reality on the other — have been forced into taking hugely high-risk internal investment decisions.
Glencore’s CEO, whom the media are wont to describe as “billionaire Ivan Glasenberg” (though that may not be the case today), was highly critical, at a conference in Barcelona in May, of the sector which has bought him such wealth. His main points were: The mining sector is suffering a crisis of confidence;
Oversupplying markets regardless of demand is damaging the credibility of the industry;
It’s been the worst-performing sector over the past 12 months, with commodity investment flows now $60bn below 2012 peaks;
Prices, equities and credit ratings have all been hit.
He took a swipe at iron ore, the world’s most desirable commodity for more than a decade, by quoting BHP Billiton CEO Andrew Mackenzie and Rio Tinto CEO Sam Walsh.
Over the past decade, Rio Tinto has invested $28bn in its iron ore business. Andrew Forrest, an Australian who has over the past decade or so attracted billions of dollars of investment into Fortescue Metals, now a significant iron ore exporter, has also been critical of the Big Three in global seaborne iron ore.
But history has been full of these swings. Commodity pricing, dating back centuries, is always a narrative of great price turmoil, riddled with speculation, and infected by the two key emotions found in any market: fear and greed (think of the tulip bubble).
Take the spot uranium price, which traded around $10/lb for decades. When the commodity cycle finally turned during 2001, uranium started motoring, and didn’t stop until 2007 when it peaked close to $140/lb.
It then collapsed to below $50 and has churned around $45/lb for the past few years.
What this meant was that in the run-up to the peak in the bubble, billions of dollars were invested in uranium projects. Similar pricing events were seen in other commodities, not least nickel, which has often been described as the most volatile of all the metals (the price topped $50 000/t in 2007 and now trades around $10 000/t).
Anglo American, which at one stage owned 25% of Anaconda Nickel, referred in May 2001 to a resource company, citing “too much debt, over-ambitious expansion plans, poor corporate controls, unrealistic forecasts and failure to deliver”.
While Glasenberg has every right to be critical of the strategy of the big iron ore miners, his solution is to highlight Glencore’s diversification. Its earnings are dominated by base metals: copper, lead, aluminium, zinc and nickel, with useful income streams from oil, gas, platinum, diamonds and thermal coal.
Which is fair enough. But Glencore’s market value looks a little light at £17bn, compared to the $61bn of BHP Billiton. And BHP’s earnings are dominated by seaborne iron ore, metallurgical coal, and copper — the star performers in the commodities universe for more than a decade.
Even Rio Tinto’s market value at $45bn is far higher than Glencore’s. And again, Rio Tinto is heavily invested in the three commodities that have done so well for BHP Billiton.
The fact is that the global seaborne iron ore and metallurgical coal markets are huge — yet, considering the number of players, they are also simultaneously small.
There might be many copper miners, but there are only a few truly world-class copper mines, and they are often distinguished from their rivals only by being astonishingly large.
Take Freeport-McMoRan’s Grasberg copper mine in Indonesia: there, the output of gold, which is only a co-product, is significant enough for the operation to rank as one of the top 10 gold mines in the world.
You can’t blame investors for being confused. Trying to predict the path of the world’s economy is, as ever, a mug’s game. But if you have to make a call, BHP Billiton and Rio Tinto are going to remain in possession of the hallmark-stamp for some time.