CHEAP RESOURCES TIME TO BUY?
The JSE’s resources sector has underperformed the broad market for the past five years – in fact, long-term holders of the index are now back to where they were before the start of the commodity super cycle in the late 1990s, which was driven by unprecedented demand from China.
With the sector now looking “extremely undervalued” in comparison to the rest of the market, and many mining bosses having adapted their businesses to a lower commodity price environment, investors have to ask: is now the time to buy resource stocks?
ANALYSTS WEIGH IN
“We think resources are a good investment,” says Piet Viljoen, chairman of investment house RECM and one of the country’s foremost value investors. It would be a long-term play though: the lead time to realise any worthwhile upside would be in the region of around five to nine years, he says.
Daniel Sacks and Hanré Rossouw, portfolio
managers of the Investec Commodity Fund, say that they believe there is “opportunity in the sector at the moment, as we calculate value in several mining companies with dividend and free cash-f low yield estimates at attractive levels”.
Recent results for mining companies have, in many instances, reported falling dollar unit costs, thanks to weaker producer currencies (including the rand and the Australian dollar), declining energy costs, labour efficiencies, cost containment and higher grades of product mined, they said in a note to clients on 13 May.
Commodity prices are also expected to improve over time as companies continue to restructure their portfolios, shutting marginal mines and approving very few new projects. “We believe that the current share prices of many mining companies underestimate the earnings that will be generated, with surprises coming both on the cost and revenue side,” they said.
Sacks says that he prefers gold over platinum, even though “we aren’t gold bulls”. The gold price is expected to remain robust as the US Federal Reserve would likely “continue to err on the side of caution when it comes to the pace of rate hikes”. China easing monetary policy to stimulate growth could also be a key factor to boost commodity prices.
Currently though, coal and iron ore − suppliers to the hapless construction and power sectors − were a “terrible idea”. Part of the problem was that marginal suppliers had not shut down despite the plummeting resources demand, while increased supply was being pumped into an increasingly lethargic market.
Peter Major, mining specialist at Cadiz Corporate Solutions, says that many base metals – commodities like copper, lead, nickel and zinc – currently looked safer to invest in than the bulk commodities, such as iron ore and coal. “There just seems to be way too much production of oil, gas, coal, iron ore and manganese right now. And we don’t seem to have the management, political, or labour environment to make the necessary changes and improvements”, such as job cuts or mine closures.”
The opportunity isn’t so much in what commodity you’re producing, Major says. “It is all about, ‘Are you an efficient producer? Are you leading the industry in efficiency and productivity?’ That is what mining is all about; not sitting on your hands praying for abnormally high commodity prices to bail you out of a poor management, political and labour environment.”
One analyst, speaking on condition of anonymity, says that local mining stocks are trading at a discount relative to their peers in the US and Canada, indicating that the market takes a dim view of the regulatory uncertainty in the local sector (see page 23). This gap could widen, he warned, and it is worth paying a premium to get exposure to listed mining stocks in the US or Canada instead.
South Africa has around 80% of the world’s proven platinum reserves and about half of the world’s gold reserves. But this benefit has become increasingly outweighed by a slew of obstacles which some analysts believe threaten sustainability unless radical policy changes are put in place.
Onerous and fluctuating state-issued empowerment mandates as well as union demands and chronic strike action, power price increases and load-shedding are some of the local issues facing gold and platinum miners. Sluggish global demand − particularly for platinum − is another.
While Sacks says they are “not gold bulls”, if he had to choose stocks to put money into, he would look at AngloGold Ashanti, which has cut costs and is planning asset sales to boost its balance sheet, and Sibanye Gold, of which he is a big fan. While Sibanye was less undervalued than other gold miners, it was “still a good divi[dend] story”.
US hedge fund manager and serious gold bull John Paulson, who holds 6.5% of AngloGold, has stayed in gold despite the disappointing returns he has had while waiting for the metal to prove its worth as an inf lation hedge.
Major, who is negative on resources generally, believes it is a “stock picker’s market”. On gold, he suggests exchange-traded funds are a better bet than investing in companies. If he were pushed to make suggestions, Pan African Resources and DRD Gold would be the most attractive options, he says.
Asset managers are bearish on the metal, as above-
ground reserves are still too high for prices to make a strong recovery. Despite last year’s five-month strike in SA taking substantial supply out of the market, falling demand and high stock levels have suppressed prices, which have fallen by nearly 23% over the past 12 months.
The World Platinum Council is predicting demand to grow by a miserly 3% to 8.155m ounces. Lonmin, which is planning 3 500 job cuts as it tries to improve its f inances, said that it expected demand f r om t he automotive industry – European carmakers are the most important buyer of the metal – to grow by 3.7% this year. Impala Platinum is perhaps more bullish on the longer-term outlook, forecasting the supply deficit to deepen from 805 000 ounces this year to 1.8m ounces in 2023.
It is this increasing deficit that miners hope will push up the price of the platinum. Another possible ray of sunshine for the metal would be quantitative easing in Europe, which would cut exports costs and push up the cost of buying the metal.
Investec Asset Management’s Sacks and Rossouw said that while the platinum price is expected to strengthen to a level where it is again trading at a premium to the gold price, “we believe the equity market is still too optimistic” and is pricing in a much stronger recovery than is likely, given the high levels of above-ground stock. Analysts, even those relatively bullish about the outlook for resources, say that coal and iron ore were no-go zones for investors, at least in the medium term.
Xavier Prevost, senior coal analyst at XMP Consulting, says that the surplus in the market was “devastating” the price, particularly as supply wasn’t being cut back.
Worse, the Institute for Energy Economics and Financial Analysis said in a report released on 18 May that the global coal industry is in continual decline and the number of utilities burning the f uel was dropping i n favour of sustainable options.
Despite this, excess supply continues to pour out of Australia from existing and greenfield projects. The price for steam coal in China has fallen 59% from its 2008 peak, and the commodity is trading at the lowest level in nearly nine years, according to Bloomberg data.
Glencore, the world’s biggest exporter of coal, closed its Australian mines for three weeks over Christmas in an attempt to boost prices. The company has also entered into talks with unions about closing some of its local Optimum Coal mines as prices continue to plummet. More than 1 000 workers would be laid off.
Local coal miners are battling to get backing to expand in preparation for new longdelayed coal-f ired power stations to start up. Medupi power station in Limpopo and Kusile in Mpumalanga are expected to require around 14.6m tons a year each. Much of Medupi’s supply will come from the Grootegeluk mine owned by Exxaro Resources − a black-empowered coal and heavy metals operation that produces around 18.8m tons a year – which will give the company a distinct market advantage. However, this boon will only take effect in around three to four years when Medupi finally fires up.
Exxaro, which also owns a 20% stake i n Kumba’s Sishen Iron Ore Company (SIOC) in the Northern Cape, announced that its half-year earnings to the end of June were likely to be at least 20% down from the same period a year ago, mainly due to reduced income from SIOC, which has been hard hit by the drop in iron ore prices.
Prices for the steel-making ingredient have dropped to 10-year lows as infrastructure spending in China has slowed down, while there has been significant new supply of iron ore from major companies, including Anglo American’s Minas-Rio mine in Brazil.
The low iron ore prices have made Kumba one of the worst-performing stocks in 2015 so far. Kumba shares are down 33.24% since January. Kumba is planning a review of its business operations, and is considering closing down its Thabazimbi mine to rein in costs and cut supply. Stocks in Assore, which mines iron ore and chrome, have fallen almost 23% this year.
THE GLOBAL COAL INDUSTRY IS IN CONTINUAL DECLINE AND THE NUMBER OF UTILITIES BURNING THE FUEL WAS DROPPING IN FAVOUR OF SUSTAINABLE OPTIONS.