Hard road to com­modi­ties re­cov­ery

Prices this year have all but con­firmed a fun­da­men­tal down­side shift in de­mand, writes Barry Sergeant

Financial Mail - Investors Monthly - - Feature -

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.

Sam Walsh …Rio Tinto CEO

Newspapers in English

Newspapers from South Africa

© PressReader. All rights reserved.