Commodities in the “Year of the Booby Trap”
Looking at the headlines today of news items covering the resources industry, I was struck by how many unexpected, or unwelcome, developments are coming out of the woodwork. Yet, just a few hours earlier, I had been reading yet another analyst note saying that we are at the bottom of the commodity cycle, and things are about to pick up. Indeed, this is a line that I have begun running with in recent weeks; after all, the cutbacks in production (especially zinc) seemed in the past week or two to have put a floor under prices.
Just last week a early stage graphite explorer, Ardiden (ASX:ADV) had seen a capital raising oversubscribed (it has its project in Canada). This was just one of many examples occurring in recent weeks where exploration announcements had seen investors piling into certain stocks. This was, I reasoned, not at all like the gloomy time in 1999 or the post-GFC period when you couldn’t sell a story – any story – to try to get get some interest in the market.
But then, again and today, there came another avalanche of gloom. How to explain this commodity dichotomy?
Then I picked up this morning’s newspaper, turned to the business section, and there it was: 2015 is the Year of the Booby Trap. This insight came from an interview in the newspaper with Ashok Jacob, who runs the A$4 billion Ellerston Capital fund.
And the booby traps? Well, there was the devaluation of the Swiss franc, the collapse of the oil price, the Volkswagen scandal and most importantly the devaluation of the Chinese yuan. I would add the European refugee crisis which could impede that continent’s economy recovery if the alliance fractures; the battle of the behemoths as the big iron ore makers ramp up production to try and crush the smaller players. And how’s that shale oil and gas revolution going? Oh, and then there was Molycorp.
And now here is today’s news, which underlines Jacob’s predictions there will be further booby traps sprung on a fragile global economy before the year is out.
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Item # 1: China’s GDP growth slowed to 6.9%. While this reflects the transformation from industrial growth to widening of the services economy (a natural progression as economies mature) it is terrible news for commodities. This undoubtedly signals a weaker commodity demand environment in China – and that means everything from iron ore to technology metals.
The impact was immediate: after the Chinese figures came out, aluminium fell 1.7%, copper was down 1.8%, lead down 1.3%, nickel by 2% and zinc was off 0.5%. Only tin defied the mood, rising 0.2% to $15,987/tonne, still not nearly enough to tempt any new producers to start up a mine.
Item # 2: The normal economic response to low prices and oversupply is for mining (and oil) companies to cut back production, at which point prices can begin rising again as supply starts to lag supply. But this is not happening, and most spectacularly in the case of the iron ore companies. Today we read that Brazil’s Vale had a record output in the September quarter of 82.2 million tonnes. This comes as Australian mines run by BHP Billiton and Rio Tinto continue to ramp up production, too. The iron ore price has fallen to $52/tonne from a 2011 high of nearly 2011. Also, it is estimated by London-based Wood Mackenzie that 55% of the world’s nickel is now being produced at a loss, but no one wants to cut back: so far, only 30,000 tonnes of capacity has been idled. The economic mechanisms are simply not working. (And, on the iron ore front, the Indian state of Goa has resumed shipments to China after the local mining ban was lifted.)
Item # 3: News agency reports say Saudi Arabia is delaying payments to government contractors as the slump in oil prices pushes the country into a deficit for the first time since 2009. Companies working on infrastructure projects have been waiting for six months or more for payments as the government seeks to preserve cash. Did anyone expect the Saudis to have a cash flow problem?
Item # 4: Iran is planning to add to the commodity glut. Bloomberg reports that President Hassan Rouhani will visit France and Italy in November to find foreign bidders for 15 projects. The country wants to boost its output of gold, iron ore, steel, chromite, aluminium, bauxite, copper and zinc. Just what the world needs!
Ashok Jacob makes the point that all the money printing we have seen from the Fed and European, Chinese and other central banks was meant to have removed the risk of booby traps, but it hasn’t; and I would add that it was also meant to restore the globe’s appetite for commodities, which it has patently failed to do. Its main legacy has been to encourage the raising of trillions more dollars of debt.
OK, so QE hasn’t worked. Anyone got any other ideas before we trip over another booby trap?
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