Has the bottom of the mining downturn been reached?
Mining is a cyclical industry and is always riding the troughs and waves of high and low commodity prices, but rarely in history has it slumped this low, this quickly.
Every day for the past year operators have been greeted to a new decline in iron ore, gold, and coal.
Lows not seen since the Global Financial Crisis were once again reached.
Many fortunes were lost, businesses continued operations built off the back unsustainably high commodity prices collapsed, and many predicted this slump as the death knell for Australia’s mining industry.
This fall was driven by shrinking demand out of China, coupled with an oversupply of most commodities in the market as miners ramped up their output in order to take advantage of the higher returns.
Some states backed themselves to the hilt in terms of exports, particularly WA, with nearly three quarters of its exports mining-related, a situation that has now resulted in a $22 billion reduction in the value of its exports year on year.
This over-confidence created a perfect storm for operators as China’s rapid growth declined and stockpiles refused to go down – and miners refused to stop pumping out the tonnes.
Smaller miners were hit the worst, with Rio Tinto CEO Sam Walsh curtly stating: “High prices brought in marginal producers, often based on overly optimistic assumptions and aggressive business models.”
“These tonnes are now exiting the market, which is part of normal supply and demand.”
BHP Billiton chief Andrew Mackenzie defended his company's and Rio’s ramping up stance amidst the downturn.
“We operate in highly competitive and cyclical markets, where earnings outperformance through the cycle depends on being the most efficient supplier, not supply restraint,” Mackenzie said.
“Any attempt to curtail low-cost supply in open markets only encourages the continuation – or entry – of more costly production. This deprives the market of its power to deliver the most efficient supply.
“Therefore our ongoing success does not rely on supply restraint but instead rests on our foundation of the right commodities, the best assets, operational excellence, balance sheet strength, and capital discipline. A combination of these attributes serves us well during all points in the cycle, but particularly in the current environment.”
For the record, both Rio Tinto and BHP saw share price peaks in 2008, well before the mining boom.
So the markets have crashed, but when will the bottom of this decline be reached?
The mining industry appears to be making its first tentative steps out of the wilderness.
Pundits are forecasting that the bottom has been reached, and stabilisation is ahead.
However in no way will the boom be back.
The low point appears to have been reached in April, earlier this year when prices hit GFC watermarks, and operators were entering into new agreements with contractors and consumers just to stay afloat.
In line with the oversupply conundrum, this was the same period in which record iron ore exports out of Port Hedland were achieved, with the port exporting two millions tonnes of ore in 24 hours for the first time ever.
In May the predictions that the trough was reached were declared.
Speaking at the Stockbrokers Association of Australia Conference, China Metallurgical Industry Planning & Research Institute’s president Xinchuang Li told Australian Mining that the bottom was reached, and there would be a plateau ahead.
The economic slowdown in the country “is the new normal,” Li stated, and this will affect Australian iron ore miners as the nation shifts from its heavy industrial phase into a more services focused era.
“China is moving from its rapid growth development phase into a new phase,” he said.
Li gave a breakdown of the market, citing a number of major issues, predominately low production and consumption fluctuations; low profitability combined with a high level of market competition in steel production; and increased downwards pressures relating to both financial and environmental concerns.
He predicted a consistent fall in Chinese steel consumption, from a country that currently accounts for 60 per cent of global consumption, dropping to 689 million tonnes in 2020, 650 million tonnes in 2025, and 610 million tonnes in 2030, at odds with Rio Tinto’s predictions for consumption rates.
According to Walsh the story out of China was being mistold, and that growth in the country is strong, even though it is changing.
“This year’s estimated increase of seven per cent in Chinese GDP is just over $1 trillion, larger than the economy of Poland,” Walsh said.
“The nature and mix of growth in the Chinese economy is also changing, and I will say more on this shortly, but let’s be clear that in this new normal we will still see continued solid economic growth from a larger base.”
Walsh said this “new normal” would see around 1 billion tonnes of Chinese crude steel production by 2030, which requires average growth of around 1 per cent per annum.”
While Li rubbished this position, he did give one positive forecast on the current market situation, stating that the April price low of US$45 per tonne is likely to be the bottom of the slide, and iron ore has already begun its stabilisation process.
“We’re likely to see a price of between US$55 to US$65 per tonne as an average for the next two years,” he said.
WA Premier Colin Barnett has now also jumped on the recovery bandwagon.
Speaking at the Africa Down Under Barnett declared: “I'm either brave enough or silly enough to suggest that we've hit the bottom.”
"Global markets are fragile but the fact that we're seeing some greater stability in commodities, oil prices, gas prices, iron ore prices – I think we have probably hit the bottom."
This was supported by JP Morgan, which – while not being bullish – has finally ended its bearish position.
Earlier this week it put a buy position on mining stocks.
While seemingly a minimal movement, JP Morgan’s note did shine a light on renewed positivity in the market.
This dial has been shifted by the growing level of mergers and acquisitions in the market; always a tell-tale sign of either the top or the bottom of the cycle.
In April Alamos Gold and AuRico announced a merger worth $1.5 billion. This is all while broad speculation continues that former Xstrata boss Mick Davis is looking to finally deploy his $5.6 billion war chest held by his company, X2 Resources.
Glencore was recently making heavy overtures for Rio Tinto’s coal mines, with CEO Ivan Galsenberg stating: “How we’ll get and how soon we can reach an agreement, I don’t know, but it’s something that clearly makes a lot of economic sense.”
Carl Ichan has bought an 8 per cent stake in Freeport McMoran, the operators of the Grasberg mine; while George Soros has grabbed a chunk of Barrick Gold.
So why is the M&A market heating up?
According to JP Morgan, because it has nowhere else to drop after the hammering commodities have endured.
“In price relative terms, mining is back to its levels from 10 years ago, when the Chinese commodity super-cycle was just starting,” it said.
The World Bank is also predicting a new round of M&A, seeing mid-sized operators as the main targets.
These companies “may take the lead in mergers and acquisitions or become interesting targets for the more capitalized companies of the sector that are looking for growth that isn’t more exploration or greenfield projects,” World Bank manager for energy and extractive industries Paulo de Sa told Bloomberg.
Looking ahead JP Morgan sees stability, although there may be a little weakness and punishing of underperforming operators earnings.
The metal’s return
The question of when mining will begin its upswing again is one of contention.
Current predictions range from the last quarter of 2015 through to mid-2016, with some even positing a 2017 recovery timeline.
According to JP Morgan, there is likely to be “some additional EPS cuts for miners near term, but again, not a step change.
“We believe that the bulk of EPS downgrades are behind us given the latest consensus projections of -44% year-on-year EPS growth for miners in 2015.”
Westpac’s chief economist says the price of iron ore won’t see a recovery until at least 2016.
Westpac economist Justin Smirk said with demand out of China unclear coming into the New Year, and high volumes of iron ore being exported to the country, price volatility would continue.
He added that the start-up of Gina Rinehart’s Roy Hill mine later this year could also have a downward effect on the price of iron ore as the operation is poised to be a large, cheap supplier.
Smirk said adjustments would come as some of the marginal Chinese miners left the market but this was not happening “as fast as some people anticipated”.
According to IBISWorld the 2015/16 financial year is pegged to quickly ratchet up, growing 7.1 per cent, with expectations for this upwards trend to continue into the following financial year with 2016/17 predicted to record an 8.4 per cent increase in revenues as recovery continues.
Its reports into the next few years have outlined how "growing output is forecast to support division growth in the next five years, which is forecast at a compound annual rate of 4.2 per cent, to reach $285.4 billion in 2019/20".
However, taking the whole resources sector into view, some pundits believe we still have a way to fall.
“We’re near the trough for coal, iron ore, and base metals,” BIS Shrapnel senior manager infrastructure and mining, Adrian Hart, told Australian Mining.
“Coal is still likely to see another 12 to 18 months before stabilisation, but when it comes to oil and gas there is still a way to fall, and it will damage the [Australian] economy for years,” he said.
“The investment downturn will continue in oil and gas, and will hurt the Northern Territory and Western Australia.
“It reached a peak of $40 billion, and is slated to fall to $16 billion at the trough, and we aren’t yet near that point.”
Grant Thornton's Brock Mackenzie was similarly cautious.
"It's always hard to call the bottom without the benefit of hindsight however things are still extremely difficult for the mid and junior caps and I would be extremely cautious in terms of calling the bottom as my feeling is things remain very difficult," he stated.
While the market is low for metals now, it appears unlikely to go any lower.
A mixed future is ahead depending on the commodity, but overall the worst is over for miners, and the time is now for savvy investors.