Mining’s rally poor for the industry

The recent rally mining commodities saw are more likely to have a negative impact in the long run, according to market analysts.

Speaking at a roundtable earlier this week, UBS analysts Glyn Lawcock and Daniel Morgan outlined the reasons for the shortlived rally experienced by iron ore earlier this month, and why the metal’s softening to more sustainable levels will be more beneficial for the industry.

The metal experienced an aggressive rally mid-March, recording the largest one day spike in years as the price for ore of 62 per cent grades jumped by nearly a fifth to just over US$63 per tonne.

At the Port of Tianjin the overnight movement turned into the single largest one day gain ever as it rose to US$62.60 per DMT, marking a 46 per cent increase since the start of 2016.

Iron ore rose close to 70 per cent above the recent low watermark price of US$37 it rested at only a few months ago.

However the metal soon receded in price, leaving many over eager investors and operators to wonder what happened.

According to Morgan the iron ore price has historically spiked around this time.

He explained it grows after Chinese New Year due to stockpiling, and the rally itself caught the market by surprise.

“The magnitude surprised the market, it as a stronger rally than expected,” he said.

UBS reports dismissed the strong upwards movement as a flash in the pan, stating it was “based on macro hopes and short-covering with little evidence of fundamentally better demand – yet”.

It stated that the sharp rise and subsequent fall was based on the typical rise following Chinese New Year combined with a predicted growth in the country’s infrastructure and property markets, Morgan adding that the “property market accounts for 40 to 50 per cent of Chinese steel demand”, however the “latest data doesn’t show an infrastructure lift – yet”.

“The trade signals are not strong enough yet for a sustainable lift in demand,” Morgan said, “prices rallied in hope.”

UBS isn’t the only investment house that believes the high price point is unhealthy and unrealistic for the current state of the industry.

Even as iron ore rose, Goldman Sachs was predicting the metal’s reversal, stating its movements were “not sustainable”.

This was echoed by Citigroup, which believes optimism over China’s economic movements will be short lived.

Citigroup remains bearish on metal’s future and Chinese demand, while Axiom Capital Management dismissed the current rally as a ‘blip’.

“Higher prices are much harder to sustain in a supply-driven market since supply is primed to return with higher prices,” Goldman Sachs analysts wrote in the report.

“But this lesson will likely only be learned through false starts.”

Jeffrey Currie, Goldman Sachs’ head of commodities research, stated, “Demand hasn’t really changed, [so] it takes lower prices to push and keep supply below demand to create a deficit.”

UBS went on to state that iron ore’s rally will continue to fade unless there is a lift in demand.

This lift looks uncertain as China’s 13th five year plan signal additional mining consolidation, particularly in iron ore, and a returned reliance to imports, but one that is unlikely to grow in actual demand levels.

According to BMI Research’s latest industry trend data, “The fall in Chinese iron ore grades from 66 per cent in 2004 to 17 per cent in 2014 will lead to heightened seaborne import demand for higher grade ores.”

“This increase in import demand will partially offset the decrease in demand from a severe cooling of domestic steel production.”

However, despite demand for high grades ores – which Australia is able to produce – BMI states that “Chinese import growth fell to 2.2 per cent in 2015 from 14 .1 per cent in 20 14 even with the heightened consolidation of the iron ore mining industry in China adding to import demand”.

“Australia, the largest iron ore exporting country to China will be hit hardest, evident from the fall in average annual export growth from 31.5 per cent in 2014 to 10.8 per cent in 2015.”

Sustainability in the long term?

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Morgan pointed to a lower price point for the long term, floating around an average of the mid US$40s per tonne, with UBS data noting: “We don’t see prices sustaining low to mid US$30s for any significant period of time; we believe supply will respond to preserve margins.”

“We forecast US$45 per tonne 16e and US$47 per tonne 17e.”

At this price point many of the smaller, less productive players are likely to shut down their operations, which in turn will remove excess supply and reduce stockpiles

Morgan warned against iron ore falling too heavily over the year.

“Prices can get too low, and the power of the major producers may increase too much, returning the industry to the oligopoly,” he said.

Morgan believes miners are already reducing outputs in order to overcome the oversupply issue, as they “are chasing value over volumes (as previously seen in the market), as there is no point in cannibalising their own earnings”.

He pointed to the major miners plans to produce less this year, although with Gina Rinehart’s Roy Hill mine coming fully online and Vale’s S11D mine on the horizon the planned reduction in tonnes may be negated.

However he also warned against the price rising too high, which could act as a catalyst for smaller operators to restart their operations, adding more tonnages and distorting the market without additional demand to support these increased output levels.

Manganese mayhem

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The iron ore crunch has also affected other metals required in steel making, such as manganese, which has seen a collapse of the industry in a relatively short period, forcing miners such as OM Holdings and its Bootu Creek mine; Consolidated Minerals and its Woodie Woodie mine; and Shaw River shuttering operations or entering administration.

“It was the steel price that led to the collapse,” Daniel Morgan said.

However in the race to lessen their exposure miners have cut too deep, Morgan explaining, “We’ve seen too much production cut in the short term, and now there is a panic over supply”.

“Due to shutdowns and cuts in production around seven million tonnes of supply out of what was a 40 million tonne market has been cut.

“We won’t be surprised to see restarts in the Kalahari from Black Economic Empowerment (BEE) groups which can get production rolling quickly to port thanks to the recent investments in infrastructure in the region.”

The Copper Crunch

The volatility recently seen in copper is unlikely to stop, with UBS predicting a price point of between US$2 per pound and US$2.30 per pound.

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According to UBS reports, “We see the market in a surplus this year, with around 200 KT more being produced compared to last year, so unless we see a shift in demand or shutdowns the oversupply and market unsustainability will continue.”

This stance was echoed by Barclays, which stated copper was at risk of a steep decline as forward movements in the price need to be supported by fundamentals, adding that investors may rapidly exit if improvements are seen, with UBS’s Daniel Morgan stating that even at US$2.30 per pound the market is still vulnerable.

The sector may also see increased merger and acquisition activity, mirroring the recent M&A seen in coal, in order to make their operations more manageable.

“Everyone is in shrinking mode,” Lawcock said.

“Vendors will be trying to get out to get out of the downturn [possibly through M&A] without selling the family home.”

Investor reluctance

Despite potential upside for the mining industry in the longer term, investor sentiment remains divided over the market.

According to the Prequin Investor Outlook, almost twice as many natural resources investors hold a negative perception of their asset class – at 33 per cent – compared to those 17 per cent who remain positive.

“Natural resources have faced challenging performance conditions over the past year, and 62 per cent of investors feel that their performance expectations have not been met,” the report stated.

Over the next 12 months approximately 41 per cent of natural resources investors plan to allocate less capital to those assets.

Barclays was less pessimistic in its report, although it did add that investors could look to liquidate bets on gains quickly, hastening mining’s decline, according to Bloomberg.

“Investors have been attracted to commodities as one of the best performing assets so far in 2016,” it said in the report.

“However, in the absence of any concerted fundamental improvements, those returns are unlikely to be repeated in the second quarter, making commodities vulnerable to a wave of investor liquidation.”

The Barclays report went on to state: “Given that recent price appreciation does not seem to be very well founded in improving fundamentals, and that upward trends may prove difficult to sustain, the risk is growing that any setback will result in a rush for the exits that could again lead commodity prices to overshoot to the downside.”

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