Mining on the mind

It has been a troubling few weeks for commodities in Australia. Investor enthusiasm for mining stocks is weak, with the S&P/ASX 200 Materials Index dipping below the 9000 mark and down by around 10 percent on what it was at the start of the year.

Coupled with this, there was a gold run between April 11 and April 16, which erased more than 12 per cent of the value of an ounce and there have been increasingly aggressive calls for miners to find efficiencies and return capital to shareholders.

“We have seen commodity prices come off a bit in the last month, copper prices have come down, we have seen the gold price sell quite sharply,” Paul Bloxham, chief economist for HSBC Australia and New Zealand told ifa.

All this, however, has to be seen in the context of weaker global demand and higher supply costs.

“Demand side from China has been a little bit soft and supply is still coming through,” Dalton Nicol Reid’s chief investment officer, Jamie Nicol, said. “We think it is going to be pretty difficult for Australian [mining] projects to get underway.”

Some have heeded the signals, with Woodside the first major player to return a significant amount of capital as dividends.

“They are choosing to return cash flows to shareholders rather than continue to invest,” Morningstar’s sector head of basic materials, energy and utilities, Mathew Hodge, told ifa.

There seems to be a consensus that this is preferable to investing and pushing up already high costs.

“We have been trying to do so much mining investment all at once, there should be no great surprise that would put upward pressure on prices and costs and that is one of the things that [the mining companies] need to reconsider in doing new investments as they are competing with everyone else,” Bloxham said.

Poor productivity and expensive labor costs are also leaving little wiggle room in the mining sector.

“We have had a government that has had the luxury of passing labor laws [that meant] we got lower productivity, [and] we have got higher wages. All that adds up to [is that] it does not makes sense to do business in Australia,” Hodge told ifa.

Tighter profit margins could also force companies to “get some more realistic prices on labour and get some more productivity” and then you “might start to see investments re-emerge”, he added.

Meanwhile, some see opportunities in other parts of the resources sector.

“We haven’t been doing all this investment for no reason,” Bloxham said. “This investment is being done so you can see a ramp-up in exports.”

There is potential in “LNG [Liquefied Natural Gas] industries in particular – [and] iron ore and coal [as well] – and we are yet to see the full result of those exports gather momentum”, he said.

This recent weak performance in commodities was made worse by the largest drop in gold in over 30 years.

“There are a lot of conspiracy theories running around about the move – it is all quite strange really,” said Hodge, who saw the sell-off as due to investors’ fears about the EU forcing Cyprus to sell some gold, and speculation in the precious metals exchange traded funds (ETF).
Bloxham, however, took a broader view, seeing it in the context of the bullish run that the commodity has had.

“The European situation looks like it is stabilising. From a precious metals perspective, investors are feeling they can hold less gold as a store of value...and that was one of the reasons that had driven the gold price,” he said.

Either way, gold mining company stocks like Newcrest and Alacer took a big hit on this drop.

“Gold equities sold off very strongly; they have started to come back a bit, but not as much as the gold price,” Hodge told ifa.

More broadly, there is still strong demand for equities, with the S&P/ASX 200 up by around 10 per cent on the start of year.

“People will continue to look for sustainable yield stocks that aren’t linked to that resource capital investment cycle,” Hodge said.

Some fund managers, however, are also looking at other stocks with a foreign market focus.

“The US economy continues to do reasonably well, and if the resources continue to soften then you would probably expect the currency to come off somewhat, so some of those offshore exposed stock might do a bit better,” Dalton Nicol Reid’s Jamie Nicol said.

There is even tentative interest among investors in commodity equities, but only if there are significant profit margins to play with.

“There is probably some value in some, as you pick through,” Nicol said. “It’s just that there is a lot of heightened risk, given that directional commodity prices seems to be down, so you definitely want to be with one that is down the cost curve.”

During the rest of the year, investor appetite for commodities will very much depend on the management decisions of the big players.
“It would be positive for shareholders if BHP and Rio followed [Woodside’s decision] because investing now makes no sense – they are pushing volumes into a weaker demand market,” said Hodge.

Nicol, however, has a more optimistic outlook: “We are attuned to the decision making process in those companies, and we think what they have been signalling so far is that they are going to be focused much more on being more disciplined in their cap-ex spend and cost cutting.”

Nevertheless, concerns remain that if the mining companies do not get their act together, eventually the market will force them to do so anyway.

“It would be nice if the mining companies fixed that problem for themselves rather than have the commodity price make the decision for them,” Hodge warned.

The month in numbers

5166.18....The S&P/ASX 200 as of 1 May 2013, according to S&P Dow Jones Indices
9100.92....The S&P/ASX 200 Materials as of 1 May 2013, according to S&P Dow Jones Indices
2.75%....The official cash rate, as set by the Reserve Bank on 7 May 2013
2.5%....The consumer price inflation rate in March 2013, according to the Australian Bureau of Statistics
5.6%....The unemployment rate in March 2013, according to the Australian Bureau of Statistics