Fear Miners Set to Fall Off 'Supercycle'
For a decade, life has been kind to miners. Perhaps more than any other, the mining industry has ridden the Chinese boom – or “supercycle” – in commodity prices.
But now investors are asking whether the sector’s best days are behind it. After the boom, they say, surely must come a bust. With metals pricesdown more than 20 percent from last year’s highs, could the supercycle be over?
The answer has profound implications for investors of all stripes, and particularly in the UK.
Following a surge in share prices and a string of listings, the mining sector now accounts for about an eighth of the market value of the FTSE 100 , and so a large chunk of many British pensioners’ savings.
“We believe that the tail wind of ever-higher commodity prices, which has been the principal driver of share prices, is now over,” says Heath Jansen, head of metals and mining research at Citigroup, in a note entitled “Super-Cycle Sunset”.
The bears’ argument is two-pronged. First, Chinese growth is slowing, and becoming less commodity-intensive.
China is the main driver of demand for commodities such as iron ore, coal and copper , accounting for as much as three-quarters of forecast consumption growth.
But Beijing has lowered its growth target to 7.5 percent, the lowest since 2004. Put that together with the prospect of rising supplies as miners’ investments begin to kick in and, some investors argue, metals pricesare unlikely to rally much from current levels.
“We are looking at an inflection point in terms of China’s growth rate, which should slow gradually over the next decade after the pulsating growth of the last decade,” says Robert Lind, chief economist at Anglo American. “That has triggered a debate about whether commodity pricescan return to their previous cyclical peaks.”
At the same time, the costs of running and building mines is rising rapidly. Kazakhmys , the London-listed copper miner, reported inflation of 18 percent in its production costs last year. Analysts at Deutsche Bank estimate that cost inflation across the industry was 10-15 percent in 2011 and predict it will slow only slightly in 2012.
The obvious conclusion is that margins will fall—and, with them, share prices. Indeed, the FTSE All-World mining index has already dropped 31.8 percent from its peak in April 2011. “This is usually the point at which the demand cycle finally matures and the supply response kicks in,” says Andrew Keen at HSBC, noting that stock valuations are already starting to discount a shift.
“If this is the case, it won’t be a repeat of the 2008/09 downturn, which turned out to be a brief intermission, but the start of a long, unwinding and normalisation of margins.”
Not everyone believes the supercycle is dead. Commodities prices could stay robust should China’s slowing growth be counterbalanced by difficulties bringing new supply to the market, as companies brave ever more tricky geological challenges and difficult jurisdictions in search of promising deposits.
“Exchange inventories are relatively low still despite this trough in demand currently affecting China and Europe,” says Simon Collins, head of bulk commodities at Trafigura, the second-largest metals trader. ”There’s not that much available material.”
Nonetheless, the idea of a shift in momentum for the mining sector is gaining greater credence among investors and executives alike.
BHP Billiton, the world’s largest miner by market value and a bellwether for the industry, acknowledged that growing caution among investors last week, when it said it would slow development of its big projects to match expectations for earnings.
Other miners are likely to follow suit, executives say, turning their focus from reinvesting profits to returning them to shareholders.
The result is likely to be a fundamental shift in mining as an investment prospect: putting money into the sector will no longer be a one-way bet.
“In the last 10 years as long as you got ‘long’ the right thing it didn’t matter,” says George Cheveley, natural resources portfolio manager at Investec Asset Management.
“That has not been the case since the middle of last year—we have seen much more differentiation in performance between companies and between commodities.”
Moreover, rising costs may not be entirely negative for mining equities.
In markets from iron ore to copper, the highest cost producers are seeing the most dramatic inflation in costs, meaning that even if prices fall, they are unlikely to return to pre-boom levels. That may help cushion margins for other producers—those at the lower end of the industry “cost curve”—even if their costs are rising too.
Those companies that are able to differentiate themselves – either by controlling costs and delivering projects on time, or by returning larger chunks of their profits to shareholders through buybacks and dividends – are likely to outperform, analysts and investors say.
“In an environment where metal prices remain elevatedbut range-bound, investors would have to pick winners and losers based on who can execute and manage cost pressures, as well as their policies on shareholder returns,” says Jeff Largey, analyst at Macquarie. “It could become a stockpickers’ industry again.”