by Chris Becker
There’s a fascinating article in The Australian this morning that is sure to give the folks (and their astroturfing minions) at the Australian Minerals Council conniptions.
The by-line is hilarious and the fact that the “premier” broadsheet is publishing what amounts to the exact opposite of its cheerleading for the past decade will make for some confusing meetings in the PR department this morning.
RESOURCES companies should blame themselves and their history of over-promotion, rather than cooling commodity prices, for the steep downturn in mining stocks.
That’s the view of Bert Koth, the managing director in Australia for the $US7.9 billion-plus ($9bn) Denham Capital private equity group, who believes it will be some time before investors are again prepared to back the resources sector with the same gusto seen over much of the past decade.
Speaking to The Australian, Mr Koth said blaming the funding crisis on falling commodity prices ignored the mistakes the industry had made during the boom.
“It’s not because China is growing a little bit slower, it’s not because there was or is a debt crisis in the US and Europe, to a significant degree it’s because the industry was over-promoted,” Mr Koth said. “When you set inflated expectations and they don’t come to fruition, people abandon the sector.”
Denham have clearly outlined the behavioural structure of any boom and bust cycle – and put another nail in the coffin of the endless mandarins and sell-side analysts who have called for an end to this ageless investment behaviour, especially as described and proved by Hyman Minsky.
This is not just the purview of the amateur investor, trying to make outsize gains on his share portfolio by taking a punt on speculative mining stocks but also the management of said companies and their lack of foresight into securing future funding as margins are compressed:
Mr Koth noted that about 95 per cent of new copper and iron ore supply on the drawing board around the world came from projects with a forecast capital expenditure of more than $1bn.
Around half of those $1bn-plus projects were in the hands of junior to mid-tier companies with little likelihood of securing funding, while the mining giants owning the balance would be very cautious about putting more money into new projects.
“Macroeconomically that’s going to mean eventually demand will meet supply,” Mr Koth said. “That’s not going to happen tomorrow, and I’d argue you’re talking multiple years rather than multiple months. So, I don’t see any swift recovery.”
We’ve seen this cycle before. As price bottoms and supply moderates, demand very slowly picks up as the price trickles along a bottom and the survivors cut to the bone their operating expenses, especially exploration. The banks or the cashed up survivors of the previous booms are reluctant to lend to fund any new projects, unless the expected cashflows are nearly guaranteed – in either case, the internal rate of return is usually very low.
As these projects go forward and demand increases further with some mild price rises, the too-conservative nature of the project is discovered by both producer and financier so more attractive options with higher returns are put on the table.
This increased economic activity then feeds upon itself and the supply/demand equation moves further up the curve with higher prices seemingly indicating a lack of supply and more mines are opened/re-opened and financed based on future cash flows at even higher commodity prices. The frenzy is on.
The next stage is spectacular – and usually helped along by a good old fashioned juicing by monetary authorities – and we get a bubble where completely speculative and marginal operations are financed by hyped-up IPOs, cheap but huge debt packages by investment banks looking to foister free money on anyone with a pulse.
The next stage is what the commodity market has been experiencing throughout 2014. A price collapse as burgeoning supply hits an overloaded, speculative demand curve as the untenable projects and share prices are wiped out, greed turns to fear and money flows to safety.
Looking ahead, Denham reckon we’re not quite at that new “beginning” stage, with the downturn still a way to run:
The upside of a prolonged downturn in the resources sector would be some relief in operating and capital expenditure pressures across the industry.
Mr Koth said that of the more than 500 mining projects that Denham had looked at in recent years, only “a handful” made financial sense. He said there were opportunities for companies to reduce their cost bases in the current climate by addressing overstaffing, renegotiating rates with mining contractors and taking advantage of the new-found availability of geological staff.
“Industry-wide I think there’s at least a 10 per cent opex and 20 per cent capex reduction potential in Australia,” he said.
Not good news for mining services companies of course, or mining wages in general but that’s the nature of the beast.
We took it by the horns, but didn’t realise the tail had a nasty sting.