For MS today:
Short-term volatility is exacerbating the mining cycle at this time. However, as we look to 2016, the nature of the cycle suggests that in hindsight now will be viewed as the wrong time to capitulate. Exposure to companies with quality assets and sound fiscal position should be increased.
Mining equities already capturing in spot prices: Further EPS downgrades are implied on a MtM basis but the mining equities have already priced this in (pg 4). Mining cycle is approaching a turning point: Capex has peaked and productivity is rising. Ratios such as a ~7% Fwd RoCE for BHP and RIO, or an Index P/B returning to 1x indicate a cyclical low (pg 7).
Energy and currency to boost margins: This may not be noticeable this reporting season, but should be more apparent by August; more so for bulk miners (pg 10).
Supportive royalty stance: WA Gov’t aids iron ore miners through temporary royalty rebate. This reassures us that economic rationalism will be applied (pg 12). China demand soft but not collapsing: PBOC rate cuts and stimulus should result in better demand in 2015. Property is improving; bauxite inventory is depleting and copper financing is no longer an overhang (pg 13).
Our stance remains: Not all our OW ratings have worked for us. Yet our conviction for owning miners with quality assets and balance sheets remains. Miners to own/accumulate at this point in the cycle: ILU, RIO, WHC, BHP, OZL, WSA and PNA. There are valid debates regarding spot price scenario outcomes, but this is not our base case assumption.
There’s really no other way to say this, I completely disagree with this analysis because:
- the bear market in commodities is not cyclical it’s structural, driven by the Chinese transition to slower and less commodity-intensive growth;
- huge oversupply in all major metals and ores that is going to worsen further as boom-time plans come to fruition;
- the US dollar bull market adds a monetary headwind to all commodity prices, and
- markets are only partly through a definiancialisation of commodity trading as the realisation grows that the age of hoarding is passed and no yield don’t stack up when prices are falling.
These four points mean miners face a decade of cost-out deflation as they chase the price of their goods downwards in an historic market share battle. In this environment, any short term relief from input costs or royalties only gets recycled as cheaper prices for customers.
It’s a margin squeeze that will turn into a volume squeeze that will wring out the entire complex for years to come and when prices finally bottom, all of that infrastructure that’s been built through the boom means volumes can swiftly respond to any pulse of new demand, inhibiting any price growth for a very long time.
Miners are once again price-takers, firmly where it hurts.
