The mining boom is dead. Long live the mining boom!
To us, that seems to have been the message greeting’s BHP’s results yesterday and the announcement that it was shelving its planned Olympic Dam expansion. BHP shares rose on the news and while this was viewed with more than a dash of incredulity by Houses and Holes, it wasn’t entirely unexpected. Indeed, several weeks ago MacroInvestor floated a pair trade idea of going long BHP and short one of the more low-margin mining services companies, on just this premise.
But how can mining do well and mining services do poorly? It’s all in the mix of capex-focussed investment versus opex, or operational expenditure-focussed investment. Mining services companies do well when capital expenditure projects are launched – whether new mines, expanded mines or mining-related infrastructure; whereas miners – at least in times of declining commodity prices – do well when the costs, or the opex, are low.
And in the case of Olympic Dam’s shelved expansion, it isn’t BHP that will suffer, but the companies contracted to do the build. With cash being set aside for presumably more profitable projects, BHP will in theory garner a better return on equity and stem any further decline in copper and uranium prices by not boosting additional supply.
Outside of copper and uranium however, the Olympic Dam announcement can shed a clearer light on the situation in bulks (particularly coking coal and iron ore) that optimistic pronouncements from mainstream economists can’t. In short, the mining boom is in a clear danger of coming to an end and there’s little that will save it. Capital expenditure – even capital expenditure that is “locked-in” – is quite easy to cancel when the chips are down, and just like a series of high-rise housing estates in Dubai or luxury shopping malls in Nevada, even the best laid plans can come to nought.
As each week passes, more and more data out of China suggests that the biggest source of Australia’s terms-of-trade boom is slowing, and China seems to be doing very little about it.
As we also discussed in MacroInvestor last week, in this year of political transition and with a virtual monopoly on national savings, China undoubtedly has the will and capacity for economic stimulus. However, much of this stimulus is likely to be redirected to the task of rescuing non-performing loans accrued in China’s first round of largely fixed-asset-directed stimulus in 2008.
Certainly, the statistics on restructured lending bear this out, as China’s state-owned banks refinance bad debt to other state-owned entities – off-balance sheet or not – in order to keep the arrears rate deceptively low. China is using tried and tested techniques to kick the can down the road, in much the same way that Spain did leading up to the present debt fiasco, and Japan did during the lost decades of zombie corporations and stagnant investment (a point expanded on by Also Sprach Analyst yesterday).
But that’s not all. While in the credit markets loans are refinanced and cans are kicked, in the macroeconomy the People’s Bank of China is injecting unprecedented liquidity into China’s repo market, to worryingly small effect. But most of all, as much as China could also mimic Japan by throwing good money after bad by stimulating beyond this rescue, officially this is still undesirable.
Although there are plenty of pending infrastructure and fixed-asset investment projects being touted by provincial and local governments – in aggregate exceeding even 2008’s RMB4 trillion in total stimulus – Beijing remains committed for now to less inflation-stoking, neo-Keynesian methods. Described in a recent editorial in the official mouthpiece, the People’s Daily, as like “drinking poison to quench thirst”, further Chinese investment is not as guaranteed as many Australian miners or economic policy-makers would like.
In terms of saving Australia’s boom then – assuming further Chinese growth is to come from consumption rather than investment – we must inevitably look at other emerging markets. One possibility is Brazil, which recently called for $US66 billion in infrastructure investment. Another alternative, Russia, is in a race to diversify away from Europe and develop the Far East (where it is estimated that only one third of roads meet the World Bank’s quality guidelines). Emerging markets in South Asia and Africa seem also to offer possibilities. After all, the developing world is crying out for the kind of spending that China perhaps did too much of during its economic renaissance since the late 1970s.
Yet the problem for these places – with the exception of India in the case of iron ore – is that they are already overwhelmingly mineral rich and have much cheaper labour than we do (something being vividly illustrated by the present strikes in South Africa). Further, these emerging markets also have their share of bad debt and economic imbalances, especially India, where numerous state-owned banks keep their own zombie clients afloat. As such, while Australian mining companies, investment bankers, lawyers, engineers and consultants may enjoy a boom, Australia – essentially in competition – will likely not, and, presuming that productivity growth won’t have time to catch up, our terms of trade will suffer.
A lack of a current account surplus precludes, for most economists, the idea of an Australian sovereign wealth fund. But maybe we should have saved something for a rainy day? Until the Australian Dollar falls and other sectors have a chance to regain competitiveness, the boom looks over and other emerging markets won’t save us.
Michael Feller is an investment strategist at MacroInvestor. Our coming edition will deal with infrastructure spending ex-China, the divergence of Australia’s terms-of-trade with the Australian Dollar, and several companies that could be most affected.