Business news is full of doom and gloom for the metals sector, but for consumers it really couldn’t be better.
Goldman Sachs (NYSE:GS) is reported in a recent article as saying recent price gains this year may be seen as a swansong for the sector and prices are expected to fall back later this year, as the underlying fundamentals reassert themselves over the recent speculative euphoria that has driven prices higher, particularly in China.
As we have come to expect with metals prices, so much has to do with China, whether it is demand in the case of iron ore, copper and nickel or supply as in the case of steel or aluminum, China dominates the landscape and calls the shots — whether it intends to or not.
The Stimulus
Beijing’s misguided cocaine snort of stimulus earlier this year caused largely retail investors to pile into the markets in a speculative frenzy, driving up prices in the first quarter. Seasoned industry watchers are said to have looked on appalled at the frenzy of buying driving up prices for which the underlying landscape had not materially changed from last year.
David Butler, an analyst at Barclays (LON:BARC), is quoted by the Telegraph as saying “We believe around 5-6 trillion renminbi (£530 billion-£630 billion or $768-$914 billion) was injected inside six months, plus there was incentivization of things like home and car ownership.”
This “incredibly generous” injection of liquidity spurred construction and, hence, steel demand, only for the tap to be promptly turned back off again as the authorities raised restrictions on trading and dampened construction activity in major eastern cities, fearful of a repeat of earlier bubbles.
Meanwhile, construction inland continues to wane in the face of oversupply and prices for new builds are still falling.
Even the Bulls Pull Back
Even the usually bullish miners recognize this. BHP Billiton (LON:BLT) boss Andrew Mackenzie is quoted as saying at a conference last week, “Markets remain oversupplied, sentiment cautious, and we expect a period of prolonged lower commodity prices and volatility.”
Higher prices will only come about when miners cut capacity and, so far at least, there is scant evidence of intent to do so. Part of the problem is falling energy prices, continued low interest costs and extensive cost cutting have reduced miners’ cost of production.
As a result, they are not hurting as much as would be expected given the falls in prices; indeed the last quarter’s price rises have been a welcome shot of profitability for many. Some, like London-listed Centrim which operates a gold mine in Egypt, are reporting higher profitability this year than last, partly on the back of increased output and cost cutting. This reduced the cost of producing one ounce of gold from $758 to $603, a trend that is helping miners worldwide weather the storm.
Most miners are hanging on for now and hoping someone else will blink first, but some are still pushing on with new mine investments. Rio Tinto (LON:RIO), for example, has just received approval for a $5.3 billion development of an underground copper and gold deposit at Oyu Tolgoi in Mongolia, although in the current climate they are unlikely to fast track the development.
For consumers, though, the omens are good. Even if mines are mothballed or put on care and maintenance to conserve cash they can be brought back onstream if prices rise significantly, and new mines such as Oyu Tolgoi will be coming onstream in the next decade to make up for capacity lost in the meantime.
Further Chinese cocaine shots are expected and eventual Federal Reserve tightening will strengthen the dollar, maybe not this year but next, adding pressure to metal prices and limiting upside.