“The theme for this year, next year and probably for an extended period will be costs… and not just operating costs but also capital costs. We will reduce the projects we are building and put more effort into controlling costs.”
This gloomy quote would barely be worth mentioning if it came from one of the many troubled mid-cap miners who are struggling now that commodity prices have softened. But it came from Tom Albanese, chief executive of one of the world’s largest and lowest-cost diversified mining companies, Rio Tinto.
Barely a few months ago, Rio was aggressively pressing ahead with almost its entire development pipeline – this despite large capital expenditure (capex) cuts being announced by key competitors such as BHP Billiton. Now, Rio Tinto is toeing the line. This abrupt turnaround shows the speed at which market participants have come round to the idea that the so-called ‘commodities supercycle’ could finally be slowing down.
And while commodity prices oscillated wildly at times in 2012 – gold’s stellar autumn run and iron ore’s dramatic slide from $140 a tonne to $85 a tonne in just three months spring to mind – base metals emerged essentially flat for the year, with bulk commodities down 15 to 20 per cent and precious metals up 8 to 10 per cent.
The Age of Uncertainty
As we enter 2013, the outlook for commodity prices is as uncertain as ever. Growth in China is at its slowest for three years while economic recoveries in the US and Europe are stumbling. True, a new generation of Chinese leaders may soon try to put the country’s economy back on the fast track, but a massive infrastructure-led stimulus package that would cause commodity prices to soar rapidly again seems unlikely. All in all, global industrial demand will likely remain subdued.
Worse still, mining equities are underperforming commodity prices. Not only are lower raw materials prices affecting miners’ bottom lines, but so too are rising labour costs, higher taxes and royalties, longer environmental and permitting delays, declining ore grades and the growing burden of community obligations.
$1,800: Gold’s last three runs have failed to break above $1,800 an ounce
Yet it would be a mistake to argue the decade-long party for miners is all but over – especially when most commodity prices remain near historic highs. The balance sheets of some major miners are robust, dividend payouts are becoming larger and cash flows are still strong for the better-quality companies that have managed to keep costs low. The market also already appears to be bearishly pricing in further falls in commodity prices, which could be artificially depressing valuations.
But what will happen to most mining equities if commodity prices do not increase considerably from here? In a deteriorating or flat commodity price environment, investors would have to seek alpha to generate the bulk of their returns – meaning they will need to turn their hands to stock-picking to find outperforming companies within sub-sectors that can post superior returns.
Brake pedal to the metals?
Gold is the big wildcard for 2013. We’re expecting another positive run up in first quarter as there’s still the US fiscal cliff to contend with and the European sovereign debt crisis has been ominously quiet for a while now. But gold’s previous three runs have all failed to break past $1,800 (£1,125) an ounce, and a third round of quantitative easing by the Federal Reserve in September didn’t provide as big a boost to precious metals as had been anticipated.
Copper prices likewise remained strong throughout 2012 even as other metals wilted. Yet there is now more downside risk to the red metal than upside. Several new big copper mines are expected to ramp up production next year and this is likely to put the copper market into surplus in 2013. Deteriorating ore grades at many long-life mines and the scarcity of new copper deposits provide some downside protection, however, and few traders are expecting an imminent collapse in prices. Faster growth in China and the US would keep prices strong.
Platinum, coking coal, thermal coal and iron ore were the dogs of the commodity world in 2012, and 2013 may prove little different. That said, we see iron ore and coking coal performing relatively better than the other two in 2013. Upside price movements across all four commodities will be capped by overcapacity and a weaker demand outlook, while high cost curves will mean miners’ stretched margins will get even thinner.
Looking ahead
Admittedly, our general view on the mining sector is neutral to mildly bearish heading into 2013. We expect the early new year reporting season to be slightly disappointing for miners on costs, capex, earnings and dividends based on lower commodity prices and the well-publicised industry challenges experienced this year. Meanwhile, all eyes will be fixed on China to see whether positive early economic indicators in the fourth quarter translate into faster growth in the first quarter of 2013.
This abrupt turnaround shows the speed at which market participants have come round to the idea that the so-called ‘commodities supercycle’ could finally be slowing down.
Nevertheless, there will still be opportunities out there. Some companies will have managed to keep operating costs low, cut their capital spending budgets and increased dividends, and the market should reward it. We generally favour those miners that can drive earnings growth without relying on higher commodity prices. We view emerging producers and mid-cap miners with high potential to grow output as most attractive, followed by companies exploring or mining high-grade, low-cost deposits in safe jurisdictions – as these will always be in demand and will be able to withstand price shocks.
Our preferred picks are Yamana Gold, Central Asia Metals, Archipelago Resources, Antofagasta, Sirius Minerals and Silver Wheaton.
| What we like | Gold Silver Potash |
| Neutral | Copper Zinc Coking coal Iron ore |
| What we don’t like | Platinum Uranium Thermal coal Nickel |
