01 Nov 2016
After four years of challenging market conditions, a rebound in commodity prices is offering producers and investors in the mining sector a window of opportunity for growth. As companies take advantage of the uptick and review their strategies and asset sales, investors will reassess their supply and demand fundamentals.
While commodity prices are still at significant discounts to previous highs, the spot price of iron ore has rebounded since the first quarter this year from multi-year lows and zinc has outperformed most others.
"The mining sector had been struggling for a number of years, focusing on capex retrenchment, pulling back operating costs and restoring the integrity of their balance sheets,” says Macquarie Securities Senior Metals and Mining Analyst, Alon Olsha. “That has all changed now: cash flow generation has been significantly better than expected and asset sale programs have actually slowed down."
Economic sentiment is behind this recovery – with the Federal Reserve’s apparent cautiousness on stifling the US recovery with tighter policy and better than expected data in China. There have also been fundamental drivers, such as demand growth and extensive cuts to supply.
Following significant cutbacks by producers, many commodity markets have transitioned from a stage of strong supply, peaking capex and falling prices, to one where inventories have been drawn down. Prices have stabilised broadly. Over the next two years, several of these commodities may be nearing or entering a stage of supply constraint, lagging capex and prices that encourage output.
Still, the supply outlook will differ among commodities and investors will need to be discerning, according to Macquarie Securities Global Head of Commodities Research, Colin Hamilton. In the longer term, the challenges of disinflation, overcapacity and lower industrial demand growth will persist, he says.
"We are in a world where global manufacturing and global industrial production are getting better," says Hamilton. "This is not driving markets into huge inflation bottlenecks, but it does mean that the metals demand trend has started to push a little higher."
The single biggest role in changing the near term landscape in the basic resources industry may have been the Chinese government’s efforts to sustain growth while trying to reform the economy. Resilient manufacturing, real estate and business confidence data from the world’s largest consumer of metals have eased concern of a so called hard landing in its economy.
"Chinese construction activity remains in a positive trend,” says Hamilton. “We continue to increase our demand outlook across industrial metals as the Chinese government prolongs its more commodity intensive phase of growth."
Olsha warns that this year’s rebound may not be the start of a sustained recovery that could influence companies to build new capacity, as medium to long term fundamentals for most commodities haven’t changed. Likewise, it would take a more prolonged upswing in commodity prices to encourage them to pursue acquisitions or return cash to shareholders, he explains.
For now, the first steps may be to take advantage of the better conditions for miners owners that will enable them to shrink their balance sheets.
"It is an opportunity for companies to unburden themselves of non-performing assets or previously unprofitable operations," says Olsha.
For more information on the report "Commodities Compendium" (29 September 2016) contact Macquarie Research