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Category: Business, Economics and Finance / Economic Trends / Iron Ore / Mining Industry / Markets

Bulls emerging in resources, but can it last?

Friday, 5 Aug 2016 13:51:08 | Stephen Letts

A worker walks by the pile of steel at an iron and steel mill yard in Hefei, central China's Anhui province, August 2007. A combined BHP Billiton and Rio Tinto would control two thirds of the globe's coking coal and around half of the world's iron ore - an alarming prospect for China at a time when the country requires huge amounts of natural resources to fuel its fast-developing economy. (Getty/AFP)

The badly beaten up global mining sector appears to be crawling off of the mat after taking a brutal hit from another China panic attack at the start of year.

Since hitting a seven-year low in late January the MSCI global materials index has risen almost 33 per cent, while the broad global equity benchmark is up just 15 per cent over the same time.

Long-time resources "bear" Morgan Stanley has capitulated and now said investment opportunities, particularly for Australian miners, are "attractive".

In a note to clients, Morgan Stanley's resources team said it expected the results season should finally show earnings per share (EPS) upgrades, rather than downgrades from the miners.

"It was a long five-year bear trade for the miners, but with commodity prices stabilising in response to supply rationalisation and cost-outs, we anticipate EPS estimate upgrades rather than downgrades over the second half of 2016, aided by positive commodity forecast revisions," Morgan Stanley said.

A big driver of the recovery has been a massive wave of Chinese stimulus after the January conniption.

That splurge has blown out China's off-budget spending to 10 per cent of GDP, well above the Government's target of 3 per cent.

Morgan Stanley mining analyst Brendan Fitzpatrick said while the application of the stimulus might slow, there was a trailing effect that provided near-term stability for resources stocks.

On Morgan Stanley figures, the positive momentum should deliver 8.6 per cent earnings growth for the miners over the next 12 months, compared to a fall in EPS growth across the ASX 200 of 11 per cent.

"The risks remain both the probable seasonal de-stocking for iron ore and an anticipated moderation of growth in China for the second half of 2016, but we consider that any weakness could be shallow and possibly short-lived," Mr Fitzpatrick said.

Macquarie sceptical iron prices will keep rising

Macquarie's commodities team is not convinced by the recent rally in iron ore which pushed prices to a three-month high above $US60 a tonne earlier this week.

"While we have written previously on our confidence in $US50 a tonne price support for iron ore holding through 2017, we are sceptical as to any fundamental support for the recent move higher," Macquarie said.

"However while the price rally has seemed surprising to us versus fundamentals, it is possible that iron ore prices may remain well supported through the remainder of the third quarter on the back of seasonal demand improvement for steel resulting from the construction 'golden season' of September and October."

FeO2 rallying again

The key iron ore benchmark has risen more than 6 per cent in the past month, but has weakened lately to be down 2 per cent over the week.

Data released by the National Bureau of Statistics reported China's crude steel production hit a record monthly high of 845 million tonnes in June, although Macquarie said this did not seem to tally with either its own observations or those of the Shanghai-based market analyst, Mysteel.

China economic performance remains "cloudy": ANZ

As ANZ commodity strategist Daniel Hynes notes, the improvement has come at a time when China's macro background remains cloudy.

"Recent data suggest China's growth momentum has started to fade," Mr Hynes said.

Fixed asset investment (FAI) — a proxy for infrastructure and property spending — for the first half declined to 9 per cent year-on-year, dragged by a significant faltering of investment growth in June.

FAI had been growing by close to 11 per cent in the first quarter in the immediate aftermath of the stimulus splurge.

As well, real estate investment rose 7.2 per cent in the first six months of 2016, down from 8.4 per cent in the first four months, also pointing to a sharp decline in June.

"This suggests that tightening measures by policymakers are starting to bite," Mr Hynes said.

The ANZ house three-month outlook is that iron ore prices could fall by around 12 per cent.

Importantly low steel inventories in China — which have been the focus of the iron ore bull case — appear to have edged up lately.

While Australian iron ore shipments have levelled off lately — following an end of financial year flourish — Brazilian suppliers have taken advantage of the higher prices and are pushing record volumes through their ports and there are signs that higher cost Chinese and Indian mines may re-enter the market.

The Macquarie team said that once the monsoon season blows through in September, the possibility of another 3 to 4 million tonnes of iron ore shipped from India each month is the force most likely to keep a lid on prices.

Valuations getting to pre-super cycle levels: Morgan Stanley

Nonetheless Morgan Stanley's view is the change in direction for investors in the mining cycle will be driven by relative valuations of mining companies moving back to "pre-supercycle" levels and mine closures having the potential to bring markets back into balance and support prices.

ASX 200 Resources Index performance

Cost cutting and efficiency drives, plus the potential the introduction of new "smart" technology in the mines have the potential to contribute to any upswing in the cycle.

Morgan Stanley noted several other more immediate positive signposts pointing to its move away from an underweight stance on resources.

These include a conviction that commodities are now well past spot price lows, the supply outlook across key commodities appeared more constrained than six months ago and belief that China's stimulus would fade rather than collapse.

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