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Comment                                                                                8 January 2017

Why relapse if you can bounce    

by Cees Bruggemans                 words 1000

The biggest surprise of 2016 for me was the extent of the rebound in global commodity prices. If something, like iron ore, is 75% down from its cyclical peak, momentum could easily knock another 10% or 20% off. Greedy but doable? The trend being your friend.

But that is reckoning without surprises, the biggest of which was 1Q16’s Fed capitulation, backpedalling on its number of expected hikes, but also allowing for some Chinese demand rebound and global supply consolidation (closing of old mines). And not forgetting slow steaming and inventory rebuilding at Chinese harbours.

 

So instead of iron ore plunging towards $30 or $20 (or worse, with so much new supply slated to come to market), the world paused around $40 in the first few months of 2016 and then started its long climb back up, topping out >$80.

Mind you, all advisories at first suggested the rebound would be very, very slow, spread over a number of years, considering the Chinese demand slump and the overwhelming new Aussie & Brazil new supplies coming into view.

Cautiously slow was a good institutional attitude to take (all wrong together). But the Fed capitulation did great things for the US bond market (the global underwriter for everything) and its slower-for-longer set the pace of rebounds for a couple of months.

And then came the Trump detonation, putting equities strongly in play, and also promising new infrastructure. Never mind that new Trump iron ore demand could possibly add 3 million tons to a 700 million Chinese market. But that is the nature of human expectations. Running away with good stories.

If that was the American background driving the global wheels, China also did surprise by the extent of re-engaging its infrastructure engine (it desperately wanted to keep its growth going). And global miners eventually surprised to the upside (after long holding out) by taking a knife to old mining facilities.

But however much the commodity price bounce in 2H16 started to surprise to the upside, the global miners sotto voice kept muttering there would be a relapse of some sort. So in the case of iron ore from a $40 low to topping $80 high, after which there could be a vigorous relapse.

Spot price this month is already down to $75, and futures suggests another $22 off by yearend 2017, and another $10 by late 2018. Market pricing keeps looking towards $40 as a consolidation price. In other words, back to what we reached early in 2016. The whole bounce forgotten…

After all the commodity hype of decades on the back of the rapid Chinese industralisation, followed by its comeuppance once the Anglo-Saxon financial crisis had drawn the teeth from rich countries growth stories, leaving China with much diminished export markets and in need of a strategy switch, and a few global miners finding alternative employment in the fast food business, it was probably inevitable that a deep caution would come to prevail amongst the next generation of global mining managers.

Anything to good to be true probably was. And so Mum was the word. Show gravitas, stress downside, be cautious, silently pray that it might be better.

That has not been a bad strategy these past six months. Old costly mining capacity had to go, the only thing the miners really controlled, also allowing debt reduction (in some cases becoming the prime concern).

The rest involved Lady Luck.

In the event, two turned up (Trump and China) while the third (the Fed) has probably been relegated to a minor force in Trump’s slipstream, as the world switches lead locomotives (away from monetary, hail fiscal).

Which raises an interesting question: why relapse if you could bounce some more?

This of course is to challenge fate. The new supply coming on stream is still truly gigantic, there isn't all that much old capacity still to cull or debt burden to trim (is there?), China is a good demand story but it can do only so much, inventory piles at Chinese harbours are again approaching insanely high levels, and Trump will probably be very good for many folks, but the infrastructure story is short on specifics, execution and global relevance.

That makes a bit of a price pullback the better career choice (only promise what you can deliver, and not a ton or Dollar more).

But if that is iron ore, it may not be oil (or coal or gas). There the boys & girls are happily promising each other all kinds of happy things, despite long histories of cheating. Market analysts are seeing potential for more upside, even beyond the consensus of $60, offering all kinds of rationale. But some are cautious here, too. Not quite trusting the supply deal to hold, for whatever reason. And the higher the oil price, the stronger American frackers are likely to respond. With Trump the wild card with opening new exploration acreage.

Brent spot is still $57, but five year futures barely see prices $2 higher. That is a very flat table top for so major a commodity. Everything hinges on the supply deal. As it goes, so will prices.

And so through many other commodities. Way off the cyclical 2016 bottom by now, but the cautious having seen overexcited rebounds before and happy to pencil in some minor relapse, stabilising on lower, if still satisfactory levels.

It really boils down to understanding Trump, China and the global supply dynamics. All three present challenges, for who knows what Trump will really still deliver qua impact on the world economy and markets, who can read Chinese minds best regarding its strategic positioning, and can you really be sure about what your mining competitors will do next?

My sense is for some more upside, even if I don't want to overstate my case. The Trump growth impact may boost business confidence enough to see strong second-round growth effect. For non-energy commodities this will benefit SA mines, while SA households and businesses will pay the energy piper, as usual.

 

Cees Bruggemans

Bruggemans & Associates, Consulting Economists

 

Website www.bruggemans.co.za

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