A Brilliant Outlook for Resources – Global Boom Underway

Key Points

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Economic growth forecasts have generally remained robust over the past couple of years despite the odd problem here and there and these growth numbers have been delivered.  Still no real sign yet of the Greater Depression, European Banking Sector Collapse or China falling over.

Equity markets have had some healthy corrections but nothing disastrous, except of course for our non gold resources.  My reviewing of all the key global equity markets shows earnings are holding up, technology is making extraordinary strides everywhere and consumer demand is robust.  This review still suggests the current economic expansion has a long time to run and commodities will be the best way to play the next few years.

Dawes Points has continued to focus on the data and on the markets themselves rather than following the ten thousand or so opinions out there on why it all must collapse. `Heed the markets not the commentators’.

The Australian gold producers have been leading the world out of the malaise and have given us a real indication of the Australian mining sector’s strength and resilience.  Accolades are due to the managers of the Terrific Ten gold producers in Australia noted in the last Dawes Points.  There are, of course, many more gold producers but the ridiculous ASX 300 Gold Index does not reflect the Australian Gold Industry, just the thought bubbles of some foreign bureaucrats who compose this index (More on this soon).

This graphic has been of MAJOR significance because it shows the true low to have been in June 2013.  Those next 33 months have been excellent and investors here have been able to ignore the garbage being thrown around by the herd of bears and gain earnings and cash flows growth, asset growth and dividends from these companies. Dividends that can only grow.

It has also been a major contributor to the overall positive tone conveyed by Dawes Points in recent years.

Most major gold sector indices overseas did not make their post 2011 lows until January 2016 and in my considered view it has not just been the A$ gold price that has been driving our Terrific Ten.

When the ASX 300 Gold Index is rebalanced from June 2016 let’s try to ensure that it is an index that reflects the Australian gold industry, not just a motley collection of non representative ASX 300 companies.

An apology is due over the ASX Gold Index share of All Ords Turnover shown in last month’s Dawes Points.  The graph was wrong.  The numerator was rising strongly but incorrect denominator data was used.  Share of turnover is around 4% now (and not the 14%!). Here is the updated version.

The conclusion is the same but not as enthusiastic as I thought the strong rises in NCM, NST and EVN on big volume were making it seem.

The Index has moved up but it still has a long way to go to the upside.

I still expect the Gold Index here to be close to 6000 by year end.

Gold will be higher again soon and gold stocks will outperform.  Are you on board?

The many other projects being developed by our tenacious local resources sector managers are there too in copper, lead and zinc and others and also in the new materials lithium and graphite that feed into the global technology markets. The magnitude of the major iron ore, LNG and coal projects crowded most of these projects out but the underlying demand for most of their resources remains robust.

The China Steel Industry naturally gets most of the attention for the Resources Sector and the `falling demand from China’ theme has been seen in the sliding iron ore price since 2011 and more recently with the industrial metals.  The major companies BHP and RIO have suffered in their share prices.   Global Crude Steel Production was down 2.8% in 2015 to 1623mt and consumption in China was down almost 5% but China exports were running over 100mtpa into growing markets in Asia and Africa so China crude steel production has held up well.  But note that China’s GDP and consumption does not include utilisation of Chinese steel and manufacturing items applied to Chinese construction projects in so many other parts of the world.

Interestingly the historic volatility in monthly annualised Crude Steel Production in China is narrowing and the impact of Christmas/China Spring Festival over December/February seems to be steadying.  Also the rate of change suggests an upturn in output is now coming.

Demand for imported Iron ore into China, far from declining, is still rising and recorded a massive 1,133mpta import rate in December to take imports to a new record of 957mt, up 2.2%.

Domestic iron ore production (all magnetite) fell a reported 130mt in 2015 (now operating at about 45% capacity) and did what we all thought it would but just came a couple of years later. Iron ore production in China is, like so many industries there, highly fragmented with numerous small operators. Total iron ore demand was down reflecting lower crude steel output but the imports were at those new highs.

The impact on Australian iron ore producers was just a lot more exports (up 7% to 767mt and likely to be up a further 13% in 2016 to 860mt) for the low cost majors and shutdowns for all the rest.  An estimated >250mt of global iron ore supply has been shut down or deferred in this recent low iron ore price environment.

It is clear that steel mills in China have had quite low iron ore inventories and with the increased reliance on imported iron ore these inventory ratios suggest inventory rebuilding is likely in 2016.

Whilst much has been made of the conversion of China’s economic thrust from investment to consumption-related focus there remains the US$1,000bn currently being spent on the One Belt One Road Project.  China’s strategic horizon has always been westward looking.  Adding the 2,000million inhabitants of Asia to China’s own 1,400m gives a 3,400m consumer market and adding Europe gives China access to 4,500m.   This project is massive and will link China to Singapore, India and Myanmar, The Gulf region and most of the`Stans then Europe.  Highways, fast trains and shipping channels and it is already underway.  The Asia Infrastructure Bank is already set up.

How much steel and copper will be required.  Can we even conceive the amount of raw materials required for this?  The Chevron-Shell-Exxon Gorgon 15.6Mtpa LNG project in WA has cost about US50bn and been Bechtel’s (and the world’s!) largest single project to date so US$1,000bn on far less challenging projects will use a lot of steel and copper.

Be aware of these infrastructure developments.  The impact could be massive.

The current improvement in iron ore prices should be seen in this light and the usual market cycle should be expected.  Some mills will rebuild inventory, the Dalian iron ore futures market with its huge turnover should see more short covering, more mills will rebuild inventory and when higher steel demand comes through there will be strong buying.   How much higher will iron ore prices rise?  Don’t know but I am sure it will be more than we expect.

Iron Ore Price basis 61% Fe


Source: IRESS

BHP, RIO and FMG will clearly benefit.  All these stocks should be bought.  Keep in mind balance sheet matters are always the key issue at times of low prices but as prices and cashflows improve the market focus goes from fear to greed.

These US$ price charts are suggesting major lows have been achieved for all three.

BHP                                                                                        RIO

FMG

Iron ore and steel will be leading the way here but copper and the industrial metals won’t be far behind.

Consumption has been robust with many metals having record consumption figures.  Additional supply has been significant but not as much as much commentary would suggest.

The big picture gives record consumption levels for almost all metals over the past six years.

Importantly, the inventory levels on LME have been in reasonably consistent downtrend for about four years and whilst LME inventories aren’t all inventories, they are a good proxy for readily available metal.  It has been fascinating to watch the daily decline in almost every metal and then the sudden appearance of 20,000t or 50,000t being marked across a white line in a warehouse over one or two days.   Clearly no mine, smelter or end user has 50,000t of metal just sitting around (50,000t is a big for any lead, zinc, copper or nickel mine/smelter/refiner!).

The composite now shows just 1.80% of annual consumption is available on LME.  Less than one week.

The individual metals tell the story as well.

What happens when purchasing managers decide to build inventory again rather than reducing?

What happens when real end use demand picks up?

Demand will be well in excess of consumption.

Copper might just be telling us something now.  A rally to US$2.70/lb is likely.

The 10% move in the week ending 4 March was telling us that shortcovering is coming.  The strong moves in the big resources stocks are reinforcing the view that the inventories of resources stocks held by major money managers are low.  Short covering coming here too.

This can be seen here in the Metals and Mining share of All Ords turnover with the past two weeks exceeding 14%.

Quite often market commentaries are all about `the Fed’ and its policies and how they will affect the world.  I have deliberately avoided comment here because it is clear that it is rare for any two commentators to draw the same conclusions on what has actually been said.  So often, however, the commentary has been that the Fed policies on raising interest rates will slow a fragile economy.

What if this interpretation is just wrong?

What if rises in Fed interest rates are helpful for the economy?

It is clear that Bernanke policies of QE to push trillions of cash into the banks did not produce inflationary pressures because the banks just kept the money. They had a zero cost of funds, it improved their own balance sheets and they then lent it back to the Fed to make a risk free margin.   Nice work.   For hundreds of billions.

The raising of the Fed Funds Rate means that US banks now actually have to lend the money to some other parties to make a margin.  Lending it to businesses and consumers.

US Fed data shows the Excess Reserves held by Financial Institutions reached over US$2.5tn post the 2008 GFC after being far less than US$20bn for decades.  These reserves are now plummeting as banks begin aggressive lending again.  Pumping another US$1-2tn into the economy might now be inflationary.

This is the data.

An implication here is that it should boost the volume and the circulation of money that could become inflationary.  Credit to Stewart Thomson of Gracelands here.

The US Banking Index suggests technical support has been achieved and will now move higher.

You know my views on the global bond markets but I consider that bonds would certainly fall in this environment.  Sale of bonds to central banks will add to liquidity and the exit of funds to equities and commodities.

So the macro is bullish, the financial markets are bullish, the demand and inventory data are bullish and so many of our micro factors for resources sector corporates are bullish.

But most people are still fearing the Worst and have built up huge reserves of cash – A$1779bn here in Australia.

The Best is now coming.

The 146% in 15 months for the Dawes 2015 Gold Stock Portfolio is a start.  The 47% gain in two months for the Dawes Points 2016 Gold Stock Portfolio is also good.

What do you think my 2016 Nano Cap Gold Stock Portfolio is now?  What will it be in a year?

What do you think the next few years Total Return will be with the Dawes Points Big Cap Resources Portfolio?  Can you imagine the Dawes Points Nano Cap Resources Portfolio?

The ASX 300 Small Resources Index is now trending above 3% market share.  Action here at last.

Join up and take the ride!

And don’t forget this for A$ bears.  If gold stocks rise, then so will the A$ against the US$.  For 20 years from 1993 to 2013 this relationship generated an R2 of 0.92!  It is catching up again.

Barry Dawes
BSc FAus IMM MSEG MSAA
I own BHP and a lot of gold and small resources stocks.

7 March 2016
Edition #46

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