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New ASX-Listed royalty company with large potential (HPR.ASX)

by Alison Sammes
  DISCLAIMER  : I AM A LARGE SHAREHOLDER IN HPR THE INFORMATION HERE IS FROM PUBLIC SOURCES OR INTERNALLY GENERATED FROM PUBLIC DATA USING REASONABLE ASSUMPTIONS AND ARE CONSIDERED ACCURATE THIS IS NOT AUTHORISED BY HPR AND IS MY OWN WORK BARRY DAWES

Key Points

  • New ASX-listed entity has royalty interests over 18 permits
  • 7 permits in the Amadeus Basin could support 100smillion bbls oil and >50TCF gas
  • Many conventional and unconventional oil and gas targets
  • Possible major world class resource of helium in Amadeus Basin
  • High leverage to oil, gas and LNG prices
  • Cash flow current from 4 income streams in 2014
  • Expect royalty income from 6 permits by 2016, 8 by 2018
  • Major exposure to third party exploration programmes
  • Multi decade asset and revenue growth expectations
  • Risked NPV12  24 month valuation target A$1.59/share
As a former Founding Director and as a major shareholder I am delighted to see the outstanding potential unfolding at long last.  Capital raising markets have been difficult these last few years but the underlying fundamentals of a good oil price and access to export markets through the new LNG projects has transformed the hydrocarbon exploration scene and the massive stealth onshore oil and gas exploration boom in Australia is now well underway.  The activity in conventional oil and gas in the Cooper Basin is extraordinary but it is the activity in the unconventional sector seeking tight oil and gas and shale oil and gas in South Australia, Northern Territory, Queensland and Western Australia that is changing Australia’s hydrocarbon fortunes. In addition, HPR has exposure to exploration activity with potentially very large targets totalling in excess of 2.0 Bn bbls in offshore projects in the Carnarvon Basin and offshore Seychelles in the new East African oil province. Phoenix is well placed to share in some of these exciting new developments and others as well. Note the performance of the large North American royalty companies like Franco Nevada and Royal Gold that have grown into major corporations with large long term portfolios that give a pipeline of growth and exposure to commodity prices and commensurate high PE Ratios. Torrens Energy (TEY.ASX) made a scrip takeover bid for unlisted Phoenix Oil and Gas royalty company and has also raised A$6m to provide working capital.  The name has been changed to High Peak Royalties (HPR.ASX) and listing is set for Monday 5 May 2014. The HPR royalty portfolio has been accumulated over almost 6 years and includes exposure to many important hydrocarbon basins such as Surat, Amadeus, Officer, Cooper/Eromanga, Bass Strait and offshore Browse and has prominent industry players such as Conoco-Philips, BG Group, Santos, Karoon, Central Petroleum and Nexus Energy as tenement operators.  The new strong working capital position should see additional royalties acquired. Revenues have been modest to date but should increase substantially with the startup of the BG Group Gladstone LNG plant(GLNG) that will produce its first LNG in late 2014 (note that an official start date for gas production from HPR’s interests in PL 171 and ATP574 is not yet available) and as oil production in STO/DLS’s ATP299 increases under the current drilling programme.  Whilst the BG LNG royalties and ATP 299 will generate the largest near term revenue it is likely that the 1% royalties over CTP’s Amadeus Basin tenements may become by far the biggest asset.  Even just the prospective hydrocarbon gas and liquids discovery with helium at Mt Kitty may prove that to be the case in the very near term. The offshore exploration activities on large targets might also mean large values to HPR despite the modest royalty interests. The potential revenues without an operating cost base or capex obligation should grow and could potentially be very large over time.  This may become a new style of asset class with the potential of increasing earnings year after year for many years to come.  This style of revenue stream should attract a high premium in the market over time and we should all be rewarded with growing fully franked dividends. Also because HPR has interests in many projects with several tier one operators the news flow should be very strong from numerous sources. The HPR opportunity is large and complex but it should be long and exciting. The royalty portfolio covers 18 tenements and can be grouped into three major sectors
  • 2.125-2.5% Qld coal seam gas royalties
  • 1.0% Amadeus Basin oil, gas and helium royalties
  • Minor interests in producing or potential producing tenements in Australia and overseas.
All may seem modest but in today’s world of growing demand for gas and oil and with the days of peak conventional oil behind us these royalties are valuable and even a very small exposure may bring in very large rewards. This table gives a quantified risked assessment of HPR's interests.  1 Queensland CSM Royalties The Queensland CSM royalties underpin the value of the company in the near term through strong revenue generating potential through export sales gas for LNG from the Peat and from the BG Group tenements.
% Tenement Name Operator Area km2 Reserves Pj FY12a FY13a FY14e FY15e FY16e Fy17e
3P 2P Pj Pj Pj Pj Pj Pj
2.125 PL 101 Peat Conoco n.av. n.av. 116.8

7.89

2.79

3

6

7

7

2.500 PL 171 Pinelands BG Gp 175 1000 136.4

0

0

0

0

0

65

2.500 ATP 574 Polaris BG Gp 231 1500 12.1

0

0

0

0

0

95

Prices for sales gas into the new LNG plants should be related to the cif (delivered) prices of LNG into the main Asian markets. Current prices are around US$18/Gj and are linked to oil prices (the so called JCC -Japanese Crude Cocktail – less about US$3/bbl).  This is usually about 14-16% of the US$ oil price expressed in US$/Gj.
Prices have been high in recent years and should stay high as the world increases its dependence on gas, and LNG in particular.  The above graphics show the LNG price into Japan(the main market) and data from BG Group in 2013 forecasting over 6%pa growth in seaborne trade in LNG out to 2025.  Gas consumption globally is around 24% of total energy consumption but is <5% in China so imports there can only increase. The royalty HPR will receive will be the same as that the Queensland Govt will receive and it should be something like a `net back’ after the cost of recovering, processing, pipelining, conversion to LNG, storage and shipping.  A conservative calculation of around US$15/Gj less US$8-9/Gj of production, transport, processing and shipping costs should give a `net back’ royalty pricing of US$5-8/Gj for gas into those export LNG markets.  Naturally Qld will seek the maximum price it can get! The Peat Tenement  (HPR 2.125% royalty) The existing Peat gas field operated by Conoco Philips and Origin Energy has become part of the 8.6mtpa APLNG Project.  The royalty income is currently quite modest and whilst the reserves are limited a higher price should apply in future years as gas is diverted to the export LNG market.  Origin has already flagged its intention to supply BG Group with ramp up gas from 2015 for 10 years.  Some portion of this may come from Peat as it is the nearest tenement to Gladstone and is already on the main pipeline. Source: Origin Energy In addition a major deep gas target lies within the tenement boundaries and may be tested in the medium term. A notional value of only about A$1m is appropriate here but this could be much larger over time. BG Group Tenements (HPR 2.50%) The BG Group permits (in JV with Senex, CNOOC and Tokyo Gas) have 3P reserves estimated at 1500Pj and 1000Pj for ATP 574 and PL 171 respectively.  The wells to date have exhibited high deliverability and should be brought into production in 2015 or 2016.  BG Group will drill 6 more wells in 2014 that should add substantially to the current combined 2P reserves of 148Pj. The exact start up of gas deliveries from these permits is not currently known but it should be in FY16.  Forecasts are from FY17. The 3P reserves are expected to provide a 60% recovery and should show high initial delivery then a sharp decline but should have a very long tail.  These figures are indicative only and need to be risk adjusted but are a useful guide. On these terms the revenues at US$5, US$6, US$7 and US$/Gj and starting in FY17 could look like this. This is pretax EPS of A$20-34m in the first full year (Pre tax EPS of A$0.12 -0.20) On the same basis the after tax NPVs at various discount rates on 165m shares would become:- 2 The Amadeus Basin Tenements  1% over something potentially really large I have had over thirty years watching the Amadeus Basin with a first visit in 1980.  The opportunity was challenging with very old rocks that might not have any more hydrocarbons, where the geology was highly fractured and where reservoirs were thought to be poor and certainly `tight’. The early wells were drilled without seismic and sited from aerial photos but the first commercial oil and gas was found in 1964 at Mereenie and more gas at Palm Valley in 1965. Gas was also found earlier at Oorammina in 1963 and another 25-30 wells were drilled with only the 29BCF Dingo gas field discovery in 1984 providing any real success.   Production began from Mereenie and Palm Valley in the mid 1980s. The geoscientists at the Northern Territory Geological Survey NTGS in recent years have done an extraordinary job in bringing so much data together through onsite mapping, aero surveys, navel gazing and picking up the work done by early explorers like Exoil (discoverers of Mereenie, Palm Valley and Oorammina), Amadeus Oil, Pancontinental Petroleum and many more. Central Petroleum has provided a wealth of information. The data is excellent and comprehensive and is serving as a very valuable base in the exploration finally now really underway with Santos’s A$150m farmin in with Central Petroleum. I had the good fortune to be the instigator of Central Petroleum with John Heugh’s Merlin Petroleum’s Pedirka and Georgina Basins combining with the Amadeus Basin companies to merge to form the new company. Martin Place Securities also underwrote the listing of Central and later on, as He Nuclear, farmed into the Magee helium/gas/condensate discovery of 1992 and the Mt Kitty prospect.  Helium is used in the high pressure gas `pebble bed’ nuclear reactors – much safer and 50% more efficient than conventional nuclear power stations, hence He Nuclear. Another MPS company, Petroleum Exploration Australia, farmed in the whole Amadeus and Pedirka shebang to earn 20% by funding seismic and a few sort of stratigraphical wells. Unfortunately the GFC limited that programme somewhat! So the 1% royalty over much of the Amadeus was a great acquisition for Phoenix and I consider it may prove to be its best asset. HPR has a 1% royalty over 7 tenements in the Amadeus.
    Targets Operator %

EPA 111

CTP 100

EP 112

Magee Santos Earning 70%

EP 115

Surprise Santos * Earning 70% (*part only)

EP 118

CTP 100

EPA 120

CTP 100

EPA 124

CTP 100

EP 125

Mt Kitty Santos Earning 70%
HPR also has two wholly owned permits EP155 and EP 156 that may have value in the future.  EP155 is very well placed geologically and has already had one well, Mt Winter, with oil shows.  Negotiations are needed with traditional owners. Four of the Central operated tenements are issued permits and three are applications awaiting issue pending future discussions with traditional owners. Amadeus Basin showing Central Petroleum’s permits.  -  HPR has a royalty over 7 of these. Source: Central Petroleum The Amadeus is very large in scope in the NT and extends another 150km into WA.  Wells are few and far between and seismic is sparse.  The age of the Amadeus extends beyond 1100m years, old in most oil terms but large oil and gas fields of similar age exist in China, Russia and Oman.  The Amadeus also has three major regional seals that have retained hydrocarbons over hundreds of millions of years. Two, the Chandler Salt and the Gillen Salt effectively cover much of the basin and make the Amadeus an extremely attractive `sub salt’ target that will bring in major oil companies over the next decade.  Mt Kitty is likely to confirm this. Note that Central Pet has now drilled four wells in the Amadeus with a 75% success rate – Surprise, Ooraminna and now Mt Kitty.  Drilling of valid 4way dip closures has had a 100% success rate in the Amadeus. An increase in drilling activity might be very exciting to watch. Geophysical work done by Central included some high definition aeromag that also highlighted many structures that will over time be followed up by regional seismic. Source: Central Petroleum This aeromag survey has been an excellent low cost alternative to the very expensive on ground seismic surveys. Over 60 new targets were identified. The Amadeus is also the target for large scale unconventional oil and gas as the concept of basin centred continuous gas or oil reservoirs is better understood along with many targets in tight gas, such as Mt Kitty. The Amadeus Basin has had very few wells and little seismic for such a large producing basin. Source: NTGS

The Amadeus is vast and complex.  Over 170,000km2  and multiple tectonic events and only about 40 exploration wells.  It has a fair claim to have the lowest drill ratio of any onshore producing basin in the world with only about 1 well per 4000km2.

It has three prominent proven petroleum systems providing source, trap, reservoir and seal in order of increasing age:
  • Stokes Siltstone -Stairway Sandstone- Horn Valley Siltstone (Mereenie, Surprise Palm Valley)
  • Chandler -  Arumbera (Dingo Orange)
  • Gillen Salt-Heavitree ( Mt Kitty Magee)
Because the Amadeus is recognised as a relatively shallow basin (targets <3000m) much of the strata has not been cooked up too much so still fits within the `oil window' which extends as low as 2500m in Surprise. This means that oil any may have not yet been heated too much, hydrogenated and converted into gas Geoscientists have also recognised the potential of another 7 other potential but less defined petroleum systems in increasing age in the:-
  • Stairway “shale”
  • Late Cambrian Goyder Formation
  • Middle Cambrian Upper Shannon Fm
  • Giles Creek Dolomite Basal shale
  • Intra Chandler Formation shales
  • Aralka Formation
  • Bitter Springs Formation (Loves Creek Member)

The maps show the Amadeus to be over 600km long and the important salt seals are over much the Basin.

The two key source rocks are the Horn Valley Siltstone(`HVS’) in the northern section and the much older Gillen Member across the southern and western sections. Petroleum System  A The HVS fits within the Larapinta Group which hosts the Stokes Siltstone- HVS - Stairway Sandstone-Pacoota strata and hosts the Surprise, Mereenie and Palm Valley. The HVS is the source of oil and gas for the current production in Surprise, Mereenie and Palm Valley.  It has a high TOC and has been recorded as up to 422m thick.  It is a source rock for conventional traps and is a major target for unconventional oil and gas. NTGS has published a series of data on unconventional oil and gas potential as shale gas and as Basin Centered Gas in the Larapinta Group with a mean of 1.14bn barrels of oil and 27.8TCF of gas. Oil

Prospective resource

P90

 (mmbbl)

Mean

(mmbbl)

P10

(mmbbl)

Horn Valley Sltst

207

1,140

2,500

 

DSWPET (2011)
Source: NTGS Gas

Prospective resource

P90

Pj (BCF)

Mean

Pj (BCF)

P10

Pj (BCF)

Stairway Sst

1,1167

(1,100)

5,408

(5,1000

11,135

(10,500)

Basin Centred Gas

DSWPET (2011)

Horn Valley Sltst

2,757

(2,600)

11,983

(11,360)

25,239

(23,800)

Shale gas

DSWPET (2011)

Pacoota Sst

2,545

(2,400)

10,392

(9,800)

20,891

(19,796)

Basin Centred Gas

DSWPET (2011)

Total (Larapinta Gp)

11,771

(11,100)

27,784

(26,200)

48,461

(45,700)

DSWPET (2011)

Source: NTGS

The thickest zones are in the north where the HVS is more than 140m thick.  A very rough area x thickness model puts about 45% of the HVS sediment volume in EP115, 15% in EP111, 12% in EP112 and 6% in EP124.

Isopachs (thickness) of Horn Valley Siltstone Source Rock Source: NTGS And the HVS becomes more oil prone in the west and mostly in EP115 and EPA124 with some in EP111. All very valuable tenements. Hydrocarbon types in Horn Valley Siltstone Source Rock Source: NTGS Geoscientists consider that the Larapinta Group with the HVS as source may have similarities with the Bakken Shale in the Williston Basin in the US in having basin centred continuous oil and gas reservoirs with hydrocarbons migrating up the Pacoota and Stairway Sandstones into conventional reservoirs like Mereenie and Surprise. Source: DWSPETT  NTGS Now consider that with the HVS (mostly in EP 111 EP 12 and EP115 where HPR holds 1% royalty) a very large hydrocarbon charge has been generated but only three holes have been drilled, Mereenie, Mt Winter and Surprise.  And note:-
  • Surprise -1 is 140km from  Mereenie oil field yet the oil is identical
  • both are tiny compared to the volumes of hydrocarbons generated.
  • The Mt Winter well (1970?) with oil shows is the only well between them.
Conclusions are that much more oil is probably trapped in reservoirs in this part of the basin. Many years of exploration will be required here before the possibilities are exhausted. Note that all successful wells have been `four way dip closures' but many other types of traps are likely to be found. HPR's wholly owned EP155 Mt Winter permit has had the only well between Mereenie and Surprise and which had oil shows. Hindsight and better seismic have shown that Mt Winter was drilled off structure and the site has five targets in three petroleum systems. Surprise West Well Section Source: NTGS This is Surprise on the west side of the fault. The top green section is the reservoir but other reservoirs may exist below.   Surprise West is 0.5-2.0million barrels and is now in production at about 500bopd.  Should it be maintained for one year that would be 180,000bbl worth A$18m and A$180,000 to HPR and perhaps a net PV of A$2m to HPR. Surprise East will be drilled in this June Qtr with a target of about 15mmbbls as shown on the left hand side. 15 mmbbls could be worth A$15m to HPR. Santos has just completed 327 line km of new seismic northwest of Mereenie in EP115 and also 1587km in the south and east and is reported to be very pleased with the results.  More action here. 2013 seismic programme west of Mereenie and in Southern Part of the Amadeus Basin Source:Santos Mar 2014 Petroleum System B   The Heavitree-Gillen Salt System The Heavitree is a basal sandstone sitting on top of basement and extending over most of the Amadeus and well into WA.  This is the reservoir. The Gillen Member is both source and seal and has evaporite and salt strata that have been mobile and can get squeezed like toothpaste into voids and can act as impermeable seals.  The Gillen Salt has sealed Mt Kitty and Magee for over 800m years and given that the helium is still present and at a very high concentration it has been a very good seal. The Heavitree extends west into WA and gets to more than 600m thick to the west.  It is well represented in EP115 and EPA 124 where HPR holds its 1% royalty.  No well has been drilled in the mid to lower half of the basin west of Wallara 1. Source: NTGS The Heavitree is extensive and may support multi-TCF resources of hydrocarbons and helium. Note that:-
  • Magee-1 recovered 6.2%He and 39% methane gas from 4.5m the Heavitree with 9% porosity
  • Mt Kitty   recovered 5.8% He and methane gas from the 109m in the Heavitree
  • Both had high nitrogen
  • The wells are identical in gas make up yet are over 100km apart
  • The Heavitree extends a further 400km to the west and is up to 1000m thick
  • The Heavitree is a continuous system  could be a massive hydrocarbon/helium reservoir

  

The Mt Kitty well followed up the Magee well drilled in 1992 by CRA.  That was the first well to penetrate the Gillen Salt to confirm the seal and find the Heavitree beneath. The Magee well flowed about 63Mscf/d to surface with the following characteristics:
  • Methane     39%
  • Condensate  9% (ethane, propane butane etc)
  • Helium         6.2%
  • Nitrogen     43.6%
The 6.2% He at Magee, like the 5.8% at Mt Kitty, is an extreme statistical outlier amongst over 400 US gasfields in having a very high He level but with high methane and other hydrocarbons. Most higher helium deposits have lots of nitrogen (air is 78% nitrogen so nothing valuable here!) so helium with no methane can be uneconomic.  Magee and Mt Kitty have both helium and hydrocarbons to establish economic operations.   Source: MPS  & USGS Source: MPS  & USGS The NTGS gives the potential at Mt Kitty very well so here it is in its own words from March 2014: Source: NTGS So the 0.5MMCFD flow was as expected.  Separate gas flows of each 0.5MMCFD were noted from four separate zones; 2144m, 2156m, 2186m and 2252m.  The well will need fraccing and/or horizontal drilling but it should flow very well. The target was 3TCF of gas/helium.  Central was more cautious at 1TCF but I have heard that the Heavitree target thickness was 60m and came in at 109m.  So could be bigger.  Who knows?  No one just now. This was the section. Source: NTGS And this the diagrammatic representation. Source: NTGS Central recently stated that the Mt Kitty discovery ` could be the catalyst to interconnect the Northern Territory with the Eastern Seaboard gas market’.  Central also published a helium project study in 2010 that concluded that a helium project could run well based on a gas input feed of 20MMCFD into an onsite LNG plant and railing and trucking LNG and liquid helium out through Darwin. Capex of A$420m gave annual revenues at A$98-143mpa and an NPV of A$111m-556m.  LNG and helium prices have doubled since then so the NPVs must be around A$1000m now. The royalty income could be A$2-3m pa just from one project. There is so much more on the Amadeus to discuss and so much is very technical but very positive.  We can now sit back and let the operators deliver whatever is really there.  I am sure many Big Oil companies will be excited by the subsalt discovery and once the remaining EPAs (especially EPA 111 and EPA124) are converted to EPs the there will be many farmin offers to Central.  And carries for HPR. I didn't get to the third petroleum system in the Amadeus nor the other royalties but they are smaller than the CSM and the Amadeus at present and I will cover them at a later date.   Do note that even the Seychelles royalty at just 0.075% covers potential of over 3.203 billion barrels to give US$240m in ground and   and 0.2% of Karoon's WA482P with this!  Note 0.2% of 2.234bn bbls@ US$100/bbl = US$446m! The risked values are far less but global exploration is continuing and the quality of these long term targets should be  assessed within the next few years. All the smaller permits are covered here. I will just leave you with these images. The geologists out there will find them fascinating.  For laypeople, the shapes of great curves with overlying flat sediments are very exciting.  Let's hope Santos decides to beef up its efforts.    And of course, do not forget this:- Barry Dawes B Sc FAusIMM MSAA MSEG 5 May 2014

The Resources Sector Show steps up a gear

by Barry Dawes

Key Points

  • Global boom accelerating
  • China crude steel output hits another new record
  • Copper prices moving up again
  • Gold prices becoming very interesting
  • `White’ precious metals looking good
  • The stealth onshore oil boom coming into daylight
  • Resources stocks beginning to really fire
Exhilarating!  It is so nice to see the gains now coming through in the form of improved market turnover, increased market share by resources stocks, greater market breadth and of course rising stock prices. And client activity is up sharply and the early investors are very happy. So much more to come. It has been frustrating over the past few years to have experienced extraordinary and mostly irrational negativity over the resources sector, particularly since the most recent highs in April 2011, now three full years ago.  The unceasing and incorrect downgrading of the outlook for China and an equally incorrect strongly bearish commentary on gold have delivered stock prices that were down 80% for the ASX Gold Index (much more for smaller stocks) and 70% for ASX Small Resources.  The net commodity price changes that the harbingers of doom have delivered is just wonderful to see. .  Not much at all really.

 

April 2011  US$

April 2014 US$

%

April 2011  A$

April 2014 A$

%

Gold

1556

1301

-16.4

1418

1402

-1.1

Copper

9370

6786

-27.6

8542

7316

-14.4

WTI Oil

114

101

-11.7

104

108

4.5

Iron Ore

182

112

-38.3

165

121

-27.0

US$/A$

1.10

0.93

-15.2

1.00

1.00

China crude steel

700

827

18.2

700

827

18.2

But stocks have fallen so much more.

 

April 2011  US$

April 2014 US$

%

April 2011  A$

April 2014 A$

%

XMM

4623

2237

-51.6

5071

2412

-52.4

XSR

5668

2165

-61.8

6217

2165

-65.2

XGD

7295

2116

-71.0

8002

2282

-71.5

BHP

41.78

35.50

-15.0

45.83

38.28

-16.5

XMM

75.50

58.41

-22.6

82.82

62.98

-24.0

FMG

5.61

4.95

-11.7

6.15

5.34

-13.2

So much carnage for so little cause.  Even earnings are so much better. We have all suffered because of this "Group think" which has pushed capital into unproductive government bonds and bank deposits and resulted in the severe mispricing of assets. But that is all history and the reverse will now be happening.  The immensity of the cash build up of A$1569bn (RBA February 2014) - greater than the A$1400bn in GDP and ASX All Ordinaries market cap of A$1550bn (just!)- relative to my Flow of Funds model says this Bull Market is going to have to run for years before the cash levels will be down to `normal'.  What level for the All Ords?  Try 10,000+. (I often wonder why Joe Hockey doesn’t just cut A$100bn off the A$410bn in Federal Budget Expenditures and somehow encourages Australians to take A$100bn out from local bank deposits and invest/spend it as offset. He could give a 5% tax deduction on the first A$100bn shifted out of a bank saving account or term deposit on a first come first served basis in the first year. Wouldn’t that be a good return on your cash and provide some fun at the same time.  The Keynesians should be delighted that the flow of funds is nicely matched and if Joe also cut A$50bn off taxes we would be running surpluses and the economy would boom. Unprecedented times of such a cash build up and unprecedented times of low velocity of circulation in the economy.) And that is just bank deposits in Australia. But the cash build up is global.  What about the misallocation of funds into overpriced government bonds worldwide that just have to have higher yields to adjust for risk? And when the world wakes up to that massive post-2007 surge in money supply that is now moving into property again and into most liquid markets like equities and commodities and probably into global PPI and CPI stats, is anathema for bond holders just where will they park their capital? Just think commodities and equities and bigger! So my global boom theme is alive and well and seeming to grow with each passing month. Also China kindly gave us all some cheer by producing another record crude steel output figure of 827mtpa, up 6% on March 2013.  So much for the slowing of China and collapse of steel production and falling iron ore prices. The inventory and output adjustments over the Chinese Spring Festival are yet to be fully understood by commentators but you will recall this very issue was raised here a month ago.  Also, it would be reasonable to conclude that the 2013 Christmas-2014 Spring Festival seasonal slowdown allowed a mill inventory rundown, a port stockpile buildup and a surge in ships to get as much iron ore at the low prices as possible.  Then of course strong steel output and rebuild of mill inventories and a fall in port inventories. There is nothing quite like going to China to see things at firsthand. Sorry, bears.  I think my idea of new highs in iron ore prices a year or two out will also come to pass. One major component in this global boom theme is this inventory issue.   It is a concept that I have mulled over for more than the past couple of decades and the more I think about it the more convinced I am that it will be a critical component in understanding the outlook of the next few years at least.  Some might recall the impact `just in time' inventory management had a over an extended period in the 1980s as pipeline inventory was run down.  Commodity prices were weaker because demand was about 1-2% lower than apparent consumption over a period.  However, when demand increased and as things became a bit tighter this inventory management was termed `just too late' ! So if we begin with the basic rational premise that markets are people and people make markets then sentiment of the market place is far more important that the PE ratio, the dividend yield or the NPV discount rate.   The volatility over the past few years have shown that these three factors have had such variation that sentiment has indeed been the key factor! So the unceasing negativity of the outlook for commodities and intermediate goods has probably encouraged most purchasing managers (ie people) to allow inventories to fall.  Without a doubt the internet has had a big influence by providing far greater transparency and allowing for a change in the mix of participants holding and delivering product. However holding costs for small operators have probably been far higher than the current global wholesale interest rate structure would suggest so it may be that the overall inventory position is even more tightly positioned. It is my view that the inventory pipeline system and the rise of the BRICs in whatever form you like has become longer and more complex.  So when consumption demand for copper rises because say China is growing at 7.5%pa (and not Wall Street's preferred 5% and falling) then each inventory manager is going to have to make a call on acquiring just a little more copper to ensure the business has enough to meet customer demand. Consider what might happen if all the participants decide to increase carrying inventory by say 5%. You probably get something like what happened in the oil market from 1998 to 2008, i.e., from US$10/bbl to US$147/bbl.  Yes a bull market.  For whatever reason. I consider that there is a real chance that this might happen in copper and this might also explain why copper prices have eluded the bearish targets of Wall Street. I hope you have been following LME copper inventories (see graph below) and the 420kt (64%) decline since July 2013. And now look at the copper price! And, as we say above, it might just happen in iron ore as Chinese steel mills decide that they have to rebuild their inventories again because demand for steel is clearly still firm. (see  Dawes Points Points 26 March 2014).  And in oil again.  And nickel.  Zinc. Lead. Gold and silver. I can also tell you that here in Australia that other inventory pipeline of stocks called shares in resources companies is also very low.   The intermediaries in this pipeline being the massive A$1500bn in superannuation funds that have shunned the resources sector and put as much as 30% of their funds offshore (on a flow of funds basis these Super fund taxes are contractionary to the local economy to the tune of about A$50bn per year or about 3.5% of GDP), the asset allocators that influence inexperienced trustees, the Financial Advisor industry that acts as another gatekeeper pushing funds into cash and of course the banks themselves whose lending policies have been risk averse and against small business.     (The mining industry could quite rightfully question how many of these bureaucratic positions are just `lifestyle' jobs?) So as this all starts to unwind in the face of continually improving local economic fundamentals, changes in Federal Government policies and un-falling commodities prices and non-collapsing China then it will be slow at first then it will be a flow then a flood. Each player in the pipeline will get a little more confident and so it will go.  For years to come. So these graphics for resources sectors of turnover and market share really do mean something.  First of all they are historically very low and that means the market is underweight.  Very underweight = SHORT! BHP is increasing market share from a low base but the Small Resources seems to have jumped about 40% from 2.5% to 3.5% so market breadth is increasing. (That must be our LMB, LNG and VXL!) The major XMM is up from 16% to 19% but Gold is better but not much yet.  It will come. And the 250 projects needing A$400bn to develop will get access to capital.    So come back to LME inventories since 30 June 2103.  Are these declines due to demand from current  consumption or for anticipated increased consumption or just more comfortable inventories.  Missing out on those last 4.2 days (240kt) of copper supply just might get embarrassing for some.   And just may be the same also for lead, zinc, iron ore, nickel aluminium, fertilisers, palladium, silver, gold, oil, .... So copper prices look good again after that little sell off skirmish and the rest of the LME metals are OK.  Even nickel when the fundamentals were getting so bad (major expansion of nickel pig iron output from Indonesia and the Philippines) and with aluminium oversupply has been remedied by closure of high cost capacity (esp here in Australia).  The best thing for low prices is low prices. Gold is always critical in the outlook and I express my continuing bullishness for  a big number on gold as this next upleg accelerates to reflect the very strong underlying physical demand from China, India and others that will have run down a lot of the loose gold inventory.  Some evidence is suggesting that there is not much inventory left because increased Chinese and the Indian demand have been well in excess of the draw downs from the ETFs.  Now that these are exhausted of easy sellers, where will the next 500t of gold come from? The technicals look constructive here and higher prices soon would be good confirmation. So gold is OK but I am also now getting very intrigued by the performances of the `white’ precious metals. Palladium is looking very strong at present and just might be leading them all higher. Platinum is following and silver is bringing up the rear. Energy prices are warming up again too with oil looking to make that long awaited breakout.  Nearly there. Over in North American the tight oil and gas (better terminology than unconventional or shale oil and gas) boom has sent stocks there into the stratosphere. Heavyweights Exxon and Conoco-Philips are well on their way.   And here in Australia the stealth onshore oil and gas boom I have been talking is now becoming very visible. It is worth noting first the character of the Nth American and in particular the US with extensive infrastructure of pipelines and services companies makes for great efficiencies and lower costs. But just for single and hopefully contiguous one square mile sections that usually have 10+% royalties and more attached. The large inland tenements in Australia allow for a totally different approach.  Having 10km of continuous and contiguous tenements gives explorers many more options. Having 50km even better.  Certainly all our costs are several times those in the US but there are likely to be significant trade offs in scale. Let’s just watch for a while.  Over to you, oil and gas industry. The tight oil and gas here in Australia is applicable to so many basins and I consider it will only increase in importance over the next two decades. The Cooper Basin is important because some infrastructure is already there and geological knowledge is broad and deep. Activity has been in conventional oil and gas and 3D seismic has provide some outstanding new oil and gas fields at a very high success rate.  The Western Flank has been very exciting and the Cooper Basin is now the largest oil producer in Australia today. But much more is happening in the Cooper. The tight gas and shale gas targets have encouraged Big Oil groups like Chevron and BG Group to farm-ins and Beach Petroleum, Drillsearch and Senex are surging along with big programmes that plan to find the gas to deliver to the ever hungry new LNG projects at Gladstone on the East Coast. Whilst concerns have been raised about CSM gas deliverability in Qld and shortages it is interesting to note Santos producing above expectations from its CSM fields and Senex highlighting its high delivery wells.  Nevertheless it will become clear that every LNG plant on the East Coast will be producing flat out and seeking to expand capacity to meet an accelerating global demand for LNG so much more gas will be needed for current capacity and wanted for expansions.  Note that a surprising number of new LNG receival stations are being built in ports all around the world as this market broadens.  LNG long term growth projections may be too low at 6%pa. So exploration for gas in other parts of onshore Australia is well underway and I continue to like what I see with the Amadeus, Georgina, Beetaloo and MacArthur Basins in their searches for tight oil and gas in Basin Centred Gas/Oil accumulations. Envision these as being similar to the coal seams in the Bowen Basin or the Sydney Basin.  Tens of kilometres of coal seam are known to be  there so it only depends on the depth and the style and quality of the coal at each site.  No exploration risk just appraisal and development risk.  And so it is with continuous tight hydrocarbon basins. It is no longer exploration but engineering.  The hydrocarbons are there but the question is how do we get them out. The Amadeus is a special target due to its large size and its three levels of regional seals that restrain all hydrocarbons as well as some very valuable helium. The recent Mt Kitty discovery by Santos with Central Petroleum could just be something very special because its continuous basin accumulation may be hundreds of km long and goodness knows how wide, up to 600m thick and covered by a massive salt blanket across the Basin. The 0.5MMCFD flow doesn't mean much just at present because it will need to be fracced to encourage fracture permeability in its 109m thick section.  Note that the Heavitree has delivered the same gas composition(including almost 6% helium) as was encountered in Magee 100km away. If it is a continuous gas accumulation rock formation and just the 2km Mt Kitty faulted structure section highlighted above is 2TCF then the number across the basin is very large.  Take note of CTPs statement that this discovery` could be the catalyst to interconnect the Northern Territory with the Eastern Seaboard gas market’.  This won’t be small. Extent of Heavitree Quartzite and strata isopachs (lines of equal thickness indicating thickening to >600m) And the Heavitree here extends over 400km to the west. Mt Kitty-1 is 100km SW of Magee-1 near the two wells Murphy and Endunde.  Watch this space. Phoenix O&G royalty shareholders should be very happy (soon to list as High Peak Royalties HPR.ASX) I own all three participants here (STO,CTP and HPR.) Other players like Santos, Beach, Drillsearch, Senex Armour Energy, Falcon Oil and Gas, Norwest Energy  and Advent have some pretty fancy targets in these tight basins and in another parts of Australia and 20014-15 should bring in some very intriguing results.  So keep watching them too. All the above is showing that resources stocks are very cheap and many stocks have already started to move.  The broad indices aren’t really showing it yet but I expect they soon will. Very soon.   The June Qtr should be quite strong. So there you have it.  Gold, oil, iron ore, copper, nickel, zinc, palladium, platinum, uranium, rare earths, technology metals, graphite and LNG.  Just about everything.  Just coal dragging the chain but it won’t be long before a change comes, particularly for coking coal. No comment here on the Fed, Ukraine, the World Bank, IMF or other distractions just watching the markets for our sector. So now talk to me at Paradigm and let us help you really benefit over the next few years. +61 2 9222 9111 Sydney 28 April 2014 Disclosure: I own BHP, DLS LMB VXL LNG HPR AJQ CTP  

Resource Equities leading to a Happy Easter

by Barry Dawes

Key Points

  • China still growing steadily
  • US$ and bonds still weakening
  • Global equity markets, well, booming
  • Commodity markets strong
  • Oil prices ready to surge
  • A$ still strong
Despite the sombre mood and all the end-of the worlders, the world economy seems to just get better.  Not that is any surprise to you who still read Dawes Points and, as unfashionable are the views expressed here,  the reality is on our side.   The great Contrarians of the markets of yesteryear seemed to give a little too much of the same.  Year after year.  End of Western Civilisation is nigh in a great debt spiral that would have gold at US$10,000 the DOW at 1000 and everyone on the breadline.   The Also-rans Group have decided that Cash is King and yield is better and let's just stick our head in the sand until it all goes away while we sit on A$1568bn in bank deposits, bank stocks and Telstra.  Yes, you win. Pity about your grandkids unable to  get a job.  Who is going to employ them?   Well, it isn't going to be the government. But hey, that is away from topic. And I was going to write about gold this week.  Well, maybe next week but the urgency for gold is still there.  Ignore it at your peril. The China Syndrome threat hasn't worked.  The collapsing of the Chinese economy that was going to drag us into a vortex of falling commodity prices, sinking of the A$, blowing up Australian Government finances, unemployment,  horrible this and horrible that and well, yes,  the Greater Depression just hasn’t happened.  Doug Casey and Harry Dent where are you now when we need you so much.  Or not. So, something else is happening.  7.4%pa for China in March Qtr.  Where are the Bears?  Oh, The Government said it was going to be  7.5% so you might say the economy is slowing.  Only US$630bnpa  added to GDP, not US$640bnpa.  But they still tell you its is slowing.  Maybe next quarter they will get it right.  But the shadow banking system is collapsing.  Unoccupied phantom cities. Too much debt in the SOEs.  Power consumption slowing.  China is a basket case now!   Crude steel production collapsed to a new annualised high of 809.5mtpa in February.   Iron ore stocks at ridiculously high levels that show 40% less availability than two years ago.  But Australian iron ore producers can’t put enough on the ships to sell to China at these current low prices.  Record shipments for BHP and FMG.  And so it goes on. Fine. Fine. But what are the markets saying? Well, let's start with the biggest markets first.  The currencies.  And the  US$ is the biggest . What are the markets saying about it.  I fear not much.  Same level as two years ago. And looking heavy.  I know you have seen it all before but we all need that boost to keep the faith. Now you can say  that the ending of the Petrodollar Era will mean the US can no longer print money.  Maybe.  Or that the debt is coming home to roost.  Fair point.  Or you can say that the US has lost its true entrepreneurial spirit  and that it has lost its way.  Maybe.  Or just maybe that the US is OK but other places are better.   Well, this is my view. Have a look at these.  The SWIFT Nowcasts are showing reasonable growth. First for OECD. Then for Europe Golly gosh.  Economic expansion. Here.  And actually everywhere. So no need for US$ safe haven. I will put in a plug here for the strong A$ but I will come back to it later. And  after the currencies come the bond markets.  About US$80tn worldwide.  Much bigger than the equity markets. The US 10 year T-Bond seems to be a little less happy about being at such low levels than the 30 year  but neither gives the appearance of wanting to stay at these low yields.   Supporting on a downtrend after a breakout is a great technical indicator of change.  It has been a slow process but I think it is doing the right thing and yields will be heading higher. http://stockcharts.com/c-sc/sc?s=$TNX&p=W&yr=10&mn=0&dy=0&i=p14048960168&a=347095810&r=1397645925447http://stockcharts.com/c-sc/sc?s=$TYX&p=W&yr=10&mn=0&dy=0&i=p11287349502&a=347095864&r=1397645792451 So much for bonds.  I hope you are not too exposed here.  After all, it has been a 30 year bull market that has already peaked(July 2012). Well then let's look at the equity markets. The US is the biggest.  And again let's look at the small caps which have led the global markets.  And also the Wilshire 5000 that gives the market breadth.  Overbought on most measures but may be not over extended.  What are they telling us?  Surely not a global economic boom? Impossible! http://stockcharts.com/c-sc/sc?s=$RUT&p=M&st=1990-07-13&en=(today)&i=p67171178202&a=273606702&r=1397646631634 http://stockcharts.com/c-sc/sc?s=$WLSH&p=M&st=1980-07-13&en=(today)&i=p77519187017&a=273606735&r=1397646800425 Well, now look at the big players.  S&P 500 and the DOW 30.  Everything overbought but not over extended.  Hmm.  Couldn't be a synchronised global economic upturn. Nah. http://stockcharts.com/c-sc/sc?s=$SPX&p=M&st=1980-07-13&en=(today)&i=p25522426848&a=273606836&r=1397647127332 http://stockcharts.com/c-sc/sc?s=$INDU&p=M&st=1980-07-13&en=(today)&i=p58019763741&a=276892999&r=1397647261041 Germany is already on its way to boom times and the UK in its own reticent way is catching up too.  Was that a surprise fall in unemployment I heard in the UK  today? http://stockcharts.com/c-sc/sc?s=$DAX&p=M&st=1980-07-13&en=(today)&i=p32505337962&a=276893002&r=1397647677939http://stockcharts.com/c-sc/sc?s=$FTSE&p=M&st=1980-07-13&en=(today)&i=p74581083786&a=276893000&r=1397647615363 And so much for the collapse in the Emerging Markets.  India surges to new highs and Korea is nearly there.  All the majors are looking OK. http://stockcharts.com/c-sc/sc?s=$BSE&p=M&st=1990-07-13&en=(today)&i=p63848639666&a=277530125&r=1397647468645 http://stockcharts.com/c-sc/sc?s=$KOSPI&p=M&st=1995-01-02&en=(today)&i=p52817967426&a=303785916&r=1397647517818 Finally Shanghai.  Full of underperforming SOEs but the PER is<10x. http://stockcharts.com/c-sc/sc?s=$SSEC&p=D&yr=5&mn=0&dy=0&i=p52062669111&a=347099740&r=1397648795659 So equity markets are not calling the end of the world.  Are commodities? http://stockcharts.com/c-sc/sc?s=$CCI&p=M&b=5&g=0&i=p51164818296&a=308865341&r=1397648932962 Well, not here. Brent is strong.  As is WTI.  Where is the recession? http://stockcharts.com/c-sc/sc?s=$BRENT&p=M&b=5&g=0&i=p10180392193&a=335711422&r=1397649061539 http://stockcharts.com/c-sc/sc?s=$WTIC&p=M&st=1980-07-13&en=(today)&i=p74540382760&a=295571898&r=1397649126009 And finally BHP.  In US$ but looking good. http://stockcharts.com/c-sc/sc?s=BHP&p=M&st=1990-07-13&en=(today)&i=p61650433710&a=317674535&r=1397649230998 And finally, finally, the little Aussie battler.  After being in Hong Kong and China in the past month I sure am happy the A$ is over US$0.90 and not at US$.80.  Those who wish a lower A$ simply don't understand wealth.   A higher A$ means EVERYONE  has to work better and more productively.  More technology.  More personal responsibility. Isn't this a ripper!  Supporting on the downtrend and kicking off!  Even if it has had a false start.  Supporting off a 100 year downtrend.  Now that is class. http://stockcharts.com/c-sc/sc?s=$XAD&p=W&yr=10&mn=0&dy=0&i=p32446109679&a=329137106&r=1397649608671 I was going to talk a little about gold too but I will leave that for another time. So I am sure now you will want me to tell how to make some money in the stock market. First of all, the broad resources market bottomed in the last week of June 2013, so we have been in an uptrend for almost 10 months. And, if you had been watching the market closely recently you would have seen that dozens of small resources stocks have  jumped in 2014. Dozens.  But there is so much more to come.  We have shared in quite a few. The majors are also building good bases and are looking good for the June Qtr upmove I have been expecting. A lot to like with BHP, WPL, STO, FMG, OSH, PNA. I will continue to recommend the usual great plays where we have played a role in recent times
  • Lamboo LMB
  • Valence VXL
  • LNG LNG
  • Blackham BLK
But also WSA, DLS,  BPT and WHC. And a very special plug for Central Petroleum which has made a MAJOR gas discovery at the Mt Kitty +1TCF target that will have a significant impact on the Australian energy scene. And our very own Phoenix Oil and Gas (now soon to be listed as High Peak Royalties HPR.ASX)  holds a 1% royalty over all of this.  Watch out for a report next week showing why you should definitely not sell and should certainly buy on the 29 April listing! So don't be caught down the hole this Easter while St Nicholas is actually flying across the sky early this year delivering  some wonderful Christmas presents. 17 April 2014

Dawes Points: Hong Kong edition

by Alison Sammes

Mines and Money Hong Kong March 2014

Key points
  • More sombre mood than 2013
  • Many excellent presentations
  • Resources  companies continuing to make operational progress
  • Great thinkers talking
  • The Robert Friedland factor
  • The rise and rise of Africa
  • Rocket scientists mining asteroids (yes in your lifetime!)
  • But it all still looks very good for resources sector
This year’s Mines and Money in Hong Kong didn’t quite have the buzz nor the numbers of March 2013 but then the subsequent carnage of April –June then softness to December 2013 probably removed half of global conference marketing budgets.  But we did receive a treat in the form of an outstanding conference format and some truly brilliant speakers. This format would be extraordinary during a real bull market.  And it is coming sooner than most think. Most of you might know that from about 2004 I used to lead sponsor the Excellence on Mining and Exploration(which became Mines and Money Sydney… and also Excellence in Oil and Gas) also Mines and Money in its early days in London, Sydney and Hong Kong. Most of you would also know that year after year the numbers of investors rolling up would continue to disappoint and I think you won’t be surprised to hear that not much has changed.  So the Disbelief and Pessimism period is continuing.  That famous 10 year Bull Market from 2001 that no one came to and the one everyone thinks is all over or at best on hold. Get ready for Stage Two. So you just have to remain optimistic that one day participation will improve and market breadth will return and everyone will be happy again.  It will be soon and it is happening now. You can see it in our Dawes Points portfolio. But the key issue for me at these conferences is to see the progress that the mining industry has made in discoveries, output, technology and sophistication. The organisers had twice as many speakers and panellists this year (about 200!) and about 150 companies were represented in presentations or at booths. Interestingly the numbers showed about 68% Australian companies on ASX, 15% on TSX a couple from AIM and about 10% Private Equity types. Gold stocks still dominated with about 34% of those present but copper (17%) and iron ore(15%) were well represented.  Good to see some opportunities on my favorites of coking coal, uranium and technology metals. But the mood was a little sombre.  Bears at play abounded, with contempt for managers in mining and sneers for poor fool investors and that any recovery was a long way off.  Or, only gold shares might be interesting in the apocalypse to come.  Everyone said iron ore was the world’s most obvious short and of course it was headed for US$60/t.  Everyone. (Except Dawes Points of course!) One speaker was very optimistic – he was awaiting the final capitulation in gold stocks before getting ready to buy! I didn’t have the heart to tell him that the market for resources had bottomed back in late June 2013 or that oil and gas stocks were making all-time highs in the US markets (but they are not resources stocks are they?) or that the US XAU had fallen 65% (with quite a few down >90%) and the ASX XGD had fallen 80.0% with lots of small stocks down >95%.  Yes, waiting for the final capitulation! Most still expected to see more “slowing” in China and more of the downturn in the US and stock markets everywhere were a “SHORT”, especially “Emerging Markets”.   Funny how a PER of <10x and price level at that of 2001 despite the economy having grown 580% from US$1,199bn to US$8,227bn in 2013 makes people bearish on China.  And so many emerging markets following the US markets to all time highs. Oh to be still a bear after the bottom! The cynics also need to be aware that record current and still growing global consumption of resources (thank you China for 45-50% of the total) needs current and growing record production and that resources and reserves need to be replenished at a record rate.  But they are not. Despite the data showing more money is being spent on exploration to find less new resource and that discovery costs per unit are rising the market thinks resources prices can only fall. Red/green/black tape has now added delays and now the average mining project is 20 years from discovery to commissioning. It was only 10 years a decade ago. Despite all this, companies are still working away to discover deposits and are still developing projects because the world needs them. The conference structure provided a good sectoral streaming that allowed comparisons amongst peers and it was helpful to have the competition for the few available funds. The results show some remarkable achievements in output, exploration and some project developments but I also saw some very bold initiatives that brought infrastructure of new railways and ports to regions that would not only provide new capacity and product to growing world demand but also new domestic markets.  Particularly in Africa, Sth America and Western China/Mongolia.  Developments in new technologies are also important to improve energy efficiencies and overall operating productivities.  We need to keep watching what is coming along next. These major mining conferences such as M&M often bring together some of the world’s best thinkers, particularly those concerned about strong money and the role of mining in the financial world with issues such as currency stability, actions of central banks and inflationary trends.  Gold producers obviously think about the impact of government and geopolitical issues on the price of gold but all in the mining industry are interested in currencies, market demand and the costs of mining, processing and discovering. Great thinkers such as Jim Sinclair, Jim Rickards, Clem Sunter and Frank Holmes gave experienced views on these issues and key industry leaders such as Nev Power CEO of Fortescue and David Harquail CEO of Franco Nevada gave business perspectives and assessments.   Real brain food. Attending these conferences allows you to also see the phenomenon of Robert Friedland in action.  Friedland is the consumate showman and his presentations are there to shock you with their scope and vision.  Jaw dropping stuff.  Friedland was in the vanguard of China bulls and his grasp of key drivers a decade ago in copper and the demographics of China were truly visionary. His latest story focusses on Africa, home of 900 m people, many of whom are attaining middle class wealth courtesy of the mining industry and as the middle classes achieve this wealth it is providing a new political stability previously unknown.  Possibly the fastest growing economic region today. His Ivanhoe Mines has two new massive orebodies and another high grade Zn-Cu mine for reopening.  Not satisfied with having sponsored the discovery of one of the world’s largest nickel sulphide deposits (Voisey Bay Canada), one of the world’s largest copper deposits (Oyu Tolgoi in Mongolia),  he has uncovered one of the world’s great platinum/palladium deposits (resource so far of ~75moz 4PGE @ almost 4g/t4PGE) at Plats Reef (ore body thickness is 24m compared with the best the nearby Bushveld’s 1m thick reefs offer - Bushveldt is probably 350moz 3g/t 3PGE) and then massive new copper deposit (Kamoa 520-790mt @~2% Cu - world's largest undeveloped high grade copper deposit) in the DRC and to top it all off he has a major new zinc deposit with 25mt of 20%zinc and 2% copper at Kipushi also in DRC.  These ore bodies are extraordinary by any standard and go to show how lucky you become when you work hard over long periods. The Ivanhoe Mines share price is ignoring all this (IVN.TO) but I am sure Africa isn’t.  The activities in the DRC and Sth Africa are well away from known trouble spots and have progressed well over several years. IVN.TO chart New Infrastructure and rising export revenues makes most Africans very happy.  All isn’t perfect in Africa but so much is improving. So we can think of Africa as being more than Sth Africa and that Mugabe creep and as 900m consumers entering the markets and requiring infrastructure of ports, railways, dams, power and telecommunications.  Just the sort of things the mining industry needs! So the rise and rise of Africa is something you should not be ignoring. The finale of the show and an excellent one at that was the presentation by Planetary Resources   about mining asteroids! And what a concept.  Some of the world's most inventive entrepreneurs have backed this and there should be an IPO sometime in the next year or so. The company has Richard Branson (of course!), the two founders of Google and Ross Perot Jr amongst many other big names and successful people. The concept is not so much as matter of mining gold or nickel but rather looking for some other high value products to strong market demand.  How about water being currently supplied into space at US$30million a tonne?   How about extra oxygen? These asteroids contain hydrogen, oxygen, carbon, water and some other useful elements for rocket fuel products. Some asteroids apparently have very high water contents and these rocket scientists consider that water can also be converted to rocket fuel. Water and fuel already in space would make Solar System space travel much easier. Not all asteroids are in the Asteroid Belt.  Many small asteroids come reasonably close to Earth so access is not too difficult. Of course there would be gold and platinum in massive size from these alloys and there may be ways to just drop the stuff down to Earth in 500t lots with a parachute!   Keep an open mind! Asteroids have a furnace on one side (the Sun) for very low cost perpetual heating and a freezer (-270oC) on the other in the shade.  And there is a vacuum to boot! Great ideas for heating then cooling.  The engineering is what you would expect from rocket scientists but it certainly is interesting. Of course there is the matter of who owns the asteroids, who to pay taxes to, who gets royalties and will it cause earthly conflicts.  And of course some NGOs will be rubbing their hands with glee about a new frontier for them to get their sticky hands onto. This is not an advertorial for M&M but it is important for everyone to see that conferences like this provide mechanisms for exchanges of ideas and allow the competitive spirit in each of us to come forward. By the way, the markets are now really moving and we have seen some very strong performances from some smaller stocks.  Signs of things to come. The iron ore price has not collapsed (told you so) and copper looks great.  The Paradigm portfolio is looking chipper, especially the smaller stocks, and the next year will be very good. Dawes Points Portfolio Keep watching China (Shanghai) and India (Mumbai Sensex) for some excitement over the next year.  China has new management( it is taking a while to flow through and with the property market taking a breather I think we might find stocks more attractive there) and India is about to have an election with a possibility of real change occurring there.  Especially for stocks, and for gold demand. http://stockcharts.com/c-sc/sc?s=$SSEC&p=M&yr=20&mn=0&dy=0&i=p78603997503&a=338155226&r=1396789556039http://stockcharts.com/c-sc/sc?s=$BSE&p=M&st=1990-07-13&en=(today)&i=p63848639666&a=277530125&r=1396789606047 Don't be left behind. I will also be looking at gold again this month and expect we will be seeing a good run very soon. Beijing 3 April 2014

Getting bullish on China again and iron ore

by Alison Sammes
  • Australia still `cashed up'
  • Synchronized global economic expansion on track
  • Chinese crude steel output hits new record high in Feb 2014
  • Understanding of Chinese New Year Spring Festival not complete
  • Iron ore price now rebounding
  • `High' iron ore inventories may not be high
  • Shanghai Stock index maybe beginning major upmove
I feel like a broken record (anyone remember those – before we had tapes, CDs and now iTunes and MP3?) with all this bullish data. Just repeating the basics on the most important markets and yet it seems that commentators are still coming up with reasons to be bearish and the build up of cash just continues. The term deposits peaked out a couple of years ago at just over A$540bn but bank savings bank accounts keeping rising and are now the larger component of deposits (building societies and credit unions seem to have been reasonably static for some years). Is this saying that some of the professional investors have shifted into equities and property but households generally are still negative? Maybe we haven't seen the lows in interest rates yet here in Australia? What interest rate is needed to get more of this cash moving? Well while we are wondering Australia's take on fear and greed, the rest of the world is getting along with life and the global economy seems to be expanding nicely. I do like this SWIFT `Nowcast' Index of transaction flows. Tells you a lot about how the whole world is working. This is for OECD. OECD is quietly picking up activity and the US is getting better. On global economic matters, however, China is always the topic of discussion and so many non-residents seem to have a wonderful ability to prognosticate quite unsuccessfully on the impending demise of China's economy. . Source:World Bank The growth rate is slowing. It has been for many years but in 2013 it added US$570bn to GDP and in 2014 this should be US$620bn to take total GDP to US$8,850bn. 2014's US$620bn is more than twice the US$ amount for 2009. Some economic slowdown! And if it isn't China's economic growth rate being a big enough talking point then the next focus issues have to be the impending iron ore price collapse and the demise of the steel industry in China. Lots of talk and talking heads who think that `Fed policies' will determine the iron ore price. Just like commentators a generation before who knew the Fed` policies' would control the oil price. Certainly didn't work there. People, we have already had peak conventional oil production 6-7 years ago. So let's look at the steel industry in China and then we will look at iron ore and then look at what it may be saying about China generally. Some very interesting stuff so stay with us here. First and foremost the steel industry in China is probably the biggest development in any Australian miner's career, experience or lifetime. Global steel production in the 1980s and 1990s was a quaint business that grew at 0.5-1.0% pa (or not!) at about 780-800mtpa. The issues of the day were overcapacity in Europe, new technologies (continuous casting, thin slab casting and new coatings on flat steel products that were revolutionizing building products) and the failure of the Japanese steel industry to get above 110mtpa out the newly installed 140mtpa capacity. Two mtpa new capacity in Rep of Korea was a major industry talking point and the whinges of miners with new underutilised mining capacity were unheard on deaf ears. So for China with February's new record annualised output of 809.5mtpa you just have to watch with jaw on the ground. In the past decade China has increased output by more than 50mtpa in a year seven times and 90% of it all comes from blast furnaces. The US produces around 88mtpa and Japan is doing 107mtpa. You should really forget about India. It is still only 80mtpa and about 65% is EAF. Production in China is around 800mtpa and the 2011-2015 5 Year Plan had a 6%pa growth rate that will probably be well exceeded. So expectations of 1,000mtpa are probably still on track. China has had a strong growth in domestic consumption of steel that has gone primarily into infrastructure and commercial investment such that annual apparent per capita steel consumption of 508kg is above that of the US 323kg (but below Japan 544kg an well below Rep of Korea 1159kg). This is concerning some people. However, China has produced about 4,000mt of crude steel over the past decade. If it is assumed that ALL of this was utilised domestically it would be 3.1t/capita which is less than 30% of Japan and Korea and about 50% of the OECD average. And of course crude steel is just that and net steel products would be 5-10% less and some must have been exported so the above numbers are conservative. And that is before considering export of finished products like ships or cars. Steel demand has been for construction and about 60% of output is long products of H-beams, rail, re-bar and wire. Much new capacity is flat and rolled products for consumer durables (vehicles and white goods) where growth is strong and should be maintained. Flat products have moved from about 30% to 40% of output over the past decade. Steel demand should therefore be maintained at about 1,000mtpa or increase for at least another decade. The dynamics of the current 1,000mt steel capacity in China show major new large scale capacity at the ports and decline in the smaller mills inland. The new large mills take ~90% imported feed so need more imports as inventory. These take hematite and not magnetite and produce more flat and rolled sheet products which is where the growth is (motor vehicles, white goods etc). The old mills produce mainly rod and bar (for rebar and H beams for construction) for local and regional provincial markets and make it from mostly local magnetite ore. What has also happened in recent times is that the demand for rebar has been so strong (has maintained a 23% output share for a decade) that the govt has been unable to close these regional mills that supply the low specification rebar steels into local markets and which are so polluting. The establishment of these new steel mills on the coast has resulted in iron ore imports in Dec Qtr 2013 running at a record of >900mtpa rate. It is important to understand this in the context of the recent build up in port stocks in China. Figures of 105mt for 40 ports data today (many tiny ports included here, some only 300kt so not true market stocks) compares with 100mt for 20 ports in late 2012 (about 90mt today) when imports were only about 650mtpa. On 20 ports data it was 100mt/650mtpa = 56 days) in late 2012. Today, on 900mtpa imports, 20 ports inventory gives just 36 days of inventory. This is why every Australia iron ore producer is selling all output and Gina Rinehart can bring another 55mtpa of capacity on line. So at 900mtpa and rising, 90mt (20 ports data not the Bloomberg 40 ports stuff) is just over a month compared with 40-45% higher eighteen months ago. The influence of the Chinese New Year Spring Festival is yet to be understood in the iron ore and steel industries but the annualised monthly steel production pattern in the diagram above clearly shows this seasonal event. The combination with Christmas when the Spring Festival comes early seems to have a disproportionate impact. So inventory issues come with steel production and also iron ore. Steel mills run down inventory at this time and this certainly happened in 2013-14. This period I consider has much to do with the current iron ore price. The decline down to US$104 was possibly the low for this part of the cycle and the sharp jump back to US$110 suggests the market is in reality still very tight. Port inventories could decline sharply as mills rebuild theirs. The other side of this graphic is that probably 60% of China's magnetite concentrate capacity is losing cash. Almost Chinese iron ore production is magnetite concentrate. 330mtpa of Chinese magnetite ore that on average costs about US$125/t (ore grade is <20% Fe and falling so needs about 6 tonnes to make a tonne of 68% Fe magnetite concentrate.) and some are small underground mines as well. 83% of this output is from small to medium mines and only 17% is from large mines. This is the marginal tonne of iron ore. High cost producers! Iron ore price has no relationship to Australia costs of production! We should expect to see as much as 150mt of local magnetite ore production from these small mines shut down and see an increase of hematite iron ore imports. But don't beat up China over magnetite. The world has used more magnetite than hematite over the past 50 years. It has only been the rise of the high quality Pilbara 63% hematite plus the Brazillian 62% iron ores that fed into Japan that got hematite running. Magnetite (67-72% Fe) is exothermic, is denser, purer and is really the preferred input into most US and European blast furnaces. Almost all Chinese old capacity has had magnetite feed. Much of the older steel mills have been constructed around Chinese iron ore mines which are almost entirely magnetite mines producing a 68-69% Fe product. Magnetite ore requires crushing and grinding of 4-6 tonnes of ore to produce one tonne of concentrate. This is costly and requires large amounts of electric power that is a direct and externally invoiced cash cost. China uses almost 1.2bn tonnes of iron ore pa and produces about 330mtpa ( ~25%) of this production is uneconomic in cash terms at US$130/t. The iron ore market may have a surplus in 2014 of about 30mt (have we had it already?) but will be in balance in 2015 and 2016. India's ban on iron ore exports has helped keep the market tight as well. I still expect higher iron ore prices this year! And new highs in the next couple of years. Coming back to the steel industry itself, China does have a massive and principally chaotic steel industry that has seen a dramatic increase in steel making capacity that has significant nameplate over-capacity. Almost all (~90%) is blast furnace pig iron from primary iron ore and very little is Electric Arc Furnace (EAF) from scrap(<10%). Much is new larger size plants that will allow closure of many small plants but the product mix is different with small plants being mostly long products (for H-beams, rod and low spec rebar etc) and the new being sheet, plate and higher quality H beam and rail. The small regional mills are ideal for local rebar supply and are difficult to close given that demand has been strong. Most old mines and older steel mills are away from the coast. New mega mills are being located on the coast and are being designed for hematite and will require imported iron ores, not local expensive magnetite concentrates. Australian miners recognise this and have built capacity to meet the current import demand and future import demand that will grow faster than pig iron production. Imports over the past decade have had a 20%pa Compound Average Growth Rate and are now about 77% of demand. BHP, RIO and FMG have increased capacity and expect to complete programmes to add additional capacity over the next few years. These capacity expansions have been at the request of customers who are seeking more ore. The reports from the iron ore companies have generally more accurate than the views of analysts in North America over the past few years as shown by record iron ore exports and a good iron ore price! Australian Iron Ore Exports   So the kick in crude steel production in China in February is very interesting and could have an impact on port inventories and iron ore prices. The next month will be very interesting! Also interesting is the kick in steel being matched by action in the Shanghai stock market. The Shanghai market jumped 2.72% on Friday 21 March and followed up yesterday with a further 0.91% on the 24th! Short term this looks intriguing. Medium term this looks very intriguing!   And long term this just looks excitingly bullish! With the stock market in India powering on to all-time highs, downtrend breaks by Japan and Taiwan and with Rep Korea and Hong Kong ready to shoot higher it seems to me we will be having an Asian Boom very soon! And with commodities ticking up again everywhere, you guessed it, an Australian Resources Boom! And to go back to the start of this note, with A$1568bn of Australian bank deposits to fuel it! That is before the foreign investors come in. To whet your appetite for what is ahead, just look at the graphite stocks mentioned over the past several months. LMB up 1500% and VXL (+1:1 VXLO) up 270%. I can think of similar numbers for stocks in gold, copper, technology metals, Cooper Basin, unconventional oil and gas, lead and zinc, tin, the many varieties of iron ore, coal and uranium over the next year or so. And many more will come out in things novel and innovative in resources and, of course, mineral discoveries. Remember them? Barry Dawes BSc F AusIMM(CP) MSAA MSEG Hong Kong 25 March 2014 Follow me on Twitter @DawesPoints Disclaimer: I own LMB and VXL/VXLO.

And so it has all come to pass

by Barry Dawes

Key points

  • Massive commodity bull market now underway
  • CRB Index up 9% in 2014 price breakout
  • Inventories of raw materials at critically low levels
  • Strong earnings reported by major resources companies
  • Resumption of Australian Resources Boom
  • ASX resources stocks are extraordinarily cheap.
And so it has all come to pass. The views expressed in Dawes Points over the past 18 months are now firmly on course. The efforts of Wall St and local investment banks to talk everything commodities and Australia down has failed and they will fail spectacularly further as 2014 unfolds. The world economy is growing and commodity demand continues to rise. A financial world focussing on `the Fed' and `tapering' and believing that pulling the monetary levers in just one country will determine economic outcomes elsewhere in the world is failing to watch the fundamental human aspirations and the laws of supply and demand.  And the most recent wailing about `failing emerging markets’ is yet more wailing from those just looking for troubles. Dawes Points has continually focussed on the markets and data that can be monitored, measured and assessed.  The markets have consistently indicated a global economy very different from the views of most of the economic commentators.  Market reality is coming to the fore. Certainly a broken clock is right twice a day but the evidence has been as clear as day that no depression in the US was happening, no collapse in the European banking system has occurred, no collapse of China has taken place and the concerns about Turkey do not make for a system crisis in emerging markets. The key points above are very clear.  Commodity prices are moving up again after about three years of consolidation.  The move up is from a much higher base than many previous declines and the structures of supply and demand are unlike any other in modern economic history. The ASX Gold Index had fallen 80% from its April 2011 high into a December 2013 low while the A$ gold price fell just 5% from A$1408 to A$1339/oz.  Today it is A$1490.   To say that again just note that at the time of the high in the ASX Gold Index at 8499 it was A$1408 and now XGD is 70% lower.   Go figure.  But then again just remember the BS from the DS at GS with their sub US$1000/oz forecasts last September. How can consensus thinking be so wrong.  Why did the ASX Small Resources fall 70% from April 2011 to last June’s low?  Where is the collapse in commodity demand/prices? It is just sentiment and the prolific opinions of financial media and its bed fellows in financial institutions.  How can it be otherwise?   Now just look what the markets are saying. The Dawes Points three ``Fasten Seat Belts'' calls of 15 Oct (ASX Metals and Minerals 3184 +3.6%),  11 December (3181 +3.6%)  and 17 Jan ( 3346 +6.7%) seem to be on track with that index rising to recent highs of 26.7% from the 2653 27 June 13 low.  And the ASX Gold Index at 2618 is up 54% since that Dec low. China now consumes more than 45% of most resource sector commodities. The US is now less than 10% in most commodities except for energy. Other countries are showing marginal rises in consumption so the pressure continues to be on supply. The pontifications of almost all things Wall Street is for lower commodity prices, lower gold and weaker currencies against the US$.  Pontifications and propaganda to protect the US bond market where these banks have large long positions and to defend the US$. As has been said before:- Defending the indefensible and protecting the unprotectable. These terrible twins of the US$ and the Treasury Bonds are suggesting a serious change in the flow of investment funds from safe refuges and paper assets to the real economy and inflation hedges.  Yes, inflation.  Is anybody here old enough to remember the bad old days?  The Moses Principle is applying here. After 40 years wandering in the Wilderness by the Israelites with nothing, the Promised Land of `flowing with milk and honey' in  er..er ..Palestine was found.  Forty years was enough to squeeze out memories of a better life in Egypt or anywhere else for that matter and to bring the Israelites to expect very little to be given from life.  Small gains seemed miraculous because the then collective wisdom knew no different. So many of the current investment communities have known only three decades of falling interest rates and bond yields to reflect their experience.  Too many erstwhile mini Warren Buffets looking for `sustainable cashflows from well run businesses' to notice that the landscape may be changing. The `Moses Principle’ applies here.  Outside of common wisdom.  Outside of common expectations. The 30 year bond uptrend is broken. The world is `long’ bonds as True Believers to the tune of US$80 trillion. But the fundamentals are rancid. Who, apart from `the Fed' will be buying this paper junk in the next few years. The US$ Index has just had a Friday close under 80.  It failed to make it into the upper channel and now has closed below both 50 and 200 month moving averages. Expect a move down in 2014 to about 3-5%. Maybe more. The weaker US$ will stimulate capital outflows to everywhere else.  Expect higher equity markets and commodities and gold.  And also a stronger A$. Mitchell Johnson was the Panzer and the Maginot Line is being outflanked.
The bond market is de facto currency with a coupon. Strains appearing in bonds and with the US$ breaking bad below 80 last week all isn't looking good for the `strong dollar' thesis. And whilst all this is happening note this extraordinary pessimism at the exact bottom of the market! Just review some recent commentary from these Wall Street gurus and their sycophants here in Australia:- In a recent AFR article :-UBS spokesman... `But he warns it’s going to be another tough year for resources. “Our expectation is commodity prices will probably track sideways, pretty much, but they’re still healthy commodity prices, But companies that will be able to generate strong free cash, reduce their debt and know where the market perceives they will be able to return cash to shareholders will be the ones that do better this year.” he says. A recent review on Bloomberg 11 Feb 2014:- `Commodity prices rose almost fourfold in the decade through 2011 on Chinese demand. The Standard & Poor’s GSCI Index of 24 raw materials posted the first drop since 2008 last year as bear markets extended from corn to gold to copper. Citigroup Inc. says the so-called super-cycle of rising demand has ended and Goldman Sachs Group Inc. said last month a reversing cycle will eventually drive raw materials into a structural bear market.’ Morgan Stanley’s chief metals economist recently left the bank after almost five years in the role to start his own research and advisory group. He understands, but possibly not the bank. He said `The collective memory of the financial industry, particularly in relation to commodity cycles, appears to me to be shrinking if not disappearing altogether..' Pontifications because the banks think they know better.  They of course have big trading arms and balance sheets that allow active participation (we wouldn’t say manipulation would we!) in some small and illiquid markets but pontifications are no substitute for knowledge at the coal face. So despite the talking down of gold, oil, LNG, copper and natural gas the markets themselves are talking a different language. And the language is almost from a different planet and is about shortages.  Have a look at these LME inventories that were mentioned last month.  Sure, Shanghai inventories are rising but the real evidence is that there is little spare metal now. Rapid declines in inventories but prices are still being held back with copper and tin being in backwardation where future prices are lower than current spot prices.  The markets are still pessimistic. LME Metals Inventories
LME Metals 000t Jan 2013  June 2013 Feb 2014 % change On Jan 13 % change On June 13 % of Jan inventory drawn down in Feb 2014
Copper

320

665

276

-14 -58 -12.2
Zinc

1220

1061

761

-38 -28 -10.9
Lead

320

198

202

-37 +2 -3.0
Tin

12

14

8.06

-33 -42 -9.3
Nickel

139

187

271

+95 +45 +1.5
Aluminium

5210

5435

5311

-2 -2 -2.1
Copper, zinc, lead and tin show very low inventories and reflect lack of new capacity.  Can you name two ASX stocks outside of BHP and RIO that produce each of these `old fashioned’ metals.  Not as racy as gold or iron ore so mostly forgotten.   Aluminium and nickel have high stocks but as always the best thing for low prices is low prices that cut output. So maybe a change could come through for these two as well. Now have a look at gold. The COMEX has access to about 7moz of eligible gold sitting in vaults around the world. This gold is known to COMEX but only gold that is `registered’, is in 100 oz bar form of high standard purity and ready for prompt delivery can be used for meeting delivery notices for the 100oz contract.  Much of the gold is on kilo, 10 kilo or other bar form and is not suitable for delivery without remelting. Recent open interest in the futures showed over 100 contract oz for each oz of gold registered for delivery on COMEX.  With Asian demand now greater than global mine production the potential is there for a short squeeze. The change in trend for gold looks very constructive.  Downtrends of gold prices in a number of currencies are now broken and price are turning up. With iron ore, the big build up in iron ore stocks in China might just be a furphy.  86mt at 20 coastal ports in China against 850mtpa of imports is still only 33 days and is 35% fewer days than two years ago.  The new large coastal steel mills get almost 90% of their iron ore feed from imports.  The old small scale inland steel mills get less than half from imports.  The current low iron ore price is closing down environmentally unfriendly old inland steel capacity along with their high cost low grade magnetite mines.  Potentially over 400 million tonnes of domestic iron ore production is in danger of progressively closing down should prices fall further.   The mining, crushing and grinding of magnetite is energy intensive and in a competitive market for energy, power bills must be paid or the power goes elsewhere.  At US$120/t probably 30% (120mt) is currently cashflow negative. The most commonly used number is for 20 ports and is 86mt.  The larger number for 40 ports adds about 14mt but this is only 750kt per additional port and probably just a tiny 200kt for many.  The 20 ports figure is more significant. So this graphic of port stocks doesn't suggest oversupply, but rather tight inventory here in the commodity the market loves to hate. Let’s see what iron ore does over the next month or so to see a clearer direction.  I still am sticking to my forecast of new highs in iron ore in the next few years.  Today, about 130m tonnes of Chinese iron ore concentrate production is underwater. The oil market is saying the same story.  Peak oil has been with us since about 2006.  Where is the new oil coming from?  The idea that the US will provide vast new production is considered to be delusional.  That has been stated here previously. What does the market say?  Brent is a global price and seems ready to jump higher. Higher oil prices in the US are likely now after the breakout last week. West Texas is enduring an increased supply from shale oil (tight oil) but it’s market is still building up and anticipating a sharp upside move. What does the US oil and gas industry say?  Gearing up for new highs in E&P stocks. And drilling activity is saying US$5/mmbtu is not enough to boost gas production.  A tight market is expected for another few years.  Gas rig activity continues to drop. Gas rigs are getting better productivity and more efficient with horizontal drilling so fewer rigs are needed but gas prices are saying something more.  Recent prices above US$6/mmBtu suggests this figure is not enough to make money in dry gas in the US. Don't worry about Asian LNG prices. Oil-indexed prices will probably be here for a while yet and US exports might not be so great after the first few new export LNG projects. This doesn't look to me like a market about to collapse. And US natural gas prices look suspiciously as if they might run much higher yet.  The sharp run up has invited profit taking but this shows strength to me.
The big ASX resources stocks have reported strong results from iron ore and oil and gas in particular. Strong results, undergeared or better balance sheets and lots of free cash for dividends.  After the recent five year Resources Sector investment binge of A$400bn, capex is tapering off and balance sheets are being rebuilt and cashflows are being redirected towards shareholders.  In the 1970s and 1980s it was usual to expect 50-65% of earnings paid out as dividends.   We should see it again.  (How long will it be before the commentators start pushing companies to go on the acquisition trail or expand output again?  Two years max?). So the next stage of the boom is underway, ASX resources stocks are rising and capital raisings are picking up nicely. The Dawes Points Portfolio is up 7% (pre dividends) against the XMM which is 2% higher (before recent dividends). Whilst the heavy weighting in the large caps slowed the portfolio (pre dividends) some of the smaller stocks have done very well. Stock picks AQA, IGO, ERA, DLS, WSA, NST, ORE, MAU and BLK have done well whilst LMB has been and continues to be spectacular! The next stage of the Resources Boom will be focussing on the 230 undeveloped projects that are in the hands of mostly junior companies. The story is the same.  The stock prices are far more advantageous and the opportunities are almost boundless.  Has there ever been a time in Australian stock market history that Resource Sector stock prices were so divorced from reality? Disclosure: I own LMB, BHP, DLS, BLK, MAU, NST. Barry Dawes 3 March 2014 BSc FAusIMM MSAA MSEG Follow me on Twitter @DawesPoints

Dawes Points: Activity accelerating

by Barry Dawes

Key Points

  • A prosperous 2014 and Year of the Horse to all
  • US Bond market breaking down
  • Leading Equity markets still making new highs into  2014
  • Laggard markets catching up
  • Resource Sector low made in late June 2013
  • Major Nth American Resources stocks powering on
  • ASX Metals and Mines Index has broken 30 month downtrend
  • Iron ore export volumes robust and growing
  • Gold sector and small resources showing increases in turnover
  • Resource Sector capex to resume with A$400bn in new projects
2014 is now with us and it is appropriate to do some crystal ball gazing for the year ahead and beyond.  The markets are providing us all with some now very clear indications of the near term and what is in store for medium and longer terms.  The Resources Market low came in late June 2013, over 6 months ago.  It does look very encouraging now and the Year of the Horse will start early this year and is rearing to go! The short term reality is however, strongly coloured by the historic poor performances of most stocks in our resources sector over the past 30 months despite the low occurring in June 2013.  Poor market action of volume and breadth say loud and clear that participation rates have been and are still low.  That means the general market place does not believe and few players from local and foreign institutional investors to even fewer punters have been playing.  But the signs are already there for a major change. Turnover volumes are rising as investors realise that all is not gloom and doom.  Production data is strong and product prices are good and firming. But before we go forward it is worth reviewing the past year, that most horrible of years, 2013. Dawes Points of 28 January 2013 started with:
The foundation for the year ahead was pointed out in a positive Paradigm Outlook from October 2012 which suggested that investors should "Heed the markets, not the commentators''.  So many market indices (Germany, India and several in the US) were then pushing all-time highs and others (Shanghai, Hong Kong, FTSE, Nikkei and the All Ords) had broken downtrends from the 2007-08 highs and were clearly looking over the horizon to some sort of better times.  Commodities were holding up OK whilst PE ratios for many stocks and markets were at the lower end of the ranges of recent times and dividend yields were looking very attractive.
Yes that was what the view was then.  And it all came to pass.  That view of the all time highs in many of the major US equity market indices leading the world, with Europe following and Asia and other emerging economies bringing up the rear, has been completely vindicated.  Also the US T Bond market continued its poor performance and the US$ Index gave back most of its 5% rally.  Oil was higher and copper has rallied back after a soggy mid year period. Unfortunately the Resources Sector was savaged.  You may well ask why. The performance of the markets in 2013 was definitely a tale of two halves with the low occurring for most indices in the last week of June.  This was the very notable 27 June that should stand as the cycle low in gold and most major indices outside of the gold share themselves (see Dawes Points 5 July 2013   - End of EOFY Sale). The North American Indices clearly led with the Small Caps (S&P 600 +Russell 2000) as the stars but NASDAQ also did well with 38.3%.  Dow Transports did 39.5% whilst the Dow Industrials was a real laggard – only 26.5%. Where is the Recession!!!    (Note that the far right column gives the % of the gain that was achieved in the Dec Half.)
Index

Dec 2012

June 2013

Dec 2013

Dec-Dec

June-Dec

% Dec Half

S&P 600 Smallcaps

343

396

485

41.4%

26.1%

63%

Russell 2000

849

977

1164

37.0%

21.9%

59%

Wilshire

14995

16992

19706

31.4%

18.1%

58%

S&P 500

1426

1606

1848

29.6%

17.0%

57%

Nasdaq

3019

2935

4177

38.3%

41.1%

107%

Dow Industrials

13104

12880

16576

26.5%

28.2%

106%

Dow Transports

5307

6174

7401

39.5%

23.1%

59%

Russell 2000

849

977

1164

37.0%

21.9%

58%

Interesting that about 60% of the performance came in the Dec Half, but NASDAQ and the DOW had all their performance and more in the Dec Half after a negative June Half. These stock market performances were very robust against a weak bond market and a US$ that gave back almost all its June Half rally.  Note rising bond yields and rising stock markets.  Never believe that junk about stock markets falling with rising interest rates!   See more below.
Index

Dec 2012

June 2013

Dec 2013

Dec-Dec

June-Dec

% Dec Half

US 10 Yr Bond

132

126

122

-7.8%

-3.1%

39%

US 30 Yr Bond

147

135

127

-13.2%

-5.1%

39%

US $ Index

79.8

83.4

80.2

0.5%

-4.0%

-735%

European Markets had a very week June Half but roared in the Dec Half to give results good but weaker than the Dow Industrials.  But Europe is following on well.  Where is the banking sector collapse!
Index

Dec 2012

June 2013

Dec 2013

Dec-Dec

June-Dec

% Dec Half

Germany DAX

7612

6416

9552

25.5%

41.2%

162%

UK FTSE

5898

6215

6749

14.4%

9.0%

63%

France CAC

3641

3739

4296

18.0%

15.3%

85%

Spain IBE

8167

7763

9916

21.4%

26.4%

123%

Italy Milan

16273

15239

18968

16.6%

22.9%

138%

Asia is following Europe with Japan on steroids via Abenomics up 56.7% and everyone but China just managing to stay positive.  Everyone outside of Japan had a very strong Dec Half.
Index

Dec 2012

June 2013

Dec 2013

Dec-Dec

June-Dec

% Dec Half

Japan

10395

13677

16291

56.7%

25.1%

44%

India

19427

19396

21170

9.0%

9.1%

102%

Hong Kong

22657

20803

23306

2.9%

11.0%

385%

Shanghai

2261

1979

2116

-6.4%

6.0%

-94%

SFT 25

39

32

38

-2.1%

15.3%

-714%

Taiwan

183

192

205

11.9%

7.1%

60%

 Kopsi

1985

1863

2011

1.3%

7.5%

559%

Here in Australia we were with the true laggards with the All Ords managing 14.8%, whilst really bringing up the rear were most things resources or gold.  The June Half was really ugly but all except gold shares were up in the Dec Half.
Index

Dec 2012

June 2013

Dec 2013

Dec-Dec

June-Dec

% Dec Half

All Ordinaries

4664

4775

5353

14.8%

12.4%

84%

Mines +Metals

3643

2747

3339

-8.3%

16.3%

-195%

ASX Small Resource

3781

1931

2172

-42.6%

6.4%

-15%

ASX Gold Index

4898

2064

1898

-61.2%

-3.4%

6%

XAU

165.6

90.15

84.147

-49.2%

-3.6%

7%

The well publicised concerns over Europe, China and the US have simply failed to materialise and global economic activity has continued to expand and the SWIFT Code Index NOWCAST is indicating accelerating growth into 2014.  Production of crude steel globally held up very well and is up 4.2% to 1.447mt for the 11 months to Nov 2013.  China maintained a rate of almost 800mtpa throughout the year although November was about 6% lower that the year to date average. So let’s look at the key driver again that was mentioned in the last Dawes Points in December.  The US Treasury Bond market.  It is breaking down.  The Maginot Line has been left behind.  Mitchell Johnson was the Panzer and he destroyed the defenders by outflanking them.  Twenty years of Conventional Wisdom is about to come unstuck as this long term uptrend in bond prices is broken and the short term is showing rising bond yields. The table earlier in this note shows a 13.2% fall in the 30 year Bond Price and 7.8% in 10 year Bonds.  These are capital losses in `risk free’ assets.  A lot more to come but keep in mind that this is a BIG market with natural long term buyers so a sharp drop is probably not going to happen. But then again it might.
The US$ itself is the next part of the puzzle and we are in for a sharp move soon because it has held a fairly steady level for over 2 years .  It could be up and would correspond with a bond rally and possibly lower gold but it might be just the opposite.  I think it will weaken and fail to lift into the Top Channel. Description: http://stockcharts.com/c-sc/sc?s=$USD&p=M&st=1980-07-13&en=(today)&i=p52458081222&a=305083431&r=1389832883813 Through most of the last decade equity markets rose as the US$ weakened and it was fascinating to watch how highs and lows in the S&P 500 seemed to exactly match lows and highs in the US$. The strength in so many equity indices around the world particularly in the US is confirming firm economic growth in the US and that is giving confidence to other countries, starting in Europe and Sth America and spreading to Africa MENA and finally Asia.  Faster growing economies should attract funds from the US and certainly out from the safe haven of US T Bonds. So lower US$ and higher equities. The positioning of these big markets (currencies, bonds and equities) will be determining the FLOW of FUNDS for future market performances.  So if these equity market surges to new highs, uptrend breaks in bonds and downtrend breaks in major cyclicals are genuine then the FLOW of FUNDS from bonds and also cash will be to equities and commodities. I consider that the current build ups in bank deposits world-wide are something quite unprecedented and should then result in something quite unprecedented in equity markets.  Here in Australia we have this extraordinary A$1,544bn in bank deposits including A$808bn in Household deposits.  What do you think will happen when the herd starts to really flow in to equities again?  Yes, big bull market! And it is global. Coming to the resources side we can revisit the performances of our major indices and also some commodities.  The resources indices were down sharply for the year before recovering but the metals themselves fared much better, apart from the structural problems for nickel and aluminium, and finished the year well, especially zinc.
Index

Dec 2012

June 2013

Dec 2013

Dec-Dec

June-Dec

% Dec Half

Mines +Metals

3643

2747

3339

-8.3%

16.3%

-195%

ASX Small Resources

3781

1931

2172

-42.6%

6.4%

-15%

ASX Gold Index

4898

2064

1898

-61.2%

-3.4%

6%

Metals (US$/t)

Copper

7915

6750

7394

-6.6%

8.1%

-124%

Zinc

2034

1823

2085

2.5%

12.9%

514%

Lead

2340

2058

2206

-5.7%

6.3%

-110%

Tin

23500

19800

22550

-4.0%

11.7%

-289%

Nickel

17085

13680

13970

-18.2%

1.7%

-9%

Aluminium

2040

1731

1764

-13.5%

1.6%

-12%

LME inventories are also in very good shape to support higher prices, except for nickel and aluminium. Note copper inventories have almost halved since end June and at the current 336kt are less than a week’s consumption at 20mtpa. And lead and zinc are each under two weeks.
Inventory (000t)

Dec 2012

June 2013

Dec 2013

Dec-Dec

June-Dec

Copper

320

666

366

14.4%

-45.0%

Zinc

1220

1061

933

-23.5%

-12.1%

Lead

320

198

214

-33.1%

8.1%

Tin

12

14

10

-24.5%

-32.4%

Nickel

139

187

261

87.0%

39.5%

Aluminium

5210

5435

5458

4.8%

0.4%

The important industrial metals copper, lead and zinc should have a strong decade due to a lack of available new capacity.  And tin now should be regarded as a technology metal given that its key use is in solder for electronics. Other commodities are doing OK with the trends suggesting a major move quite soon within the March Qtr 2014. Iron ore, as has been stated so often, still looks strong and I expect new highs in the next couple of years.  Coal is bottoming and beginning its upturn.  Oil is behaving well and should resume uptrend.
So let’s get back to the Metals and Mining Index.  Down 25% in the June Half and up 22% in the Dec Half, and now having broken its downtrend from April 2011 is looking to move sharply higher.  The most recent surges following the strong iron ore production and export figures are probably indicating that the next stage of `fasten your seat belts’  (Stage I Dawes Points 16 Oct +8.6% , Stage II Dawes Points 11 December +9.2%)  is about to get underway in earnest. The downtrend was broken, the break out returned to the downtrend and break line and then bounced off nicely.  If all goes well this should really accelerate before the end of the March Quarter. ASX XMM Metals and Mining Index 2009-2014 The data in last month’s Dawes Points on projections on iron ore, coal and LNG exports should be sufficient to get the major stocks BHP. RIO, FMG, WPL and STO moving but it will be the price moves on the metals such as copper, zinc, lead and tin that will really drive the OZL and PNA type stocks and of course the hundreds of juniors. I also want to stress the importance of uranium and all the technology metals like antimony, lithium, graphite, palladium, platinum, tungsten and tantalum that should be strong performers over this new and exciting stage of the cycle. Evidence is everywhere for the disdain the market has for resources and I even saw yesterday that an economist from a major foreign `Investment Bank’ was still talking about the end of the Resources Boom.  Well it certainly is still the Conventional Wisdom but the markets are telling me something very different. Even the new Australian Federal Government has given the go ahead for another A$400bn in resources projects yet commentators are still skeptical. The latest market share graphics shows that XMM share of All Ords ASX turnover value had dropped almost in half from the 28-33% of 2010-12 to well under 20% for most of 2013 but the early 2014 figures show that market share is now just over 20%.  Encouraging news!  Even more important is the data for Small Resources (XSR) after collapsing from ~5% to ~2.5% is now over 3.5% in 2014.  A very healthy sign!  The data for these charts is limited and is only available from 2006 for the XMM and 2000 for the XSR.
The much abused gold sector is improving its share of turnover and a strong end of year/start of year week gave a 3.5% surge to show gold stocks are coming back into favour. Gold shares around the world have been beaten up and are now well down but are also well down against gold and also against stocks.  When the market decides that the incredibly strong demand for physical gold out of Asia, the buying of gold by central banks and general still firm demand for coins is enough to absorb the last of the ETF sales and the shenanigans of the hedge funds, then the net effect on gold should be very strong.
It is also notable that the gold bars registered on COMEX are now just 370,000oz.  Just enough for 3,700  100oz contracts to take delivery. Not much.  The figure was 638koz two months ago and 3.0moz in March 2013. This is not the only metric to watch here but it is a useful indicator. The extremes in the values for the XAU in the two charts above are suggesting very firmly to me that gold did in fact bottom on 27 June 2013 and that we will get a sharp shortcover rally and then a lot more.  My view and I am sticking to it. The ASX Gold Index is back over 2100 which is almost 25% up from the December low at 1703 but is still down 75% from the April 2011 high.
Importantly while the Gold Index made a new demoralizing low in December most other indices did not and so the Small Resources (XSR) is now looking very attractive.
Within the Small Resources there are dozens of stocks that offer extraordinary value and some I mentioned a few issues ago. The opportunities are just extraordinary.  So many and hard to choose which are best for short, medium and long term! I do like the graphite sector as a new growth area and particularly recommend LMB and VXL but I think we might be hearing a lot more about these stocks and similar stocks in the technology metals this year. Finally the A$ is getting beaten around too but you should all be familiar with this correlation graphic of monthly closes where the co-efficient is 0.73.  It was well over 80 until early 2013 but I think it will catch up again.  What it says is that where the gold stocks go, so will the A$.  And rather than it suggesting that the US$/A$ has to fall back to US$0.70 I consider it to be saying when the gold stocks turn up, the A$ will be following them up. And finally this weekly graphic suggest the US$/A$ is only correcting and consolidating against a very high level of negative sentiment.  The next few weeks should just do it. The markets are turning our way, the misery of the past few years should be lifted from our eyes and we should all be looking to making some money again.  LMB and VXL have been very kind to us in this regards but I can see many more coming. Barry Dawes BSc F Aus IMM MSAA MSEG 17 January 2014

Resources Boom Continuing

by Barry Dawes

Fasten Seat Belts Even Tighter - Now Enjoy the Ride

The US is not in another Great Depression (stock market at all time highs and ground breaking new technologies are changing the face of the US), Europe's banking system has not collapsed (German and UK stock markets at all time highs) and China's economy has not slumped.  The Resources Boom is not over.  The super capex boom might be trending down but the revenue gains are really only starting. Gold is now starting the next upleg.  Global resources stocks are responding.  You need to be on board. And despite most commentary, commodity prices are not falling but are stabilising and many are rising.   I note, too, a growing sense of underlying excitement developing in the whole sector. But the conventional wisdom has it otherwise. How often have you heard that these falling commodity prices will send resources stock prices lower along with the A$ in a long term downtrend that has no end in sight and that resources stocks are a most unattractive asset class.  And they don’t pay dividends, always are diluting shareholders by wanting more money and the management is rubbish.   Just lifestyle companies. How could this particular groupthink have eventuated? Where have all the thinkers gone today?  Is Australia made up of a new generation of wowsers and bureaucrats?  Regulators and bean counters who need the structures of ASIC and APRA and FoFA and FWA to tell people what to do and how to do it?  And then asset allocators with no real world experience dictating asset portfolio structures that are fixed by looking in the rear vision mirror.  And we are talking real money here.  A$1550bn in super fund assets. You all know the comment about generals still fighting the last war (particularly if they were the victors!) with a vested interest in maintaining their empires and structures so that strategies and tactics will be played out in a reasoned and rational manner. All applaudable reasoning.  Yes, the generals can show the politicians their crack polished troops and noisy toys so the politicians can tell their electorates that all their taxes are being spent on the right stuff so that if any of those XYZs get up to mischief as they did in `98, we will be ready. The Maginot Line of fixed fortifications was built at great financial cost by France in the 1920s and 30s to prevent an expected resurgent Germany, likely to be unhappy after the lop-sided Treaty of Versailles, invading across their long border.  A brilliant piece of engineering and long term planning over almost 20 years.  But the Germans with theirBlitzkreig (lightning war) simply skirted around through the mountainous forested Ardennes region of France and Belgium and outflanked the French and captured Paris within a six week campaign.   Fixed structures, mobile attackers. And more recently, the England cricket team arrived on our shores to continue the dominance shown in the three previous Ashes series over the seemingly rabble team and to maintain its high ICC ranking.  Mitchell Johnson has so far `outflanked’ them and their current thinking is scrambled over consideration of attack (with exactly what?) or defend (and admit defeat?).   Of course, in the end, what will be will be. So let’s come back to the main game.  Investing and making money. Investing is all about increasing wealth through balancing return against risk.  A compound 3%pa gain over inflation (real return) gives 34% pretax over 10 years.  Capital is maintained and Samuel Clements’ (Mark Twain) quip of the return of his money being more important than the return on his money, is respected.   And we are all painfully aware of the past 32 months giving the ASX Gold Index a 79% fall (and worse for smaller stocks) and making the return of our money only just a flicker of hope in a nightmare of despair. So this is all wonderful as asset allocators check the MSCI rankings and weightings and take into account JP Morgan/Goldman Sachs/Morgan Stanley/UBS/Deutsche Bank/etc  views on interest rates and currencies.  The eternal US$ up, Euro down, A$ down, commodities down (gold definitely DOWN), interest rates low and a large dollop of bonds (especially US Treasuries) required for safety and income in a very difficult world.  And avoid small caps and anything illiquid and just say NO to any investment that requires any additional pre-cashflow capital. Yes.  Everyone is set for the great extension to the US Great Recession and as China falls over and those Euro-sclerotic European banks and economies just roll over and die.  Everyone is set for the next ten years at that 3.0% pa pretax return.  And don’t alter that spreadsheet. But then there is Murphy’s Law, or as the great everyman’s economist Don Stammer would say, the X factor, to come into play.  Don probably isn’t following Mitchell Johnson at the moment. So the first graphic in this edition refers to the world’s second largest asset market (currency is first).  The global bond market is around US$80trillion with about 50% being US with US T bonds being about US$17trillion with municipal government, mortgage debt and corporate bonds making up the rest.  The numbers are difficult to precisely define as some double counting seems to apply but I am sure you get the drift. Anyway the first graphic refers to yield on long dated US Treasury bonds from an earlier major cycle low in 1942 and the 39 years of rising bond yields (and falling prices).  After the peak in yields in Dec Qtr 1981 there has been over 30 years of declining bond yields (and rising bond prices).  You have seen this graphic before but it is just as relevant as ever. Graphic 1 US long Term Treasuries Yields 1940-2013 The wowsers have had a great time.  (In another world this might have been Revenge of the Nerds).  And they obviously think there is more to come. No inflation and the Fed will bail us out so let’s just keep it going.  And this is one big slow moving ship of state type market that will take a while to turn.  It has been on this course for over 30 years so it has its own momentum. Looking at the past thirty years in price, however, it seems some ominous signs might be developing in the long term trend.  The uptrend line is being approached with a certain precariousness.  The absolute high in 30 Year T-Bonds occurred in July 2012, well over a year ago.  The bonds might bounce from here but if we check again with the yield perspective these rises in yield make the probability that the precarious is indeed precarious. Graphic 2 US 30 Year Treasuries Price Index 1980-2013 Yields in more recent times are rising here and the trend line break, support and `goodbye kiss’ on the trend line and subsequent rise, suggest higher yields are coming. Graphic 3 US 30 Year Treasuries Yields 2009-2013 Is that Mitchell Johnson out there or is it that a Panzer I hear? Apologies if this T-Bond stuff is repetitive in Dawes Points but this is history unfolding right before your very eyes as they say.  Stuff you can tell your grandkids.  `I was there when it happened’. So anyway we were talking about the renewal of the Resources Boom. Two new graphics.  Resources Sector capex and total exploration.  The Resources Industry in Australia has spent a cumulative A$418bn in new capital expenditure since 2000 and A$94bn in FY2013 alone.  Mostly on iron ore, coal and LNG projects. Graphic 4 Resource Sector Capital Expenditure 2000-2013    Exploration has been at an average rate of over A$2000m pa for minerals in the past six years (over A$13bn in this period) and A$4,000m pa for petroleum (over A$25bn).   Looking at the markets you would consider nothing has been discovered or developed.  Who is fooling whom? Graphic 5 Resource Sector Exploration Expenditure 2000-2013 Cumulative A$418bn in resources sector capex on new capacity.  Which the wowsers say won’t make any return.  Lifestyle companies.  Rubbish management.  No dividends.  Oversupply at the market top. And these are the resulting production forecasts. Iron ore and coal. The results of this will be some impressive production and export numbers for iron ore and coal. Over 500mt iron ore in FY13 and on its way to over 800mtps by FY2018. Graphic 6 Australian Iron Ore Exports 1965-2013 – BREE forecast to 2018 And 300mt of coal and more than 400mt in FY2018. Graphic 7 Australian Coal Exports 1968-2013 – BREE forecast to 2018 And  LNG. Graphic 8 Australian LNG  Exports 2000-2013 – BREE forecast to 2018 Prices for iron ore have been well above most commentators' expectations in FY2014 and coal is also better.  LNG exports should also rise by about 200% by FY2017. The net result in export revenue could be like this. Graphic 9 Australian Resources Sector Export Revenues 2000-2013 – Paradigm forecast to 2018 And these revenues are at roughly today’s prices and US$0.95 on the currency. If commodity prices are higher, and not lower as almost every commentator has incorrectly suggested, the numbers could be much higher. You know the story, A$54bn resources sector exports in FY2004 and ten years later A$220bn.  And the big three iron ore, coal and LNG alone will provide an increase of A$80bn by FY2017 to take it over A$300bn.  Quick check on operating margins for iron ore and LNG gives at least 50%, coal less but others OK.  40% EBITDA margin is A$120bn.  Some rubbish management.  Some lifestyle company. About A$60bn after tax. Traditionally resources companies paid out over 60% of their NPAT as dividends.  A$36bn in fully franked dividends.  >A$700bn grossed up at 5% yield.  Market cap of A$600bn on PER of 10.  Assuming prices don’t rise and some other smart alec starts talking about it being a long term growth sector and should have PERs expanding.  And higher commodity prices would bring growth in dividends.  Come on all you Warren Buffets disciples.  Do the maths. Of course, not all the investment is by ASX-listed companies but BHP, RIO, WPL, STO, FMG have contributed mightily. And have a look at this.  Over 200 more projects identified by BREE as feasibility studies or better.  Needing your money to develop them.  Hundreds of companies with projects.  Most trading at a few per cent of the project NPVs.  Just waiting for capital. Graphic 10 Australian Resource Development Projects 2003-2013 And it is your capital that is needed.  Not huge swags of foreign equity and debt. The A$1,537bn in bank deposits including A$547bn in term deposits, and A$595n in savings and building society accounts.    And around A$1550bn in superannuation (some double counting here of course).   And here I am sitting in Shenzhen, China, seeking a few million for some ultra cheap mining project that should achieve minimum IRRs of 30% while the wowsers are jumping for joy over bank dividends that are paying 5%. These are true alternatives to having ALL of your money in the banks and Telstra.   These opportunities are just begging for attention and funding. The A$1550bn tied up in Australia’s superannuation funds has mandated inflow of over A$100bn and an investment time horizon of at least 20 years.  Yet it is seemingly exceptionally `risk averse’ and seeking 3 month returns.   A major rethink is needed here.  Some recent ABS stats indicated that A$1.8bn in superannuation taxes (sorry, `contributions’) were paid by the mining industry in FY2012.  How much came back to it in investment over FY2013?  A$1.8bn out, not much back in. Some Australians might feel that they have missed out on the benefits of the boom but they haven’t really, because corporate earnings prior to 2008 provided substantial boosts to government tax revenues and allowed repayment of debt and gave reductions in tax rates.  And the best benefit any government can deliver is economic policy that produces a strong currency.  At US$1.00 the A$ makes you 25% wealthier than at US$0.80.    Cheaper food, cheaper energy, cheaper cars and cheaper TVs etc. And cheaper holidays. A 25% stronger currency is far better than a 25% pay rise.  Think about it. But a stronger A$ should also mean that interest rates should have a downward trend.   A strong currency should force governments to cut their public expenditures, firstly to reduce any borrowings and force cuts in interest rates.  Secondly to reduce the size of the least productive sector of the economy. A strong currency makes everyone wealthier. And this is the latest update on the long term trend for the A$.  Just pulling back to test support on the long term downtrend of the 90 year variety.  A powerful message here.  If the A$ gets above parity to confirm this thesis we will be in for decades of strong currency. Graphic 11 Long term US$/A$ Exchange rate 1913-2013  Now having had a look at this data and I think you might agree that the best for Australia is yet to come! And resources stocks are unloved, despised, underowned, down 80% from their highs, back to the levels of a decade ago, cheap and just rearing to go!. I will close with this busy graphic that just might be confirming that gold is now getting serious about renewing its bull market.    The low was back in late June 2013.  The rally could be very sharp now but the high will be many years away in this extraordinary bull market. Graphic 12 Gold bull market about to surge    11 December 20013 Shenzhen China Barry Dawes B Sc F AusIMM (CP) MSEG MSAA

Mines & Money Melbourne

by Barry Dawes

Mines and Money in Melbourne - More bullish news!

Key Points

  • Melbourne looking a very civilised city!

  • Rick Rule seeing value and turning bullish

  • Presentations with strong outlooks for iron ore, coking coal and copper

  • Strategic metals as good as ever

  • `Professional's Capitulation' has arrived and passed

  • North American major stocks in cyclical upturn

  • US Treasury Note yields rising with stronger economy

  • China's 3rd Plenum Sessions should be powerful for resources

  • Market internals very encouraging for resources

  • 30 recommended resource sector stocks

Tough market conditions continue for the general resources sector locally but the international picture is providing broad and conclusive evidence for a very good 2014. Action in the smallcap space is encouraging for all of us.  The bears' last gasp attempts are now failing against the growing surge of expanding demand from China and the other emerging countries for gold, oil, copper, iron ore and coal. The action of the past couple of weeks can be focused on a recently attended conference.  The Mines and Money (M&M) people organised their first-ever M&M in Melbourne to tap into the growing confidence of that city as Australia's leading resources investment centre with resources sector leaders BHP, RIO, Orica and a few others standing out and being well supported by ANZ and NAB on the banking side.  The activity there is real a with a certain sense of power that is a little classier than Perth with its oil and gas, gold, iron ore and nickel and stronger than Brisbane's coal and oil and gas and well ahead of Adelaide's oil and gas and its new forays into copper and iron ore.  Darwin has been booming in a real pioneering sense with its LNG and other petroleum activities.  Makes Sydney seem very sleepy.  And of course Hobart, well don't bother waking them up. This Conference was notable in having an outstanding series of speakers ranging from Rick Rule of the Sprott Group and Chris Powell from GATA in the US to Dr Pan Guocheng and Chen Biao from China with talks about iron ore and coking coal. Shaun Browne from AME with its extraordinary data bases reinforced the view that China had only been having a quiet breather that did not even rate as a cyclical slowdown in a secular bull market in iron ore and steel. Rod Whyte, a veteran Aussie broker in London provided his valuable perspectives whilst UBS and Morgan Stanley gave some views on the mixed outlooks for copper (good) and nickel (soft). Sean Russo gave his usual passionate spiel on hedging and Richard Karn showed he knows more about strategic minor metals than anyone on the planet. The attendance was down on the organiser's expectations but we probably haven't seen an investor-crowded conference since the 1980s.  Talk about Disbelief and Pessimism! And we have yet to see the adornment girls that were ubiquitous and essential at every event in the exciting markets of the 1980s. Rick Rule put it well with his comment on `Professional's Capitulation' whereby even the pros and diehards have thrown in the towel and are now focussed on other sectors. Conferences are interesting places to see key industry spokesmen, commentary and debate on major issues, chances for companies to showcase their projects and of course to catch up with old friends.  I think M&M in Melbourne was very useful for all these reasons. It was also useful noting a number of new private equity players on the scene and also some of the North American royalty and product streaming companies offering non-equity and non-debt financing.   Each has its place in the broader capital markets and as at present, the lack of equity investors certainly makes these forms of financing attractive. These conferences are also reflections on the markets   No sponsorship from ASX or even TSX this time and certainly not much from brokers.  Investors were few and far between.  These are the signs of the `professional capitulation'. Moving on, you would have noted that I have tended to focus on the major global markets and follow many major resources related indices as indicators or proxies on what should be happening here.  The senior North American stocks tell us a lot about how the world is really travelling and how the major investors are viewing the commodity sector.  Take oil for example. I have suggested that oil seems to be leading the commodities higher reflecting strong demand and limited new supply.  Oil is having a slight breather just now but inventories are still tight, China is now a bigger importer than the US and the US tight oil business seems to be having a few operating issues to deal with.  Tight oil production figures from the Bakken, Eagle Ford and others are on track to reach a combined 2-2.5mmbblpa in 2017 but a disturbing trend is now showing that single well production declines appear to be steeper than expected so that production declines now make up 6.6% of total production, 20% higher than 5.5% in 2012. Source: ASPO This means these fields need to produce 6% more each year to offset the declines before seeing production growth. Costs are also rising per recovered barrel and many of the sweet spots seem to have been already discovered.  No panacea here for long term US oil supply from these fields.  The US will remain a net importer of oil. No drama on the oil price itself, just coming back to support on both the downtrend and uptrend lines.  This is often a very typical technical feature pullback to support and should be the base for another advance.   Recall that US Exploration and Production stocks recently made new all-time highs and did so with little fanfare. http://stockcharts.com/c-sc/sc?s=$WTIC&p=M&st=1980-07-13&en=(today)&i=p74540382760&a=295571898&r=1384120885991 You should then look at Copper with the Freeport price powering on.  A pullback is possible but bears don't have shares.  Freeport is leading copper.  Copper technicals are looking encouraging and LME inventories are 32% lower than the peaks in June and are just 462kt against 20mtpa consumption. But the bigger picture is that many large cap basic materials stocks in the US are having strong performances from extended periods of low prices.   Alcoa has been mentioned previously but have a look at US Steel and Cliffs Resources. US Steel.  What can you say?  Already up 71% from its June low.  Cliffs is a little less exciting but the downtrends are being broken everywhere.
US Steel.png
Chinese steel is still strong and around 780-800mtpa. The iron ore price is challenging US$140/t again so that it is A$145/t and very profitable for producers such as BHP, RIO, FMG, AGO and good for juniors.  I still think new highs are coming within a year or so.
Gold is still intriguing and I am still running with the idea that the low was seen back in June. Low gold prices mean that physical demand will be strong, particularly from China and India (despite the import restrictions but note an election is due in June 2014).  Also note that COMEX gold inventories of `registered’ gold available for immediate delivery is down to just 638koz, the lowest level in this bull market.  Gold is almost back to supporting on the latest downtrend line after breaking upward a few weeks ago.  Technically positive.
http://stockcharts.com/c-sc/sc?s=$GOLD&p=D&yr=1&mn=0&dy=0&i=p27163996205&a=323438098&r=1384298929129
Also of interest is the way gold stocks are not weakening as much as the gold price suggesting that gold stocks want to rally and perhaps gold might do that also.
Short term steadying     Long term grossly oversold against gold
http://stockcharts.com/c-sc/sc?s=$XAU:$GOLD&p=M&st=1980-01-03&en=(today)&i=p79093628381&a=295490354&r=1384300882124
Again on the macro, do note the outcomes from the four day 3rd Plenum Meetings in China held last weekend. Proposed reforms will assist in growing China but the details are still awaited.  The Chairman of Chinalco has already indicated that the proposed changes to Chinese economic policy should be very good for resources and echo the comments from BHP and FMG as well as others that Chinese demand is increasing. Whilst crude steel production in China is almost 600kg/capita, a high figure in world terms, it must be appreciated that total production since 2000 is only 6,000mt or just 4.5 tonnes/capita conservatively assuming all steel is used and no net exports.  The capital stock in steel for many  OECD countries is 10-15t and nearby countries such as Japan and Sth Korea have as much as 20t/capita.  China has a long way to go building those roads, offices, apartments, high speed rail (at 30,000t per metre to give the straight elevated platforms or so I have been told), bridges and roads.  And then cars and trucks. Some other data from China indicates that online sales will make up 45% of total retail by 2015 and that the more than 400 cities with over 1 million people will make up 75% of world growth by 2025.  If you haven't yet been to China you probably won't really appreciate the enormity of that country. In keeping with the macro themes it is important to also keep watching the US bond market as the key to the resources markets. The low in yields for the past 32 year cycle certainly appears to have made been in July 2012 and is now in a long term uptrend that will probably be at least 30 years in duration.  The last one was for 39 years of rising bond yields before peaking in 1981. The short term yield changes look powerful and the long term `rising wedge' shape for the 30 year Treasuries does suggest sometime soon there will be a crack in price. I provide these graphics to encompass prices histories and major changes in trends and usually the price patterns give helpful indications of future market activity.  The circle used here is a bit of fun but you just have to ask `Why is it so?'.  It certainly suggests something is occurring as the energy of the market place is manifest in a certain symmetry.
Long Term 30 Year T Bond Price    Medium Term 30 year T Bond Yield
http://stockcharts.com/c-sc/sc?s=$USB&p=M&st=1980-07-13&en=(today)&i=p17206863323&a=273626798&r=1384301575105 http://stockcharts.com/c-sc/sc?s=$TYX&p=W&yr=5&mn=0&dy=0&i=p30217644434&a=322979898&r=1384301615220
A recent report from Reuters indicated a US$54bn inflow to equity mutual funds in October in the third largest inflow on record and all three records inflow levels have occurred in 2013.  The US$286bn year to date figure is the largest since 2000. In contrast, bond fund posted five consecutive monthly redemptions outflows since late 2003 with US$13.5bn in October being almost three times that of the US$4.9bn in September. This is the `Great Rotation' and is clearly indicating an improving economy and not the end of the world. The resources market here in Australia is also getting its own share of excitement as beaten down companies come up from their lows with good bounces and surges.   The major XMM has now broken the April 2011 downtrend so expect a good long term upswing to begin to accelerate soon. Whilst we haven't got the indices moving all that much, individual stocks have done well.   Have a look at these in order of size.
Stock ASX Mkt cap A$m June low Current Price Recent high % change Now vs low % change High from low
Fortescue FMG

17,400

2.87

5.58

5.62

94

96

Orecobre ORE

266

1.32

2.26

2.46

71

86

LNG Ltd LNG

98

0.12

0.32

0.385

167

221

Kimb.Diamonds KDL

51

0.24

0.83

0.86

248

258

Minemakers MAK

40

0.092

0.16

0.18

79

96

Kings R Copper KRC

21

0.024

0.14

0.26

483

983

Lamboo Res LMB

13

0.075

0.18

0.185

140

147

Note that even big stocks can make good moves as we can see from FMG.  I expect to see similar moves in other stocks as we run into the end of year period.  The signs to date are that 2014 will be a very good year! Here at Paradigm we have participated in several capital raisings since June and these have been performances.  It is safe now to go into the water.
June low Acts Placing price Acts Current price Acts Recent post placement high Acts % change Now vs placement % change High from placement
GGX

1.9

2.2

2.4

2.9

9

31

SOC

10.0

20.0

22.0

24.5

10

22

ELT

1.0

1.4

2.2

2.5

57

78

LMB

7.5

6.0

17.5

13.5

125

208

QHL

13.5

20.0

22.5

31.0

12

55

LNG

12.0

20.0

32.0

38.5

60

92

Stock Recommendations

I have refrained from making specific stock recommendations for a while during the wild irrational volatility of recent times but I now consider that the case for a strong 2014 is well positioned and the evidence to confirm this view is now around us daily.  Also keep in mind that many projects are now in operation and these will generate a lot of cash so the stocks are likely to have some large increases in dividends, particularly in 2014.  So here we go. Large caps  -     Iron ore coal and petroleum look good
Stock Price Mkt cap A$m Sector Operations Price drivers Yield %
BHP

37.88

122,140 Diversified Copper, coal iron ore oil Output growth 3.3
FMG

5.58

17,360 Iron Ore Pilbara Output growth 3.6
STO

14.85

14,400 Oil and Gas Cooper   Qld/PNG LNG Output growth 2.3
WPL

39.23

32,320 Oil and Gas NWS Oil gas LNG Output growth 5.1
OSH

8.44

11,377 Oil and Gas PNG MENA Output growth 4.4
Mid caps  Iron ore copper
Stock Price  Mkt cap A$m  Sector  Operations  Price drivers  Yield% 
AGO

1.16

1064

Iron ore Pilbara Output growth 4.0
AQA

2.25

926

Coking coal Iron ore Qld Pilbara Project develop n. a.
IGO

3.77

879

Gold Nickel Yilgarn Output growth 1.1
ERA

1.28

665

Uranium Ranger Uranium  price n. a.
DLS

1.22

525

Oil and Gas Cooper Basin Output growth n. a.
WSA

2.60

510

Nickel Yilgarn Output growth 2.5
CDU

1.98

405

Copper Cloncurry Output growth 15.0
Small Caps
Stock Price Mkt cap A$m Sector Operations Price drivers Yield%
NST

0.71

301

Gold Ashburton Basin Output growth 5.6
ORE

2.26

266

Lithium Argentina Project develop n. a.
ALK

0.38

144

Rare Earths Dubbo Zirconia NSW Project develop n. a.
CTP

0.40

123

Oil and Gas Amadeus Basin Project develop n. a.
LNG

0.30

95

LNG Magnolia Proj La USA Project develop n. a.
Micro Caps
Stock Price Mkt cap A$m Sector Operations Price drivers Yield%
REY

0.115

73

Oil and Gas Canning Basin Exploration n. a.
AJQ

0.24

53

Oil and Gas Macarthur Basin Project develop n. a.
ROL

0.40

41

Gold +BM Indonesia Project develop n. a.
MAK

0.16

38

Phosphate Northern Territory Project develop n. a.
IBG

0.054

22

Zinc Greenland Project develop n. a.
CNQ

0.06

17

Tungsten Atherton Tableland Mine expansion n. a.
AGE

0.07

14

Uranium Northern Territory Exploration n. a.
BLK

0.15

13

Gold Near Wiluna Project develop n. a.
LMB

0.17

13

Graphite Kimberleys Project develop n. a.
MAU

0.13

11

Iron ore Magnetite near Perth Project develop n. a.
ANW

0.008

5

Tin Taronga NSW Project develop n. a.
KBL

0.054

21

Copper gold Lachlan Fold Belt Mine expansion n. a.
GGX

0.023

16

Oil and Gas Philippines Project develop n. a.
These stocks are chosen based on assessment of near and medium term potential. Potential problems exist for all of them due to currency or product price and management issues can always arise.
Everyone should also note that there are hundreds of resources companies listed on ASX and many have quite decent projects and operations. Almost all have been starved of capital over the past six years so will need additional funds to develop projects into cash earning operations.
You should take advantage of low prices to gain highly leveraged positions in assets that must be more valuable tomorrow than the prices applying today. Follow me on Twitter @DawesPoints

Fasten seat belts – Here we go world!!

by Barry Dawes
  • Global equities explosion now underway
  • Commodities readying for upsurge
  • Major resources stocks about to fly
  • Major sharp rally ahead for small resources?
  • Is the early 1990s period of the Shanghai Stock Index an analogue?
A couple of weeks ago the Dawes Points comments of The Resources Boom Accelerating and the Equities Explosion Coming seemed a little courageous to many but the passage of the past two weeks has provided more concrete evidence of the continuation of the global economic expansion. The Wall Street gloomthink and the charade being played out in Washington seems to be ignored by the markets except by the usual New York Bozos who just love bashing the gold price to protect the unprotectable and defend the indefensible, i.e., the US T Bond market and probably the US$. And a strongly growing world economy is far more attractive than sitting in in a ten year T-Note for 2.7% or in a 30 year T-Bond for 3.7%    And if it is safety you want, well, bonds at this price seem very unsafe – all that risk and so little reward. Global equity markets are exploding upwards.  The Leaders are leading.  The Russell 2000 scored a new all-time high this week and Wilshire 5000 and the S&P 500 are not far behind.   The Dow 30 has been remarkably volatile and so has diverted attention from the better performing indices. The DAX is making all-time highs, the FTSE is getting ready to move and the Nikkei has bounced off its downtrend and is heading up again.  Hong Kong and Shanghai are looking very encouraging. And the local ASX 200 and 300 look just fine. And resources commodities look good too. Oil is leading the charge driven by tight supplies with Libyan output down again.  US tight oil is only about 1million barrels oil per day and it might grow to 2.5-3mbopd within a few years but China now is a bigger net importer than the US and it alone will absorb another 1mbopd per year.  So no oil surplus in the years ahead. But higher prices of course. Two charts here of US Oil Index and the E&P Index show new all-time highs.  Catch up Australia!
Now the iron ore price at US$134/t still hasn’t collapsed and RIO this week announced record shipments of iron ore (and other things as well).  And copper is starting to really look good now. Have a look at the copper price and look at Freeport Copper, the world’s largest listed producer of copper with over 1.5mtp copper output rising over 35% by 2015 at cash costs of under US$1.60/lb.  Capitalised at about US$33bn with an EBITDA multiple of <3x, over 2mozpa gold and 35million barrels of oil equivalent.  And a 6.5% dividend yield.  Better than bonds!  Downtrend broken and leading the copper market. LME copper stocks are down 25% from the highs in July 2013 to just 500kt and just 1.3 week supply at current consumption levels of 21mtpa.  Copper will be much higher soon.
http://stockcharts.com/c-sc/sc?s=$COPPER&p=M&yr=10&mn=0&dy=0&i=p38674516184&a=318139370&r=1381822274116 http://stockcharts.com/c-sc/sc?s=FCX&p=M&b=5&g=0&i=p75597707101&a=319422432&r=1381820660244
    I continue to be very impressed with the prospects for several other metals in the years ahead.  Supply limitations together with growing demand make for great opportunities. With Zinc, the supply side(11% closure of existing mine capacity) is inversely matched by a projected growth in demand as China increases its proportion of steel protected by zinc galvanizing. LME inventories are down 19% from the beginning of the year to <1mt.  Expect a big jump in zinc prices as the mine shortfall becomes really obvious and few listed investment opportunities exist. With Lead, the US, Europe and Japan are supported by recycled metal but China and other emerging economies have little scrap so newly mined metal is needed.  Few mines are available now and LME inventories have been essentially declining for two years and are almost 40% lower at just 238kt or just two weeks supply at current consumption rates.  Shortfalls expected here too. With Tin, the supply is now quite limited with very little new capacity to come onstream in the next few years to meet growing demand.  LME inventories have been in a three year downtrend and are just 13,000t- about 2 weeks supply on 340ktpa consumption. With Uranium, reactor demand is already well above mine supply and the  warheads to power rods transfer has now finished.  68 new reactors coming on stream and not much in the way of new mine production. Just watch this space. The demand for raw materials from the Non-OECD is now well over 50% of all demand and the growth should be accelerating against a background of supply constraints for most resources commodities. And this leads us to our favourite area – the small resources stocks that can give those exceptional returns.  And because these are all tied up with gold they tend to perform together. The poor performance of listed gold stocks and small resources stocks over the past couple of years have been perplexing and great wealth hazards.   It has certainly been puzzling as to why the market action has been so extreme particularly against such strong fundamentals.  Well certainly the fundamentals that I see and not those of the Wall Street cabal. I have spent some time searching for analogues where markets have had so much volatility and have fallen so much against what appear to be good fundamentals. Stocks falling >90% are usually associated with severe recessions and for an index to fall almost 80% you would expect the worst to have happened.  The searches showed that such markets are very rare and apart from the Dow Jones in 1929-1932 Crash in a very different environment there have been few even vaguely similar. So why has all this happened and what does such volatility really mean?  Let’s go back to the ASX All Ordinaries Gold Index.  This is real volatility in a bull market. Certainly there was a bull market that began in about 2000 (when the Index was started) that ran well into 2008, had a sharp pullback then rallied hard to new highs in 2011.  The subsequent decline into the June 2013 lows has been vicious. So we had a good +594% run into 2008 then the 61% pullback, up 218% then down our famous 77%. Just note the performance of the US Philadelphia Gold Index with similar volatility with essentially co incident timing on highs and lows. It is hard imagining the combination of a major bull market with such volatility against still strong fundamentals. But I have found something that does seem similar.  Lots of volatility and has major moves over a short period.  And it is an Index! Look at the volatility in a bull market!  Up 1300% in 18 months!  Down 73% in 6 months then up 300% in 3 months!  Wow! And there is more. Down 79% in 15 months (see XGD down 77% in 26 months!) and then the stupendous jump of 223% in 1994 over just TWO MONTHS!!! This was a new market with lots of speculation and volatility but look where it is now. I actually think the Chinese might decide that they like stock market speculating again very soon.  It just needs only about a 1% rise to break a four year downtrend. So coming back to the resources sector what might we soon see? With the very strong fundamentals for so many commodities the value for these small companies is outstanding.  Given how underweight the world is in these stocks we just might get the big run as we saw for Shanghai.  200% in just two months? Now have a look at this for the Philadelphia Gold Index (XAU). A rubbery 12 month downtrend in the bear market since April 2011.  The downtrend has been broken and the XAU has come back to support on the downtrend in a declining wedge. http://stockcharts.com/c-sc/sc?s=$XAU&p=D&yr=1&mn=6&dy=0&i=p92731593672&a=318608303&r=1381893712088 Usually such price patterns are resolved in the opposite direction to the declining wedge so itshould break sharply upwards. And something very interesting took place in the US markets on 15 October that might be indicating a major turning point. Our favourite Bozos in New York markets thumped the gold price down US$22/oz to almost US$1250 then the market jumped up over US$30 to the current US$1285.  It was almost as if the gold market said that “If that is that your best shot then you shorts are now finished!”. The XAU countered by closing up 2.4% as well!  This just might be a confirmatory price reversal. So if it is a price reversal then the bottom of the declining wedge should be the completion of the Right Hand Shoulder of the overall reversal pattern. The upside breakout could be very powerful indeed. So go back to the Shanghai analogy.  +200% in two months. Let’s just watch and see if markets are strangely stronger tomorrow. If so it will be a great ride. 16 October 2013