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


Leave a Reply