China’s National People’s congress has not, so far as I know, made an entry into this column before, but everything comes to those who wait. The congress meets today and, irony alert, no huge political upheavals are expected.
It will give an indication, though, of where China’s economy is heading. There are expectations of further stimulus plans and this has been behind some of the recovery this week in Chinese markets and of the yuan and is one factor powering the pronounced recoveries in both world commodities prices and shares in global mining companies.
This week the price of copper hit its highest level in almost four months and enjoyed its biggest weekly gain since September. Iron ore, which was almost $90 a tonne in February 2011, bottomed out at below $40 in December and is now above $50 a tonne.
The shares in global miners have reacted accordingly and are largely behind the 11 per cent rebound in the FTSE 100 since mid-February. Rio Tintois up by more then 30 per cent since its low point in January, Anglo American a whopping 140 per cent-plus. Both are heavily involved in the production of iron ore, which, unlike the more volatile copper, tends to more accurately reflect global economic trends. Both their iron ore operations are profitable with the price at its current level and, indeed, right back down to £40 a tonne.
There are a few other reasons behind the rise in commodities prices (I am going to deliberately omit any consideration of gold here, the price of which moves around according to factors that have little to do with global GDP; I and others have warned about using gold as an investment tool). One is the weaker dollar, there being an inverse correlation between the two. The greenback has been losing ground for any number of reasons, from the delay in any rise in US interest rates to the possible election of Donald Trump as president. There are precious few other pointers to suggest any sustained further rise in commodities prices that will support those share price gains, other than optimism over China.
Advertisement
In any event, for investors the damage is already done. BHP Billiton and Rio Tinto have abandoned plans to grow dividends through the cycle in favour of payouts that will reflect future cashflow. Glencore has taken an axe to its dividend entirely; Anglo has suspended it for this year.
That reduction or loss of income and those share price rises make some of those shares look expensive. Anglo sells on a forward earnings ratio for this year of 37 times, Rio on 48 times. This week Moody’s took a dim view of the prospects for BHP Billiton and downgraded its rating based, in part, on a negative view of the sector as a whole. The ratings agencies did not exactly cover themselves in glory in the run-up to the financial crisis, but their views still have weight. Moody’s believes there is a “fundamental shift” in commodities prices that goes well beyond the cyclical downturns we are used to.
Equally gloomy was a paper this week from Goldman Sachs, which goes through a litany of reasons why commodities will fall further. Its main point is that instead of cutting production by closing mines, so allowing supply and demand to move back into equilibrium, the miners are responding by cutting capital spending and dividends or are reducing their borrowings by selling assets to other miners. This does nothing to reduce output but, according to my interpretation, plays pass the parcel with assets that should be taken out of production. Something similar has happened in oil, with producers hoping that someone else will fail first.
Goldman says that while it is easy to cut costs by increasing production from the same assets, so reducing the cost of producing a unit of metal, this is self-defeating. Moreover, something similar has been seen in four out of the five past commodity price downturns.
No matter what emerges from Beijing, those long-term trends would seem to be with us. If so, I suspect the response to the present strength in the price of the global miners will be a degree of profit-taking, from those fortunate enough to be in profit.
Follow me on Twitter for updates @MartinWaller10