The performance of the FTSE 350 miners mirrored a general slump in commodity prices in the second half of 2014. Above all the fall-away in iron ore receipts undermined valuations. By Christmas, Chinese steel mills were paying $66.84 (£44.22) for a tonne of iron ore, roughly half the five-year average. Given that global iron-ore producers Rio Tinto (RIO) and BHP Billiton (BLT) together account for more than half the FTSE 350 mining index, it’s hardly surprising that the index lost 13 per cent of its value.
A year ago, new supply from Australia’s Pilbara region was surging onto global iron ore markets, but there was no subsequent rush from Chinese ports and steel mills to replenish stockpiles. As a consequence, over 20 iron-ore projects have been cancelled since July, removing around 150m tonnes in additional capacity over the next few years. The price slump should shake high-cost producers out of the market, but much will depend on how rapidly China’s economic policy transitions from a model fuelled by construction to one reliant on the services sector and domestic consumption.
Admittedly, iron ore prices have improved marginally this year as Chinese port inventories have finally dwindled. There has also been speculation that Beijing is intent on bringing forward around $1.1 trillion in infrastructure projects this year. But the National Development and Reform Commission – China’s principal planning agency – has downplayed any prospect of a substantial near-term stimulus.
In the coal mining industry, capital budgets were rationalised as prices continued to fall last year. That said, large-scale producers in Australia and Indonesia actually bumped up output, presumably in an effort to cut unit costs and force lower-margin producers out of the market. In the event, a number of factors, not least a sharp contraction in energy prices, have lowered the industry’s price floor. Nevertheless, the price for thermal coal fell by around a quarter last year, while metallurgical coal prices hit a six-year low.
Meanwhile, the LME Metals index (LMEX), which covers the six main industrial metals - copper, aluminium, lead, tin, zinc and nickel - fell 13 per cent in the second half, and has now fallen at an annualised rate of 10 per cent over the past two years. Prices for aluminium, zinc and nickel were actually rising through much of the year, but retraced in the final quarter. Meanwhile, the price of copper - widely viewed as a bellwether for the global economy - was undermined by a shadow-lending scandal in China, where the metal is widely used as collateral for domestic loans. Although production of refined copper is expected to exceed demand by about 390,000 tonnes in 2015 - representing a 2 per cent global surplus - long-term prospects for copper pricing are actually quite strong.
Commodity price
Prices for most industrial commodities tend to be negatively correlated to the US dollar, which is likely to gain near-term support from the European Central Bank and its newly launched quantitative easing programme. Another problem is that diesel fuel - priced in increasingly expensive dollars - often accounts for a hefty proportion of miners' cash costs. Yet these translation effects will be smothered by the 56 per cent drop in crude oil prices since July, and a strengthening greenback will also benefit miners that incur labour costs in emerging markets currencies and sell their output in US dollars.
The experience of 2014 underlines commodity producers' lack of pricing power, which makes their business models inherently cyclical. And the macroeconomic factors that weighed on metals and bulk materials prices in 2014 have not gone away. With the critical exception of production in some key areas, industry metrics (prices, demand, projections, capex, employment, wages and cash-costs) are all in retreat - along with many investors.
| Company name | Share price (p) | Market value (£m) | PE ratio | Dividend yield (%) | 1-year performance (%) | Last IC view: |
| Anglo American | 1,122 | 15,664 | 8.3 | 4.9 | -17.3 | Buy, 1,295p, 27 Oct 2014 |
| Antofagasta | 713 | 7,024 | 11.8 | 8.2 | -13.1 | Hold, 790p, 27 Aug 2014 |
| BHP Billiton | 1,427 | 30,139 | 9.4 | 4.9 | -25.6 | Buy, 1,750p, 2 Oct 2014 |
| Evraz | 158 | 2,380 | na | 0.0 | 51.6 | Hold, 115p, 27 Aug 2014 |
| Glencore | 258 | 33,781 | 10.6 | 4.0 | -22.7 | Hold, 360p, 20 Aug 2014 |
| KAZ Minerals | 207 | 924 | 15.6 | 0.0 | 11.5 | Buy, 305p, 22 Aug 2014 |
| Rio Tinto | 2,925 | 41,357 | 8.2 | 4.2 | -9.5 | Hold, 3,460p, 8 Aug 2014 |
| Vedanta Resources | 437 | 1,174 | 147.3 | 9.0 | -51.9 | Hold, 798p, 14 Nov 2014 |
Favourites
We think both BHP Billiton and Rio Tinto are better placed than rivals to ride out the ongoing slump in iron-ore prices, due to benefits of scale and the relatively low cost of their new output from the Pilbara region. Admittedly, with around a third of revenues generated through its energy division, BHP is also feeling the pinch of a slumping crude oil price. But a forward earnings multiple of 10 and a dividend yield of 5.2 per cent compare very favourably with the FTSE 350 averages of 15 times and 3.4 per cent respectively. For long-term investors, there is a clear contrarian opportunity.
Outsiders
The rise to power of a business-friendly administration under Narendra Modi was a potential boon for India-focused Vedanta Resources (VED). But any knock-on benefits might not become obvious for a while yet, given underlying commodity price weakness, operational problems linked to the group's copper operations in Zambia and regulatory hurdles in Goa. Vedanta has some great assets, but managing them effectively is a real challenge for new chief executive Tom Albanese, former boss of Rio Tinto.
