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Mining: the end of the affair

Created:
9 October 2008
Written by:
Daniel O'Sullivan

With attention focused on the banking sector, headline-writers have missed the other ongoing massacre, which is taking place in the mining sector. In the past month, shares in the four diversified mining behemoths of BHP Billiton, Rio Tinto, Xstrata and Anglo American have respectively fallen 27 per cent, 35 per cent, 44 per cent and 34 per cent.

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While industrial metals prices have been in retreat for some time, what has finally done for the large diversified miners is a swift collapse in both confidence and prices in the global steel industry. Until recently, steel was the last refuge for 'stronger for longer' commodity bulls and a key differentiator for the four heavyweights, all of whom have significant exposure to essential steelmaking inputs like iron ore, coking coal and ferroalloys.

The notion that Chinese urbanisation and industrialisation would continue apace despite western woes had encouraged analysts to draw a distinction between base metals and these so-called 'bulk' commodities. The logic was that bulks are key ingredients in the steel for which Chinese appetite appeared insatiable. Chinese demand also affects base metals but the fact that they are traded on liquid futures markets means they are subject to speculative flows, which makes it hard to untangle the fundamentals from the froth. Not so for the bulks, which are generally priced through annual contracts between miners and steelmakers.

Until recently, bulk prices were holding up, which supported the idea that Chinese demand had indeed decoupled from the credit crunch. But, in the past month, it has become obvious that China is slowing. Local Chinese steel prices have dropped some 10 per cent and deep cuts have been announced in state-owned steelmaking capacity. The knock-on effects have been dramatic. The spot price for iron ore coming into China has dropped 25 per cent in the month and is now below the level at which BHP Billiton, Rio Tinto and Brazil's Vale negotiated eye-watering annual price increases for their Chinese shipments earlier this year. On this basis, Chinese buyers will be looking for price reductions next year. Meanwhile, coal has yet to exhibit quite the same collapse but its previous constant climb through the year in fact levelled off around July.

IC VIEW:

We lost enthusiasm for BHP, Rio and Xstrata some time ago (see Withering hopes for commodity bulls). Anglo American is now down more than 50 per cent since our buy tip earlier in May, but we believe it is worth nursing this loss as Anglo is very well-placed for recovery when China rekindles its growth. For those not yet in the stock, it looks a compelling long-term buy at current levels.

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