Stimulus Not a Boost for the Mining Sector
Calla is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In early September, the United States, the European Union, and China announced stimulus measures. Indexes across the globe bounced. Most of the bounce was justifiable, but some individual stocks and even sectors bounced irrationally. The mining sector bounced too high too fast, and investors should expect to see last week’s correction continue.
As I wrote recently, the mining sector offers high-quality bargains for the long-term investor even as the Dow toys with multiyear highs, but the short-term outlook is choppy. The stimulus announcements do not significantly change the sector’s short-term outlook.
A Waning Commodity Boom
China’s expansion drove metals to all-time highs, creating a decade-long mining boom. China’s voracious demand had two important effects. First, it created short-term scarcity pricing as demand outstripped mining capacity. Companies invested to expand capacity and scarcity pricing induced new companies to form. As a result, sky-high profits are over and not likely to come back.
Second, China’s demand created smaller booms in source countries like Brazil, Angola, and Mongolia. These countries pushed global demand higher as the business community put proceeds from mining into construction and to a lesser extent domestic industry. However, the source countries’ growth depends on sustained commodity demand. As China reduces its demand – and its iron ore consumption is down 50% -- it pushes down the economies of a couple dozen smaller countries, spreading and deepening the slowdown. Iron ore producers, such as Vale (NYSE: VALE), Rio Tinto (NYSE: RIO), and BHP Billiton (NYSE: BHP), have been hit hard and even with the stimulus bounce have severely underperformed indexes, returning -16%, -4%, and -3% to shareholders, respectively, year-to-date.
Stimulus and Mining
The European Central Bank’s announcement that it will buy up troubled countries’ bonds reassures financial markets that European countries will not get locked out of borrowing. The announcement very indirectly affects mining. It means steel demand from Europe should not decline precipitously in the near future, but what the mining sector needs for a boost from Europe is sustained new growth.
The Federal Reserve’s announcement to buy mortgage-backed securities puts a floor on segments of the market and keeps the dollar low, potentially lowering the cost of US mining operations. Precious metal stocks, particularly gold but also silver, spiked on the announcement, as a low dollar makes precious metals relatively more valuable. However, QE3 will also put the already high Canadian and Australian dollars higher, pressuring margins of operations in those countries. BHP, the world’s largest mining company, already shelved several capital projects in Australia and Canada due to high costs and falling revenues. Rio Tinto, on the other hand, is plunging ahead with $4 billion in expansions to its Australian iron ore operations, even as its earnings and share price fall hard.
China announced over a trillion dollars in infrastructure projects, putting a temporary floor on Chinese metal demand. However, in subsequent weeks, multiple sources have reported that Chinese iron ore demand has declined instead of increased. In any case, the projects are a medium-term measure to prop up falling GDP, provide jobs, and improve infrastructure, not a sign that the demand of the last 10 years is back. China’s demand is particularly critical to Vale, which relies on China for over 30% of its revenue and unlike BHP or Rio Tinto does not have a diversified product line.
Last week Alberto Calderon, a BHP executive, broke the news on falling Chinese iron ore demand: “What we have seen in the past 10 years is not only a function of massive demand coming from China but the industry not being prepared,” Calderon told Bloomberg. “This won’t be repeated. Margins will still be good but that scarcity pricing we won’t see again, on average.”
Mining stocks have been low and should see a continued correction from early September’s bounce because demand is dropping and nobody knows when or from where the decline will stop. Well-managed, well-capitalized, and diversified companies in this sector will survive the decline -- and if you believe in long-term global growth, those companies become a solid long-term play.
CallaMarie owns shares of Companhia Vale Ads. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.