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Resources: the cycle turns

Anthony Fensom  |  12 Oct 2017Text size  Decrease  Increase  |  
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Australia's resource sector has enjoyed gains in 2017, with stronger-than-expected economic growth in China and a strengthening global recovery lifting commodity prices. Is it time for investors to get on board?

 

China, the world's biggest consumer of resources, has enjoyed a reported 6.9 per cent increase in GDP in the first half of 2017, with Beijing keen to keep the economy on track ahead of the communist party's National Congress.

Global growth has also picked up steam, with the International Monetary Fund (IMF) projecting in its July report a 3.5 per cent GDP gain this year, rising to 3.6 per cent in 2018, helped by improved performances in both advanced and emerging economies.

Copper, long considered a bellwether for the global economy, has recently hit three-year highs, with rising coal, gold, and iron ore prices helping the benchmark S&P/ASX 300 Metals & Mining Index to a nearly 20 per cent gain as of 6 October.

Among the major miners, Rio Tinto (ASX: RIO) was showing a one-year return of 39 per cent as of 6 October, followed by a 19 per cent rise in shares of BHP Billiton (ASX: BHP) and a 12 per cent gain for iron ore miner Fortescue Metals (ASX: FMG).

The adjusted profits of the three miners rose by US$9 billion (A$11.5 billion) in the recent earnings season, helped by higher iron ore prices.

The renewed industry confidence has resulted in increased exploration activity. According to accounting group BDO, total exploration spending by ASX-listed explorers rose by 11 per cent to $338 million in the June quarter, with median exploration spending up 30 per cent to its highest level since 2014.

Net investing cash flows more than doubled, while net operating cash flows also advanced to their highest level since 2015.

Investors have voted with their wallets, as indicated by the increasing number of initial public offerings (IPOs) launched by mining companies, including recent debutants Mayur Resources (ASX: MRL), Northern Cobalt (ASX: N27), and Okapi Resources (ASX: OKR).

"Miners remain in a sweet spot--spot commodity prices are high, costs and capex remain low (though rising), growth aspirations are muted, balance sheets are overcapitalised, and cash flows exceptionally strong," Morgan Stanley says in a September report.

Commodity forecaster CRU expects the prices of 30 of 36 commodities to increase through to 2020, with copper and zinc seen as particularly strong due to expected supply deficits.

BHP has also pointed to China's planned spending under its "Belt and Road Initiative" (BRI), which could cost US$1.3 trillion to deliver, boosting Chinese steel production and adding to demand for Australia's coal and iron ore exports.

However, Morningstar senior equities analyst Mathew Hodge cautions against jumping on the bandwagon, suggesting that the recent share price gains in the major miners have resulted in overstretched valuations that are unsustainable.

"Much of the overwhelmingly positive commentary about BRI lacks context and is wide of the mark," Hodge argues, saying the overall boost to demand is "small in the context of China's already heady spending on fixed asset investment."

Hodge says BHP's estimate of the impact on steel demand from BRI would translate to a one-off rise of just 0.9 per cent--not a huge rise in the context of China's total steel production.

"The market has jumped on the rally and seems to have forgotten about the structural issues in China. I don't think you need too much to change for the focus to switch back onto the long-term challenges to demand for iron ore and coking coal," he says.

Elsewhere, Hodge says a recovery in mineral sands prices is "well underway," helping Australia's major mineral sands miner, Iluka Resources (ASX: ILU).

"Our optimism on the outlook for a cyclical recovery in zircon and titanium dioxide feedstock prices has played out relatively quickly ... There is still potential for further price upside in the near to medium term, given mineral sands usage tends to peak later in the cycle than steel-making materials and base metals," he says.

Morningstar is also positive on gold, with rising Chinese and Indian gold jewellery purchases expected to boost prices to US$1,300 per ounce by 2020. Gold was trading at US$1,260 on 6 October, boosting Australian gold miners such as Newcrest Mining (ASX: NCM).

Rising demand for electric vehicles has supported Morningstar's positive view on lithium, while uranium is seen benefitting from the growing number of new plants planned in China and the United States.

Quentin Hill, managing director of Carpentaria Exploration Limited (ASX: CAP), suggests investors are returning to the resource sector due to its long-term prospects.

"Population growth, urbanisation rates, and economic development underscore long-term demand growth, especially in India, ASEAN, and Latin America," he says.

However, in the short term, mining investors are advised to pick carefully, with consideration of the potential risks as well as Morningstar's research recommendations.

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Anthony Fensom is a Morningstar contributor and holds shares in Carpentaria Exploration. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.

© 2017 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

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