The Current View
Growth in demand for raw materials peaked in late 2010. Since then, supply growth has generally outstripped demand leading to inventory rebuilding or spare production capacity. With the risk of shortages greatly reduced, prices lost their risk premia and have been tending toward marginal production costs to rebalance markets.
The missing ingredient for a move to the next phase of the cycle is an acceleration in global output growth which boosts raw material demand by enough to stabilise metal inventories or utilise excess capacity.
The PortfolioDirect cyclical
guideposts suggest that the best possible macroeconomic circumstances for
the resources sector will involve a sequence of upward revisions to
global growth forecasts, the term structure of metal prices once again
reflecting rising near term shortages, a weakening US dollar, strong money
supply growth rates and positive Chinese growth momentum. None of the five guideposts is "set to green"
(after the most recent adjustments in December 2016) suggesting the sector remains confined
to near the bottom of the cycle.
Has Anything Changed? - Updated View
From mid 2014, the metal market cyclical position was characterised as ‘Trough Entry’ with all but one of the PortfolioDirect cyclical guideposts - the international policy stance - flashing ‘red’ to indicate the absence of support.
Through February 2016, the first signs of cyclical improvement in nearly two years started to emerge. The metal price term structure reflected some moderate tightening in market conditions and the guidepost indicator was upgraded to ‘amber’ pending confirmation of further movement in this direction.
As of early December 2016, the Chinese growth momentum indicator was also upgraded to amber reflecting some slight improvement in the reading from the manufacturing sector purchasing managers index. Offsetting this benefit, to some extent, the policy stance indicator has been downgraded from green to amber. While monetary conditions remain broadly supportive, the momentum of growth in money supply is slackening while further constraints on fiscal, regulatory and trade regimes become evident.
China Investment Bid Underpins Mining Industry
Future
Chinese president Xi Jinping has brought 28 national leaders together in
Beijing to promote his One Belt One Road initiative which, some say, is a
source of future prosperity for the mining industry.
The fortunes of the mining industry have depended historically on periods of relatively strong economic growth with particularly supportive conditions coming from periods of elevated investment spending.
Between 2003 and 2007, for example, as miners
experienced a surge in industry prosperity, global investment spending rose
at historically strong double digit rates for five consecutive years. There
is nothing similar on the horizon.
Since 2010, growth has weakened amid an investment slump. Excess production capacity has limited the need for private sector investment. Fiscal imbalances have restrained the willingness of governments to drive infrastructure spending higher despite its potentially beneficial impact on productivity.
Falling productivity growth has placed a lid on wages growth in many advanced economies which has, in turn, acted as a dampener on growth.
The Chinese government One Belt initiative is being promoted as a massive infrastructure building program to connect China with Europe through central Asia. One Road will connect China’s maritime routes to east Africa and the Middle East to the Mediterranean region.
The initiative will contribute to improved living standards in many participating countries. Some have compared the Chinese moves to the Marshall plan which drove development in Europe after the second world war.
Despite the obvious development benefits and potential to precipitate stronger growth in many developing countries, considerable scepticism exists about the motivation of the Chinese leadership.
From China’s perspective, One Belt One Road will open up new markets for its goods and services as its domestic growth slows. However, the motivation clearly extends beyond economic considerations.
One Belt One Road also projects China’s potential political influence in an unprecedented fashion at a time when the USA and Russia are preoccupied domestically. China’s plans reassert a pivotal political role on the global stage.
One Belt One Road also has a military dimension with China using its commercial and political connections to establish a naval presence within the Indian ocean region despite its historical opposition to others bidding for regional military influence.
Among the major developing economies, India has been conspicuously hostile to Chinese overtures. The Italian prime minister attended the Shanghai meeting of leaders but other major European leaders were absent.
To avoid offending the Chinese government with whom they want to do business, many countries, like the UK, sent senior representatives despite their lukewarm response.
One Belt One Road is, so far, much bigger on paper than in reality. The buildup in spending and construction will be slowed by a lack of shovel ready projects.
The ambitious Chinese plans will also depend, to some extent, on participation by other international funding organisations, advanced economy governments and private money.
Scepticism about China’s motives will slow their embrace as will financial constraints among already highly indebted national governments and, among existing development agencies, fears about ceding too much influence to newly formed funding institutions to back the Chinese efforts.
To the extent the Chinese government is also trying to recruit private sector money, rates of return will be important. In many of the 68 countries China has signed up to its development initiative, unsubsidised risk adjusted returns may still fall short of what is available in advanced economy markets.
The speed of adoption may not depend entirely on commercial considerations. One suspects progress in deploying funds could be rapid to the extent the Chinese government wants to demonstrate its determination by funding projects in those countries most willing to embrace the opportunity.
Absent the Chinese efforts and against the backdrop of historically weak global growth and lowered investment contributions limiting raw material usage, a cyclical upturn for the mining industry seems unlikely in the foreseeable future.
Even where there is discussion about improved growth prospects, such as in the USA after the election of Donald Trump as president, targets are quite modest with few expecting the U.S. economy, in the best of circumstances, to grow sustainably faster than 3%.
To some extent, Chinese supported infrastructure construction may be compensating for reduced spending domestically limiting the extent to which the mining industry can count on higher demand for its products even in the event of the Chinese program being fully implemented.
The Chinese government has flagged a willingness to spend around US$150 billon a year to get its grand plans underway. China may be the only country able to make such a commitment. Without it, the economic landscape look formidably bare for the mining industry.
The G20 which had nominally committed in recent years to implement policies to raise growth appears to have made no meaningful progress toward better growth outcomes and, as a group, now shows no sign of offering alternative ways to engineer a stronger pace of growth.
China is the only game in town for those looking for improved global growth outcomes and, in particular, a source of stronger growth in demand for the raw materials offered by the mining industry.
China’s motives may be self serving but no country is entirely selfless in doling out its development funds.
The mining industry will be better off for having China’s economic muscle behind developing country infrastructure spending but the impact of the spending could be easily exaggerated. Spending even US$150 billion would be equivalent to just 0.2% of current annual global GDP or 0.8% to global investment spending.
