The Current View
A lengthy downtrend in sector prices had given way to a relatively stable trajectory after mid 2013 similar to that experienced in the latter part of the 1990s and first few years of the 2000s.
The late 1990s and early 2000s was a period of macroeconomic upheaval during which time sector pricing nonetheless proved relatively stable.
Relative stability suggests a chance for companies genuinely adding value through development success to see their share prices move higher. This was the experience in the late 1990s and early 2000s.
Still vulnerable cyclical conditions were aggravated in the second half of 2015 by a push from investors worldwide to reduce risk. Sector prices were pushed to a new cyclical low. These conditions were reversed through 2016 and 2017 although sector prices have done little more than revert to the 2013 levels which had once been regarded as cyclically weak.
With a median decline in prices of ASX-listed resources companies through the cycle of 89%(and 30% of companies suffering a decline of more then 95%), the majority of stocks remain prone to strong 'bottom of the cycle' leverage in response to even slight improvements in conditions.
Has Anything Changed?
The strength of the US dollar exchange rate since mid 2014 had added an unusual weight to US dollar prices. Reversal of some of the currency gains has been adding to commodity price strength through 2017.
Signs of cyclical stabilisation in sector equity prices has meant some very strong ‘bottom of the cycle’ gains.
Funding for project development has passed its most difficult phase with the appearance of a stronger risk appetite.
Resource Sector Weekly Returns
Market Breadth Statistics
52 Week Price Ranges
Equity Markets
The prospect of a global equity market correction was looming large by the end of the week despite a brief respite from falling prices on the last day.
A bout of market weakness is not a surprise as a change in direction for the nine year bull market has been a point of discussion for months.
Expected volatility surged as global equity markets were caught up in a reaction to rising interest rates, slowing global economic growth and the fear of business disruptions due to the Sino-US trade dispute.
Revised forecasts for global economic conditions published by the International Monetary Fund were also a market dampener insofar as they confirmed the Fund’s view that growth may have already passed its peak rate and, constrained by structural and capacity limitations, set to slow over the five year forecast horizon.
The developing economy market decline has been especially pronounced through 2018 as the broader equity market risks have been magnified by the currency effects of monetary tightening in the USA and expectations of a similar policy adjustment in Europe.
Resource Sector Equities
The equity market sell-off (and greater pessimism about global growth prospects) translated into lower natural resource equity prices. Within the Australian market, price indicators for the largest and smallest stocks in the resources sector fell 5- 6%. Gold related equities provided a relative safe haven.
Interest Rates
US government bond yields reached the highest levels in seven years before retreating slightly. While higher than in recent months, the extent of the yield rise has been modest by historical standards and well below what many analysts would have been expecting so far into the cycle and with US economic growth topping 4%, at least in the short run.
Once equity prices started to fall, some tendency for yields to decline suggested market ructions might make the Federal Reserve less likely to push ahead with its projected schedule of interest rate rises although the latest minutes of Federal Reserve meetings indicated a firm commitment among policy makers to the projections which they had already placed on the public record.
A lower than expected consumer price index for September was also taken to mean less pressure for monetary tightening.
Market fixation with rates is set to continue. Higher interest rates have often truncated market appreciation but that is not a necessary outcome. The impact of policy will depend on how aggressively rates are pushed higher. A gradual rise which recognises the steady expansion of the US economy, for example, may boost confidence and underpin higher equity prices. Sudden or large changes, on the other hand, are likely to spook markets as investors fear that the Fed has lost control or has underestimated the extent of needed monetary tightening.
In Europe, Italian bond yields rose after the government confirmed that it intended to pursue a more growth-oriented fiscal policy than its predecessor in office in defiance of European Commission wishes, with an estimated budget deficit in 2020 of 2.1% of GDP compared to the balanced budget outcome previously proposed and supported by the Commission.
Exchange Rates
The US dollar was subjected to a mix of countervailing influences which resulted in only minor net changes.
Higher US interest rates and bond yields supported the currency but evidence of the European Central Bank heading down a similar path removed some of the upward pressure on the US dollar.
European Central Bank minutes showed a similar determination as Fed policymakers to wean the euro area off its easy money settings, providing some support to the euro and offsetting some of the upward US dollar bias.
Although developing country currency moves had become less dramatic, the bias to the downside generally persists.
The Australian dollar has reverted to the levels at which it traded in the second half of 2015 prior to the most recent resurgence in raw material export prices.
Commodity Prices
The general upswing in commodity prices since mid 2017 had been given added impetus by stronger crude oil prices.
Diminished momentum has left prices within the bounds of a cyclical trough, albeit at the upper end.
The flip side of the benefits for commodity producers and exporters of higher commodity prices is the cost pressure now being experienced by users of agricultural and raw material commodities. Reporting companies have been suggesting this as a source of margin compression.
Business surveys closely watched by central banks are showing signs of upward pressure on selling prices as a result of higher raw material prices.
Gold & Precious Metals
Gold prices jumped during the week as equity prices weakened dramatically and, at the end of the week, as US bond prices also moved higher, also an indication of a desire for a safe haven.
Despite its rise, the gold price remained only slightly above the US$1,200/oz mark to which it had sunk over the past several weeks.
The gold price is now in a tug of war between its safe haven status (needed to counter equity price volatility), on the one hand, and rising interest rates (bringing a stronger US dollar), on the other.
Silver prices are losing their battle to recover recent declines, in contrast to palladium, the other precious metal with a strong industrial orientation.
Gold related equity prices showed modest gains with Australian listed company prices benefiting from a weaker Australian dollar to leave the ASX gold index near the upper end of the trading range it has occupied for two years.
Nonferrous Metals
Daily traded non ferrous metal prices were generally higher during the week although still mostly within recent trading ranges and lower than four weeks ago.
The divergence between copper prices and US government bond yields remains suggestive of a need for some further relative adjustment between the two. The circumstances supporting higher yields would normally also support higher copper prices whereas the latter appears to be weighted more heavily to a prognosis for a slowing global economy.
Bulk Commodities
Chinese economic growth reports show the national economy meeting its targets, as one would expect for a centrally planned economy, but suggest it is only doing just enough. There are no signs of upside risk. The tariff fight with the USA is beginning to take a toll on activity rates in an economy with a bias toward less strong growth in the years ahead, in any event.
The latest manufacturers purchasing managers index for China, measuring conditions in September, implied a slowing momentum albeit within the context of a still expanding sector. The fall in the monthly reading was the largest since October 2017.
Higher steel prices had not been reflected in stronger iron ore price outcomes despite the improved profitability of the steelworks, although they did firm somewhat during the week. Higher steel production is possibly in anticipation of more government construction stimulus to keep growth on target. There is also uncertainty about the extent of production curbs over the balance of 2018 as environmental restrictions on production are implemented.
Coal prices continue at high levels reflecting China’s drive to source cleaner energy and as constraints on new mine development keep a rein on supplies although they are retreating from the strongest levels of recent weeks.
Oil and Gas
Crude oil prices dropped as concerns about demand growth loomed and supply constraints appeared looser.
OPEC has been losing control of the market as US and Russian production has become more significant and while several OPEC members lose their historical clout.
Reimposition of Iranian economic sanctions by the US government has put upward pressure on prices. The failure of effective government in Venezuela has been another contributing influence on higher prices.
The Iranians have been lobbying European countries to prevent more widespread application of sanctions but the likelihood of relief appears slim as long as funds must circulate through US banks.
US production, in any event, continues to rise and is now matching output from Russia and Saudi Arabia. Texas alone is positioned to be the third largest producer after Russia and Saudi Arabia. Export infrastructure limitations may be the greatest impediment to US production having a greater effect on international energy prices.
US stock holdings reported in the last week were higher than had been expected. OPEC also disclosed in its monthly market report that it expected demand for crude to grow less strongly in 2019 than it had previously forecast in another sign of the decelerating global economy.
The prices of oil related equities reacted negatively to the change in market conditions. In reacting more aggressively to negative moves in crude oil prices than to upward moves, equity prices have produced no net change since May and no reaction to the higher prices since late August.
Battery Metals
Eighteen months of rising lithium-related stock prices have given way to a prolonged period of market reassessment as a lengthy pipeline of potential new projects has raised the prospect of ongoing supplies better matching expected needs.
Potential lithium producers have been able to respond far more quickly to market signals than has been the case in other segments of the mining industry where development prospects have been slowed by reticence among financiers to back development.
Movements in lithium related equity prices had been aligned more closely with overall sector equity prices in recent weeks with the lithium stocks tending to display a greater leverage to changes in market sentiment about the mining sector.
The median fall from their 52 week high within a large sample of 80 Australian and Canadian listed stocks with lithium exposure, mostly with an exploration orientation, has been 56%. Every one is trading below its peak price from the last year.
Battery metals remain a focal point for investors with recent attention moving to cobalt and vanadium.
Doubts about political conditions in the Democratic Republic of the Congo (and instances of Ebola) have added a dimension to cobalt prices lacking in other metals caught up in the excitement over the longer term impact of transport electrification.
In the longer term, cobalt is the most vulnerable of the battery related metals to substitution with high prices likely to stimulate research in that direction.
A spokesperson for Panasonic, manufacturer of batteries for Tesla motor vehicles, has been quoted as saying that the company intends to halve the cobalt content of its batteries because of uncertainties over supply although, offsetting such a move, will be the rapid increase in the number of units produced.
Uranium
The uranium sector is in the midst of forming a prolonged cyclical trough as market balances slowly improve. Power utilities are still not prepared to re-enter the market for contracted amounts of metal to meet longer term needs. A slight upward bias in prices has been evident in the past month.
Slightly higher equity prices from time to time, in the hope of improved conditions, have not been sustained but could be repeated as speculation about improved future demand ebbs and flows. The effect of an announcement by Canadian producer Cameco to extend the duration of its previously implemented production cut gave the market a very slight but quickly lost lift.
News that the Kazakhstan government intends to list its state owned uranium producer and the world's largest producer, may suggest greater responsiveness to market conditions and less emphasis on production to maximise government revenue.
The Steak or Sizzle? blog LINK contains additional commentary on the best performed stocks in the sector and the extent to which their investment outcomes are underpinned by a strong enough value proposition to sustain the gains.
