London to a BRIC, the resource boom has a long way to go
Orica was Friday's high-profile casualty of the resources sector slowdown as its share price slumped in the wake of a profit downgrade, but the resources "super cycle" is not dead.
The commodity price bubble that accompanied China's infrastructure investment boom won't be repeated. When China's demand for commodities surged a decade ago, the miners had been closing mines down and cutting exploration and development for decades. Today, China is growing more slowly and in a different way, and the supply pipeline is larger.
The trend that Goldman Sachs global research head Jim O'Neill highlighted in 2001, when he first predicted the rise of the the BRICS - Brazil, Russia, India and China - is far from over, however.
It's difficult to appreciate how revolutionary O'Neil's prediction that emerging nations, and China in particular, would become powerhouses was when it was made.
He exposed a massive emerging market dynamic, one that dominated economic management in Australia as it played out.
With the benefit of hindsight, O'Neill and Goldman underestimated China's impact. China has consumed more steel in the past decade than it did in the previous 60 years, and its share of global iron ore consumption has risen from 20 per cent to 56 per cent. Its share of consumption of coal used for steel-making has risen from 20 per cent to 57 per cent in a decade, its consumption of nickel is up from 9 per cent to 41 per cent, and its consumption of other commodities shows similarly stellar increases.
O'Neill's BRIC hypothesis created two related and highly influential market mantras. The first was that the BRICs were seeding a resources "super cycle" as they expanded, and as supply-side bottlenecks developed. The second was that the super cycle would be super not just in price but also in duration: commodity prices would be "stronger for longer."
Analysis by Goldman at the end of April showed that the spoils fell unevenly after the boom took off in 2003, and will fall unevenly again as the super cycle moves into its next phase.
The iron ore price is 500 per cent higher than it was in 2003, supercharging the profits of the big three iron ore miners, BHP Billiton, Rio Tinto and Brazil's Vale. Over the same decade, the aluminium price rose by only 47 per cent however, as China expanded domestic production of the metal using captive power supplies.
Rio, therefore, robbed itself of some of the the momentum it was getting in iron ore by paying $US38 billion for the Alcan aluminium group in 2007. The world's biggest aluminium producer, Alcoa, has also struggled, and so have iron ore "have nots" including Anglo American. BHP's shares have risen 243 per cent in the past decade. Rio's shares have risen 129 per cent, Anglo's shares are up 28 per cent, and Alcoa's shares have fallen 69 per cent.
The interplay between costs and selling prices has also been crucial. Labour and materials prices soared as the miners rushed to expand production but they paid what it took to get new capacity online, and hoped prices would rise even faster.
It worked in the iron ore business: costs rose at a compound average growth rate (CAGR) of 15 per cent a year in the decade to 2012, and prices rose at a CAGR of 22 per cent. Copper was also a winner - costs rose at a CAGR of 11 per cent, and the copper price CAGR was 18 per cent. A less steep 6 per cent aluminium cost CAGR was outstripped by a price CAGR of 4 per cent over the decade, however, and the cost-to-price trade-off for coal and nickel was line-ball.
Goldman catalogues other effects of the super cycle that is now a decade old. The London share and debt markets have, for example, became the home of the super cycle as takeovers eliminated mid-size miners (including WMC, MIM, Normandy and Equinox Minerals here), and as the biggest new mining floats went to the London Stock Exchange. Seven of the top 20 miners including dual-listed BHP and Rio are London-listed, and while the LSE handled only 2.5 per cent of the new mining floats by number in the decade, they accounted for 40 per cent of total initial public offering value.
Long-term contract pricing was replaced by market-based current pricing for coal and then iron ore, and an underbelly of bulk commodity derivatives inevitably sprang up, adding to price volatility. Exchange-traded commodity funds emerged and attracted about $120 billion of investment money, creating a new source of commodity demand and price pressure.
Where to from here?
The S&P/ASX 200 materials sub-index that contains the miners is 46 per cent below its high in May 2008, 39 per cent below its post global crisis peak in April 2011 but still 32 per cent above its global crisis low in November 2008. Most importantly, it is still 98 per cent higher than it was.
"The cycle is not finished, it's just evolving," is how Goldman puts it.
The investment bank doesn't think newer emerging economies including India, Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, Philippines, Turkey, South Korea, and Vietnam can replace China's infrastructure boom for intensity. It does however there's enough demand coming through to keep the demand-supply equation tight, and the super cycle alive.
Mining will be harder to do in the next decade of the super cycle as environmental concerns grow and development approvals become more time-consuming.
It is going to be increasingly a game for heavyweights, too. The size of individual projects will continue to grow to lock in economies of scale, and the big groups with the funding lines will dominate. And as household consumption becomes a bigger part of China's economy and its steel-hungry infrastructure boom cools, iron ore and coking coal prices will be less hot, and consumer linked commodities including copper and potash (a raw material for fertiliser), will be hotter: BHP's copper mines and Canadian potash reserves leave it well placed.