Prepare for a resources rush

The commodities outlook has brightened ... especially for three leading mineral resources.

Summary: Cashed-up offshore investors widening their hunt for higher returns are eyeing Australian resources stocks. The outlook for commodities has brightened considerably as global manufacturing picks up, with diamonds and base metals such as tin and zinc likely to move higher first. Supply and demand factors will dictate movements in other metals such as copper and iron ore.
Key take-out: If anything can be described as a certainty, it is that 2014 will be a better year for resources than 2013.
Key beneficiaries: General investors. Category: Commodities.

The hunt by cash-rich European and British investors for higher returns in a world of ultra-low interest rates is the key factor in a forecast recovery in the Australian resources sector next year. Moreover, it is clear as we race towards 2014 the three resource investments that are expected to lead a wider uplift are diamonds, tin and Zinc.

That was my most important conclusion after attending this week’s Mines and Money conference in London, an event which focuses more on financing the resources sector and less on the physical process of mining.

The difference between mining and mining finance is critical in understanding the point reached in the Australian resources sector. Most ASX-listed stocks have been heavily sold off because of the collapse in some commodity prices, and there are concerns it will be years before there is a recovery.

Hundreds of small mining stocks (mainly explorers) have simply run out of money, with limited access to fresh equity and no access to debt. This makes any change in financial markets critical to their survival, and London – as the world’s mining finance capital – is the place where a revival will start.

An important lesson about London’s mining-finance power was learned at the same event last year when it became obvious to me, from speaking with bankers and investment advisers, that money was being withdrawn from gold at an increasingly rapid rate.

That led to an important comment in a December 10, 2012, article “gold warning bells chime” that gold is in trouble – which became much clearer over the next 12-months as the price plunged from $US1,712 an ounce on the day that comment was published to its current $US1,238/oz.

Today, it’s money-flow in reverse. The drive is not so much about taking money out of gold (though that’s still a theme). It’s more about finding entry points into a resources sector getting ready for a rebound.

After this year’s immersion into the world of mining finance, it was clear that the case for gold remains weak because of the yield issue, and the steady recovery in the value of the US dollar.

The problem with gold is that it pays nothing in its physical form, and yields little by way of dividends from most gold-mining companies, which are struggling under the pressures of a falling price and rising costs. Gold also cannot compete with the prospect of higher interest rates as the US central bank moves to end its money printing and seeks to normalise the US economy.

The poor outlook for gold, which seems destined to fall further, perhaps even below the $US1,000 an ounce mark over the next 12 months, was a key take-away from this week’s conference, and the gloomiest. (See David Gilmour's article today, Gold in the cold).

Other observations were more optimistic, thanks to growing interest in resources as a recovery story after two years of decline. Key themes included:

  • The falling value of the Australian dollar has put ASX stocks back on the radar screens of international investors. When (not if) the dollar falls below US90c, the lure of a “double whammy” effect of immediate commodity and future currency benefits should combine to trigger a rush into Australian resources by foreign investors.
  • A wall of private equity funds, measured in tens of billions of dollars, has been marshalled in Europe and North America, for resource investment and must soon start to be deployed or risk annoying the owners of the cash.
  • Diamonds, tin and zinc are seen as the commodities most likely to move higher first and, in the case of diamonds, that trend can already be seen.
  • Copper, the bellwether commodity of the resources world (Dr Copper!) will be slower to move but could deliver a surprise as stockpiled material is quickly absorbed by rising levels of industrial production in major manufacturing economies such as China and the US.
  • Big resource companies, such as BHP Billiton and Rio Tinto, will suffer from an “embarrassment of cash” over the next few years as they maintain low capital-investment discipline and harvest huge inflows of revenue from existing projects.
  • The number of delegates at this year’s Mines and Money conference was up 10% on last year, another tell-tale sign of reviving interest in the heavily sold-off resources sector.
  • A reasonably convincing argument was mounted that the once heavily promoted resources super cycle has not ended, and will return as global recovery takes hold.

The man most convincing about the eventual return of the commodities super cycle was Vaughan Wickens, a senior executive in the mining and metals division of the South Africa-based Standard Bank.

He argues the case that the mining super-cycle is simply pausing before a recovery. His argument is based on population growth in emerging markets and increased levels or urbanisation. This is supported by recent economic data such as rising levels of manufacturing activity in China, where the purchasing manager’s index has risen consistently for the past six months.

“Rising demand for commodities is meeting inelastic supply,” Wickens said.

The mothballing of major potential mining projects, such as the expansion of BHP Billiton’s Olympic Dam mine in South Australia, is an example of the removal of the elasticity factor from the overall resources equation, with companies opting to reward shareholders with higher dividends than invest in additional mineral supply.

Tightening supply, which is yet to be seen in most resources, is an issue in a commodity once an Australian favourite, diamonds.

Lack of exploration success drove most companies out of the diamond sector, but that trend might soon be reversed thanks to rising demand for diamonds in China, coupled with falling supply, which is causing a strong rise in gem prices.

One company on the ASX tells the diamond revival story. Kimberley Diamonds (KDL) owns the Ellendale field discovered more than 30 years ago by Rio Tinto. Since early July its share price has more than doubled from 40c to 95c, even adding half-a-cent yesterday as the rest of the market fell.

A Swiss investor at Mines and Money, who declined to be named, said he had been buying Kimberley since earlier this year because of forecasts of declining diamond supply from major investment banks such as Citi, meeting rising diamond demand.

Tin is another commodity likely to be an early mover in next year’s resource sector recovery, with London money earmarked for investment in the commodity. Tin is enjoying a revival, thanks to its use as an environmentally acceptable replacement for lead in the solder used in electronic appliances. (See Getting in on tin).

Zinc, which has been mentioned several times recently, is another metal expected to enjoy the benefits of a supply/demand squeeze but precisely when, remains an unknown. (See Stirring in the zinc pot).

The wall of cash

The conference was not about tipping winners and losers in either the equities or commodities sectors. It was about emerging trends that will shape the mining market in the year ahead. Without doubt, that big event next year will be the breaking of the dam holding back a wall of private equity cash, which is yet to be applied in a major deal.

Most big investment banks, and a host of smaller fund management companies, have recently created specialist vehicles for emerging resource-sector investment opportunities. One of the best known is the $US1 billion X2 fund, headed by former Xstrata chief executive, Mick Davis, and co-founded by the commodities trader, Noble Group, and the private equity specialist, TPG.

During the conference one of the smaller London-based funds, Appian Natural Resources, acquired a bigger stake in the Canadian gold miner, Red Eagle Mining, in what was seen as a courageous counter-cyclical move.

Judging how much money is sitting on the sidelines waiting to move back into resources is a significant unknown, because no-one is collating numbers and bankers are inclined to boast about how much cash they have access to when they might not have much at all.

However, an Australian resource specialist and director of the investment bank, RFC Ambrian, Stephen Allen, said there was no doubt that money was being marshalled for the right projects when they became available.

“The cash is definitely there; it’s case of finding the right projects,” Allen said.

One Australian miner at the conference who has been an early beneficiary of the return of European interest in Australian resources is Mark Bennett, chief executive of the nickel-project developer, Sirius Resources. Sirius recently completed an $83 million capital rising, with 20% of the funds coming from London-based investors.

Nickel, however, is one of the metals seen as “least likely to succeed” in 2014, thanks to chronic over-supply which has flooded the market. Not even a forecast of double-digit production of stainless steel (the major use of nickel) can cope with the export of low-cost, unprocessed, ore from Indonesia to China.

Commodities prospects

For investors, the overriding impression from this year’s London conference is that most commodity markets have hit the bottom thanks to flat or declining supply and steadily rising demand as industrial production expands, especially in China and the US.

Not all commodities will move up at the same time, and some might move down.

Diamonds and tin are likely to lead the way up. Gold and iron ore could lead the way down. Copper and nickel are likely to be late upward movers, depending on the speed at which their stockpiles are absorbed.

However, if anything can be described as a certainty, it is that 2014 will be a better year for resources than 2013. This is why the private equity funds are piling up in London and, apart from that, 2014 couldn’t possibly be worse for resources.

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