Resource giants at the crossroads

The resource giants may be cheap, but many question whethe they are value propositions.

The pall of gloom that has hung over heavyweight miners for the past two years cleared briefly last week as the resource giants led stocks higher.

But the immediate future is filled with uncertainty and conflicting signals about the future for steel making ingredients.

At the moment, there is furious disagreement between investment bank analysts, many of whom are predicting big falls in raw material prices, and mining industry executives about the short to medium term outlook for the industry.

For months, there have been serious concerns about the impact of a massive increase in iron ore supply from recent production expansions, just as demand is waning.

China’s economy, the main driver of raw materials prices, is showing signs of a rapid slowdown.

Trade figures released midweek for both imports and exports went into sharp reverse, the International Monetary Fund lowered estimates to a still optimistic 7.8%, while China’s finance minister Lou Jiwei forecast growth this year for as low as 7%.

Despite clear indications of waning demand for raw materials, iron ore prices have moved higher in the past fortnight, settling well above $US122 a tonne following an easing in the recent credit squeeze that saw interbank rates soar in China.

Chinese steel mills have been running down inventories for months, which industry insiders argue will help offset the seasonal slowdown in September that last year saw iron prices in a dramatic plunge to $US80 a tonne.

The improved prices also could have been boosted on the supply side as unseasonal wet weather in the Pilbara region of Western Australia caused a shortfall in shipments during the June quarter, normally a more benign quarter from point of view of weather.

BHP, Rio Tinto and Fortescue will deliver their quarterly production reports this week, which should provide some clues as to how much the supply shortfalls have boosted prices. 

On that front, there have been suggestions Rio Tinto’s $5.4 billion Western Australian expansion plans – that would boost output by 70 million tonnes a year – is in a deliberate go slow (see Tim Treadgold's Re-examining Rio).

If correct, that could seriously impact the pricing dynamics for iron for at least three years, preventing any serious price meltdown.

Given both BHP and Rio are in a desperate cost-cutting phase, offloading assets and delaying previously announced expansions, such a strategy would not be out of the question. Any hints about capital expenditure cutbacks will be be lapped up by the market.

With its diversified portfolio BHP is less vulnerable than Rio, which earns the vast bulk of its revenue from iron ore.

Australian iron ore suppliers are facing a serious challenge from Brazilian producer Vale, which has seen its competitive position strengthened by a plummeting currency. In recent weeks it has used that advantage to threaten high-cost producers, such as Fortescue.

But it has a long way to go. Australia exports 60% more iron to China than in 2009. During the same period, Brazilian shipments have slipped.

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