The sluggish economic growth here and abroad has spawned three significant developments – falling commodity prices, looming deflation and near-universal currency devaluations against the dollar. With slowing to negative economic growth throughout the world, it’s no surprise that commodity prices have been falling since early 2011 (Chart 1). While demand growth for most commodities is muted, supply jumps as a result of a huge expansion of output for many products a decade ago. China was the focus of the commodity bubble that started in early 2002, soon after China joined the World Trade Organization at the end of 2001.
China, The Manufacturer
As manufacturing shifted from North America and Europe to China – with China now consuming more than 40% of annual global output of copper, tin, lead, zinc and other nonferrous metal while stockpiling increased quantities of iron ore, petroleum and other commodities – many thought a permanent commodity boom was here.
So much so that many commodity producers hyped their investments a decade ago to expand capacity that, in the case of minerals, often take five to 10 years to reach fruition. In classic commodity boom-bust fashion, these capacity expansions came on stream just as demand atrophied due to slowing growth in export-dependent China, driven by slow growth in developed country importers. Still, some miners maintain production because shutdowns and restarts are expensive, and debts incurred to expand still need to be serviced. Also, some mineral producers are increasing output since they believe their low costs will squeeze competitors out. Good luck, guys!
Copper, Our Favorite
Copper is our favorite industrial commodity because it's used in almost every manufactured product and because there are no cartels on the supply or demand side to offset basic economic forces. Also, copper is predominantly produced in developing economies that need the foreign exchange generated by copper exports to service their foreign debts. So the lower the price of copper, the more they must produce and export to get the same number of dollars to service their foreign debts. And the more they export, the more the downward pressure on copper prices, which forces them to produce and export even more in a self-reinforcing downward spiral in copper prices. Copper prices have dropped 48% since their February 2011 peak, and recently hit a six-year low as heavy inventories confront subdued demand (Chart 2).
Even in 2013, after two solid years of commodity price declines, major producers were in denial. That year, Glencore purchased Xtrata and Glencore CEO Ivan Glasenberg called it “a big play” on coal. “To really screw this up, the coal price has got to really tank,” he said at the time. Since then, it’s down 41%. But back in February 2012 when the merger was announced, coal was selling at around $100 per ton and Chinese coal demand was still robust.
Nevertheless, Chinese coal consumption fell in 2014 for the first time in 14 years and U.S. demand is down as power plants shift from coal to natural gas. Meanwhile, coal output is jumping in countries such as Australia, Colombia and Russia. China’s imports of coking coal used in steel production are down almost 50% from a year ago. Many coal miners lock in sales at fixed prices, but at current prices, over half of global coal is being mined at a loss. U.S. coal producers are also being hammered by environmentalists and natural gas producers who advocate renewable energy and natural gas vs. coal.
Losing Confidence?
Recently, major miners appear to be losing their confidence, or at least they seem to be facing reality. Anglo-American recently announced $4 billion in writedowns, largely on its Minas-Rio $8.8 billion iron ore project in Brazil, but also due to weakness in metallurgical coal prices. BHP took heavy writedowns on badly-timed investments in U.S. shale gas assets. Rio Tinto’s $38 billion acquisition of aluminum producer Alcan right at the market top in 2007 has become the poster boy for problems with big writeoffs due to weak aluminum prices and cost overruns.
Glencore intends to spin off its 24% stake in Lonmin, the world’s third largest platinum producer. Iron ore-focused Vale is considering a separate entity in its base metals division to “unlock value.” Meanwhile, BHP is setting up a separate company, South 32, to house losing businesses including coal mines and aluminum refiners. That will halve its assets and number of continents in which it operates, leaving it oriented to iron ore, copper and oil.
Goldman Sachs coal mines suffered from falling prices and labor problems in Colombia. It is selling all its coal mines at a loss and has also unloaded power plants as well as aluminum warehouses. The firm’s commodity business revenues dropped from $3.4 billion in 2009 to $1.5 billion in 2013. JP Morgan Chase last year sold its physical commodity assets, including warehouses. Morgan Stanley has sold its oil shipping and pipeline businesses and wants to unload its oil trading and storage operations.
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http://www.mauldineconomics.com/outsidethebox/commodity-weakness-persists
