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The commodities cycle has not yet bottomed out

Michael Rawlinson

Michael Rawlinson, Global Co-Head Mining & Metals at Barclays, looks at market sentiment ahead of the 2015 Mining Indaba in Cape Town

While the sharp drop in global oil prices has reduced costs for mining companies, it has also added to uncertainty in the market and may prolong the wait for the commodity cycle to turn upwards again.

Gold is likely to benefit most in 2015, from higher margins but also because of gold’s role as a safe haven in times of political and market uncertainty.

At last year’s Mining Indaba there was a bit more optimism that the commodity cycle had bottomed. Since then however, there have been two big events - the drop in iron ore prices and the sudden collapse of the oil price.

No one thought the oil price would halve, and it happened within two months. It was incredibly sudden, a high beta event for which no one has a good explanation. This makes people more risk averse, and the mood in boardrooms is a lot less aggressive. M&A thoughts are being put on hold.

Last year there was also the expectation that private equity groups would start buying, signalling an upturn in the market. This may well happen this year, as funds available for investment have grown and private equity groups have a greater appetite for risk than the major mining groups.

Nor can we expect Chinese investors to come to the rescue in 2015. They have lost a lot of money in recent acquisitions, such as in DRC and Guinea. In fact, there have not been many happy stories about Chinese investment in mining. The Chinese government’s crackdown on corruption is also likely to increase investor caution.

Nevertheless, we are getting to the bottom of the cycle, though it’s not the same for all commodities. For some, such as iron ore and thermal coal, it will take a while before they start rising. Copper has come off a bit but is looking positive and platinum is likely to turn this year.

But it is gold where there is most cause for optimism in 2015.

Gold is the anti-dollar. The dollar has been in the ascendancy, and that is not great for gold. But because it’s a safe haven commodity, the run on the euro has helped gold. As such, gold is coming back into favour and will probably appreciate in terms of the euro and the yen.

Producers of gold are probably looking at higher margins because of the lower cost of fuel oil. Things are looking better for gold, and we think we will see some hedge funds coming back into gold this year. The market is factoring in the prospect of slower economic growth rates in China after years of very rapid growth.

Chinese demand for commodities is still growing, but at a slower rate. Now people are getting used to the idea of China growing at 7% and have adjusted their modelling to more reasonable margins. Commodities prices are affected most by changes in supply, rather than demand which has been remarkably consistent for years. This year will be no different - there is not going to be a huge change in global demand for commodities. It will be any changes in supply that make the markets move.

After previous rises in commodity prices, there have been long periods of low prices, such as now.

The market is worrying about a deflation cycle. We can see that in iron ore and some other commodities. The market will wait for the lack of money going into new mines to tighten up supply again and lead to price rises. These are some of the issues that will frame debates at the 2015 Mining Indaba - concern over when the commodities cycle will turn, investment prospects and what this means for the supply of various commodities and, as always at the Indaba, the future of gold.

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2015: A Year for Restructuring in the Mining Industry

Paul Knight

Paul Knight, Toronto-based Global Co-Head of the Mining & Metals at Barclays, says low prices and high debt are going to force consolidation in the gold and coal sectors in 2015

This year is likely to be marked by M&A and restructuring as well as very selective equity raising in parts of the global mining industry. That’s particularly true in the gold and coal sectors, where some companies took on too much debt for expansion in optimistic times will have to sell assets or raise equity in order to survive continuing lower prices.

The challenge affects both thermal and coking coal companies - and in the US may well see some companies being restructured. In the gold sector, the issue is global and some companies are going to have to sell assets or raise equity. There are gold companies that tried to grow on the back of high gold prices but because of generally declining production and too much debt they cannot generate free cash flow at current gold prices. There is considerable pressure to reduce gearing and focus on tier 1 assets, but this is easier said than done. These are the hard questions being asked in boardrooms around the world.

The markets are also making sharp distinctions between those companies with strong management teams and track records, tier 1 assets and prudent debt levels, and the rest. The former may seek to take advantage of this moment to optimise their asset portfolio.

The situation is fundamentally better in some base metals such as copper, nickel and zinc. The middle and long-term fundamentals are good, and there is a real scarcity of actionable tier 1 assets so M&A activity is likely there as well.

Another tough year ahead, but Mining Indaba presents opportunity for industry, government and labour to collaborate on solutions

Miyelani Maluleke

Miyelani Maluleke, macro analyst at Barclays Africa looks at the prospects for the South African mining industry in 2015

Though the South African mining is facing another challenging year, an opportunity exists for mining companies, labour and government to help the industry get through the difficult times ahead. The industry is the cornerstone of the South African economy and in addition to directly employing more than 400 000 people, mining has strong linkages with other sectors in the economy. We continue to believe, as stated in our 2013 report “South Africa’s troubled mining sector” that the South African mining industry certainly faces difficulties which if not addressed will continue to negatively affect the sector’s growth performance and its ability to create jobs.

Last year was particularly challenging with total industry output contracting by an estimated 2.4% and we don’t expect much improvement for the industry in 2015. One of the major challenges for this year is going to be the softer commodity price environment. Since the start of last year, coal prices have fallen by 27%, iron ore prices are down 54% and platinum prices are 8% lower. China, the main market for South Africa’s exports of iron ore and to a lesser extent coal, is expected to see slower growth this year so we could see prices of those commodities come under some more pressure. Another important downside risk to the sector’s growth outlook, are the persistent and seemingly intensifying electricity shortages. All of this, combined with labour productivity failing to match wage increases adds up to a less than optimistic outlook for the year ahead.

However, there are also a number of factors on the positive side. Labour stability has improved since last year’s five-month strike in the platinum industry and the South African government has shown greater interest in resolving disputes and restoring stability in the mining industry, which is encouraging. We do not expect another year of labour confrontation, particularly after last year saw a few multi-year wage deals in a number of key mining areas. Nonetheless, this is always an ever present risk and the gold sector wage negotiations later in the year are worth watching. The wage deal in gold mining is due to expire in the second half of this year.

On the issue of mechanisation, we see this as unavoidable for gold and platinum mining, which are the two areas that are generally more labour intensive. However, this is not purely a reaction to the recent strikes and high wage demands. Labour instability is only one factor.There’s also the safety factor as mines get deeper and the risks of sending people underground increase. So mechanisation will be a structural change for South Africa’s traditionally labour-intensive mines.

The government’s decision to refer the contentious Mineral and Petroleum Resources Development Act (MRPDA) Amendment Bill back to parliament is a positive signal, in our view. There was widespread criticism from gas and oil industry representatives about some of the provisions, including an automatic free carried interest in gas and oil projects, amongst others. The rejection of the Bill, which was supported by mineral resources Minister Ramatlhodi opens up an opportunity for the government to engage the industry again and also to split oil and gas regulation from the regulation of the rest of the industry. The Chamber of Mines has called for urgent finalisation of the legislation in order to eliminate the policy uncertainty and restore investor confidence.

Commodity price cycles are also important for mining investment. While it’s hard to forecast when the commodity price cycle will turn again, mining investment will be driven by more than just commodity prices. Countries are competing for investors’ money, and the regulatory environment and policy certainly play a big role in that. So it is very important for South Africa to try to draw investors in by making the regulatory environment more competitive.

Another important way in which the government could help the mining sector is on the issue of beneficiation. Instead of the present broad emphasis on beneficiation, the government should engage with industry to identify South Africa’s competitive strengths and focus on the opportunities for viable beneficiation.

But we reiterate our point that we don’t see the SA mining industry as a sunset industry, as long standing challenges for the sector and the commodity price cycle could not be any less helpful right now. However, many of the problems in the mining industry are domestic. We need strong leadership from mining companies, labour unions, and government to get cooperative, innovative solutions to the many challenges facing the industry.

Mining insights from the Mining Indaba 2015

Gain valuable insights into economic and mining developments from leading experts around the African mining landscape. Listen to Alec Hogg as he interviews mining executives and other guests at this year’s Mining Indaba and gives us his view on the discussions.

A front row seat to the Mining Indaba 2015

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