Rio Tinto Group

Minerals boom under cloud as market romance begins to cool

PUBLISHED : Friday, 17 February, 2006, 12:00am
UPDATED : Friday, 17 February, 2006, 12:00am

Bumper profits from Australian mining giants BHP Billiton and Rio Tinto this month have proved last year was the best yet for the country's resources sector. But there are some conflicting views on whether the good news will continue to flow for investors this year.

The Australian Bureau of Agricultural and Resource Economics says the country's mineral exports tallied more than A$25 billion ($143.22 billion) last year, and the figure reflected on BHP Billiton's Australian record interim net profit of US$4.36 billion announced this week and Rio Tinto's earlier US$4.95 billion full-year result.

The two companies' performances have been credited with triggering a succession of new highs for the Australian share market, with the main benchmark gaining 18 per cent last year.

Not only are shareholders in both companies grinning over the share price gains, they are also delighted at their higher dividends and buy-backs - A$4 billion from BHP and A$5.3 billion from Rio by the end of next year. BHP has soared 130 per cent and Rio 185 per cent over the past three years.

'I think it is pretty clear we are not seeing a slowdown in China in terms of commodity demand' was the bullish assessment of BHP's normally reserved chief executive, Chip Goodyear, this week.

Most analysts are confident that demand from China - the main driver of the boom - will continue to deliver good results for both firms this year, but whether their share prices will reflect that is another matter. Questions are being asked whether now is the time for some profit taking on the miners.

Part of last year's boom came from merger and acquisition activity, such as the A$9 billion takeover of WMC by BHP. However, high valuations and a lack of new acquisition targets could mean that activity will slow this year.

Investors are also shunning a new wave of resource industry floats, with several recent flops at the junior end of the market despite the record prices.

The Federal Treasury has already warned that the commodities boom was unlikely to last because strong global mining investment would increase the supply of key commodities, pushing prices down as much as 18 per cent.

About A$30 billion has been invested in the Australian mining industry over the past three years as companies have attempted to boost output to meet demand and take advantage of record prices for commodities such as coal, iron ore and copper.

The increasing affluence of China's middle class also reflects on the growing interest in Australian diamond deposits, which have been known for years but uneconomical to mine. In December last year, Rio approved a A$1 billion underground expansion of its Argyle mine in Western Australia.

Ramping up production brings inherent risk. The new infrastructure investment will boost output capability, which will then be more sensitive to demand fluctuations.

'As more productive capacity comes into operation around the world, commodity prices will slow or fall back somewhat,' the treasury report says.

It says China and India's industrialisation is no guarantee mineral prices will keep rising. The treasury has begun a study on how a commodity slowdown will affect economic growth, government revenue and the exchange rate.

'The minerals boom will not last forever and we cannot factor in these sorts of prices forever,' Federal treasurer Peter Costello said.

While most analysts are bullish on Chinese demand, David Thurtell, a commodities strategist at CommSec, agrees that the supply and demand balance will change for most commodities this year.

'There is a view out there that a lot of these metals have gone too far and too fast,' Mr Thurtell says.

'I think that [this year] will see the supply and demand balance change for most commodities and I think that prices may have a bit more of a downside risk than they have had. The main metal I think which will continue to be in chronic undersupply is zinc.'

He cites recent volatility in the resources sector as a sign of nervousness among investors. Profit taking on resources stocks has seen the All Ordinaries Index dip about 2 per cent this month. Even so, one metal is seen as a hedge against a falling market - gold. Over the past month, gold prices have risen about 25 per cent, hitting a high of just under US$580 an ounce.

Does this reflect fears of a bear market and inflation, or is it part of the ongoing romance with commodities? Fund managers' answers diverge but the market's performance this year should settle that question.