Glencore’s idling of zinc production a sign commodities rout could be bottoming out
Last week’s decision by commodities giant Glencore to idle half a million tonnes of global zinc production, rather than sell into what it considers an undervalued market, may paradoxically signal a four-year-long commodities rout is finally close to bottoming out.
Glencore’s action is the latest production halt by a major mining firm in recent months as the industry grapples to reverse a more than 50 per cent price fall in key metals since 2011, when a surge of new mining capacity came on market just as developed economies entered a wrenching downturn.
“The lower investment will eventually reduce capacity, and lower production should eventually lead to a rebound in metal prices. The more prolonged the slump in metal prices, the sharper the likely eventual reversal,” economists at the International Monetary Fund wrote in a report published this month.
Annual capital investment by the 10 largest metals companies climbed from US$20 billion in 2006 to reach a peak of around US$55 billion in 2012, IMF data shows. It’s since fallen around 18 per cent to US$45 billion last year.
The IMF expects metal prices to decline 22 per cent this year and 9 per cent in 2016, before levelling off.
Mark Tinker, head of Framlington Equities Asia, sees value in certain mining stocks.
“If we look around now at a stock like Rio [Tinto] … we see that it is currently on a forward price-to-earnings ratio of 12.8 and a yield of 7.4 per cent, having fallen 25 per cent this year,” Tinker said in a research note .
“If, as we did in 2003 and again in 2009, we view these cyclical equities like bonds trading at a large discount to par and are happy to collect the yield while not having to mark to market the equity price, then we are getting paid handsomely to wait.”
Glencore’s announcement that it would shutter roughly 4 per cent of global zinc production sent the firm’s Hong Kong-listed shares up 7.44 per cent on Friday to HK$15.30, while the price of London-traded three-month zinc contracts hit a one-month high.
Last month, the firm said it would curb annual copper output at two African mines by 400,000 tonnes. Australia-based Fortescue and US-based Freeport-McMoRan also announced mining output cuts in recent months.
Copper prices will rise 30 per cent by the end next year, Caroline Bain, senior commodities economist at research firm Capital Economics, wrote in a research note. She cites data from the International Copper Study Group that forecasts a copper deficit of 130,000 tonnes next year, versus an earlier estimated surplus of 228,000 tonnes, as the result of recent mine mothballing.
The market was also too bearish on Chinese demand, now a primary driver of commodity prices, Bain wrote.
“Given that demand indicators in China are holding up … we expect pick-up in activity, in response to policy stimulus, as we move into next year,” she said.
A positive outlook for metals assumes global demand picks up next year, an outcome that is by no means guaranteed.
Adding a note of caution, Fitch Ratings predicts demand for key metals from India and China will gradually lessen between now and 2020 as economic growth slows. The ratings agency forecasts China’s gross domestic product growth will fall from 6.8 per cent this year to 5.5 per cent in 2017. The ratings agency worries China has an overcapacity of new homes and so homebuilding, a big user of metals, will stall.
More mines will need to close and the industry become leaner before prices – and company stocks – rebound, Fitch analysts said.