The commodity run of the past two years has paid off in spades for SA: the rand has remained improbably strong, while SA’s fiscus has benefited from an overall revenue overrun of almost R300bn. .
It’s a windfall that has allowed the authorities to loosen monetary policy and raise government spending, allowing SA to recover faster from the pandemic than many thought possible.
But analysts are skittish, pointing to the fact that prices had risen so high, a fall seemed inevitable. Over the past year, for example, platinum has fallen 21%, palladium has fallen 24.3% and iron ore 24%. And while gold has actually risen 5% — peaking above $2,000/oz at one point — it has dipped 3.3% over the past month.
This has fed into SA’s mining giants: Anglo American is down 9% over the past month, Amplats is down 12.4%, Sibanye-Stillwater is down 6.8% and Impala is down 5.5% (and 23% over a year).
The slump is not universal, mind — Thungela has rocketed 296% over the past six months as coal prices went through the roof — but it has stoked fears that the party may be over.
Is now the time for investors, who’ve ridden the commodity cycle to its peak, to cut and run?
“Whether it’s the top of the cycle or not, I’m not sure,” says Old Mutual strategist Izak Odendaal. “I don’t think anybody knows. But I think there are concerns that the next couple of months will see a slowdown in growth and, with that, demand for commodities.”
But Odendaal says you need to look at the recent weakness in context.
“A lot of these [commodity] companies have had terrific runs behind them, and their share price fall needs to be seen in the context of overall global equity market volatility,” he says. “Clearly, mining companies are always at the extreme end of a wobble in equity markets.”
John Biccard, value investor and portfolio manager at asset manager Ninety One, says investors should all be a bit concerned.
“All those metals are very high, [interest] rates everywhere are going up pretty quickly, and that is just not good for a commodity cycle. In a world that is so leveraged, if US rates go up 3% there’s a good chance that something breaks,” he says.
Reserve Bank crossing its fingers ...
When the party does end, however, it’ll be bad news for SA’s fiscus.
For the year to March, the government reaped the windfall of company taxes that were 49% better than the budget estimate. They provided the biggest slice of the extra R198bn in revenue collected in taxes, which came on top of a R100bn overrun the year before.
This improvement played a central role in stabilising the rand following its sharp depreciation
— Arthur Kamp
This was vital, allowing the government to sweeten its public sector wage offer and head off a labour impasse. And it gave the Treasury scope to extend the R350 social relief of distress grant — the Covid grant — for unemployed adults.
To get a clearer picture of just how much could be wiped off the table, consider mineral sales and tax revenues. Mineral sales in current prices increased from R552bn in 2019 to R851bn in 2021, raising the gross operating surplus of SA’s mining sector — a proxy for profits — by 25.6% in 2020 and a further 47.7% in 2021.
Sectors with strong ties to mining — think transport and machinery manufacturers, for example — also benefited. As the value of exports of commodities surged, SA’s current account balance swung from a deficit of 2.6% of GDP in 2019 to a surplus of 3.7% last year.
“Undoubtedly, this improvement played a central role in stabilising the rand following its sharp depreciation [in 2020],” Sanlam Investments economist Arthur Kamp tells the FM. “In turn, this helped dampen inflation pressure, allowing the Reserve Bank to maintain an accommodative monetary policy stance.”
In other words, were commodity prices to fall sharply, the rand would come under pressure again, and many of these gains could be lost. At worst, SA could face a recession and new credit ratings downgrades as it would battle to meet its ambitious debt stabilisation targets.
“Any sharp depreciation of the rand would be an unwelcome development, increasing the risk of the Reserve Bank front-loading interest rate hikes,” says Kamp. As a result, he says, “growth forecasts would likely be revised lower with a significant probability of a growth recession”.
Which — in a country with unemployment of 35.3% (or with an expanded unemployment rate of 46%) and parlous low growth — is the last thing anyone needs.
So much for the ‘green transition’?
Of course, a lot would depend on the extent of any decline in growth. A fall to pre-pandemic levels would be problematic — but for now, that seems unlikely.
Last week, the World Bank released its April Commodity Markets Report, which said energy prices are expected to rise more than 50% this year due to sanctions against Russia, before moderating in 2023-2024. Metal prices, too, are expected to increase as much as 20% in 2022 before easing. And even then, the organisation expects commodity prices to remain “well above the most recent five-year average”.
Which isn’t to be sneezed at, if you consider that the JSE’s resources index shifted from about 32,000 points in May 2017 to 77,000 five years on.
War and disease may not sound like the best conditions for capitalism to thrive, but they do appear to have been positive forces for the commodities market of late, as they cranked up the minerals supply deficit.
In part, this is because of the push for “decarbonisation”, and the move to renewable power. It’s hard to overestimate the scale of investment or volume of minerals required for the world to meet its climate-change obligations.
Erik Heimlich, head of base metals supply at mining research house CRU, for example, reckons the world needs to put $100bn into mining capacity if it is to close an estimated annual supply deficit of 4.7Mt by 2030.
And you can add that to fears of supply tailing off.
“Many of the projects currently developed have been in the making for almost three decades,” a recent Bank of America report warns, “and with exploration activity relatively limited in recent years, supply increases may fade from 2025.”
The green transition, the World Bank says, may end up on the back burner due to falling supply, high fuel costs and increasing metals prices.
The picture, in other words, is a “little confusing”, says Old Mutual Investment Group portfolio manager Ian Woodley.
Woodley says the world was heading for a commodity slowdown at the start of the year, with China’s economy slowing down and interest rates expected to rise — but then Russia invaded Ukraine, and all predictions were upended.
“You’ve seen it in some commodity prices: iron ore is probably higher than what people were anticipating, coal most definitely is, gas is ... and that has given us a little bit of an extra leg to the commodity cycle,” says Woodley.
But if there’s a lesson to be taken from last week’s drop, it’s that investors taking a long-term view of commodities have to be aware of increased volatility.
In fact, of 10 mining companies covered by banking group Goldman Sachs, including JSE bellwethers Anglo American and BHP, seven have posted significant declines in first-quarter mineral output. And, for about 10 days from mid-April, Anglo American led share price declines in its peer group, falling an average 12% in value, according to Goldman Sachs.
A blip, or top of the cycle?
For Ninety One’s Biccard, any view on commodities at present — and any reading of the recent downturn — needs to be mindful of three factors.
First, he points to “an incredibly weak global stock market” due to fears of inflation and rising interest rates. “When the market starts going down, people sell their winners,” he says.
But this doesn’t mean the broader drive for commodities has disappeared. Rather, if the market drops 15%, shares that have gone up three or four times “will take a smack”, he says — even if there’s nothing fundamentally wrong with them.
The second concern relates to rising interest rates. While the prices of iron ore, copper and coal have all come down a bit, they’re still very high.
As Odendaal points out: “Ironically, we’re talking about commodity prices falling, but the elevated prices are a drag on growth everywhere.” He’s concerned that the US Federal Reserve and other central banks will sacrifice further growth in their determination to deal with inflation.
Finally: the China factor. The lockdown in China has raised concerns about its growth, and even the possibility of recession. China is vital to the mining sector because it consumes roughly 60% of total metal production — such as copper and zinc.
Ironically, we’re talking about commodity prices falling, but the elevated prices are a drag on growth everywhere
— Izak Odendaal
“These lockdowns may continue for quite a long time,” says Biccard. “There’s no doubt that’s going to do damage to the Chinese economy, and the Chinese economy is still the dominant driver of commodities.”
He cautions that commodities could be headed for the top of the cycle. While shares that trade on a low p:e are usually cheap, the reverse is true of mining stocks, he says. “They’re trading on very low ratings ... that is usually what happens at the top of the commodities cycle.”
At the same time, he adds, “when a share goes up 10 times, it doesn’t matter what the story is, you just sell it. Because if there’s a little worry somewhere — and somewhere down the line there always is — before you know it, the share is down 40%.”
Of course, if there’s a genuine commodities supercycle — and stock prices go up for 10 years, not just three — Biccard says this rule of thumb might not hold.
The truth about commodities stocks is that their prices are hostage to the global price of the metals. “They might not collapse but the share is not going up if the metals are going down,” Biccard says.
Still, some people are still positive this is just a blip.
Says Goldman Sachs analyst Heydar Mamedov: “I might be on a more bullish side, as I believe that China’s lockdowns [and] steel production decline [are] rather temporary factors and China’s reopening will inevitably follow. The current situation is just deferring demand, if anything.”
Perhaps the risk most carefully watched by investors is inflation. Sanctions on Russia have only put a greater squeeze on supply chains — which had already been disrupted by Covid — and pushed global prices higher.
This was evident last year, when a shortage of electronic components led to a fall in vehicle production, which stunted sales of platinum group metals (PGMs) to the car market.
And some of the cost predictions are brutal. Goldman Sachs, for example, expects the price of inputs such as labour, electricity, fuel and consumables to rocket more than 35% for 2022. On a net cash cost basis, it pegs the increase for this year at 15%.
Rising energy prices are the most significant factor. Oil prices were already high before Russia invaded Ukraine; the sanctions have only raised fears of energy security — sparking a giddying rally in coal prices.
“We think higher energy costs place downside risks on growth and persistent supply chain disruptions put upward pressure on inflation,” HSBC says in a recent report. As a result, the bank has lowered its global GDP growth expectation to 3.5% this year, from a previous forecast of 4.1%, and reduced its 2023 outlook to 2.9% from 3.2%.
As Odendaal notes, “everything we’ve seen still points to mining companies being reluctant to spend and invest in extra capacity ... So supply remains constrained — especially in a world where Russia, presumably, is going to be more or less locked out of the global market for some time.”
The silver lining
So if the picture for commodities stocks isn’t as bleak as the cynics think, is the recent weakness perhaps even a chance to buy more?
That’s the view of some experts. “We view this as a buying opportunity ... as we think that yields and valuations remain compelling,” says Goldman Sachs. In particular, it rates Glencore, Anglo American and Rio Tinto a “buy”.
Gold, especially, seems to have some support. White-hot inflation and geopolitical distress are positive buy signals for the metal. The countervailing force, though, is a more hawkish approach to interest rates, especially at the Fed.
Colin Hamilton, an analyst for Canadian bank BMO Capital Markets, says gold prices should stay high for now, but this should moderate as the year wears on. Pent-up demand for jewellery is expected to have been released by year-end, especially in India, a key buyer of the physical product.
Hamilton also highlights the pressures on gold producers to tackle rising costs. “Inflation is flowing through to labour, consumables, freight, diesel, power and royalties,” he says.
So what of platinum?
Woodley says Old Mutual was lightening up on its exposure to platinum companies before the Russian invasion.
“We thought that with interest rates going up, car sales, which were supposed to bounce, would probably be a little under pressure. At the beginning of the year, people were looking at car sales and they were talking mid to high 80-million [units] this year, now it’s closer to 80-million,” he says.
But there is a shortage of cars globally, so Woodley reckons when the supply chain gets sorted out, you might see car production edge up closer to 90-million cars, which could support platinum companies.
Last week, Impala Platinum (Implats) CEO Nico Muller spoke of how “escalating geopolitical conflict, rampant inflation, constrained supply chains and a tight labour market” have compounded the production squeeze first imposed by Covid.
It’s a snapshot of some of the stresses facing the mining sector — a series of challenges that saw Implats post a 3% decline in quarterly volumes, pretty much in line with its competitors.
Coal flies through the roof
But the real action in the commodities market is in coal.
The sector, unloved in recent years as the world pushed for decarbonisation, stormed back after the EU instituted sanctions on imports of Russian coal, which normally meets 45% of the region’s needs.
“The impact of the acceleration of this ban is being reinforced by customer self-sanctioning,” Investec analysts said in a report last month. The analysts cited the example of Japanese trader Idemitsu Kosan, which rejected coal from Russia in favour of Australia due to the uncertainty in payment and possible logistical constraints. “In the light of the EU ban, we expect to see further reports of self-sanctioning outside of the European market,” the bank said.
The result is that the SA export price for coal has risen 74% this year alone, and 224% over the past 12 months.
This is why the price of the JSE-listed Thungela Resources has burst through the roof, and is now up 800% since it split out from Anglo American in July. Had you put R1m into Thungela shares on January 1, it would now be worth R3.2m, just five months later.
Exxaro, whose core business is coal, has risen 44% this year.
And, it seems, there is more to come. Investec has now doubled its forecast for thermal coal exported from Richards Bay to an average of $241/t — an improvement that extends into 2023, when the bank thinks SA thermal coal exports will average $200/t.
Wherever that gas is getting diverted from, those guys will probably have to use coal. I think energy really is probably the safest place to be
— Ian Woodley
As Old Mutual’s Woodley says, the EU has already said it won’t import Russian coal in three months’ time, “and you’re already hearing stories of tankers refusing Russian oil”. The upshot, he believes, is that Europe will get gas elsewhere, and “pay up for that”.
“And wherever that gas is getting diverted from, those guys will probably have to use coal. I think energy really is probably the safest place to be.”
These sky-high prices of coal aren’t sustainable in the long term, he says — but in the short to medium term, they could well be.
Old Mutual, as a result, is hanging onto its energy stocks, particularly Thungela, Exxaro and Glencore.
For the Swiss-headquartered Glencore, coal and zinc (another hot commodity) are expected to account for about three-quarters of earnings before interest, tax, depreciation and amortisation in the six months ended June.
“A one- to two-year period of elevated coal prices could make Glencore one of the leading shareholder return companies in the market,” says Deutsche Bank.
Its analysts have calculated that Glencore could even make a total two-year return of more than 50%, given its target price and cash return assumptions.
This isn’t a minority opinion either. Morgan Stanley analysts say a prolonged period of higher coal prices would allow Glencore to generate significant cash “and potentially deliver outsized capital returns to shareholders”.
There are, of course, other factors influencing the global market.
The troubles at Transnet Freight Rail in respect of meeting customer offtake obligations are well documented in SA. But perhaps less appreciated is that these snafus can occur everywhere. A temporary export ban on Indonesian thermal coal in January, and continued restrictions in Colombian coal production, have also contributed to shortages.
Coal, in other words, isn’t cooling down any time soon. Nor are some other commodities, however heated they may seem already.
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