Key Points

• Pessimism calls very strong again
• US markets recently made new highs
• Asian equity markets breaking out upwards
• Shanghai stock market up 17% since July
• Chinese steel production running above 810mtpa
• Activity in the smaller caps continues to improve
• Sharp falls in commodities now overdone?
• Could be an important low developing and creating value

The past few weeks has provided a salutary lesson in the volatility in the market place and early calls for the market upturn in all things resources.  The fundamentals of economic growth still look very good and recent market gains for many small cap resources appeared quite constructive.  Stock markets around the world are still signalling much better days ahead.

But pessimism is again strong globally and the short term trading trends continue to spook these thin markets where traditional investors are still holding onto defensive positions and lots of cash.

A surging US$ has recorded a 7% rise in the USDX since mid July and sent the world looking for deflation/catastrophe havens again due to ISIS and also the tensions in the Ukraine. And whatever else.

Most commodities came off more than the rise in the US$ and the continuing chants of Down with China and China Down reached another crescendo despite the Shanghai stock market surging 17% since July and the PMI remaining a good 51.1!

The iron ore price and the A$ sank together.

So is it all over now for resources?

Let’s just review the evidence and consider with the graphics from the last Dawes Points.

First

• The world’s largest securities market, US T Bonds, peaked in July 2012, over two years ago. Higher bond yields are now surely coming because the deflation is over and the US economy is expanding. Cash levels are still high.

• China’s economy continues to grow at >7%pa with crude steel production likely to be up >6.5% in 2014 with 8mth YTD figures up 7.6% and iron ore imports at new records approaching 1,000mtpa and up >16% YTD.

• China steel industry data also show a 35% increase in steel exports. The rise in port iron ore inventories gets a lot of attention (note these may have peaked and are now falling) but inventories of iron ore and finished product at steel mills are very low indeed

• Many commodities have fallen 15-20% since July in a market that reeks of hedge fund forced selling.  Some much more. Interestingly, Sugar has experienced a sharp fall but it has reversed and is now heading higher.  Is it a leader?

• The current high volatility into lows for in the US equity markets could be suggesting a trend change – to up!

• Gold in US$ is still doing OK but during this time of dollar strength we have gold prices in most currencies breaking 3 year downtrends and turning up.  Encouraging but there is very bearish sentiment.

• Most metals have low or declining inventories and several like tin, zinc and nickel have medium term structural deficits that MUST result in squeezes. Many other metals are just tight.

• The A$ in most of 2014 had been consolidating after its last selloffs in 2013 and then in January.  This last pullback of 7% matches the US$ rise and very interestingly is just back to the support on the 100 year downtrend line of A$ vs US$.

• So many markets have broken the 2011 downtrends with good rallies only to fall back to support on these important downtrends.

My travels in the past few months have taken me to site visits in some exotic locations but also Singapore and just now Melbourne for IMARC.

I delivered a paper at IMARC on an outlook for the A$ with key conclusions being

• Resources exports having risen from A$50bn in 2014 to almost A$200bn in 2014 will get another big kick from the new LNG plants that will increase this to A$280bn or more by 2020.

• The LNG exports will stimulate a major surge in activity in onshore oil and gas.

• The A$ looks very good on the cross rates against Yen, Pound and Euro.

IMARC also brought out the extraordinary productivity gains in mining technologies such as Orica’s amazing new blasting techniques that can separate overburden from ore and also cleverly use chemical energy to fracture rock to smaller pieces rather than using slower and more expensive mechanical energy.

RIO, too,  is well on the way to higher productivity in iron ore mining with driverless blast drilling, driverless excavators, driverless truck and of course driverless trains.

The productivity benefits are only now being felt but you can be assured that the blow out in costs is being rapidly wound back and that Australian mining companies will again be very competitive.

All these market actions seem to me to be suggesting a short term panic that has just about run its course and is leaving outstanding value on the table.

Barry Dawes

Head of Resources

BSc F AusIMM(CP) MSAA MSEG

Follow me on Twitter @DawesPointsBarry Dawes’ expertise in the Australian resources sector is based on his knowledge as a geologist combined with over 30 years’ experience in the resources investment sector. Prior to founding Boutique Investment Firm “Martin Place Securities” in 2000, Barry had worked in senior executive roles of investment management with BT Australia, equities research for Bain Deutsche Bank and equities research and corporate finance for Macquarie Bank. He is currently a Director of a number of unlisted public operating companies. Barry has a substantial depth of knowledge and experience in the international resources industry and is well known for his views on the sector.