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Captain, we have a problem
Brenton Saunders
Posted: Wed, 20 Aug 2008
[miningmx.com] -- FOR the time being the party’s over. The beer has run out and the mid-cycle slow down manifested itself like a New Year’s Day hangover… as painful as it is unavoidable.
Resource stocks are feeling the pressure and resource stock managers (current company included) are taking the strain. Should we be surprised? With the benefit of hindsight, of course not, all the signs were there: exponential commodity prices, record stock markets and an all round mining nirvana. Unfortunately it’s never that easy.
But, let’s not lose sight, there are two very different things going on here. Firstly, the explosion of the credit bubble and the collateral damage that is having, and has had, on the property markets around the developed world, the global banking industry and the health of the western consumer need to be seen in context. But not before we look back, if only to reflect
on some hard learnt lessons.
In April 2007 one of my most learned friends sat me down and explained to me that “debt is the new equity”. This was in an attempt to explain to me how investment banks and private equity consortia were able to significantly outbid him in his attempts to buy assets for a well intentioned, value seeking black economic empowerment firm.
It was here that I realised
that either the financial market equivalent of Generation X had rendered me redundant in my inability to understand the web of woven debt instruments, or something was not right.
As it turns out these instruments are not too dissimilar to instruments that went “Fizz Pop” in the sub-prime crisis and were all that were being created to take advantage of anomalously low credit spreads to buy assets for prices that could never represent value.
Despite several hundred billion dollars in write downs and several bankruptcies, it unfortunately seems that, if at all, the fat lady is only getting warmed up here.
If the financial press is to be believed write down to date are in the order of $475 bn versus an estimate of $1tr……yes, one trillion dollars.
The ability of the world’s largest central banks to counter the unveiling of this financial dark force threatening to dump the western world into a mind numbing recession is debatable.
Helicopter
Ben has been hard at work and bless his soul – without his best efforts to sure up the financial system I suspect the current to and froing about a potential global recession would not longer be a point of debate, but rather a point of fact.
With the Fed largely out of ammunition we will be looking to the reserve banks of the EU, Australia, Canada and others to come to the party. On past form this is an unsympathetic source of monetary stimulus especially in the face of high and rising inflation – we can only hope. The reality is that dataflow in the EU is softening quicker than even the staunchest inflation hawk would like to contemplate.
The flipside of this coin is what is going on in physical commodity markets.
Not to suggest for a second that the two issues are unrelated, of course they are not, but I’d have to say markets seem to have forgotten about the drivers of commodity markets that got us all so hot under the collar from 2002 to 2007. The
industrialisation of the emerging world and more specifically China.
All is not lost here.
The Chinese economy has grown at close to 10% per annum for the past three decades. Currently economists are debating whether that falls to either 9.0% or 9.5% in 2009 from it’s more recently +10% levels.
Clearly this comes at a bad time and is not unrelated to western market woes, but is hardly a significant change from trend growth.
Consider this. The process underway in China is expected to take 500-600 million people over the next 10 years and move them into cities – the single biggest mass migration in the history of mankind – that’s equivalent in population terms to a mid-to large-sized European country every year for the next 10.
This means that in 10 years the urbanised consumer base in China is expected to be bigger than the US, European and Russian consumers combined. China’s incremental annual GDP growth is equivalent to the entire
economy of a mid-sized Western European country’s economy (every year).
China remains responsible for more than 60% of the marginal demand for most industrial metals like steel, copper, iron-ore, cement, zinc and aluminium. China’s aspirant population are experiencing real growth in income which are increasing their per capita consumption of many basic materials from current levels toward developed market norms, still in some cases an order of magnitude higher than current levels.
In the shorter term, China’s ability to weather a storm over the Atlantic appears good. Given that the processes driving economic activity in China is largely driven by internal activities, it’s much less so a function of how well other major consumer markets are doing. It’s not over.
What’s going on in China and many other industrialising economies is unlikely to be de-railed short of a socio-political catastrophe. This continues to be evidenced in non-terminally traded
commodity markets like coal. I saw recently a report that one of the metallurgical coal companies had done a deal at $400/ton – that’s four fold the number 18 months ago and a third higher than settlements earlier this year!
If that’s the case, we should not be scared to go back into the water, the fundamental outlook for commodity markets and especially equity valuations of most of the best resource companies in the world are nothing short of mouth-watering.
Timing will be an issue. The reality is that currently (and likely going forward) equity market rating/sentiment is driven by the well being of the western consumer/investor.
He’s likely to be nursing his not insubstantial credit market hangover for sometime, definitely months possibly years. Every sustained market recovery in the last three decades has been led by a bottoming and early stage recovery in the property markets. Property markets are still declining, some have just started to
decline.
Take solace from the fact that the changes in the global commodity consumption drivers we have seen in the last seven years are here to stay, which will continue to make for good business in Basic Materials industries.
When the market chooses to reflect this is difficult to determine, but for the time being this resources fund manager has got a headache to nurse and some value stocks to buy. Buying real value takes a lot of the agonising out of market timing and makes for easier sleeping. Sweet dreams.
*****
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