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Mining stocks resemble ‘a big Walmart sale’ as low commodity prices persist

DOWNWARD TRAJECTORY The commodities price collapse has left many resource firms trading at all-time lows

Photo by Bloomberg

FRANK HOLMES The mining industry is on sale at the moment

ONLY DIRECTION IS UPWARDS The gold price has bottomed and, yes, it can go higher, says Doug Casey

Photo by Reuters

12th February 2016

By: Henry Lazenby

Creamer Media Deputy Editor: North America

  

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Sentiment remains negative about the mining and oil and gas industries as the supercycle nears a protracted potential bottom, resulting in dwindling market capitalisations for companies large and small and cruelly undervalued stock prices – creating a buyer’s market for the savvy investor.

CEO and chief investment officer at US Global Investors Frank Holmes, who specialises in natural resources and emerging markets investing, notes that the mining industry is on sale at the moment.

“The entire industry’s stocks are like a big Walmart sale. There’s a big sale happening right now, and it is the cheapest area of the equity markets by far,” he stated during the recent Cambridge House Resource Investment Conference in Vancouver.

Pan American Silver founder Ross Beaty agrees, saying this market is a phenomenal buying opportunity for oil and gas and mining stocks. “It’s a wonderful time to be in the market,” he says.

Market Collapse
The commodity price collapse of the past couple of years or so has left many resource firms trading at all-time lows, putting them in the territory of penny stocks.

Since the start of the year, majors such as Anglo American, Glencore and BHP Billiton have all seen volatile trade, losing more than 10%. Mining companies are pruning back their businesses to survive in an era of lower commodity prices.

Glencore and Anglo have abandoned their dividends and sold assets. Gold majors such as Barrick Gold and Goldcorp have been selling noncore assets in efforts to repair indebted balance sheets, after gold fell from record highs.

Moody’s Investor Services recently fingered China’s economic slowdown for its gloomy outlook for the natural resources industry, citing a “substantial risk” that oil prices will recover only slowly from 12-year lows of less than $30/bl and prompting it to recalibrate its commodity price outlook for 2016.

Moody’s previously warned of an impending “deeper and longer” downturn in 2016. Companies were already signalling distress, with the mining sector exiting a “very gloomy year” by deteriorating even further in January.

Reflecting an effort by the ratings agency to recalibrate mining portfolio ratings to align with the fundamental shift in the credit conditions of the global mining sector, Moody’s has placed 55 mining companies on review for downgrade.

The list includes Anglo American, BHP Billiton, South32, Rio Tinto, Vale, Alcoa, Barrick Gold, Newmont Mining, Gold Fields, Petra Diamonds, AngloGold Ashanti, Metalloinvest, Nord Gold and Alrosa.

As part of an ongoing assessment of mining companies, Moody’s sharply reduced its price sensitivity assumptions in December, after which credit conditions in the mining industry weakened further, with prices continuing to decline, resulting in many producers’ share prices tumbling to historic lows.

The slide highlights investor fears that companies will struggle to maintain dividend payments and refinance debt as revenues decline.

Moody’s has put the 2016 base price of gold at $1 100/oz, metallurgical coal at $80/t, thermal coal at $55/t, aluminium at $0.70/lb, copper at $2.15/lb, nickel at $3.80/lb, iron-ore at $40/t and zinc at $0.75/lb.

“China’s outsized influence on the commodi- ties market, coupled with the need for significant recalibration of supply to bring the industry back into balance, indicates that this is not a normal cyclical downturn but a fundamental shift that will place an unprecedented level of stress on mining companies,” said Moody’s.

However, with commodity prices plunging below the threshold that has allowed mining companies to limp along until now, distress sales are expected to drive increased mergers and acquisitions activities in 2016, as companies move to shed capital-draining noncore assets and raise cash in a troubled environment.

Companies have remained focused on reducing both capital and operating costs, conserving cash and resisting doing deals; however, the question for mining groups is how long they can limp on before a spate of distressed assets come up for sale.

Weaker global growth expectations, softening demand, the strength of the dollar and continued uncertainty surrounding metal demand in China have maintained pressure on commodity prices, especially base metals.

Masked Ball
The downturn has hit the mining exploration industry particularly hard.

“This is like a survivors’ ball. It reminds me of writer Edgar Allan Poe’s Masked Ball. The way structural things are going, we could all be dead in two years, or see the best results ever,” Kaiser Research Online head John Kaiser recently said in Vancouver.

According to him, fewer than half of TSX-V mining listings have positive working capital left, totalling only $1.6-billion.

One positive aspect of the downturn is that it is getting rid of so-called lifestyle companies with little or no working capital, with trivial or no work being accomplished on projects.

“[Because of these companies], the market has lost its ability to speculate on the positive outcomes of exploration,” he laments.

He explains that, among the cheap companies listed on the TSX-V, there is not much working capital in their treasuries and there is a lot of paper issued.

“The implication is that a very brutal rollback cycle lies ahead for the majority of TSX-V juniors, with the result that we will end up with a sea of shells lacking sufficient capital to pay for the overheads of maintaining their public listing. This is a structural problem for the industry whose only solution is a massive purge of this surplus of ineffectual companies,” Kaiser said.

The supercycle is dead for another five years at least, he adds. Copper is expected to decline further, driven down by macroeconomic pressures, such as China’s slower growth trajectory, and oversupply. However, security of supply remains a relevant aspect.

The low oil price is also a destabilising factor, setting up a “train wreck” globally, as economies tied closely to oil implode.

The biggest probability for a bump in nonprecious metals is from a geopolitical risk event, or an infrastructure failure (such as the electricity shortage in Zambia). China’s environmental awakening, to take a lot of the dirtiest production out, could also shift the supply balance for zinc and add to the price of gold, Kaiser said.

Holmes states that, with markets being 36 months down, it is going to be a tough first quarter for the majors. Covenants are in peril and bankers are in trouble as lenders cannot realistically expect to make money through collateral asset sales.

Happy Ending?
Holmes notes that China recently surpassed the US gross domestic product per capita growth, which is a critical indicator that the rise of the middle class will prove a boon for tourism and trade, as well as for luxury goods sales, such as diamond and gold jewellery.

“The world is at a tipping point as the expanding middle class embraces the ‘love trade’, where it becomes customary to buy luxury items as expressions of love,” he notes.

American venture capitalist Douglas Casey is bullish on gold. “I think that gold has bottomed and, yes, it can go higher – it absolutely can,” he stresses.

He foresees a big move out of paper currencies in the future, as governments printing billions have weakened trust in fiat currencies. He notes that the Chinese renminbi has been in a bull market against the US dollar in recent years, and few realise that the Chinese have been printing significantly more money than the US did during the height of its quantitative easing programmes.

However, the growing mountain of global debt could prove to ultimately be the straw that breaks the camel’s back and prompt a flight to capital safe havens, such as gold. Casey predicts a greater depression than the Great Depression of 1926 to 1946 coming.

Cyclical analyst Bo Polny, of course, agrees, and sees a “crash of the century” taking place on October 2. This would not be a stock market crash, but a significant geopolitical event that would spell the end of fiat currencies and send gold and silver prices to record highs – triple digits in the case of silver – before the year is out.

Edited by Martin Zhuwakinyu
Creamer Media Senior Deputy Editor

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