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Chinese, US macroeconomic developments raise hopes for a more bullish mining sector

POWERED BY CHINA The global resource super cycle of 2003 to 2010 ushered in a modern age of decadence for many within the mining industry

Photo by Reuters

TAPERING TO QUANTITATIVE EASING While indicative of a growing economy, quantitative easing means gold is not needed anymore, which should send the yellow metal scurrying down

GOLD CUBES Chinese one-tael gold cubes, equal to 38 g of gold

Photo by Reuters

JOHN KAISER The American housing market is reviving, while the commodities-intense vehicle market has also performed relatively well

LI KEQIANG Greater urbanisation in Chinese towns and smaller cities will undoubtedly assist the Asian country’s growth

XI JINPING Played an important role in directing the new reform and development plan, widely known as The Decision

Photo by Bloomberg

KEY FACTORS The economic health of global giants China and the US will undoubtedly determine the fortune and direction of metals and minerals in the year ahead

Photo by Bloomberg

24th January 2014

By: Simon Rees

Creamer Media Correspondent

  

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Nothing is new under the sun. Consider this commentary from the second century BCE Huainanzi that describes the effects of an even more ancient Chinese resource super cycle: “When the age of decadence arrived, people cut rocks from the mountains, hacking out metals and jades. They extracted the pearls from oysters, and smelted copper and iron-ores.”

Powered by China, the global resource super cycle of 2003 to 2010 ushered in a modern age of decadence for many within the mining industry. Today, previous excesses continue to take their toll on company balance sheets, the situation compounded by the bear market’s continuing stranglehold.

But there are increasing glimmers of hope, particularly with Chinese and US macro developments. The economic health of these two global giants will undoubtedly determine the fortune and direction of metals and minerals in the year ahead. The bear market has also forced mining and exploration companies to become leaner and more competitive. For the juniors and midtiers, the avenues through which financing and investment is secured are also experiencing a sea change.

Meet the New Boss
The growth in China’s gross domestic product (GDP) has pulled back from the white-knuckle ride of the 2000s when double digits were the norm. GDP growth is within a 7% to 8% bracket, reflecting a maturing economy that China’s new leadership hopes will become increasingly market driven.

Both president and secretary-general of the Communist Party Xi Jinping and Premier Li Keqiang played an important role in directing the new reform and development plan that was unveiled on November 16, and is widely known as The Decision.

“The Decision details a lot of the reform measures,” Scotiabank VP economics and commodity market specialist Patricia Mohr tells Mining Weekly. “They aim to start rural land reform by providing a mechanism whereby farmers get some kind of compensation if they move away from their farmland to smaller towns and cities.”

Greater urbanisation in towns and smaller cities will undoubtedly assist Chinese growth. “That’s because urbanised regions allow people to be more efficient in their economic activity and undertakings. It also creates a much larger consumer base for goods and services that will, naturally, be important for commodities,” she says.

“The main industries now have more than enough manufacturing capability,” she adds. “So the Chinese also want to shift their economy towards one that is increasingly driven by consumer spending and development of the service sector.”

In addition, the leadership wants to increase the role of the private sector within the wider economy. “They want to reform the State-owned enterprise system to encour- age more private investment in what are currently State-controlled sectors,” Mohr says. “However, there are a lot of vested interests in these things, so it will take a lot of political jockeying in order to implement the leadership’s objectives.”

Fiscal reform and easing the municipal debt burden will also be important. “Back in 2008, Beijing announced an enormous fiscal spending programme to lift the Chinese economy out of the global slowdown. A lot of infrastructure was then put in place by munici- pal governments and, as a consequence, they took on a lot of debt at that time,” she says.

“Therefore, fiscal reform is intended to get municipal finances into better shape. One of the things [the leadership] will allow is to grant municipal governments the ability to issue debt, traditional debt. Up until this point they’ve been using a lot of shadow banking instruments to finance their activities,” she explains.

At a wider level, the Chinese uptake of commodities remains solid. “I’m not expecting any retrenchment. In 2013, actual demand by China for most key base metals, particularly copper, was quite robust. Indeed, demand for copper in tonnes will be up about 9% for 2013. Iron-ore demand was also quite good, as was aluminium,” Mohr says.

“A lot of the moderation in metal prices that occurred this year related not so much to any slowdown in Chinese demand but to new mine supply coming on stream around the world,” she adds.

QE or Not to QE

By contrast, the US’s economy continues to make bumpy headway. Robust employment news in November was followed by disappointing December figures, with just 74 000 jobs created. More positively, the US trade deficit contracted in November to its lowest level in four years, with exports assisted by growth in oil sales.

The American housing market is also reviving, including new construction work, while the commodities-intense vehicle market has also performed relatively well. “Car sales have been picking up, although primarily because people have put off buying a new car for long enough,” head of Kaiser Research John Kaiser tells Mining Weekly.

On December 18, the US Federal Reserve announced that it will begin to reduce its bond purchases to $75-billion a month, down from $85-billion a month. This “tapering” to the quantitative easing (QE) programme starts effective January and, although the decision came as a surprise to some, the level of reduction was generally seen as fairly conservative.

Gold has had a bumpy ride since the decision was made: the London pm fix was $1 225.50/oz on December 18, falling to $1 195.25/oz two days later. It has since rebounded, standing at $1 248/oz on January 13.

“[Tapering to QE] means the economy is growing. [Traditionally,] it means you don’t really need gold anymore, which should send gold scurrying down. For example, Goldman Sachs keeps hammering the point that it’s a no-brainer that gold is going down,” Kaiser says.
Gold bulls might contend that the potential impact of tapering has already been factored into prices following the yellow metal’s slide throughout 2013 and the supports for gold have certainly held firm since the announcement. But gold bears would argue that the effects have yet to be fully felt and that the pace of tapering will accelerate during 2014.

Not as widely debated is gold’s longer-term dynamic, which is linked to the developing world’s desire to substantially increase its holdings of the yellow metal, according to Kaiser.

“Take a longer-term view and realise who’s buying the gold: it’s mainly going to countries like China and other emerging market economies, [and driven by] their central banks,” he says. “People need to realise that global prosperity is going to drive demand for gold and push it to higher real prices. It’s not about the pending collapse of fiat currencies or anything like that.”

“Also consider America’s share of global GDP and you can see it is declining. In the long run, and relatively speaking, the US economy will become smaller. The US dollar as the world’s reserve currency will also come into question,” he added. “We’re looking at 10 to 15 years of considerable turbulence, with recognition of this starting in the next couple of years. That’s when interest in gold as a kind of transitional asset class will step up.”

Rick’s New Rules
For the medium term, the blows inflicted on mining companies by the current bear market are still being tallied and more damage is likely to come. “We’ll be in a bear market for two more years,” chairperson of Sprott US Holdings Rick Rule tells Mining Weekly.

“The excesses of the 2003 to 2010 bull market were so epic that we need time to wring them out of the system and not merely in a financial sense but also in the sense that people’s attitudes need to change,” he says.

“The issuers came to believe that the capital-raising conditions that existed between 2003 and 2010 were normal when, in fact, they were optimal,” he continued. “The best management teams now understand that the market capitalisation enjoyed five or six years beforehand is a thing of the past. They’ve also realised that they need to raise capital on reasonable terms to advance their projects and not to just hunker down and merely try and survive.

“The sort of gloom and doom you see at investment conferences is due to the fact that traditional sources of capital for the industry – the generalist mutual funds, the retail punters, the capital aggregators of the last cycle – are dead,” he adds. “What people don’t recognise are the new sources of capital that are more disciplined than the last sources of capital. That will ultimately be good for the business.”

Private equity represents one of these new avenues of potential capital injection. “[Private equity is] interested in buying an interest directly into the properties of juniors. And that will be an excellent discipline for the juniors because, in order to get paid, their management teams will have to perform and not just attempt to perform,” he says.

“The top thing on my wish list for 2014 is broad market capitulation. I want to see that final spasmodic capitulation we saw twice in 1999 and 2000, where the junior equity markets go ‘no bid’ and where issuers finally get a dose of reality and admit they need to solve their company financing problems over the next two or two-and-a-half years,” he adds. “I want to see that cathartic purge.”

Edited by Martin Zhuwakinyu
Creamer Media Senior Deputy Editor

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