Advance Australia Fair

tincans6

Generali wrote: »

The most Australian way to answer your questions would be to remind you that if my Aunt had balls she'd be my Uncle.



As for the iron ore price? Well that's seen as a proxy for the Aussie economy as a whole. Mining is, from memory, under 10% of the Aussie economy and iron ore mining is less than 20% of that (happy to be corrected). Also whilst falling investment in mining will reduce GDP, a lot of the stuff bought as a result of that investment will have been made abroad.

The part that pessimists, and indeed optimists like our Chief economist at my work, are missing is that the past few years of investment will produce decades of output and employment. Employees and shareholders gaining from profits will use that money to buy stuff in Woolies and Coles.

I reckon, as does the bloke that sits opposite me who runs AUD65,000,000,000 of money, that BHP and Rio Tinto are great buys at the moment. The investment boom is over which is fantastic for anyone that owns their shares as they'll be throwing off billions and billions of dollars every year.

If the iron ore price falls from USD135 to USD40/tonne while the AUD also falls in value then the impact will be lessened. That's the great thing about floating interest rates: as the terms of trade change your FX rate changes to cushion things.

A year on and the iron ore price almost halved (less than $70) with JPM forecasting $67 for next year and $65 the year after.

http://www.bloomberg.com/news/2014-12-09/jpmorgan-cuts-iron-ore-outlook-as-growth-in-supply-beats-demand.html

I'd say they are being way to optimistic and that it will be below $50 in a years time and it will be at least a decade possibly 20 years before we see the peak price exceeded. Capacity continuing to rise and even when the smaller players in Australia go pop as surely they will, one of the big 2 will take over their mines and continue to dig.

Mining, once the investment stops, doesn't produce lots of employment in fact WA has seen recent job losses as miners look to slash costs. I'd be guessing the days of fly in / fly out fitters earning $7k a week are numbered.

BHP & Rio ain't doing to well either - down 20-25% in a year, and I wouldn't be rushing to buy them despite the juicy dividend.
In fact they look like 'value traps' to me, and who could be surprised to see them cut their dividend say from 2016.

Housing bubble to go pop next ?

And if that does happen, it will take the banks down too.

Generali

tincans6 wrote: »

A year on and the iron ore price almost halved (less than $70) with JPM forecasting $67 for next year and $65 the year after.

http://www.bloomberg.com/news/2014-12-09/jpmorgan-cuts-iron-ore-outlook-as-growth-in-supply-beats-demand.html

I'd say they are being way to optimistic and that it will be below $50 in a years time and it will be at least a decade possibly 20 years before we see the peak price exceeded. Capacity continuing to rise and even when the smaller players in Australia go pop as surely they will, one of the big 2 will take over their mines and continue to dig.

Mining, once the investment stops, doesn't produce lots of employment in fact WA has seen recent job losses as miners look to slash costs. I'd be guessing the days of fly in / fly out fitters earning $7k a week are numbered.

BHP & Rio ain't doing to well either - down 20-25% in a year, and I wouldn't be rushing to buy them despite the juicy dividend.
In fact they look like 'value traps' to me, and who could be surprised to see them cut their dividend say from 2016.

Housing bubble to go pop next ?

And if that does happen, it will take the banks down too.

You seem very certain of all that and it's interesting that you predict a different iron ore price and one which is a long way below consensus. Would you care to share with us the methodology you use to get there?

If the price of iron ore falls then GDP as a number falls but as production in Australia is generally pretty efficient and also reliable (would you rather run an iron ore mine in Brazil, India, Russia, Ukraine, the next largest producers down the list, or Australia?). I think we're then into a discussion about how useful GDP and how well mining wages at the average reflect the productivity of mining workers.

My opinion on BHP and RIO are that they are both cracking buys for income: now they're not investing into marginal production they can divert earnings from CAPEX into dividends. BHP were paying ~5% fully franked last time I looked. Due to the vagaries of the Aussie taxation system that's a pretty tasty sum net of taxes.

Housing bubble? That's a more interesting area. Houses are undoubtedly expensive in Australia and only an idiot would argue otherwise.

However, the mining boom has only had an impact in a limited way in most places outside of WA. CBA et al would be in all sorts of trouble if there was a house price crash across Australia. However, there is no reason to think that house prices will fall in Sydney and Melbourne because WA miners are losing their jobs.

I see no reason to change my earlier views except for to say that I no longer sit opposite that man and he now runs quite a lot more money. We did have a chat in the lift today though. Nice guy although a Leeds Utd fan.

tincans6

Generali wrote: »

You seem very certain of all that and it's interesting that you predict a different iron ore price and one which is a long way below consensus. Would you care to share with us the methodology you use to get there?

.

It's more just a gut feel.

Huge amounts of capacity have been added and is still to come on stream including West Africa.
Much rubbish ore from China & India will be knocked out of the market as its lower grade and needs sintering, but high grade ore from Brazil & Africa won't be knocked out.

Marginal players in Australia will go bust, but their problem is too much debt and cost of access to port where BHP & RIO control the railways. BHP & RTZ will take over their mines and keep them running as they are in the same area (Pilbarra).

There used to be huge mounds of scrap iron / steel at UK ports awaiting shipment to China. China will be increasingly generating their own scrap adding even more to the over capacity. Its not trivial - the estimate was that 14% of steel came from scrap in 2012 - it will be closer to 20% next year. Using scrap is cheaper and more energy efficient.

I find it impossible to believe that China will need as much steel for infrastructure in the next decade as the past decade, and unless India replicates the China experience (unlikely) that demand won't come from anywhere else. Obviously they should be making more consumer good (fridges & washing machines) but not enough to replace infrastructure steel.

BHP & Rio costs are something like $40-45 (including royalties and shipping) per Tonne. Cash costs excluding capex are closer to $20.

The bigger players have demonstrated that they want to counter falling prices by increasing output & they will continue to do so & can afford to do so. They could survive with a price of $25 per tonne - but obviously that won't allow them to develop new mines or shell out to shareholders.

There have been commodity cycles in everything from agriculture, oil & mining, to shipping and electronics for ever (obviously the Phoenicians weren't watching on flat screen TV's) - and there always will be. The Iron market isn't a finely balanced one like oil, were small lost capacity can spike the price upwards. The over capacity I think will last for a decade.

Most of all - the analysts have been dismally slow to update their price forecasts - and they always are in a falling market.

tincans6

Generali wrote: »

You seem very certain of all that and it's interesting that you predict a different iron ore price and one which is a long way below consensus. Would you care to share with us the methodology you use to get there?

.

Not so far below the consensus now.

$55 and falling.

Even Fortescue and Vale can land ore in China at a tad over $40.

As they are the 3rd and 4th biggest players in the world, what does that tell you about where the price is heading ?

It won't even take to the end of the year to slide below $50.

Price won't hit $100 for a decade - colossal overcapacity with no prospect of demand increasing. China already has an overcapacity of everything from housing to manufacturing to airports.

Generali

tincans6 wrote: »

Not so far below the consensus now.

$55 and falling.

Even Fortescue and Vale can land ore in China at a tad over $40.

As they are the 3rd and 4th biggest players in the world, what does that tell you about where the price is heading ?

It won't even take to the end of the year to slide below $50.

Price won't hit $100 for a decade - colossal overcapacity with no prospect of demand increasing. China already has an overcapacity of everything from housing to manufacturing to airports.

Just a couple of points:

1. As the iron ore price has fallen, output and sales have soared, up 24% last year.
2. You're measuring the USD price of iron ore (not unreasonably). There is a secondary effect caused by the value of the AUD. As the AUD declines, the AUD value of iron ore sales increases.

To show the power of part 2, Australia missed a large chunk of the runup in gold prices as the dollar rose along with the gold price, negating a lot of the rise.

tincans6

well that didn't take long did it. Below $50 before the Easter Bunny arrives.

Next stop $40 which may take a little longer.

The miracle is that BHP and Rio's shares are holding up (to some extent).

My bet will be that all that US $ debt they have will start to weigh heavy on their shares. Good shares for yield or big value trap ?

I'd say the latter.

Heard it so many times - 'once all this capital spend is out the way, we will be making billions' - Never works like that.

tincans6

Still just over $50 but did hit $44.

Next to no chance of it being over $50 from 2016 - 2018

Even the 3rd tier players like Fortescue are claiming cash costs of $18

What does this mean ?

I reckon BHP (certainly) and Rio will be cutting their dividends. If you look at the yield on these it spells huge value trap.

BHP don't currently generate enough cash to cover their dividend - it will be even worse when Iron ore price is in the $30 's

HappyMJ

tincans6 wrote: »

Still just over $50 but did hit $44.

Next to no chance of it being over $50 from 2016 - 2018

Even the 3rd tier players like Fortescue are claiming cash costs of $18

What does this mean ?

I reckon BHP (certainly) and Rio will be cutting their dividends. If you look at the yield on these it spells huge value trap.

BHP don't currently generate enough cash to cover their dividend - it will be even worse when Iron ore price is in the $30 's

Isn't $18 the cost of extracting the ore from the ground. Excluding all other costs. It'll be cheaper just to close the mine rather than run a loss if prices keep falling.

Thrugelmir

HappyMJ wrote: »

Isn't $18 the cost of extracting the ore from the ground. Excluding all other costs. It'll be cheaper just to close the mine rather than run a loss if prices keep falling.

Cutting the wage bill is one way of reducing costs.

Generali

tincans6 wrote: »

Still just over $50 but did hit $44.

Next to no chance of it being over $50 from 2016 - 2018

Even the 3rd tier players like Fortescue are claiming cash costs of $18

What does this mean ?

I reckon BHP (certainly) and Rio will be cutting their dividends. If you look at the yield on these it spells huge value trap.

Agree with you up to here. They can't really cut CAPEX any further and the market will see through continued borrowing to pay dividends soon enough.

There is one thing you might be missing: BHP and RIO have both been heavily sold to small investors by brokers who are pretty keen to maintain the dividend narrative: there is a massive tax advantage in Aus to getting dividends from companies like BHP and RIO as they come 'fully franked'. This 'franking', which comes from the fact that BHP and RIO have paid tax in Aus, reduces your taxable income which is great for retirees wanting an income in a country which doesn't have a tradition of annuities.

tincans6 wrote: »

BHP don't currently generate enough cash to cover their dividend - it will be even worse when Iron ore price is in the $30 's

You do devalue your own argument when you say with absolute certainty that the iron ore price will be in the $30s. You also still fail to account for the currency effect in Aus: the AUD is pretty much tracking the iron ore price down and that makes Aussie iron ore exports all the more attractive. That doesn't make BHP a good investment but it does mitigate the impact of lower iron ore prices in Australia.