Commodities Still Face Iron Laws of Supply and Demand
Investors should watch miners’ 2016 results carefully to see whether firms take the bait of higher prices and let capital expenditures drift up again
By Nathaniel Taplin
Mining executives are a sober lot these days. “Capital discipline” has replaced “commodity supercycle” as the industry catchphrase.
Things are looking somewhat brighter recently, however. Chinese metals demand has staged a limited, but real, rebound, and U.S. President-elect Donald Trump is touting an infrastructure-investment plan. Share prices of the big five diversified miners are all up over 100% from lows hit in January. Given the improved demand environment, investors could wonder whether mining-company capital expenditures have come down enough to produce another sustained period of rising prices for industrial metals.
Unfortunately, the answer is probably not yet, although a global infrastructure push led by Mr. Trump’s America could move the needle if it were large enough.
Mining capital expenditures have fallen rapidly since its peak in 2012, but the slowdown in Chinese construction, the main driver of demand, has been more drastic. Even after this year’s real-estate bounce, floor space under construction in 2016 is on track to be about 2.69 billion square feet higher than last year. That is below annual gains running at about 3.23 billion square feet in the middle part of the last decade.
Meanwhile, despite falling by over half since 2012, aggregate capital expenditures by the top five global miners— BHP Billiton, Rio Tinto, Vale, Anglo American and Glencore—remained more than 50% higher in 2015 than in 2006. This year has seen bigger cuts. Most of the big miners have cut a further 40% from capital-expenditure budgets.
The Chinese uptick in real-estate demand has helped close the gap. The issue is the real-estate bounce is likely temporary, driven by buyers rushing to take advantage of cheap mortgages. Fundamental Chinese demand for housing probably peaked at about 18.8 billion square feet earlier in the decade and is now set for a slow decline, according to Gavekal Dragonomics analyst Rosealea Yao.
Real-estate investment, which lagged behind housing-price gains for most of 2016, has recently shown signs of perking up. That means metals demand may have room to run in the short term. Iron-ore prices have been on a tear in recent weeks, with prices up nearly 30% since September despite giving up some postelection gains.
But absent a new demand driver on the scale of China, which sucks up half of copper and iron ore world-wide, mining investment still looks high. A large enough Trump infrastructure push could make a difference. A Republican-designed stimulus, however, may favor tax cuts rather than direct investment. And $1 trillion over 10 years, which is Mr. Trump’s official plan, is less impressive than it sounds. Chinese infrastructure investment in 2015 alone was nearly $2 trillion, and it is increasing at about $300 billion a year.
Investors should watch miners’ 2016 results to see whether firms take the bait of higher prices and let capital expenditures drift up again, a dangerous move with margins still squeezed and interest rates rising. Unless Mr. Trump’s infrastructure plan proves far more robust than it looks, the iron laws of supply and demand look set to reassert themselves before too long.