Miners can't stop digging themselves into a rout: Goldman Sachs
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Goldman Sachs says miners are poor at self-regulating supply. Ryan Stuart
by Stephen Cauchi
The commodities rout is set to continue, says a new report from Goldman Sachs, because the mining industry is unable to stop itself from digging.
The paper, The best way to get out of a hole is to stop digging, said oversupply and a failure to close mines had worsened the bear market.
Miners were "poor at self-regulating supply", the report said.
It stated that miners were more likely to sell mines to each other than close them.
As a result, an "elongated bear market looks likely" for commodities, including iron ore, copper and coal.
However, in the short-term, most commodities are off their lows.
Despite a considerable fall in global commodity prices, supply-side volumes had been slow to respond, Goldman Sachs said.
Only coal was among the major minerals showing an absolute reduction in volumes over the past three years.
This was not a new phenomenon, the report said.
During four of the five past commodity price downturns – the 1979 oil crisis being the exception – supply volumes went up despite lower prices.
Oversupply issues would drive prices lower in the "medium term".
"We reiterate our bearish view on the mining sector," Goldman Sachs said.
Instead of closing mines, miners were undertaking alternate strategies to shore up balance sheets, including asset sales, equity raisings, and reduction in capital expenditure and dividends.
Miners were reluctant to close mines or reduce supply because they were worried about the effect on revenue, Goldman Sachs said.
"The easiest way to reduce costs is to increase productivity of the asset base, lifting volumes, spreading fixed costs over more volume and, thus, reducing unit costs," the paper said.
"However, this strategy is one which is, ultimately, self-defeating as it exacerbates oversupply and prolongs the commodity price downturn.
"In the current bear commodity market, it has only been the coal sector that has seen absolute shuts."
The commodity rout had left debt as a percentage of sector enterprise value at 27 per cent; "the highest it's been this century".
"Many companies are approaching what we view as financial distress levels."
China had some of the biggest debt issues, the paper said, as 75 per cent of the distressed debt was in the listed Chinese mining companies.
China would probably increase the mine closure rate in 2016, but this would not be enough to bring commodity markets back into balance, Goldman said.
Many miners were selling non-core assets to help with debt issues, Goldman said.
"Divesting the assets on to another set of owners may shore up the seller's balance sheet in the short run, but it does not address the oversupply in the market.
"Until a balance is struck between selling and closing assets, we are unlikely to see equilibrium return to the supply/demand equation for many commodities and challenging conditions are likely to continue."
Commodity prices would continue to be punished by weakening commodity currencies such as Australia's, coupled with low oil prices and deflationary cost pressures, the paper said.
Coal, iron ore and copper prices would fall "substantially" from here, the paper said.
Rio Tinto was given a "sell" as falling iron ore and aluminium prices placed pressure on cash flow and valuation, while Fortescue would suffer from lower iron ore prices compressing margins and cash flow.
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