Plenty of trouble and strife for commodity stocks but opportunities are just around the corner…

The commodity sector seems to have been beset by nothing but a long list troubles of late, not helped by plunging commodity prices. It seems that management of many of the major commodity plays has gotten complacement about prices after the meltdown of 2008. Belief in the commodity “super-cycle” is still alive and well after the seemingly insatiable demand by China to fuel its economic growth. With the super bets on mega projects, so came the super size salaries of many of the CEO’s. Now they are giving up their bonuses, but for the last few years mega million packages for the likes of Mick Davis from Xstrata have become the norm. He took home over £5 million in 2011 and is due to get £29 million if the merger with Glencore goes through!

Continuing operational issues in SA

There were rumours this weekend that Lonmin, the world’s third largest platinum miner, is looking to potentially get a $1 billion rights issueaway after the serious violence that has erupted at its South African Marikana mine, near Rustenburg, north of Johannesburg.  The dispute has forced the mine complex closure since August 10^th and has also made a serious dent in Lonmins cash flow to boot. Last week South African police shot dead 34 protestors at the mine and there are fears that without a cash injection, Lonmin will breach its banking convenants – its debts totaled $356m at the half year results stage in March. Marikina accounts for 90% of Lonmin’s outputs and employs 24,000 people. Lonmin itself is 25% owned by Xstrata, as a result of its failed takeover attempt in 2008.

Lonmin produced around 2,000 ounces of platinum a day, or 60,000 ounces a month until the disruption and global output in 2011 was 6.5 million ounces. The stock moved down 15% to 639p last week and is 47% lower on a YTD basis. 

In February this year, clashes during a strike at the world’s largest platinum miner, Impala Platinum Holdings at its Rustebnberg site in SA between between Association of Mineworkers and Construction Union (AMCU) and the National Union of Mineworkers lead to four deaths and a six-week closure.

Aquarius Platinum, the world’s fourth largest producer and FTSE 250 member, recently mothballed its Marikana and Everest mines. In early August it reported that a ‘very serious security incident’ occurred at a production unit at Kroondal, near to Rustenburg leaving three dead and at least 20 injured after around 200 ex-workers some of whom were armed, forced their way into the mine. The workers were dismissed following illegal strike action in June. Aquarius Platinum dropped only 1% last week to 38p but is down 86% in the last 12 months.

Platinum prices have dropped shareply recently as the car industry has reduced demand and overall sits on large stock piles. Similarly, costs have increased sharply in recent years as energy prices and labour costs have risen. The other primary major buyer of platinum are the jewellery purchasers but, as the global economy has stagnated, so has demand. Of the 26 major South African platinum mines, eleven are operating at a loss with a further four marginal at best.  For example, at Aquarius, weighted average on-mine unit cash costs in South Africa increased by 39% in Rand terms in the year to June from the year before. New car registrations dropped 7.4% in European Union countries in the first half of 2012 which means less demand for the platinum used in catalytic converters. Europe accounted for about a quarter of demand in 2011.

Platinum rose 5.5%  to $1,472 however last week on the disruption issues – its biggest weekly gain since late February 2012 to $1,472. The gap between platinum and gold has narrowed to $150 compared with a record difference of $230 set at the beginning of last week. The current “platinum-gold ratio,” has recently fallen to the lowest level since 1985. 

Given that 80% of the world’s platinum reserves are in South Africa with an estimated $2 trillion of worth, the labour issues so acute in SA are a worrying trend for the indsutry. With $1.3 billion of short positions in platinum, any reversal in prices will be swift when it occurs, but some bears are calling a bottom in the current down trend to around $1000 an ounce.  The uptick last week may be a sign that the hedge funds are starting to close their positions, and one to monitor for sure.

Mick Davis, Xstrata CEO

On to another major event in the commodity space, the merger of mining group Xstrata and commodity trader Glencore. Qatar Holdings is now Xstrata’s second biggest shareholder with a 12% or $5 billion stake and it is looking increasingly likely that they will block the deal given that they are demanding 3.25 Glencore shares rather than the 2.8 shares currently on the table.  With Xstrata’s core earnings under serious pressure in recent months, it is unlikely that Glencore’s Ivan Glasenberg will budge too much. It will be interesting to see how this plays out…

BHP Billiton, another FTSE 100, mining and energy company has also had a tough time of late, not being immune to the collapse in gas prices in the US as a result in the glut of shale gas. In early August, the world’s biggest miner, took a $2.84 billion writedown on the value of the U.S. Fayetteville shale gas assets it bought in 2011 from Chesapeke and Petrohawk for $17 billion and a further $450 million writedown for Australian nickel assets.

Rio Tinto took an $8.9 billion charge on its aluminium business on Thursday, reducing the book value of the company’s Alcan unit, purchased for $38 billion at the peak of the commodities boom in 2007 before the 2008/09 financial crash. This caused net results for the July-December 2011 period of $1.76 billion following a profit of $8.4 billion the previous year.

Finally on to Anglo American and the troubles of its Chief Executive Cynthia Carroll. In July, Anglo announced that first-half earnings had fallen 46pc to $3.7bn (£2.4bn). The shares of the £17 billion, FTSE 100 company, are down 22% in the last year and 45% lower than their peak in May 2008. Unlike BHP Billiton and Rio Tinto, italso  has a large platinum business which has been hit hard. At the end of 2011, it said that development costs at its largest project ,the Minas-Rio iron ore mine in Brazil, had risen by by 15%, to $5.78 billion due to permitting issues, land access and the discovery of caves which required assessment. The mega project required a 525km slurry pipeline and port facility. Then, in July, opening of of the mine was delayed to late 2014. The mine was originally bought for $4.2 billion in 2007 and was expected to open in 2010. The latest delays mean it is nearly 5 years late. The company has also been embroiled in a legal dispute over its Los Bronces copper mine in Chile due to a sale of a stake in the mine.

So, in sum, plenty for investors in the big cap commodity stocks to consider. Some are starting to look good value at their current depressed prices. The key for a reversal now is further stimulus from China, the US to continue to gain traction and an alleviation of issues in the Eurozone. A contrarian bet in this sector looks smart, but it may not be the time just yet. Commodity stocks are a proxy for the global economy and plenty of uncertainties remain, phased buying in may be the best bet on any further weakness. With the FTSE 100 and Dow having had a good run, waiting for a sell off may be an advisable strategy.

Contrarian Investor UK