Resource World Magazine

62 www.resourceworld.com A P R I L / M A Y 2 0 1 6 e p i l o g u e D a v i d D u v a l E conomists like to tell the story about one of their counterparts who pre- dicted 10 of the last five recessions – no, that's not a typo – which on a statis- tical basis is not too bad a record for this, perhaps deservedly maligned, profession. Perhaps more than anything these statistical misses speak to the increasingly perilous art of predicting the future based on historical information (i.e. technical analysis), and/or the often bogus or unreliable economic data that drives policy decisions by the world's central banks. Is today's commodity market anything like the past or could this one really be different I'm often asked? Viewing the price action of iron ore during the first few months of this year suggests it very well might be different. The price of iron ore climbed almost 40% off its near decade lows reached in mid-December – a recovery, that to my knowledge, has no historical precedent. Even more surprising is the fact this epic recovery has unfolded in the face of a global economic slowdown not to mention huge volumes of new iron ore production that are coming into the marketplace over the next few years. The same goes for oil which has climbed over 40% off its lows in January despite only modest reductions in output from US shale producers, Iran preparing to increase its production by at least 400,000 barrels per day by year end, new oil sands pro- duction coming on stream from Alberta, and OPEC members unable to agree on production cuts. In the near term, supply disruptions in Iraq and Nigeria are help- ing erode the glut in oil markets which is still estimated at around 2.0 million barrels per day. The supply/demand situation in oil markets could start to re-balance in the third quarter, some analysts are predicting. China is likely the primary driver of these price anomalies in the metals after announcing increased government fund- ing for infrastructure along with new measures to increase bank lending to support this important fiscal initiative. Analysts estimate the country will spend a trillion dollars over the next decade for roads and related infrastructure, consum- ing plenty of steel, copper, aluminum and zinc. China is exporting about 100 million tons of steel annually and apparently iron ore demand is still at record levels, suggest- ing that market sentiment has not matched supply/demand fundamentals. Not only has this negative sentiment helped drive down a broad range of industrial com- modities, it has pummeled the share prices of many large global mining entities, Rio Tinto, BHP and Vale being among the big- gest losers. The scale of China's latest infrastructure plan will likely be substantially less than the previous program in 2008-09 which, as it played out, boosted iron ore prices to over $187 per tonne. However, its impact on industrial commodities could be signifi- cant nonetheless. Also, one would expect that a smaller more focused infrastruc- ture program would serve to reduce price volatility in commodity markets while decreasing the probability of another sud- den commodity bust. A period of price stability would hopefully bring some sanity back into the marketplace where mining companies got overextended, taking on excessive debt to bring on pro- duction that the market could simply not absorb. In recent months, China has announced plans to introduce supply side reforms as a means of resolving industrial overcapacity which has led to internal supply gluts that present major challenges to future growth. It's no secret that China suffers from a capacity glut in several industries from iron and steel to solar panel production. And government officials readily admit that this has contributed to a debt crisis in the country in addition to causing trade frictions abroad, with Chinese manufactur- ers being accused of dumping products at below-market prices in an effort to protect profits. In fact, the global steel industry has largely been rendered bankrupt by Chinese steel exports – and new steelmak- ing capacity coming online will only make matters worse. According to The Diplomat, an Asia- Pacific business publication, "The overcapacity problem is a symptom of China's previous economic model, where government investment in key sectors built capacity far beyond what demand (both at home and abroad) could support." Of all the metals impacted by the global commodities crash, gold has arguably per- formed the best – although you wouldn't think it looking at the share performance of gold miners which have recovered somewhat this year but are still off their highs. The "best of the best" explorers are doing well, Kaminak Gold, for example. However, many juniors are still struggling. Much of that poor performance was their own making when you consider how many of them failed to capitalize on escalating gold prices by not controlling their production costs. In most cases those costs moved lockstep with higher gold prices with little or no benefit accruing to shareholders. The competition by mining companies to leverage their balance sheets by increasing gold output saw them debt fund capital-intensive, low grade gold projects – many of which have since been abandoned or sold – that might well cap their share prices for years to come. n Volatility in commodity markets without historical precedent

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