February 5, 2014 10:51 am

Miners cheer fall in commodity currencies

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Mining companies are set to receive a boost when they report figures this month thanks to a fall in “commodity currencies” against the US dollar.

Many of the world’s largest miners have adopted austerity measures as they seek to reduce debts and atone for years of overspending. These efforts have coincided with the depreciation in local currencies, which is helping to lower production costs and boost margins.

Analysts estimate between 15 and 50 per cent of miners’ costs (items such as wages and power bills) are in local currencies such as the South African rand, Australian dollar, Brazilian real and Chilean peso, which have all fallen sharply.

At the same time commodities, which are denominated in US dollars, have proved relatively resilient in spite of the recent turmoil in some emerging markets, an important source of demand for raw materials, and concerns about slowing growth in China.

The result could be consensus earnings upgrades for the sector for the first time in several years – and some happier shareholders.

Since the US Federal Reserve started to discuss the tapering of its vast bond-buying programme in May last year, emerging market currencies (many of them also commodity currencies) have been under pressure. They have fallen further in recent weeks amid capital flight from developing countries.

The rand has weakened the most, falling 20 per cent against the US dollar since May followed by the real (18 per cent), the peso (15 per cent) and the Aussie dollar (10 per cent).

With a large chunk of operating expenses denominated in these currencies, this should feed through into lower production costs for companies such as Anglo American and Rio Tinto when they report results for the six months to the end of December over the next couple of weeks.

“There was a very definitive first half, second half split for the miners last year and we haven’t seen many numbers from the second half,” said George Cheveley, natural resources portfolio manager at Investec.

Analysts estimate a 10 per cent fall in the value of the rand against the US dollar gives a 15 per cent boost to earnings at Anglo American. For Rio Tinto the gains are even bigger, with a 1 cent fall in the Australian dollar versus its US counterpart boosting earnings by more than $100m, according to Citi.

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However, the gains could be offset this year by weaker prices for raw materials. Historically falling commodity prices and emerging market currencies have been negative for prices.

“Weaker currencies in emerging markets often precede a period of lower GDP growth and fixed asset investments,” analysts at Morgan Stanley wrote in a recent note.

For the moment commodities prices have not fallen sharply. The exception is thermal coal, which has dropped by more than 8 per cent in January. Thermal coal is seen by many analysts as the commodity most closely correlated to growth in emerging economies because it is the cheapest fuel source for power stations.

“Fed tapering and the prospect of global monetary tightening clearly have negative for equity valuations. But they also reflect recovering economic activity, which is good news for commodity demand,” says Caroline Bain, senior commodities economist at Capital Economics. “Indeed, the recent turmoil in some emerging markets is unlikely to prevent an acceleration in global industrial activity in 2014.”

FT Video

2014: commodities

January 2014 : Commodities have been falling for a couple of years and the correlation between stocks and the metals market has broken down. John Authers considers whether there could be an opportunity to bet against the broad consensus that commodities will suffer again in 2014.

China’s growth prospects remain the most important driver of commodity prices. Concerns over a slowdown have caused the most recent decline in the iron ore price.

Analysts warn, however, there are negatives to weakening commodity currencies. Lower production costs will help keep some marginal producers in business. This is a problem in commodities where supply outstrips demand, such as thermal coal, or where there are large stockpiles of metal, such as aluminium.

“Where there’s a commodity in surplus you actually want producers to cut output,” says Mr Cheveley. “Otherwise it prolongs the agony.”

Arguably many more Australian coal mines would have closed if the local currency had remained above parity with its US counterpart.

For the moment, the big mining houses are in something of a sweet spot, providing the weakness in emerging market currencies does not lead to a full-blown crisis that impacts China.

But Mr Cheveley says if it is just the case that EM currencies were too strong and now they are being re-priced to a more sustainable level, then it is potentially very bullish for companies operating in those countries. “Under this scenario you get the currency devaluation without the subsequent fall in commodity prices.”

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