No matter how you look at it, 2015 was an awful year for metal prices. But if the majority of experts are correct, 2016 is going to be worse. Maybe a lot worse.
Put simply, market sentiment for commodities has not been this bad in at least 15 years. Nearly every metal is in oversupply, and almost no one thinks China can bail the market out, as it did the last time prices crashed in 2008.
“I think the whole commodity complex has been over-hyped, overbuilt and it’s going to take years to dismantle it,” said portfolio manager John Stephenson, head of Stephenson & Co. Capital Management.
That pretty much sums up the consensus outlook. But for those who are patient and have the capital to ride out the tough times, 2016 may provide an incredible opportunity to pick up assets at fire-sale prices. In mining, that means private equity players ought to be very busy.
“The next two or three years are going to be very, very, very tough,” said Isser Elishis, chief investment officer of private equity firm Waterton Global Resource Management LP. “Guys like us will have tons of opportunities. We’ve prepared for something like this.”
Metal prices are plumbing depths that would have seemed unimaginable a few years ago. Iron ore is worth about US$40 a tonne, compared to a peak price of nearly US$200. Nickel is below US$4 a pound, compared to an all-time high of about US$23. Gold is a relative outperformer by those standards — it is down just 43 per cent from its peak in 2011.
Overall, the Bloomberg Commodity Index, a broad tracker of commodities, is around its lowest level since 1999.
It is not hard to identify the problem: supply is going up while demand from China is weakening. Unless China’s economy can outperform expectations — and most of the data is not encouraging — there is no reason to see the supply glut disappearing anytime soon.
Market watchers want to see production cuts to bring the market closer to balance. Unfortunately, they do not expect many of them in 2016. Since most currencies are down sharply against the U.S. dollar and commodities are priced in U.S. dollars, miners outside the United States are getting a huge currency benefit that offsets much of the drop in prices. And while it may seem absurd that new mines are entering production right now, that is precisely what is happening. A lot of mines that were greenlighted several years ago are coming onstream at the worst possible time.
Of course, the mining industry is suffering. In nickel, for example, more than half of global output is in the red. That should be a signal that production cuts are inevitable.
But experts are not convinced they will happen anytime soon. Jessica Fung, a commodity strategist at BMO Capital Markets, said miners have some more “levers to pull” to stay in business, even though she does not expect them to get much more help from exchange rates.
“Miners are not commodity market speculators,” she said. “Their job is to run operations as efficiently as possible and earn a profit. As long as that’s what the supply side is doing, it’s hard to see sufficient cuts next year.”
One of the things miners are doing to withstand the tough times is sell non-core assets. Plenty of good assets are on the market right now, and there will be more to come. Notably, Anglo American PLC announced this month that it will sell 60 per cent of its assets.
The obvious question is who will buy all these things. Most miners are too shell-shocked to buy anything at this stage of the cycle, and the royalty and streaming companies are getting tapped out from the many acquisitions they have done.
That leaves private equity as an obvious buyer. There have been fewer private equity mining deals than investors expected over the past few years, though groups such as Waterton have done plenty of small-scale acquisitions. We may finally see more big transactions next year, especially with the Anglo assets going on the block.
“(Private equity) have only been dipping their toes (in mining) because they’re not used to resource-type exposure,” said Michael Amm, co-head of the mining group at Torys LLP. “We know they’re holding billions and billions of dollars. At some point, they will deploy it.”
Many former mining CEOs have moved over to the private equity side, including big names like Mick Davis (of Xstrata PLC) and Aaron Regent (of Barrick Gold Corp.). They have been reluctant to pay large premiums for assets in a declining market, but they stand to benefit if more sellers are determined to liquidate to protect their balance sheets.
Forced liquidations are already commonplace on the junior side of the market, and Waterton is taking advantage. Elishis estimated that his firm struck about 15 deals in 2015, and he expects 2016 to be another “extremely active” year. He noted many small mining companies are in breach of their debt covenants or close to it, which will force them into action.
“At the prices we’ve paid for a lot of deals (in 2015), we really couldn’t get it for any less,” he said. “It was at the point where a million dollars this way or that way doesn’t really matter.”
That shouldn’t change in 2016. But with metal prices in the dumps and even more mining assets likely to be for sale, one side of the bargaining table will be holding all the power.
