Materials

Miners' selloff takes a pause: Why commodity prices need to stay high

Tue 28 Jun 22, 3:56pm (AEST)
Mining 1 metals iron ore ocpper

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Key Points

  • Large cap iron ore, oil and copper stocks are stabilising after a brutal selloff
  • Recent data from China and the US shows the economy is chugging along, albeit at a slower pace
  • Commodity prices need to stay high to inspire new supply as margins are squeezed

Its been a rough patch for the S&P/ASX 200 Materials Index, with a June peak-to-trough dip of -16.3% amid a broad-based pullback for commodity prices.

On the cost side, miners are facing significant headwinds due to labour shortages, adverse weather conditions and rising costs, notably in the form of electricity, freight and diesel.

The double whammy has squeezed miner margins and seen the sector as a whole, sell off quite aggressively, but still tracking ahead of the ASX 200 from a year-to-date perspective.

ASX 200 Materials vs. ASX 200
ASX 200 Materials vs. ASX 200 (Source: TradingView)

Selloff takes a pause

Key commodities including iron ore, copper and oil have started to stabilise, buoyed by data showing China's economy is beginning to rebound.

A survey of more than 500 Chinese smaller firms showed that “demand and production recovered strongly among manufacturing,” and export-oriented smaller firms outperformed, as Bloomberg reported.

On Monday, the US reported better-than-expected durable goods data, up 0.7% in May. Economists polled by the Wall Street Journal were expecting a gain of 0.2%.

The data signals that US factories are still producing long-lasting goods such as autos and heavy machinery, even in the face of ongoing supply chain challenges and poor consumer sentiment.

Massive outflows in the US

The stabilising narrative is very much the same in the US. Though, materials and energy sectors have experienced two of their largest outflows since 2017, a sharp U-turn from the largest inflows just a few months earlier.

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Source: Bank of America

Outlook: Supply tightness to buoy prices

Demand-side worries has distracted investors from otherwise alarmingly low inventories across several key commodities.

Copper stocks at LME warehouses sit at 124,850 tonnes in LME approved warehouses, according to Reuters. Though, approximately 40% of the metal is due to leave the LME system. Aluminium stocks are at 21-year lows and zinc is facing a supply squeeze as inventories plunge.

The supply side limitations is expected to support commodity prices, and as covered earlier, the market could be caught in a cycle of falling commodity prices, followed by higher demand thanks to lower prices, which then brings prices back up.

Why prices need to stay high

Oz Minerals (ASX: OZL) and Evolution Mining (ASX: EVN) are the latest two miners to fall victim to production downgrades and higher costs.

Oz Minerals raised its cost guidance by 17% due to lower production and current cost inflation of approximately 8%. With copper prices down -12.5% in the last 12-months, production falling and costs going up, does that not paint a rather gloomy year-on-year picture?

Copper supplies are at critically low levels, but weak prices will struggle to inspire new supply to hit the market.

So now the market is stuck in between a rock and a hard place. If commodity prices rally, then inflation becomes an issue. If prices fall and supply doesn't come online, then supply itself becomes the binding constraint for growth.

Written By

Kerry Sun

Finance Writer & Social Media

Kerry holds a Bachelor of Commerce from Monash University. He is an avid swing trader, focused on technical set ups and breakouts. Outside of writing and trading, Kerry is a big UFC fan, loves poker and training Muay Thai. Connect via LinkedIn or email.

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