Ann: Preliminary Final Report-WOR.AX, page-80

However in yesterday's paper Stephen Bartholomeusz doesn't share Fitzgerald's confidence.

The key to the commodity surge puzzle.

• The Australian 11:23AM October 11, 2016
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• STEPHEN BARTHOLOMEUSZ
  
  Business columnist
  Melbourne
  
  

The continuing surge in commodity prices is causing some head-scratching, as resource sector executives and analysts try to come to conclusions about its sustainability.
The oil price hit a year-high of $US52.92 a barrel overnight, as the prospects of an OPEC-led production cut, or at least freeze, appeared to strengthen.
Coal prices have soared, with metallurgical coal above $US200 a tonne and thermal coal above $US80 a tonne. The iron ore price rose 2.6 per cent to $US55.80 a tonne overnight.
The oil price is being driven by its own particular circumstances and by assessments of the likelihood that the Saudi-led market share strategy, which has led to OPEC production at record levels, might be abandoned because of the level of self-inflicted damage it has done.
The Saudis, who have been rapidly running down their massive foreign reserves and have had to introduce harsh fiscal measures to offset the impact of low oil prices on government revenues, are about to hit debt markets for about $US15 billion to fund their budget deficits.
The pricing regime has also hit non-OPEC members, like Russia, very hard, hence Russia’s declared willingness to co-operate in a production freeze, albeit while it is producing at record levels itself.
The rebound in coal and iron prices has a different explanation. It’s all about China.
Earlier this year, China’s economy was spluttering and commodity prices were depressed. Then Chinese policymakers acted, pumping credit into the economy and encouraging an infrastructure and property investment boom.
That massive injection of stimulus coincided with a medium-term plan to cut excess and inefficient capacity within its economy, with a focus on the steel industry that flowed through to its domestic raw material suppliers.
The authorities want to cut between 100 million tonnes and 150 million tonnes a year from the steel sector’s capacity by the end of the decade and domestic coal production by about 500 million tonnes a year over the same period.
While the rate at which uneconomic capacity is being withdrawn appears to be already lagging the authorities’ targets, it has still been material and, coinciding as it has with the boom in infrastructure and property investment, has pumped up demand for imports of coal and iron ore.
Whether or not the consequent surge in prices for steelmaking commodities is sustainable hinges on whether or not the credit-driven growth within China is sustainable. There’s considerable scepticism that it is.
Recent economic data has been solid but there are concerns about the fragility of its financial system. The Bank of International Settlements and the IMF have recently warned of the potential for a financial crisis within China as a result of growth in credit and leverage that they believe is unsustainable.
With an overhaul of the Communist Party leadership scheduled at next year’s 19th Party Congress, the authorities will inevitably do whatever they can to maintain economic growth and social stability, but commentary from the authorities does suggest they, too, are concerned about the potential for the property markets to overheat. There are signs that some local governments are acting to dampen property market activity.
Longer term, however, China will want to refocus on its planned transition — a transition that has been occurring — away from a dependence on exports towards greater levels of consumption and domestic activity.
For iron ore and coal, there are also walls of new supply and latent production that could be expected to impact prices should they remain at their current levels. BHP Billiton has identified iron ore as the last of the commodities within its portfolio where the market’s supply-demand equation will rebalance.
The pick-up in the key commodity prices is inevitably fragile, and not just because of its reliance on China being able to maintain its demand.
The rest of the world remains quite weak, the outcome of the US presidential election, while receding, perhaps, as a threat to global stability, remains open and there is a very real prospect that the US Federal Reserve Board may raise US interest rates before the end of the year.
The US dollar has been strengthening against most of the major currencies, which isn’t normally a positive for commodity prices that are priced in US dollars.
That may be in anticipation of a US rate rise or a retreat to a safer haven for the trillions of dollars of speculative funds pumped into the global system by central banks that ebb and flow according to investor perceptions of risk.
There is certainly rising nervousness about the financial market settings the central banks have created with their unconventional policies, which appear to have exhausted their effectiveness and may now be destabilising the system and their — and others’ — economies.
Protectionist pressures have also strengthened in the major economies, which is a potentially damaging development for China and resource producers reliant on it.
For oil, the future price path depends initially on whether OPEC and the major non-OPEC producers can strike a deal to cap or cut production, on whether they can stick to it (in the past, producers, including Russia, have agreed to reduce production and then ignored their commitments) and ultimately whether higher prices reignite the US onshore oil sector.
Given how unpredictable commodity markets have been since the financial crisis, it is impossible to predict with any confidence how sustainable their current pricing might be.
It feels, however, more like a false dawn than the bottoming of the resources cycle and the continuing focus of the major miners on their balance sheets and costs suggests that, while they’ll happily book the higher prices, they are still prepared for a prolonged and attritional period of pricing pressure.
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