Business

Miners Set To Benefit From Low Oil Prices And China Growth

The depressed and volatile price of oil may not be good for businesses in the oil sector, but it is good for miners, that’s according to a new report from Credit Suisse due to a strong positive correlation between industrial commodity prices, note the analysts.

Credit Suisse’s latest Global Equity Strategy report, put together by the bank’s global equity research team notes that of all sectors, the mining sector is best positioned for a near-term rebound thanks to attractive valuations, economic growth in emerging markets and growing margins thanks to a low oil price.

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Miners Set To Benefit amid positive correlation between industrial commodity prices

According to Credit Suisse’s analysis, Around 20% to 30% of mining costs are energy related (more so for aluminum), and thus a rise in energy costs tends to push up industrial commodity prices. As a result, “there tends to be a strong positive correlation between industrial commodity prices and oil prices, and a weaker but still positive correlation between industrial commodity stocks and the oil price.”

But it is not just the low oil price that has sparked Credit Suisse’s interest in the sector. The bank also likes the industry as after several years of restructuring structurally “the mining sector is now more attractive and is less disrupted than oil.”

There are several reasons behind this conclusion. First of all the European mining sector’s capex to depreciation ratio has declined sharply to at least a 35-year low as miners have aggressively cut costs to improve margins in recent years. These actions have dramatically improved free cash flow and at the same time imply “scope for supply shortfalls going forward” thanks to underinvestment.

The benefit for investors is, that unlike big oil, the majority of publicly listed miners are at the bottom end of the cost curve, which not only gives these miners a strategic advantage but “in some areas, the very concentrated market structure allows potentially more benign corporate behavior.”  As the top four seaborne producers of iron ore account for nearly 70% of the market, they can achieve massive economies of scale and dominance over the market only big oil could dream of making.

As you can see from the chart below (from CS and the IEA), most of the oil complex cannot match OPEC's low production cost. However, as the chart at the bottom shows, the major iron ore producers are much better positioned to profit than others.

Miners correlation between industrial commodity prices positive correlation between industrial commodity prices Miners