“As if we haven’t head enough of this commodity/ iron ore/ steel super-cycle thing in the past few days, Citi is acknowledging that the end will come.
While some point to the fact that the apparent intensity of use for steel (in terms of kg per capita) for China is still well below some of other countries at their peak, Citi reckons that in terms of “value in use”, China has already above most of the developed world. In other words, while consumption of commodities in terms of volume still lags behind many countries, the value of the commodities China is consuming has already been higher than most countries.
The structural story — The bulls on the sector point to intensity of use charts for commodities on a kg/capita basis and extrapolate this into the future. This ignores one vital component which is price, as it assumes that developing economies will continue to consume ever increasing quantities of commodities regardless of the price. If we look at value in use rather than intensity of use this changes the argument and suggests China has already overtaken most of the developed world. Arguably for commodity consumption to increase globally then prices need to come down.
Margins have peaked — Mining margins peaked around 2007 and since then the industry has faced higher depreciation costs, higher operating costs, higher oil prices, higher exchange rates, higher capex costs and higher salaries – all these factors are continuing and margins will continue to come under pressure.
Returns have peaked —On an EVA basis (ROIC – WACC) the peak returns for the sector occurred in 2006, yet earnings momentum peaked two years later in 2008 and has subsequently moved higher. In our view the mining sector bought earnings momentum through M&A, and the mining sector is now buying earnings momentum through unprecedented capex spend. Importantly ROIIC is falling.
And arguably, China’s investment boom in the recent years have been getting less and less efficient.
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