Last week's BHP Billiton's share price increased 19.2% (this is a very large and unusual movement for such a sizable company.) This week, the market was more moderate, but its share price was still up another 9.2% until COT Thursday (totaling 30.1% for the last two weeks - quite remarkable, really). So, what are our thoughts in relation to the rally we have seen in the miners?
Commodity and energy prices
Commodity prices have rallied this calendar year. They are still a long way off their boom highs, but there has been a clear change away from the downwards trend. We can see this in the following graphs for iron ore and copper.
The oil price has also rallied quite strongly this calendar year, as shown in the graph below.
However, part of this was based on the hope of obtaining a more balanced supply / demand dynamic across the globe. Earlier this week, talks in Doha failed to agree some sort of production agreement (with the Saudi's and the Iranians the main antagonists).
Overall, oil production has not really decreased adequately to meet the current demand, with US shale production continuing in earnest, Iraq increasing its production after coming off sanctions, and OPEC members acting in a quite un-cartel-like manner. Until the supply / demand imbalances rebalance, we expect to see more volatile movements in the oil price.
This year's commodity and oil price increases have translated to improved sentiment and outlooks for the resources and energy companies, with BHP being front of mind. South32 (which is also a holding in your equity portfolio) didn't rally to the same extent in recent weeks, but it is up 64.3% for the calendar year to COT Thursday (versus BHP's +17.9% rise).
China / Sentiment
Why have commodity prices increased this year (and BHP's share price likewise)? We believe that China is a big part of it. Essentially:
1. China has been stimulating their economy, and
2. People have realised that the Chinese economy is not falling apart.
China's GDP figures recently released growth rate was 6.9% for the year (including Q1CY-16), generally in line with expectations. (Although some caution needs to be heeded in relation to Chinese statistics, see here)
Certainly, we did see many resource companies' share prices getting too far below their fundamental value - even with low long term commodity / oil price assumptions being used to form their valuations. This is why, when considered in relation to the sentiment turn on China, we believe the recent rally has occurred.
As to whether both the commodity prices and the share prices of the miners are sustainable from here, we would need that elusive crystal ball. But it should be remembered, just as we saw an overshoot to the downside (in our opinion), an overshoot to the upside often occurs on share-markets as well. We are mindful of this in relation to the mining and energy sectors at the moment.
In relation to oil in particular, as mentioned above, we do certainly expect more volatility. And we really should expect this more broadly across the resources sector.
As an aside (#1), we have seen a strong and sudden rally in the AUD (as shown in the graph below). The (far from perfect) correlation between commodity prices and the AUD is holding true. It has been compounded (in our opinion) by weakening sentiment in relation to the USD.
Aside #2: the higher AUD comes at a bad time for our exporters (specialist manufacturers, tourism, educations etc). Benefits were just starting to flow though, and this recovery in the AUD is likely to be detrimental for them. Furthermore, this translates poorly into Australia's economy overall - hurting efforts to transition from the mining boom economy, to a more broad-based, balanced economy.
Mining and energy services
We have yet to see the positive developments detailed above translate into the mining and energy services sectors. Many of these companies are trading on record low multiples. We expect to see this change, although the timing is uncertain, and the resources and energy company recovery would need to prove itself as somewhat sustainable.
Mining and energy services companies you own are Ausenco (~2.9% of your equity portfolio weight) and Emeco (~1.4%). Cardno (~2.4%) also has a division that provides services to the energy sector. As you can see, your portfolio exposure to the mining and energy services sectors is not high. However, there is significant leverage in them.
We have seen a quite unprecedented rally in BHP Billiton's share price over the last two weeks. Sentiment change associated with China has been a factor behind this, in conjunction with share prices overshooting to the downside. We are mindful of the risk of an overshoot to the upside from here.