Rio Tinto to Halve Capital Spending by 2015 in Focus on Cash
Comment of the Day

December 02 2013

Commentary by David Fuller

Rio Tinto to Halve Capital Spending by 2015 in Focus on Cash

Here is the opening for this cyclically informative story from Bloomberg

Rio Tinto Group (RIO), the world’s second-biggest mining company, will cut capital spending to about $8 billion in 2015, less than half its outlay last year, as mineral producers conserve cash after prices fell.

“Our capex is reducing, and will come down further,” Sam Walsh, chief executive officer of London-based Rio, said today in a statement. “From where I stand, we continue to see market fragility and volatility.”

Rio’s cutback underlines efforts by the world’s largest mining companies to rein in spending as a decade-long boom in metal prices wanes. Vale SA (VALE5), the biggest iron ore producer, yesterday slashed its investment budget for a third straight year to $14.8 billion, the lowest since 2010.

“It’s quite a substantial drop and it does suggest that right now Sam Walsh is concentrated very, very hard on affordability,” Evan Lucas, a Melbourne-based markets strategist at IG Ltd., said by phone.

“Over the longer term, I remain optimistic about demand for our products,” Walsh said according to the statement. “China’s urbanization will continue and the development of other economies as they continue to grow at pace, such as India, Vietnam, Indonesia, the Philippines, the Middle East, the former Soviet Union, South America and Africa, will also contribute to ongoing demand.”

David Fuller's view

This is the way the highly cyclical industrial mining sector plays out.  When prices are high, as we last saw in 2007 and early 2008, miners pay too much for undeveloped greenfield sites and produce too much from their developed brownfield properties.  This eventually creates oversupply relative to demand.  In recessions, demand declines further and metal prices slump.  Miners eventually curtail expansion to reduce supply and high-cost mines are closed.  When demand eventually picks up miners are initially reluctant or unable to increase supply which drives metal prices higher.  This eventually reduces demand at a time when supply is actually increasing.  The cycle repeats itself over a number of years.

Where are we in this cycle today?  Miners are belatedly reducing supply and this process is likely to continue because demand is not picking up in the slow-growth global economy.  We do not know when demand will pick up but central banks are trying to stimulate economic activity.  However, they are not having much success, so far, because it takes at least five to seven years for GDP growth to return to normal after a credit crisis recession. 

My guess is that it will take somewhere between one to five years for GDP growth and global demand for industrial metals to pick up.  However, China is the key and it would be surprising if the new government did not begin to stimulate demand at some point in 2014 and 2015.  China will not be importing the same quantities of industrial metals as we saw from 2005 through 2007, but it would lift Asian GDP growth generally, adding to the demand for metals.  Patient, contra cyclical value investors may understandably be tempted to nibble at the big-cap, higher-yielding Autonomy miners on dips within their current ranges.   

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