Market Update & Important Indicators
U.S. stocks pared earlier gains in afternoon trading, dragged down by biotechnology stocks. Other than biotech stocks in the U.S., markets generally steadied after the Fed's decision last week to keep interest rates at record lows sparked a global selloff amid fears about the fragile state of the global economy. Although rock-bottom rates have helped fuel years of rising stocks since the financial crisis, the Fed's reluctance to lift borrowing costs was seen as a reminder that growth in the U.S. and elsewhere remains vulnerable to a slowdown in China. The Dow added 126 points, or 0.8%, to 16,510 while the S&P 500 gained 9 points, or 0.5%, to 1,967.
Stocks in Europe also steadied, with the Stoxx Europe 600 closing 0.9% higher, having fallen 1.8% in the previous session. Markets were also encouraged by Alexis Tsipras's resounding win in Sunday's Greek election. Mr. Tsipras's re-election after agreeing a bailout deal may soothe tensions with European creditors that jolted markets during the summer. Germany's DAX lagged behind most markets in Europe, rising 0.3%. The index was held back by heavy losses for shares of Volkswagen AG, which fell 17% after the U.S. Environmental Protection Agency accused the car maker of deliberately cheating emissions tests. The company halted American sales of popular diesel-powered cars and issued an apology for violating customers' trust.
Shares in Australia fell by their sharpest in more than a week and led most Asian markets lower on Monday, as anxiety about the pace of global growth sent investors fleeing to safer assets, including the U.S. dollar. Australia's S&P ASX 200 fell 2.0% to end at 5,066. The Hang Seng Index was down 1.1% and South Korea's Kospi was down 1.6%. Japanese markets were closed for a holiday and will reopen Thursday. The Shanghai Composite Index closed up 1.9%. Its gains came late within the last hour of trade, a frequent buying-window for Beijing-backed funds to support the market.
Base metals were mixed overnight on the LME. Copper gained 0.2% and nickel climbed 1.9%, although zinc finished 1.9% in the red. Crude oil showed strong gains, with Brent up 3.1% to $48.92/bbl and WTI up 4.5% to $46.68/bbl. Gold lost 0.6% overnight to $1,133/oz, while iron ore dropped 0.7% to $57.30/t.
Thought for the Day
Record production – working through excess industry capacity
In a recent report, we noted ABS data to June 2015 showed that minerals exploration metres drilled had fallen to levels last seen more than a decade ago (see Minerals exploration – wallets growing cobwebs, 10 September 2015). This is across geographies and commodities, although gold has held up best. We believe that we have likely seen the worst, although a recovery in exploration metres drilled will be slow, and an improvement in the margins for exploration service providers will be even slower while surplus capacity exists.
Yet, while exploration has been falling to decade lows, mining production has climbed to record levels. A slide in Seven Group Holding’s (SVW) FY15 results presentation amply demonstrates this (see below). Iron ore in particular is a standout, with export volumes trebling over the last decade.
The ramp up in volumes over the last few years dramatically pushed up demand for new gear to support production. It wasn’t too long ago that demand for big yellow gear far exceeded supply, in some cases resulting in delivery delays of more than 12 months. The chart below, taken from SVW’s results presentation and focusing on WesTrac’s revenues, shows the sharp ramp up in product sales (i.e. new gear) 2-3 years’ ago.
WesTrac’s product sales have since fallen dramatically, and the results for the last half show that sales of new mining gear had fallen to the lowest level in at least a decade. Conversely though, product support for (i.e. maintenance of) the much larger installed base of mining equipment has grown substantially, and for WesTrac, as shown on the chart, this is now at record levels.
With the benefit of hindsight, the equipment supply response from firms across the resource services sector was way overdone, and there is now a well-documented surfeit of mining equipment on the market. However, as long as there are limited sales of new equipment and record production, surplus gear will eventually get whittled away.
Further, oversupply has led to significantly reduced prices for second-hand equipment, and it can now make much more sense for a miner to hire equipment or to subcontract mining services. Smaller miners, that are currently capital constrained, may not even have the choice.
At the end of the day the market will work as it should. While maintenance services appear to be one bright spot in an otherwise very tough sector, we expect the overcapacity issues in the industry to steadily dissipate over the next couple of years.
In This Issue
FAR Limited (FAR) | 3 value add wells drilling in Senegal, Q4 | SPEC BUY
FAR Limited (FAR) is an oil and gas explorer with exploration and pre-appraisal assets in Senegal, Guinea-Bissau and Kenya. In 2014 FAR participated in two significant oil discoveries offshore Senegal in JV with Cairn Energy Plc (40%) and ConocoPhillips (35%), which highlighted the value of its Senegal leases. Follow up drilling to appraise the Senegalese discoveries (SNE) and test new targets (Bellatrix) will start in Q4 2015. FAR has A$43m cash, nil debt, an experienced Board & strong relationships in Africa.
In addition to its African assets, FAR holds acreage in Western Australia. Due to the discovery and upcoming drilling, FAR’s 15% stake in Senegal remains the focus. Positively, whilst JV partners ConocoPhillips and Cairn Energy, who farmed into the leases for US$196m plus $10m in cash for a 2 well program, have effectively cut global exploration spend, but they remain committed to the upcoming African drilling program. Spec Buy.
Recent Contacts & Presentations
TFS Corporation (TFC), HRL Holdings (HRL), Tox Free Solutions (TOX), Sino Gas & Energy (SEH), Dacian (DCN), Carnarvon Petroleum (CVN), Otto Energy (OEL), Empire Oil & Gas (EGO), FAR Limited (FAR), Central Petroleum (CTP)