It is probably not news to most investors that the global mining industry is in trouble at this point. The Chinese, long one of the biggest buyers of mined commodities, are awash in steel, local debt, and ghost cities. With neither India nor Brazil ready yet to assume the mantle of emerging market growth engine, this leaves the mining industry up the proverbial creek without a paddle.
Adding to this dilemma, there is considerable and increasing pressure on the coal industry due to both decline in oil prices and concerns over the environment. Put these two trends together, and its little wonder that mining companies have been some of the worst performing stocks of late.
Unfortunately the outlook does not appear poised to improve anytime soon. Related: Indonesia Banking On A Big Return To Oil And Gas
Inevitably as sectors underperform, even the most stalwart investors will eventually get tired and jump ship. That appears to be happening now. The Qataris are apparently tired of the poor returns in the mining industry and appear ready to throw in the towel on that market. The Qatar Investment Authority (QIA), Qatar's sovereign wealth fund, are reportedly shifting away from the mining sector.
Not only is non-precious metals mining doing badly, but the oil and natural gas industry are facing a period of uncertainty and over-supply, and gold mining has been a mess ever since the lack of inflation led to that metal's price collapse a few years ago.
None of these trends show any sign of reversing in the near future. Inflation is still barely a blip in the U.S., and deflation is a bigger problem than inflation in much of the world. Oil prices have recovered somewhat, but few are predicting that they will return to $100 a barrel any time soon and most of the money in that sector is likely to come from more efficiency in individual company operations rather than commodity price inflation. Related: How Big Oil Was Saved From The Oil Price Crash
Iron and copper mining are perhaps the most problematic and least understood sectors, but the global industry is still producing far more than the world needs right now. With all of that in mind, the wonder is why it has taken Qatar this long to consider pulling out.
Qatar is not the first sovereign wealth fund to back out of commodities, and they probably won't be the last. As the closure of Phibros and sale of Morgan Stanley's physical commodities business both show the commodities world is changing rapidly.
As major institutional investors back out of the space, there will probably be two major effects. First, commodities companies are going to face increased difficulty in funding their capital expenditures needs. That's probably going to put severe strain on some firms and it is certainly going to force a focus on maximizing cash flow.
Second, over time as capital dries up, lower production and output will follow. This, in turn, will set the stage for the markets rebalancing themselves. That won't happen overnight, but it will happen eventually. Related: Why The Oil Rally May Well Be Over
Investors should look at the Qatari move as something of a canary in a coal mine. The focus needs to be on high quality firms with solid project economics, not on speculative names in the sector. Companies like BHP and Newmont are likely to fare better than junior miners and troubled mid-caps. This is definitely a time where investors will get what they pay for with stocks. The industry pressure will also hurt some of the servicing and equipment companies that operate in the industry.
Finally, there will probably be some upside for various private equity funds who should have ample investment capital to pick up and restructure distressed assets on the cheap. A lot of these firms from Apollo (APO) to KKR (KKR) have seen their stocks fall over the last year as investors worried about where future gains would come from. The latest move by the Qataris underscored that question.
By Michael McDonald of Oilprice.com
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Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance… More