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Commodity thematics takes its toll

We continue to sharpen our focus on commodities – iron ore moved to US$38.65 a tonne, Brent crossed into the US$39 handle but closed at US$40.2 a barrel, WTI remained at US$37, while industrial metals were mixed. The underlying thematic themes of 2016 are taking a sharp turn.

Oil
Source: Bloomberg

We have been strong on our views around oil:

  • OPEC would not cut or even cap production; this has come to fruition as expected. The fallout from the Vienna convention is the group has signalled that it’s each to their own. If we are honest, it’s not in OPEC’s interest to balance the oil market on the supply side. This will fall to the likes of Canada, Norway, Russia and the US.
  • The USD/oil trade has been textbook and well correlated in 2015. What we are now having to ask ourselves is after the FOMC meeting and the expected ‘lift-off’, will the theorised USD selling after the fact cause a reversal in the USD/oil trade? It will certainly moderate further declines.
  • China’s demand has been down on historical data; trade balance after trade balance since mid-2014 has shown China’s demand for crude has slowed – however it has yet to contract. Future demand is clouded – environment impacts in major cities will see larger scale restrictions like those currently in place in Beijing while demand on the industrial side has been hit by falling export demand as global slowdowns hits Chinese export goods. This thematic is expected to continue into 2016 and could have an even bigger effect.

We remain of the view that oil will stay below US$50 a barrel into the foreseeable future.

The industrial metals and iron ore thematics are basically facing the same factors that are influencing oil:

  • Australian and Brazilian output remains at record levels in iron ore, which is only expected to increase in 2016 as Gina Rinehart’s Roy Hill project looks to add a further 55 mega tonnes per annum.
  • Supply side in copper is seven to 11 months oversupplied according to Rio Tinto’s copper chief. Yet Rio is now looking to ramp up its Oyu Tolgoi mine in CY16 which will make it one of the three largest copper producers in the world. This will push the supply/demand ratio ever further to the left.
  • Thermal coal – the demand thematic here speaks for itself.

The cracks open up

The fall out of Anglo-American will spread through the big five. Glencore started the year as the ‘bad boy’, but AA is taking the title for the end of the year as it cuts 85,000 jobs globally (2/3 of its work force). It’s headline grabbing – however it’s the change to its progressive dividend policy that should have mining investors sitting up by completely scrapping its payout policy until 2018.

Just two weeks ago, BHP maintained its progressive dividend policy, however it clearly laid the ground work to retract it if conditions persist.

Jac Nasser’s statement that the balance sheet will take precedence is enough to make me believe that the likely write-downs coming at the half-year numbers in February to the mass decline in commodities will lead to a policy change.

BHP’s Australian listing has a dividend yield of 9.8%. Its London list is over 12% based on its current policy. The 2016 commodity thematics make BHP’s progressive dividend policy hard to swallow and the Anglo-American moves overnight just adds pressure to scrap what is an out-step program.

Ahead of the Australian Open  

We are calling the ASX down 29 points to 5079.

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