Increasing costs, rising rates and labour shortages give investors much to mull

Gold edged back towards $US1,900 an ounce this week, but the more important development was cost inflation and a timely warning from a leading investment bank that some Australian iron ore producers are sailing into stormy weather.
18th November 2021
Tim Treadgold

Morgan Stanley, in its weekly Data Dig report, singled out Mineral Resources and Fortescue Metals as iron ore miners with cost and quality challenges which could affect their profitability and dividend-paying potential.

According to the bank, the mines of Mineral Resources are currently unprofitable based on an iron ore price of $US90-a-tonne for high-grade ore and then applying a discount for the company’s low-grade material, which indicates implied costs for the company of $US101/t.

“Cost profile indicates too close for comfort at Mineral Resources,” Morgan Stanley said in a headline in its report, adding that free cash-flow was further affected by capital expenditure for the company’s Ashburton low-grade iron ore project “which we expect could be at risk given current iron ore prices”.

Fortescue is better placed on costs, but the company’s dividend might be “under threat”, according to Morgan Stanley, given that 10% of profit after tax is committed to Fortescue Future Industries and that the dividend target is 80% of net profit after tax.

“Net profit needs to be at least $US4 billion-to-$US6 billion, below which internal project spend, or dividends, could be at risk,” the bank said, adding that at the current spot-market iron or price of $US90/t the net profit outlook for this year was $US3.7 billion.

Investors seemed to take note of the Mineral Resources iron ore issue, rubbing 87c off its share price this week, which slipped to $39.58. Fortescue did better with a decline of 72c to $15.42. Other iron ore stocks also weakened with Champion Iron down 36c to $4.10.

Iron ore miners are not alone in confronting mounting cost pressure. Morgans, a stockbroking firm, said that while inflation fears could push gold higher there was cost pressure across the gold sector with labour shortages a major worry – especially in WA – with December 1 a danger date as the State’s Covid-19 vaccine deadline kicks in on that day.

Morgans used an industry-wide measure of all-in sustaining costs to demonstrate its point, noting that producer costs rose from $A1,533 an ounce in the June quarter to $A1,635/oz in the September quarter – offset by a higher local gold price which rose (quarter-on-quarter) from $A2,158/oz to $A2,328/oz.

Over the past week, the U.S. dollar gold price has risen by a marginal $US8/oz to trade around $US1,870/oz but, after the currency effect of a fall in the local dollar to US72.5c (or a rise in the U.S. dollar if you prefer your currencies that way), the Australian gold price was up $A34 to $A2,576/oz.

Citi, another investment bank, reckons gold will hit $US1,900/oz in the next few weeks, aided by gold buying during the annual festival season in India and China, but will ease back into a range of $US1,700/oz-to-$US1,800/oz later.

Local gold stocks were mixed with sector leaders heading off in different directions. Evolution added 19c to $4.41 after reporting a deal to give it full ownership of the Ernest Henry mine in Queensland while Northern Star slipped 23c lower to $10.54.

Smaller gold stocks in the news also had a diverse week. Sunstone did best with a rise of 3.5c (52%) to 10c after reporting a thick and rich intersection at its Alba target in Ecuador, with a best assay of 111 metres at 2.3 grams of gold a tonne, plus a core of 7.2m at 26.9g/t.

Other gold moves included:

  • Medallion Metals, up 1c to 22c after reporting encouraging assays from its Kundip project in WA’s south coast.
  • Oklo, up 2c to 16c after reporting 6m at 12.56g/t from a depth of 124m at its Dandoko project in Mali.
  • Black Cat Syndicate, up 2c to 62c after reporting 13m at 37.43g/t from a depth of 151m at its Fingals Fortune project.
  • Kingston Resources lost 4.5c to 20c after announcing a capital rising to buy the Mineral Hill gold and copper mine in NSW.

Overall, the ASX had a flat five days, tugged in different directions by global economic and political forces. The all-ordinaries index and the metals index both slipped 0.5% lower while gold index, despite a promising finish, was actually up just 0.1% over the week.

Investors continue to struggle with the fear of an inevitable increase in interest rates and the growing belief that everything is over-valued thanks to central banks continuing to pump excess liquidity into the financial system, even as the global economy recovers after the Covid-19 slowdown.

Bill Gross, one of the world’s most highly regarded investors and founder of Pimco, lashed out during the week saying that investors were “living in a dreamland”. It’s dangerous, he said: “It’s all dreamland supported by interest rates that aren’t where they should be”.

Adding to this complex brew of competing optimism and pessimism is the energy challenge which gets tougher by the day with the COP-26 climate conference in Glasgow winding up without any great achievement, except to reinforce the appeal of battery metals – especially lithium – but also sparking fresh interest in oil and coal because discouraging new supply means prices will continue to rise, until renewables kick in as a reliable and sustainable source of power.

Thermal coal hung on to a price of $US150/t, more than double where it was at this time last year. Oil was trading around $US80 a barrel, with Russia’s leading producer, Rosneft tipping a rise to $US120/bbl by the middle of next year – which will pile pressure on to the miners with their heavy use of diesel fuel.

Lithium stocks were another example of good and not-so-good news with fresh forecasts of tight supply and an accelerating shift to electric vehicles, followed by sector-wide share price weakness.

Delegates to a UBS conference in Sydney were told that EV makers were facing lithium supply bottlenecks just as demand picked up – a point reinforced by Macquarie which said it expected a lithium deficit to emerge in China “in the near term”.

On the market it was a different story with sector leaders Pilbara Minerals up a modest 2c over the week to $2.43 while Orocobre lost 4c to $9.47, and Liontown could only manage a rise of 0.5c to $1.69, even after announcing a “cutting edge” native title deal covering its Kathleen Valley project. Macquarie disagreed with the market, refreshing a buy tip on Liontown and lifting its price target to $2.

Other news events and market moves, either way, included:

  • Galileo added 5.5c (27%) to 26c after reporting encouraging mineral readings on a hand-held X-Ray Fluorescence device from drilling Norseman project near the WA nickel mining centre of Kambalda. The XRF reader indicated minor amounts of nickel and copper while palladium, platinum and gold results require laboratory testing.
  • Chesser Resources reported what analysts called a larger-than-expected maiden resource of 781,000 ounces of gold at its Diamba Sud project in Senegal, only to be marked down by half-a-cent to 15c. Euroz Hartleys, a Perth stockbroker reckons Chesser is heading for 30c.
  • BCI Minerals took another big step towards developing its Mardie salt and potash project in WA with a $360 million fund raising backed by the company’s major shareholder, the Kerry Stokes-owned Wroxby Pty Ltd. The stock last traded at 48c before trading half kicked in ahead of new shares being issued at 43c.
  • Gold Road lifted reserves at its Gruyere project in WA by 31% to 1.07 million ounces, followed by an 8.5c share price rise to $1.67 and a buy tip from Bell Potter which sees $1.90 as the price target, and
  • Rex Minerals said it was pushing ahead with its long-delayed Hillside copper project in South Australia with early work, including a road realignment and power connections underway. The stock was steady at 26c, but Euroz Hartleys sees it heading for 80c.

 

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