Australia’s Resource Sector Enters A New Phase

February 20th, 2014
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Investing Daily Article of the Week

by Ari Charney, Investing Daily

When we write about Australia’s resource boom, it’s important to remember that this term refers to the period of high commodity prices and the record investment that followed as a consequence. But just because commodity prices have fallen and mining investment has peaked, this doesn’t mean that Australia’s resource story is over.

In fact, many of the projects that were initiated during the peak years of investment in the sector are about to come on line, meaning that we’re now entering a strong production phase, with rising commodity volumes as a result.

Follow up:

While the slowdown in mining investment could detract half a percentage point from gross domestic product (GDP) growth in 2014 and a full point in 2015, according to economists with Westpac, that will be more than offset by resource exports, which are expected to contribute nine-tenths of a percentage point per year to GDP during this period.

However, Westpac does caution that these numbers don’t account for how the decline in mining investment could negatively affect the labor market or incomes. Still, as investors in many resource-oriented names, it’s important to note that even if lower sector investment has a negative effect on the economy, our companies could still perform well if rising production is met by ample demand.

Fortunately, the Australian dollar’s rise and subsequent fall have proved timely for the mining sector, according to Christopher Kent, an assistant governor with the Reserve Bank of Australia (RBA).

In an address before the Committee for Economic Development of Australia (CEDA), Mr. Kent noted that the high level of the exchange rate during the resource boom helped facilitate a reallocation of capital and labor toward the mining space, without causing wage inflation in other industries.

And now that the mining sector is moving from its investment phase to its production phase, a lower aussie should help make its products more competitive in the global market. That’s especially important in helping absorb the glut of commodities that will result from all the new projects that are starting production.

Though the Australian dollar’s decline only began in earnest in the middle of last year, Rio Tinto Ltd (ASX: RIO, NYSE: RIO) is already benefitting from the effect of a lower exchange rate. The falling Australian dollar gave the metals and minerals producer a USD1 billion boost in earnings, equivalent to a 10 percent rise. While the exchange rate also caused the company to record a USD2.7 billion loss on its foreign debt, this was a non-cash expense that doesn’t affect operations or cash flow.

Analysts with Deutsche Bank said other mining companies will likely enjoy a lift in earnings from the currency effect, though they noted that this could be temporary, as currency fluctuations in other countries where these firms have operations could lead to wage inflation.

Chinese demand will also continue to be a huge factor in resource sector earnings. The country’s economy is slowing, but its demand for commodities has still been brisk in recent months. Thankfully, Australia’s proximity to the Middle Kingdom gives its mining companies an edge over other developed-world commodities producers, in addition, of course, to its now-lower exchange rate.

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