Fathom Geophysics Newsletter 22

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Industry Conditions: Oz miners back in business

THE Australian mining industry gathered steam in the March 2017 quarter, and explorers have felt the need to ratchet down their drilling expenditures and meterages amid apparent demand-induced increases in drilling contractors' prices.

Our latest analysis of Australian Bureau of Statistics (ABS) data incorporates figures publicly available as at 28 June 2017.*

During the March quarter, the industry continued to build upon the above-average activity level that first emerged in the December 2016 quarter (see red line in Figure 1) as we revealed in our previous newsletter in April 2017.

National economic activity blossomed in tandem with the mining sector (see gray line in Figure 1). In fact, we've noticed that Australian GDP estimates for the third and fourth quarters of 2016 seem to have been revised in a strongly upward direction since our last analysis. We may even be approaching a 'gangbusters' situation for the national economic picture.**

For a recap about the 37 ABS economic series that are factored into our industry analysis and about how we handle the data, see our first mining-industry conditions write-up, which appeared in Issue 17 of the Fathom Geophysics newsletter.

Figure 1Figure 1: Activity level of the Australian minerals exploration and mining industry (red solid line) compared to Australian income from gross domestic product (grey solid line). Data were sourced from the Australian Bureau of Statistics and were the latest available as at 28 June 2017. Results are plotted on a financial quarterly basis (x-axis) and are shown in terms of the number of standard deviations above or below average (y-axis) for the time period analyzed (from the June 2005 quarter up to and including the March 2017 quarter). Dashed lines denote a relatively greater amount of uncertainty, which arises inherently near series end-points upon calculation of 7-term Henderson moving averages. To view a larger version, click on either the image or this text link.

According to our analysis of the latest available data, as at the March 2017 quarter national GDP was running at slightly greater than one standard deviation above the 2005-2017 average. Meantime, the Australian mining industry's overall activity level had just surpassed half a standard deviation above average.

It puts us in one of the more rarefied parts of the upper-right quadrant of Figure 2. Whenever the industry was in this general region of its trajectory (relative to GDP) in the past decade or so, it wasn't very many quarters before a marked change of tack became evident.

When plotted together like this, GDP and industry activity interact in a way that resembles a rollercoaster. Progress when chugging toward great heights tends to be uncomplicated, but once it has peaked, the downward ride involves frequent twists, turns, and loops. During those ebb times, the trajectory plot records the industry's convoluted writhings, as it attempts to resuscitate itself.

Figure 2Figure 2: Trajectory plot of the Australian minerals exploration and mining industry's activity level (y-axis) relative to Australian income from gross domestic product (x-axis) for the time period analyzed (from the June 2005 quarter up to and including the March 2017 quarter). The scale on both axes are constructed in terms of the number of standard deviations above or below average. Dotted gray squares show the +/-0.5 standard deviation iso-line (inner square) and the +/-1.0 standard deviation iso-line (outer square). Note that a relatively greater amount of uncertainty arises inherently near series end-points upon calculation of 7-term Henderson moving averages. Note also that the trajectory line has been smoothed for ease of viewing. Data were sourced from the Australian Bureau of Statistics and were the latest available as at 28 June 2017. To view a larger version, click on either the image or this text link.

Industry is behaving atypically

Turbulence within the industry — which we define as behavior that's atypical — was high in the March quarter, as measured by the data's Mahalanobis distance. This measure was in the vicinity of one standard deviation above average for the 2005-2017 period being analyzed (see dotted line with asterisk datapoint markers in (Figure 3). It's telling us that the underlying action in the various constituent datasets we use is looking relatively non-routine — relatively weird — as opposed to being humdrum and business-as-usual.

If you were, say, analyzing a stream of data from a group of road-traffic sensors and you were using the Mahalanobis distance to scrutinize traffic-flow patterns over time, and you had a result that looked like this, you'd conclude that things are looking quite anomalous. You'd surmise that an atypical number of severe storms, or slow pokes in the fast lane, or construction-related bottlenecks, or car-accident-rubbernecking traffic jams (or some combination of all these) have been happening out there. [1]

If values for the industry's level of unusualness continue to increase as the data for upcoming quarters come in, then many of the important industry activity-related factors we're automatically weighing up as part of our analysis will have reached 'remarkable' levels — in broadly the same way that you'd describe winning the lottery or going through a 1-in-100-years flood as remarkable.

If the Australian mining industry's underlying atypicality continues to grow, and something doesn't give in the meantime, it won't be long before the industry reaches 'extraordinarily weird circumstances' territory.

We're not sure what this would mean for the industry (For instance, would it mean that the industry is headed toward some kind of economic cliff?), because throughout the entire study period we've been studying so far, the Mahalanobis distance hasn't exceeded one standard deviation above average — not even in the lead-up to the highly irregular Great Financial Crisis of 2008-09.

Hopefully, the current level of strangeness, if it's real and not some artifact in the data, resolves in a way that automatically involves a soft landing for the Australian mining industry and its supporting sectors, which have only recently emerged from around five years of adversity.

Whatever eventuates, it'll probably happen within a few quarters, because it seems the degree of strangeness going on in the industry can be very changeable from one quarter to the next (see the circuitousness of the path shown in Figure 4).

Figure 3Figure 3: Activity level of the Australian minerals exploration and mining industry (red solid line) compared to the degree of unusualness or turbulence of the industry's situation as defined by the data's Mahalanobis distance (gray dotted line). Data were sourced from the Australian Bureau of Statistics and were the latest available as at 28 June 2017. Results are plotted on a financial quarterly basis (x-axis) and are shown in terms of the number of standard deviations above or below average (y-axis) for the time period analyzed (from the June 2005 quarter up to and including the March 2017 quarter). Dashed lines denote a relatively greater amount of uncertainty, which arises inherently near series end-points upon calculation of 7-term Henderson moving averages. To view a larger version, click on either the image or this text link.

Figure 4Figure 4: Trajectory plot of the Australian minerals exploration and mining industry's activity level (y-axis) relative to the unusualness or turbulence of the industry's situation, as defined by the Mahalanobis distance (x-axis) for the time period analyzed (from the June 2005 quarter up to and including the March 2017 quarter). The scale on both axes are constructed in terms of the number of standard deviations above or below average. Dotted gray squares show the +/-0.5 standard deviation iso-line (inner square) and the +/-1.0 standard deviation iso-line (outer square). Note that a relatively greater amount of uncertainty arises inherently near series end-points upon calculation of 7-term Henderson moving averages. Note also that the trajectory line has been smoothed for ease of viewing. Data were sourced from the Australian Bureau of Statistics and were the latest available as at 28 June 2017. To view a larger version, click on either the image or this text link.

Productivity returns to the sector

Our subindex charting the Australian mining industry's production and income has reached quite giddy heights in the March 2017 quarter (see gold line in Figure 5). The subindex has only reached this sort of level on three previous occasions since early 2005. The industry's collective selling off of less productive parts of the farm ('non-core assets') over the past couple of years helped set the scene for this. [2]

Nevertheless, inventories of mineral commodites (see green line in Figure 5) still look stubbornly high despite robust-looking exports (see purple line in Figure 5), despite an apparent firming of sales (see salmon line in Figure 5), and despite all of the market discipline imposed on the industry in the past few years.

Inventories seem to be hovering around the whole study period's average. This may be explainable in large part by moderation in China's economic growth as it moves toward becoming a consumption-led economy and toward implementing industrial reforms and environmental curbs [3]. China is also said to be attempting to knock down its high and growing levels of financial system over-leveraging, which may in turn weigh down China's GDP growth, depending on how Chinese authorities choose to approach the task [4]. And things seem fairly lukewarm worldwide: global GDP growth projections are generally expected to be in the vicinity of 3.5% in 2018, which is essentially the amount of annual global GDP growth achieved over the past few years. [4] [5] (And don't forget that such nominal GDP growth figures are reduced by inflation to a smaller 'take home' figure.)

Expenditure (see blue line in Figure 5) is trending back toward the study period's average, but is still low by anyone's standards. (Industry wages are stagnant and so aren't currently driving our expenditure subindex up in any material way.)

Overall, the various recent movements in the Australian mining industry's subindices suggest that the sector has finally been seeing a bit of relief from years of 'rebalancing', a euphemism for 'desperate times'.

Figure 5Figure 5: Mineral commodity demand-side and supply-side subindices: Production and Income, Expenditure, Exports, Sales, Inventories. Also shown is the unusualness or turbulence of the industry's situation, as defined by the Mahalanobis distance. Data were sourced from the Australian Bureau of Statistics and were the latest available as at 28 June 2017. Results are plotted on a financial quarterly basis (x-axis) and are shown in terms of the number of standard deviations above or below average (y-axis) for the time period analyzed (from the June 2005 quarter up to and including the March 2017 quarter). Dashed lines denote a relatively greater amount of uncertainty, which arises inherently near series end-points upon calculation of 7-term Henderson moving averages. To view a larger version, click on either the image or this text link.

And profitability comes roaring back

It's no hyperbole to say the profitability of the Australian mining industry has shot through the roof in the past few quarters (see various red lines in Figure 6). This profitability resurgence first emerged in late 2015, and climbed steeply throughout 2016. The phenomenon has been noted in the news media. [6]

While significant worker layoffs, the idling of support services, and the culling of other expenditures (see blue line in Figure 6) have paved the way for improved profitability, this isn't the whole picture.

The real driver behind the money making has been better commodity prices for exporters (see green dotted line in Figure 7).

"The increase in commodity prices since late 2015 has boosted the profitability of firms in the mining sector," the Reserve Bank of Australia said in its May statement on monetary policy. [4]

"However, this has not led to a material increase in new investment or employment in the sector, partly because the increase in prices is not expected to be sustained."

The central bank said that companies in the industry had instead been applying profits towards debt and dividends obligations, and to boost share buybacks.

Figure 6Figure 6: A look at various measures of mining industry company profitability. CPBIT-M is mining company profits before income tax and is shown as a solid red line. CGOP-M is mining company gross operating profits and is shown as a dashed red line. RAT-BGOP/S-M is the ratio of mining business gross operating profits to sales and is shown as a dotted red line. Our expenditure subindex and inventories subindex are shown for comparison purposes. Data were sourced from the Australian Bureau of Statistics and were the latest available as at 28 June 2017. Results are plotted on a financial quarterly basis (x-axis) and are shown in terms of the number of standard deviations above or below average (y-axis) for the time period analyzed (from the June 2005 quarter up to and including the March 2017 quarter). For each subindex shown, dashed lines denote a relatively greater amount of uncertainty, which arises inherently near series end-points upon calculation of 7-term Henderson moving averages. To view a larger version, click on either the image or this text link.

Explorers chagrined at rising drilling prices

In the first quarter of 2017, exploration drilling went through a more precipitous drop-off than one might expect given the sizes of the previous drilling 'pauses' seen around the changeover of each calendar year (see the brown lines in Figure 7). The marked drop-off occurred in terms of both meters drilled and dollar expenditures.

But we don't think this is due to a simple lack of interest in drilling on the part of explorers. Rather, we suspect it's because explorers have begun to become a little too eager to finally get out there and drill after a very long lull.

Here's how our thinking goes.

We've noticed that in the September 2016 quarter exploration drilling activity-by-meters (the dashed brown line in Figure 7) and the activity-by-expenditure (the solid brown line in Figure 7) converged. Our data analysis currently puts these two measures practically in lock-step with each other. It looks like the last time this happened was in late 2012 and early 2013.

The convergence may have contributed significantly to the current drilling activity drop-off.

We say this because you could regard Figure 7 as a litmus test for the collective purchasing power of explorers working in Australia. When the activity-by-meters is riding higher than the activity-by-expenditure in relative terms, we can infer that buyers of exploration drilling services are experiencing a favorable pricing environment, while the service providers are undergoing an only-the-fittest-will-survive 'sweating'. And the more widely the by-meters and by-expenditure measures diverge, the more service providers are sweating.

The converse — when drilling activity-by-expenditure is greater than drilling activity-by-meters relatively speaking — indicates drilling service providers are able to call the shots more when it comes to commanding higher prices for their work (all else being equal).

We think the industry is on the cusp of crossing over from a buyer's market to a seller's market when it comes to exploration drilling services.

This seems to gel with reportage out there. According to a story by The Australian back in October, a small drilling service provider said that during the September 2016 quarter its average number of monthly drill-rig operating shifts had increased by 45% compared to the previous September quarter. [7] The driller attributed part of its greater workload to its clients' responses to increased prices for key commodities. And the same news story said that bigger drilling companies were making similar remarks last year during half-yearly financial results reporting time. Other news coverage around the world mid last year about drilling service providers painted the same commodity-price-induced-drilling-pickup picture. [8]

Our analysis tells us that the most recent bottoming out of average export prices took place around the September 2015 quarter, and prices attained above-average levels around the June 2016 quarter (see green dotted line in Figure 7).

Figure 7Figure 7: A look at exploration drilling activity. EPI-BOPC-AVE is the average of three different mining-related ABS export price indices by balance-of-payments classification of exports (they are the price index for metal ores and minerals, the price index for other minerals, and the price index for metals excluding non-monetary gold) and is shown as a dotted green line. NONPET-MINEX-EXP-AUS-AVE is the average across new deposits and existing deposits for expenditure on mineral exploration other than for petroleum and is shown as a solid brown line. NONPET-MINEX-MTRS-AUS-AVE is the average across new deposits and existing deposits for the number of meters drilled in mineral exploration other than for petroleum and is shown as a dashed brown line. Our Industry Activity Level (solid gray line) is shown for comparison purposes. Data were sourced from the Australian Bureau of Statistics and were the latest available as at 28 June 2017. Results are plotted on a financial quarterly basis (x-axis) and are shown in terms of the number of standard deviations above or below average (y-axis) for the time period analyzed (from the June 2005 quarter up to and including the March 2017 quarter). Note that a relatively greater amount of uncertainty arises inherently near series end-points upon calculation of 7-term Henderson moving averages. To view a larger version, click on either the image or this text link.

Drilling boycott may be short-lived

So on the face of it, mineral explorers seem to have become disenchanted with drilling as evidenced by total expenditure and total meters, at least for the moment, perhaps seeing it as an overpriced service.

This services-price sensitivity and elasticity may be due to nervousness among explorers about the robustness of the industry's current recovery, given current outlooks for mineral commodity prices. [9]

Explorers may therefore be taking a tentative, wait-and-see-what-commodity-prices-do approach for now. A news story in May relayed figures that the number of non-ferrous metals exploration holes drilled in Australia more than tripled in the March 2017 quarter relative to the corresponding year-ago quarter. [10] This suggests that explorers may be trying to work around rising drilling prices by distributing the fewer total meters they purchase across more holes.

The implication is that each hole on average must be quite shallow — arguably a short-sighted approach when trying to achieve exploration success.

But memory is notoriously brief. Ahead, if export prices remain high, the industry's famous 'make hay while the sun shines' motto threatens to kick in as usual. [2] The World Bank in its April quarterly commodity markets outlook said it projected that metals prices would increase by 16% in 2017. [3]

And if sustained high prices were then to prevail for long enough, the same overexuberant, 'do or die' attitude seen back in 2006-07 and 2010-11 may reappear when it comes to competing for drill rigs and for contractors who can execute production capacity expansion projects.

The fear of being crowded out of a boomtime sellers' market runs strong in the industry.

And perhaps it's stronger than the fear of the ensuing punishment from shareholders and lenders, who will inevitably desert those miners that have allowed their productivity and profitability to be wiped out again by another unsustainable blowout in spending.

* We came up with our data analysis because we wanted a formalized, agnostic and at least semi-realistic snapshot of the state of the industry, instead of relying on statistics like Diggers and Dealers attendance figures, idle drill-rig counts, Gina Rinehart's current net worth, or the price of coffee in Perth, Australia. It's our hope that our industry activity index, our industry turbulence index, and our group of demand-side and supply-side subindices spark useful debate and discussion. Please note that the results of our analysis and our discussion of them should not be regarded in any way as advice (e.g., investment advice, financial planning advice, career advice, and so on). If you choose to act upon the information contained in the above material, then be it upon your own head.

** Keep in mind that the various ABS time series we rely on are subject to upward or downward revisions with each new data release (which is inherent in doing economic surveys). Revisions tend to be only quite minor, and tend to affect only the most recent quarters. But if enough small revisions occur, and if they tend to occur together in one direction (e.g., mostly upward, or mostly downward), then that can significantly reset industry trends seen in the final analysis. It means, for instance, that once all of the next quarter's datasets are made completely available, we may end up seeing a re-jigging of the trends we're currently examining and pondering about in this write-up.

References

[1] R. Warren, R.E. Smith, and A.K. Cybenko (2011) "Use of Mahalanobis distance for detecting outliers and outlier clusters in markedly non-normal data: A vehicular traffic example", Air Force Research Laboratory, 711th Human Performance Wing, Interim Report Number AFRL-RH-WP-TR-2011-0070, Defense Technical Information Center, 52 pages.

[2] J. Smyth (2017) "Big mining groups rebound to extract a profit", Financial Times, 26 April 2017.

[3] World Bank Group (2017) "Commodity Markets Outlook", April 2017, Washington, DC, 63 pages.

[4] Reserve Bank of Australia (2017) "Statement on Monetary Policy", May 2017, 60 pages.

[5] D. Thurtell (ed.) (2017) "Resources and energy quarterly", March 2017, Office of the Chief Economist, Department of Industry, Innovation and Science, Australian Government, 143 pages.

[6] See, for example: M. Janda (2017) "Company profits surge as wages fall", ABC News, 26 February 2017.

[7] T. Boreham (2016) "Glimmers of hope in mining services sector", The Australian, 24 October 2016.

[8] See, for example: J. Yeomans (2015) "Capital Drilling sees signs of recovery in mining sector", The Telegraph, 17 August 2016.

[9] See page 15 of Thurtell (2017), which said: "[M]ining companies appear to be exercising more caution, given that the price gains in 2016 and early 2017 are expected to be at least partly unwound over the next 18-24 months."

[10] M. Chambers (2016) "Mining services set for a comeback as exploration surges", The Australian, 31 May 2017.

About Fathom Geophysics

In early 2008, Amanda Buckingham and Daniel Core teamed up to start Fathom Geophysics. With their complementary skills and experience, Buckingham and Core bring with them fresh ideas, a solid background in geophysics theory and programming, and a thorough understanding of the limitations of data and the practicalities of mineral exploration.

Fathom Geophysics provides geophysical and geoscience data processing and targeting services to the minerals and petroleum exploration industries, from the regional scale through to the near-mine deposit scale. Among the data types we work on are: potential field data (gravity and magnetics), electrical data (induced polarization and electromagnetics), topographic data, seismic data, geochemical data, precipitation and lake-level time-lapse environmental data, and remotely-sensed (satellite) data such as Landsat and ASTER.

We offer automated data processing, automated exploration targeting, and the ability to tailor-make data processing applications. Our automated processing is augmented by expert geoscience knowledge drawn from in-house staff and from details relayed to us by the project client. We also offer standard geophysical data filtering, manual geological interpretations, and a range of other exploration campaign-related services, such as arranging surveys and looking after survey-data quality control.