Emerging Markets Analysis – Thursday, April 28, 2016

Country-Sector Focus: Philippines – Mining


This emerging markets analysis examines the primary external factors affecting commodities, Philippine mining sector with a closer look at Nickel Asia, and the outlook for Philippine equities and mining stocks from the perspective of an analyst/trader that utilizes fundamental, technical, quantitative, and intermarket analyses. Lastly, a Philippine Mining Sector Dashboard is provided.

The Party Ends When The Punch Bowl Is Removed

As the 2013 Taper Tantrum foretold, anticipation and the eventual ending of QE3 in Oct 2014 led to massive unwinding of leverage trades and re-assessment of yield-searching investments. As capital returned to the US, the greenback strengthened, boosting the USD Index from around 80 to over 100, or 25%, within eight months (Chart 1). Simultaneously, huge capital outflows from China resulted in the weakening of the renminbi as the PBOC side-stepped the dollar freight train (Chart 2). The Fed givenths and takeths away.

For the Middle Kingdom, its credit-fueled investment boom ground to a halt that, along with the appreciating USD, increased volatility, withdrawal of liquidity, excess capacity, and global slowdown in business investment, contributed to the bludgeoning of commodities. In the aftermath, China’s banking and financial system remains a major risk as rising NPLs and special mention loans (loans very likely to become non-performing) on normal on-balance sheet loans at commercial banks and imploding off-balance sheet/SIV high-interest paying wealth-management products  continue to be a prime drag on the economy as loan officers, rightly so, are hesitant to lend. China’s regulators seem to be buying time by forcing banks and financial institutions to equitize certain NPLs (swap NPLs for common stock). Should the underlying companies turn insolvent, the central government would most probably provide capital infusions to needy financial institutions and the more viable, troubled private companies become nationalized.

As discussed in previous reports, the Fed’s dovish shift in mid-Jan leads this author to believe that no interest rate hike is forthcoming in 2016 and that the next major move shall be a rate cut, ZIRP, NIRP, or QE4 (even, possibly, “helicopter money”), most likely occurring after the 2016 US presidential elections (Emerging Market Analysis for Apr 4 2016 and Market Analysis for Mar 29).

Philippine Mining Sector

Over the last 24 months Philippine miners get caught in the maelstrom, under-performing the blue chip PSEi by 30% through the recent Jan lows (black arrow, Chart 3). Those miners recognizing the global macroeconomic and monetary policy implications would have started serious hedging in Sep 2014, if not earlier, as the GreenMango PSE Mining Index penetrated below a previous swing-high in early-Sep and swing-low in late-Sep (horizontal green dashed lines, Chart 3).

Nevertheless, miners’ fortunes took a turn for the best when the Fed, after a widely anticipated rate hike in Dec, suddenly reversed stance just weeks later. The PSEi and mining stocks, after falling for eight months and upwards of twelve months, respectively, immediately bottomed-and-reversed in a “V”-shaped fashion (green dashed “V”, Chart 3). In the last 13 weeks Philippine mining stocks are up 21.8% vs PSEi 13.8% and in early Mar was outperforming blue chips by nearly 20% (Chart 4). A closer look shows that a handful of miners really attracted the eyes of investors: Global Ferronickel +78%, Nickel Asia +52%, Philex Mining +47%, Lepanto Consolidated Mining +46%, Century Peak Metals 45%, and Marcventures +45% (Chart 5, Chart 6, Chart 7).  The constituents and weightings of the GreenMango PSE Mining Index are provided at the end in DB Table 1 and DB Chart 1. Next, a glance at leading Philippine lateritic ore nickel producer Nickel Asia.

Nickel Asia

After a brisk run-up, Nickel Asia’s twin mountain top price formation in late-2014 / early 2015 gave way in the wake of the termination of QE3 (left side, Chart 8). Like all miners, Nickel Asia’s share price was hammered, falling from an intraday high of P16.11 in late-Dec 2014 to intraday low P3.30 in late-Jan 2016. For the last two months, NIKL has been range-bound between P5.85 and P5.10-P4.74 (Chart 9).

The bottoming formation currently taking place in Nickel Asia’s share price (green ellipse, Chart 8) could acquire legs as global investors once again hunt for yield and OFW remittances pick up steam following Feb’s 9% YoY rise (Emerging Market Analysis for Apr 4 2016). Furthermore, as China may likely re-peg the renminbi to the depreciating greenback to reinvigorate its exports, economy, and create inflation to give relief to its growing debt problem, commodities would get another boost.

20160428 Chart 11
Chart 10. Source: InfoMine.

For Nickel Asia, the global economic slowdown led to a glut of stainless steel (SS) product world-wide of which China has been trying to sell-off over the last 18 months, or so (upsetting local SS producers in some countries). Until the SS inventory overhang alleviates and/or SS production capacity reduces, sustainable increased demand for raw nickel will be slow to realize. Hence, LME warehouses remain flush with nickel at 415,075 MT (Chart 10), while spot nickel price sits at around $4.26 per pound (as of Apr 29), having traded above $9/lb in early 2014 and $13/lb in early 2011 (Chart 11). But, the tide seems to be turning as spot nickel is up 23% from its nearly 13-year low in early April.

Looking ahead, the LME 3-month nickel future price stands at $9180/MT, up +10% from early Apr (Chart 12), signifying increasing future demand. For China, rising demand may stem from abroad, from domestic consumption, or both. According to Stainless Steel World, China’s growing domestic consumption of SS shall outpace the country’s GDP rate of growth for years to come.

With Indonesia’s mineral export ban still in place (since Jan 2014, although some concession on nickel concentrates may be forthcoming in 2017), the Philippines and Nickel Asia, specifically, is well-positioned to pick-up any increased demand for nickel from China. Major potential competitors in New Caledonia have long-term supply contracts with South Korean and Japanese firms and South American and North American nickel miners would have additional logistics and transportation costs to contend with.

Outlook for Philippine Equities and Mining Sector Stocks

As discussed last week, since mid-Mar, a flag pattern has emerged in the PSEi signifying a rolling-stop as early-profit takers depart and new equity investors clamber aboard – note confirming volume slow down.  As a continuing indicator, the flag suggests the PSEi would likely run to about 8600-8700 before the first significant correction. Looking ahead, forceful penetration of the upper resistance zone of the flag at around 7370-7380 denotes resumption of the bullish trend. The trigger could emanate from any direction: poor Q1 US earnings announcements, more dovish Fed talk (next FOMC Meeting, Jun 14-15), major FDI announcement, strong OFW remittance inflows, relatively smooth Philippine presidential election (May 9). Two major risks facing Philippine equities and mining stocks are the perceived outcome of May’s elections and yet another flip-flop by the Fed. A down-break below 7180 on heavy volume nullifies the bullish trend set-up, requiring reassessment of the (then) current situation.

Mining companies face other factors, such as shifting USD, USDPHP exchange rate, demand for metal and mineral commodities, energy and transportation costs, and regulatory environment, to name a few. All told, should the Fed push through with an easing monetary policy, causing USD Index to break below its lower support level at 93-94 (lower green dashed line, Chart 1), that would set the stage for further greenback weakening, bringing respite to the mining sector.

So, what is the likelihood of a pick-up in natural resource commodity demand, specifically from China? According to Reuters, Chinese off-balance sheet local government financing vehicles (LGFVs) issued over 538 billion yuan ($83 billion) in bonds in Q1, including a record 287 billion yuan ($44.3 billion) in March. Much of this capital shall likely go to funding infrastructure projects as last year the government raised the debt-to-equity ratio for project financing. This can only help Philippine miners.

Nevertheless, sustainable demand for final products, consolidation or capacity reduction, and further cost reduction and inventory draw-down may still be needed to ensure that metal and mineral prices continue its recovery. Of course, should central banks lose control of the money printing apparatus to create not just moderate inflation, but high inflation, gold, silver, and other metals and minerals would truly show what a price recovery looks like. Presently, spot gold trades at around USD1250/oz  (as of Apr 27), up from USD1050/oz in Dec, or +19%, while silver has risen 25% over the same time frame to roughly USD17.25/oz.

Philippine Mining Sector Dashboard20160428 DB Table 1

DB Table 1. Source: Philippine Stock Exchange

20160428 DB Chart 1