It looks like the US Federal Reserve is getting set for a long, hot summer of interest rate hikes, as fighting inflation moves to the front and centre.
The big question market watchers are asking now is whether or not Fed chief Jerome Powell will be able to pull off the trick of raising rates and avoiding recession at the same time. On the whole, the consensus is that he won’t.
When rates rise, so does the dollar – as we’re already seeing. Over the past 12 months the DXY – the measure of the dollar’s value against a basket of other major currencies – has risen from just above 90 to almost 105. These are not small percentages at all, and the expectation is that there’s more to come.
Unsurprisingly, equity markets have not responded well to this new dynamic, and there are several reasons for punters to be bearish in such an environment.
First off, there’s tightening of the easy money that’s going hand in hand with the rate rises. Printing money made the dollar worth less, and as a natural correlation everything else – including equities – worth more. It may have been artificial, but it felt good.
More seriously for equity markets is the impending recession itself. That contraction of economic activity isn’t good for anyone, and certainly takes the appeal out of putting in any large buy orders.
We’re not yet at the stage of meltdown, though, and it may be that carnage along the lines of the late 1970s or even 2008 can still be avoided, given that the Chinese economy is to be bouncing back faster than expected from recent lockdowns.
That resilience bodes well for the mining industry, which for the last 20-odd years or so has come to rely on China to keep demand levels high, and supply tight.
Mining company shares have moved down in line with the boarder equity markets, but they haven’t cratered in the way that you might expect if a deep global recession was looming.
Partly, this is because of the unusual nature of the current international economic dynamic – the attempt by the US to lock Russia out of global trade has had the effect of tightening supply in most major metals, as well as oil and agricultural produce. That in turn means that prices are holding up relatively well, even in the face of the stronger dollar, when in more normal circumstances a strengthening of the dollar would naturally lead to a decline.
After all, metals are priced in dollars, and all other things being equal if a dollar is worth more, the metal is worth less. But all other things aren’t equal. Just when the effects of the covid stimuli were petering away, along comes another artificial stimulus created by the Biden government: Russian sanctions.
The fact that these sanctions are largely being paid for by Western consumers through inflation seems to have been lost on the higher echelons of government in Washington. But it hasn’t been lost on voters, who look likely to deliver a significant swing to the Republican party this November.
Whether that swing will make any difference to the miners or anyone else is an open question.
It’s too late now to rescind the trillion dollar stimulus package, and only libertarian-minded Rand Paul has presented any kind of real plan to get the US’s finances back into shape.
What’s more, even if inflation is brought under control, the price hikes that we’ve all seen over the past several months are unlikely to be rolled back. The higher prices are here to stay, and the dollar’s likely to remain strong too as the efforts to tame inflation continue.
That means that for those in industries like mining, which sell their products in dollars, significant opportunities for margin boosts may well arise. Companies that incur costs in currencies that are weaker against the US dollar, but which nevertheless book revenues in US dollars have a clear advantage.
Canada, Australia and South Africa are all cases in point, and yes the loonie, the Aussie dollar and the rand are all down against the greenback over the past 12 months.
That’s all well and good, but inflation isn’t only occurring in the US, and the miners are likely to see a constant given and take over the next few years between favourable currency environments and rising costs.
And then there’s oil, the wildcard.
Oil is a big cost centre for the mining industry, not just because it is used in the huge haul trucks that move the rocks from mine face to processing plants, but also because many an operation is located so remotely that trucking in diesel is the only way power can be provided.
The miners do talk a good game about going green, but at the moment the greening of the industry is really taking place on a case-by-case basis. Oil remains a major input, and with the oil price so high, one wonders whether BHP shareholders really can be that pleased about the recent divestment of the oil division?
On the other hand, reports this week showing that significant swathes of European opinion favour a negotiated peace between Ukraine and Russia may mean that oil will plunge back down to pre-invasion levels in short order. If that happens, it will be a weight of everyone’s minds.
But don’t bank on it.