So, it has begun. On Wednesday 18 December Federal Reserve chairman Ben Bernanke announced that the US Central Bank will begin to scale back its bond buying programme – what’s known as quantitative easing. The era of abnormally low interest rates is coming to an end.
Well, eventually.
To my mind, Bernanke could only have been more timid with his ‘taper’ if he and his central banking colleagues had decided not to taper at all.
From January, the Fed will buy $10 billion fewer government bonds and mortgage-related securities each month. But it will still be buying $75 billion worth.
What’s more, Bernanke went out of his way to stress that ultra-low interest rates aren’t going anywhere – in fact he committed to keep the bank rate at rock-bottom lows even after US unemployment falls below the threshold of 6.5%.
All of this could repercussions for resource giants like BHP Billiton (LSE: BHP) (NYSE: BBL.US), although their fate is hardly the first thing on Ben Bernanke’s mind!
Boom and doom
During the past decade, BHP Billiton and the other mega-miners boomed on the back of rising commodity demand and prices, thanks largely to the seemingly insatiable demand of China.
While Western onlookers gasped as yet another million person city rose in the world’s most populous country, mining executives – and investors – saw dollar signs in the skyscrapers.
As a result, they kicked off new mining projects, convinced the world had entered a commodity ‘super-cycle’ that would ensure the profitability of new mines for years.
However, since then we had the little matter of the financial crisis, and an arguably related slowdown in China. Demand for raw materials has abated, and prices have fallen. Add the impact of that new supply and over-capacity, and the result has been plunging turnover and profits for the likes of BHP Billiton.
As a result, BHP and other big miners have promised to curb capital expenditure and get costs under control – and have occasionally even shown signs of doing so. Investors who have bought into BHP Billiton for its chunky 4.3% yield don’t want to see its cash flow wasted on mines that aren’t likely to immediately turn a profit.
So where does the Fed fit in?
It’s a long way from Washington to Antamina – BHP’s jointly owned copper and zinc mine in Peru – but even there managers feel the impact of the Federal Reserve’s decisions every day.
Low-to-negative real interest rates from QE have long been blamed for pushing up oil prices despite slackening demand, which increases the cost of the energy required to run a huge mine. But they also boosted metal prices, since QE weakened the dollar, meaning it took more of bills to buy your dollar-denominated raw material of choice.
However, the mere mention of the possibility of reducing QE in May has increased US bond yields, and caused so-called ‘hot’ money to flow out of emerging markets worldwide. That’s threatened the stability of a host of developing world currencies as well as their markets, and such weakness is hardly conducive to growing demand for raw materials.
The copper price fell sharply in the weeks following Ben Bernanke’s first comments in May – not what BHP staff on the ground at Antamina would have wanted to see, given that output at the pit had just been boosted 40% following a $1.3billion investment programme.
One step forward, two steps back
However, since summer the copper price has recovered somewhat, and I think this holds the real clue to BHP’s fortunes in the wake of the Fed’s tapering decision.
You see following the pandemonium caused by his mention of tapering in early summer, Ben Bernanke and his colleagues have gone out of their way to reassure us that tapering does not mean tightening.
That proviso was double-underlined in a news conference following the $10 billion taper announcement. US interest rates will stay low for the foreseeable future.
And there’s more. The Fed chairman stressed he was starting the taper because he sees real traction in the US economy, with housing and autos showing undeniable strength. While much of the material used in US manufacturing is recycled from previously extracted metals, a strong pick-up in activity – together with that Fed commitment to keep interest rates low for longer – should help put a floor on prices, especially if it boosts confidence in the emerging markets.
Dig for victory (for now)
All of this should be positive for BHP Billiton. It needs growing demand and firmer prices to justify the capital expenditure it made when the commodity super-cycle was all the rage.
Expectations may have been toned down, but the US Central Bank – not to mention the Bank of Japan and those closer to home in the UK and Europe – remain committed to triage for the global economy, which should mean sustained consumption. A weaker dollar from continuing low interest rates is the icing on the cake.
Shareholders in the mega-miners seem to have been let off the hook for now. Someday the Central Bankers will take away the punchbowl, but now is not that day.
