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Brian Tora: Mining firms on shaky ground

The stalling Australian economy and Glencore’s £5bn write down show how things have changed for the mining sector and will continue to adversely impact the FTSE.

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The Australian general election takes place on 7 September and while the potential outcome is hardly being followed with the intense scrutiny accompanying the German elections, due later in the month, there is some reason to take note of the arguments being presented at the hustings.

It is increasingly looking likely that the incumbent Labour administration will be ousted. And the reason? It’s the economy, stupid, as Bill Clinton once remarked.

To many of us, having watched with envy at the growth enjoyed by the Australian economy and aware also of the strength of the dollar there, this seems rather strange. But life has become tougher more recently as shrinking Chinese demand reduces the earning power of Australia’s most important export – raw materials. The Aussie economy has become dominated by mining companies and the prosperity of the nation has been built on the seemingly unstoppable growth in China.

But no longer, it seems, as mining company after mining company reports falling profits and the emphasis moves away from finding new resources to managing costs more efficiently.

Moreover, the strength of the Australian dollar impinged adversely on that other great export from down under – wine. The economy will clearly be more of a focus for the electorate as the nation endeavours to find new ways of maintaining momentum.

As it happens, a number of leading mining companies have their primary listing in London, so how they fare will have a profound effect on the behaviour of our benchmark FTSE 100 share index. The growth in the importance of this sector once again demonstrates how misleading an index this can be. Once it was financial stocks that ruled the roost in London. Now it is resource companies, so our market has suffered from the decline in demand from China.

To give an indication of how things have changed, Glencore recently wrote down the value of its acquisition of Xstrata by nearly £5bn – and the deal was only concluded earlier this year. The reason it gave was the different environment in which mining companies now operate. A few years ago it seemed as though the demand for iron, coal, copper and other minerals could only rise. Now we know that a conventional cycle was in play – it just went on for longer than in the past.

The end of the great building boom in China is not the only challenge these businesses have to face.

In South Africa, another resource-rich nation, union militancy has led to civil unrest and the promise of damaging strikes as workers demand a better deal from the mine owners. The fact that China has been sourcing many of the raw materials it still needs from this still relatively under-developed continent has not been lost on union leaders.

Mining is a global business and one which is always likely to reflect the state of the world economy. Slower growth will mean less demand and tighter pricing, The days when these resources could be extracted with little regard to cost are now clearly over but this is too important a sector to ignore, especially given the effect the performance of these companies is likely to have on our domestic market.

Perhaps the other related issue worth remarking on, aside from the growing tensions in the Middle East, is the rise in the oil price which reached a six-month high last week. Perhaps it is even higher still now but it has not just been the Syrian conflict which has been responsible for dearer petrol. Libyan output has collapsed, partly due to strikes but also because the security situation there is dire. The Middle East has once again exerted its grip on market sentiment.

Brian Tora is an associate with investment managers JM Finn & Co

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