Faltering economic recovery
Early in 2011, the world economy appeared to be growing robustly. Most regions were enjoying robust economic growth after the dislocation of the global financial crisis and a severe recession. The large emerging economies - notably China, India and Brazil - were leading the upswing, but there were also more encouraging trends in the major advanced economies. During the year, all of the world's major economies faltered, contributing to a marked global slowdown. There were three reasons.
First, there were some significant 'shocks' during the year. Political uncertainty in North Africa and the Middle East pushed up oil prices, which depressed activity in the major oil-importing countries. Additionally, Japan's earthquake/tsunami and consequent nuclear power emergency led to a severe fall in domestic production and severely disrupted global supply chains, notably in the auto industry. The recovery has been slow.
Second, policy settings in the emerging economies became much more restrictive in the first half of 2011, contributing to the slowdown in the second half. In particular, central banks tightened monetary policy aggressively as they sought to restrain inflationary pressure. The Brazilian central bank was particularly aggressive and its monetary tightening led to a pronounced economic slowdown in 2011. The Reserve Bank of India (RBI) and the People's Bank of China (PBOC) also tightened policy appreciably, with the macro-economic effects becoming clearer during 2011.
Third, Europe's financial crisis intensified during 2011. Critically, the crisis spread from small peripheral economies to larger economies at the core of the euro zone. During the year, financial markets began to question the government solvency of Spain and Italy. Additionally, investors became much more nervous about the implications of strained government finances on the European banking system. In spite of a series of policy initiatives, markets remained sceptical that policymakers would resolve the crisis. Increasing market volatility and rising risk premiums contributed to a European economic slowdown.
The macro-economic outlook
By the end of 2011, most of the world's leading economies had reported a material weakening. China, India and Brazil reported slower GDP growth rates and falling inflation. This opened up the scope for looser policy. Brazil and China have already moved to loosen policy settings and this should help to cushion their economies in 2012. Lower inflation should enable the RBI to loosen monetary policy, which should also support India's economy. In 2012, real GDP growth should be lower than in 2011, but the major emerging economies should avoid a sharp downturn.
Europe remains the principal source of concern. There are growing worries that the crisis has now become so complex there is no practicable solution. It is possible this could lead to a further intensification of the crisis in 2012 and a deep recession. More likely, policymakers seem to have done enough to contain the crisis. Governments have emphasised their commitment to stabilising the euro and the European Central Bank (ECB) has become more involved in providing liquidity. This should be enough to remove the extreme downside risks to the economy and the financial system.
In the longer term, we expect further significant growth in the main emerging economies as they 'catch up' with the advanced economies. With real GDP per capita still well below levels in the US, there is considerable scope for the convergence of living standards through technology transfer and productivity gains. Over the next decade, this should mean all of the major emerging economies grow rapidly.
Developments during 2011
An attractive pricing environment prevailed for much of the year, underpinned by strong supply and demand fundamentals. In 2011, average prices for Anglo American's main commodities were on average 5% to 39% higher than in 2010.
A year of two halves
Commodity prices were particularly strong during the first half of 2011, despite disrupted trade flows caused by the Japanese earthquake/tsunami and the uncertainty created over the European sovereign debt crises.
Pricing in the first half was well supported by China's demand growth, which remained resilient notwithstanding a general tightening of monetary policy to control inflation. Together with steepening cost curves and widespread supply disruptions, this provided a level of support for pricing, with new record levels set in metallurgical coal, copper and iron ore.
Measures to tighten monetary policy and control inflation in emerging economies such as China and India started to have the intended effect and the rate of growth decelerated in the second half of the year. In addition, a lack of coordinated policy response to tackle the European sovereign debt crises impacted investor sentiment and credit availability. As industrial activities slowed and commodities consumers destocked across the inventory chain, demand for commodities was negatively impacted. On the other hand, supply continued to recover from various disruptions earlier in the year. As a result, individual commodity prices responded, trending lower towards the end of the year.
The main outperformer among the commodities produced by Anglo American was coking coal, particularly in the first half of the year, as producers continued to recover from the flooding and industrial disruptions in Queensland. While prices for coking coal declined in the second half of the year, at the end of 2011 they were broadly in line with the prices achieved in December 2010.
Thermal coal also demonstrated relatively resilient pricing, drifting by only 4% in the second half of the year. All other commodities produced by Anglo American fell by 13% to 23% in the second half of the year.
The December 2011 average price of copper, coking coal, thermal coal and iron ore all remained well above analyst consensus forecasts of long term 'through the cycle' prices, with only nickel and PGM prices at or below long term outlooks.
While analysts adjusted their near term price forecasts as 2011 progressed, their long term price expectations have been increasing, in particular for thermal coal, copper, steel and iron ore. One of the driving forces behind the upgrades to long term prices has been the recognition of the challenges in delivering new supply and an anticipated increase in the capital and operating costs.
Maturing emerging markets
Longer term trends in commodity demand
Although the short term macro-economic outlook appears uncertain, the medium to long term prospect for global commodity demand remains robust as China continues to urbanise and industrialise. China is an important market for most of the commodities produced by Anglo American. Nevertheless, as China shifts from an investment intensive to consumption driven economy, the growth rate in demand for steel materials is expected to moderate to a more sustainable level.
This shift, however, is expected to drive a stronger demand growth rate for commodities such as diamonds and PGMs. These products have completed less than half of their build-up to expected long term demand per capita in China, implying that significant growth potential exists.
Both commodities are experiencing similar growth patterns in intensity of use, which reflect comparable rates of growth in intensity of use per gross domestic product (GDP) in rapidly industrialising countries such as China. Typically, intensity of use reaches a peak quite quickly, to be followed by a declining growth rate - though overall consumption continues to rise.
While Chinese intensity of use per GDP for commodities such as copper and steel may have peaked in recent years, we expect sustained growth for PGMs and, particularly, diamonds.
Of course, China is not the last country expected to experience this cycle of commodity demand; India and other rapidly growing emerging economies such as Indonesia, the Philippines and Turkey are expected to be significant consumers of commodities. Just as China filled in the gap left by slowing demand growth in the developed world, these countries will generate increasing rates of commodity demand growth as they progress economically.
Supply constraints and increased capital intensity
While demand is clearly one key driver of prices, supply side factors also play a crucial role in commodity price performance. Mine-specific costs, both capital and operating, have been rising markedly since around 2004 and are expected to continue to provide upward pressure on prices across the mining industry over the medium term.
For example, the availability of more readily mined copper deposits has declined over the last decade, while falling average grades, increasing infrastructure requirements, growing technical complexity and more frequent use of underground mining have resulted in cost escalation significantly above general inflation. Such structural challenges have been exacerbated by industrial action, shortages of equipment and skilled labour, higher mining taxes and royalties, a weaker US dollar and increasingly onerous environmental and social legislation.
This is not a commodity-specific phenomenon; similar cost inflation is being experienced across the mining industry and, as a result, both capital and operating cost escalation have had an impact on the rate of introduction of new capacity across most commodities.
Our strategy in action
Our ambition, strategy and unique portfolio
Anglo American aims to be the leading global mining company - the investment, the partner and the employer of choice - through the operational excellence of world class assets in the most attractive commodities, and a resolute commitment to the highest standards of safe and sustainable mining. We believe attractive commodities to be those that generate superior returns through the economic cycle, based on favourable supply-demand fundamentals. We consider world class assets to be those that are low cost, large, long life and with clear expansion potential.
In order to achieve this, we own, operate and grow, through discovery and acquisition, mining assets in those commodities and businesses that we believe deliver the best returns through the economic cycle and over the long term. We aim to focus on businesses in which we have advantaged positions, i.e. large scale assets with long lives, low cost profiles and with clear expansion potential.
Anglo American has a unique and diversified portfolio. Its mix spans:
- Bulk commodities - iron ore, metallurgical coal, thermal coal and manganese ore. These materials are typically used in investment and infrastructure development in earlier stages of economic development.
- Base metals - copper, nickel and niobium. These commodities are typically used more during the 'consumptive' stages of economic growth, which correlate to the middle stages of economic development.
- Precious metals and minerals - platinum and diamonds, in both of which we are a global leader. These businesses are typically later cycle, with peak demand coming from richer, more developed areas.
Anglo American's current portfolio is uniquely diversified, with material exposure to metallurgical coal and iron ore, which both benefit from continued industrialisation in emerging economies, while also having exposure to later cycle businesses through platinum and ultimately, diamonds, as GDP per capita increases.
Cash flow allocation
In a long cycle industry such as mining, the inevitable investment decisions, capital allocation and balance sheet management require sound judgement to build a sustainable and value creating company.
The Board of Anglo American has a balanced and disciplined approach to capital management, focusing on:
- Delivering value accretive growth through our attractive projects pipeline and opportunistic M&A to supplement the pipeline.
- A clear dividend policy, providing a base dividend that will be maintained or increased through the cycle.
- Maintaining a robust balance sheet through the cycle.
- Returning surplus cash to shareholders.