Dear China, When Will Commodity Prices Rise? Thanks, Caterpillar Inc.

In the first part of this article, we wrote about how big a percentage mining equipment represents of Caterpillar’s declining sales, and how Rio Tinto, BHP Billiton and other mining majors will be cutting back on investment expenditures.

Cat’s machine sales in the Asia Pacific region dropped 24%, according to the FT. Clearly Asia, which would include Australia, was hit by both falling commodity prices and the strong Aussie dollar, depressing earnings and mine expansion, but sales in North America to the coal industry have also been hit by the shale gas revolution.

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Lower natural gas prices have worked their way into power generation, hastening a switch from coal to natural gas as a feedstock and hitting the sales of diggers and dump trucks for coal miners. Coal production is down 10% this year with no sign of a turnaround.

Nor is Caterpillar alone – their rivals are in the same position.

The FT reports that Joy Global, a Milwaukee-based mining equipment services group, reported a roughly 30% drop in orders in the quarter ended Jan. 25, to $1 billion, compared with a year earlier. In the previous two quarters, Joy orders dropped 5% and 25%, respectively, year-on-year.

So should we take Caterpillar’s assertions that the worst is behind them, and a return to growth in China in H2 2013 and 2014 will see commodity prices (and hence demand for mining equipment) pick up again?

Certainly the firm has positioned themselves well for the downturn, but predictions of an upturn this year or next is, in our opinion, premature.

Construction remains depressed in the US and there is expectation the US could go into a mild recession later this year or next. The HSBC China Manufacturing PMI reading for April slipped to 50.5, compared to 51.6 in the previous month, still in growth, but slowing. The report detail showed a drop in new export orders as the main driver of the easing back in activity, not surprising when Europe is back in recession and the US is looking wobbly.

Where is a sharp pickup in demand going to come from, one that would push up commodity prices?

As we have written about recently, commodities like iron ore, coal, copper, etc., are in surplus and new mines are coming onstream. A sharp upturn in mining activity and mine investment seems unlikely in the next 18 months.

The best Caterpillar can hope for is a steady revenue flow on the back of cost-cutting and streamlining, actions the firm have well in hand.

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