Don’t worry about who’s swimming naked, we now have bodies floating to the surface

Confession time. It always precedes annual reporting season and arrived on cue this week with IGO first to admit to an almighty blooper when it wrote off close to $1 billion, or almost 75%, of what it paid last year for nickel miner Western Areas.

By Tim Treadgold.

Message in a bottle

To borrow a graphic description from New York fund manager Seth Klarman, the Western Areas deal was the “first of the bodies to float to the surface”.

In IGO’s case, the body of Western Areas cost $1.3 billion, of which between $880-and-$980 million is being written off in what’s a truly horrible deal for IGO shareholders.

Technically, the write-off is a non-cash, pre-tax charge. But it is still money flushed away because IGO obviously paid too much for an asset about which it knew too little – until it was too late, costing IGO shareholders a $1.05 (6.5%) share price fall to $14.94.

There could be more to come with another example of unexpected problems being Woodside Energy reporting this week that its Sangomar oil project in Africa will cost 13% more than expected and be six months late.

Next off the confessional cab rank could be the local investor favourite, Wesfarmers, with Citi saying it is concerned about bloated lithium asset values being used by market analysts.

Citi said a consensus value of $4 billion for Wesfarmers half share of the Covalent project did not reflect the challenges of building a lithium project or the prospect of lower lithium prices. The bank said $3.1 billion was a more accurate value, adding to a case for a sell tip on Wesfarmers and the prospect of an 18.7% share price fall to $40.

The reckoning underway in all sectors of the market is part of a sea-change which is likely to include one (or two) further increases in interest rates to try and squeeze the last drop of inflation out of the financial system, followed by a pause lasting into next year before rate pressure eases.

Waiting for the change is heightening investor uncertainty, as are the latest doubts about the strength of the Chinese economy and that country’s appetite for Australian commodities, and the worsening health of the European economy, which is burdened by the Ukraine war.

The overall result is the stock market taking one-step forward followed by one step back, a two-step polka which saw the all-ordinaries index rise this week by 0.7% to be almost exactly where it was a month ago - a situation called going nowhere.

Gold was again the best of the metals world, adding US$20 an ounce to US$1985/oz as investors prepared for the turn in interest rates. Citi refreshed a forecast that gold will rise to around US$2200/oz in the first half of next calendar year.

Before getting to the detail of this week’s news-and-moves it’s worth considering a bit more from Klarman, if only because he is normally an ultra-low key fund manager.

His comment about bodies floating to the surface was part of a podcast in the Capital Allocators series (Seth Klarman – Timeless Value Investing (EP.328) - YouTube) in which he described the market as “ the weirdest in 40 years”.

The most pointed remarks by Klarman, who manages US$25 billion of other people’s money, is that small investors are partying like there’s a boom while professional fund managers are more underweight than they were during the depths of the 2020 Covid crash.

Successive market bubbles in credit, followed by a bubble in meme stocks, and then a bubble in cryptocurrencies encouraged rampant speculative activity which includes this year’s rally in the U.S. market which Klarman said is hard to explain given the tough financial conditions and sharp interest rate increases.

“We haven’t seen a lot of bodies float up. I don’t know what that means. But I would be worried,” Klarman said.

Morgans, in a preview ahead of the flood of annual and half-year reports, said the key feature to look for will be quality of earnings.

“Key themes to watch for include financial ’24 earnings trends, higher interest costs, cyclical signposts (such as consumer demand and industrial margins), small cap performance, short selling and positioning in resources,” Morgans said.

A taste of what’s to come, and the divergent views of professional analysts and enthusiastic amateurs, was the reaction to BHP’s production report which precedes the annual result.

On the market, the amateurs kept buying BHP even as it slipped 1% lower to $44.74, while investment banks urged caution with RBC tipping a price target of $38 and UBS going a notch further down at $37, complete with a sell recommendation.

Genesis led the way among the gold stocks with a rise of 22c to $1.46 as it beds down the Gwalia acquisition. Evolution was the best of the gold majors with a rise of 6.5c to $3.75, whereas its rival for top dog status, Northern Star, lost a hefty $1.42 to $11.80 after missing consensus production forecasts for the June quarter.

Other gold moves included:

  • Bellevue slipping 5.5c to $1.53, rubbing a little of the gloss off its 22% rise over the past month as investors take position ahead of the first gold pour in the December quarter.
  • Astral adding 1c to 7.7c after reporting a fifth resource upgrade at its Mandilla project near Kalgoorlie in WA which is now estimated to contain 1.25 million ounces of gold, and
  • Black Cat Syndicate losing 2c to 43c despite encouraging exploration news from work at its Paulsens project in WA. Shaw and Partners retained a buy tip and 83c price target.

Mineral Resources made the big move this week in lithium with the announcement of a revised deal covering the joint venture it has with U.S.-based Albemarle, which is said to simplify the arrangement, a move which helped MinRes rise by $3.22 to $75.73.

Leo Lithium was the other newsmaker but for reasons yet to be revealed having requested a trading suspension pending the release of correspondence with the government of Mali where it is developing the Goulamina project. Before trading was halted, Leo was down 7c at $1.14.

Other lithium news and moves included:

  • Patriot Battery Metals down 23c at $1.56 as it wards off a short-seller attack.
  • Narryer Metals up 6c (54%) at 17c after announcing the acquisition of a portfolio of lithium exploration assets in Canada.
  • Azure Minerals, up 10c to $1.81 as grades in its Andover project in WA get better. Bell Potter refreshed a buy tip and price target of $3, and
  • Citi forecasting a balanced lithium market for the next two years after two years of deficits with the result being a slight easing in prices for the battery metals.

Iron ore was steady during the week at US$116 a tonne but Rio Tinto warned that the outlook for demand was cooling as uncertainties grew about future Chinese steel demand.

That warning helped shave $2.28 off Rio Tinto’s share price which slipped to $116.50 while Fortescue, the biggest pure play iron ore miner, added 30c to $22.56 despite being in the news for the wrong reasons early in the week over governance concerns.

Elsewhere, newsmakers included:

  • Sovereign Metals adding 6c to 52c after announcing a deal with Rio Tinto over its Kasiya rutile project in Malawi which will see Rio Tinto pay $40.4 million for a 15% stake in the asset.
  • Australian Rare Earths rose by 1.5c to 32c after announcing encouraging assays resulted from its Koppamurra project spanning the Victoria/South Australia border.
  • Nimy said it had identified geophysical features which might point to high grade nickel mineralisation at its Mons project in WA. The stock added 1c to 17c.
  • Citi stirred the copper sector with a repeat of its forecast that the metal will trade up to US$5.40 a pound (US$12,000 a tonne) by 2025, a hefty 41% increase on the latest copper price of US$3.82/lb, and
  • Peninsula Energy slumped by 6c (34%) to 12c after reporting that a uranium processing partner at its Lance project in the U.S. had withdrawn.

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