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Managements Leading Companies Off a Cliff

The quickest and surest way for investors to lose money is to invest in companies where the management is, to put it politely, incompetent.

Numerous instances exist throughout history. But we’re perhaps seeing the worst example ever, and it’s from the global mining industry. The level of incompetence being displayed is simply astonishing.

Chinese Steel Collapse

China has the world’s biggest steel industry, producing half of all steel. Crude steel output there soared more than 12-fold between 1990 and 2014.

But now, thanks to overcapacity, the Chinese steel industry has shifted into reverse in a big way. Prices have fallen by nearly 30%. Steel rebar prices in China on the Shanghai Futures Exchange are at all-time record lows. Rebar prices are down 30% this year alone.

As losses continue to mount for the industry, even Xu Lejiang, Chairman of giant steelmaker Shanghai Baosteel, said that the industry’s output will collapse by a fifth in the not-too-distant future. Forecasts are for a drop in production of at least 23 million metric tons (mmt) over the next year.

The China Iron and Steel Association is in general agreement. It says that output probably permanently peaked in 2014 at 823 mmt. In effect, we’ve seen peak steel.

Iron Ore Dreams

That’s bad news for the major iron ore miners – Vale S.A. (VALE), Rio Tinto PLC (RIO), and BHP Billiton (BHP). China will cut back on its imports of iron ore, a key ingredient in steelmaking.

The evidence is already there. The Baltic Dry Index, which includes ships that carry ore, hit its all-time low on November 20 at 498. Iron ore itself hit an all-time low – spot pricing began in 2008 – about a week ago at $43.40 per metric ton.

Logic would dictate the miners cut back production. So does Economics 101.

But the managements at the big three continue to live in a fairy tale. They continue clinging to their forecast – that Chinese steel output will rise 20% over the next decade – like drowning men to a life preserver. In fact, Rio Tinto still forecasts that annual Chinese steel production will hit a billion tons by the end of the decade.

So the three blind mice (iron ore miners) continue raising output, using a scorched earth policy to eliminate the competition. In fact, next year, Vale will open the world’s largest iron ore mine (Serra Sul in Brazil).

And the iron ore sector isn’t alone. Other mining segments – including copper, zinc, and nickel – continue to produce as if there’s no tomorrow.

How to Spot the Bottom

Eventually, the long nightmare for shareholders in mining companies will end.

So how do you spot the signs that a bottom is coming and brighter days are ahead?

Output cuts will help. But if Company A cuts its production, the dreamers at one of the big three miners will simply raise their output even more.

A true signal will be the removal of one of these totally incompetent management teams. That should start the ball rolling toward real change.

I then expect the big miner that made the change to finally say “uncle.” And I don’t mean just deciding to finally cut back on output. I mean throwing in the towel completely, walking away from a segment like iron ore, and permanently shutting down production.

If a permanent shutdown doesn’t occur, miners will be in the same boat as shale oil producers. As soon as the price blips up a few dollars, a flood of supply hits the market. A commodities version of Sisyphus, if you will.

That may happen sooner rather than later. In iron ore, for example, the price is quickly approaching the breakeven level for some of the big miners. This is despite falling freight, oil, and currencies helping to lower miners’ costs.

Until the permanent shuttering of mines occurs, the sector will remain in its downward spiral.

Good investing,

Tim Maverick

Tim Maverick

, Senior Correspondent

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