Glenn Freeman: Morningstar's Matt Hodge has recently put out a special report on Australia's mining sector. And in this, he outlines why we've got quite a different view to the rest of the market on iron ore and commodity prices, on the sustainability of Chinese demand and how this plays into some of the giants of this sector, BHP, Rio Tinto and Fortescue.

Mathew Hodge: If you look at where China is on the – if you look at their GDP per capita, say, they consumer more copper, more aluminum, more steel than pretty much any of the countries that have come before, and they have done it at an earlier stage of their cycle. If you take something like steel, it's not really consumed in a single year like oil is. It goes into buildings and cars and things that are in the economy. So, when you add all that up, the steel is still in the economy. If they keep consuming at the rate they are at, they will have as much steel per person in their economy as the western world does now in 10 years' time. So, they are rapidly using up their runway for more commodities. And we see that in the kind of investments they've made. But if you step back and look at the debt versus GDP, that's been growing quite rapidly. But we haven't really had any severe repercussions for that yet.

If you look at the kind of assets that they are investing in and the returns that they are getting on that, it's not justifying the spend. That's why the debt to GDP ratio is rising. And it's been very few times where the debt to GDP ratio has been rising like it has in China where that's ended benignly. In Japan, it ended with a long period of stagnation. But in other places, you have had worse scenarios than that. So, to expect prices to stay high and for returns for the miners to stay high, I mean, the market has really just kind of taken its eye off those structural issues that it was concerned with a couple of years ago. But really, all that's happened in the interim is that debt has grown in China and that's been used to fuel more consumption. So, we've re-based higher, but it's going to be even harder to keep that rate up.

It's tracked quite a different path from the others. So, it's more volatile. It's got more leverage because it's the higher cost. But also, in the past, sort of, year or so the discounts for the lower-grade oil have really blown out and that's impacted its share price. I mean, the peak was around $7. It's now $4.50-ish, something like that. So, while BHP and Rio have continued to go up, Fortescue has come back. And the market has been factoring in increasing amounts of what the current discount is. So, for Fortescue, we think in a more normal environment where steel margins aren't as high, then the penalty for steelmakers using lower-grade oil would be less and the discount won't be as bad. So, that would partly offset the falls that we expect in the iron ore price. So, that's the key reason with Fortescue.

Rio is the most expensive, because iron ore is really the main game for Rio. It's more than 60% of this year's earnings. And steel is the commodity where we are most bearish like steelmaking materials. Because A, we see China's demand falling for the reasons I talked about before, but also, we expect scrap to take an increasing share of steel production. So, that will be to the detriment of iron ore and coking coal.

BHP, because of oil, we are a bit more positive on oil. But if you look at BHP and Rio together, they are basically pricing in pretty close to spot rates. And given that operating costs have come down quite a bit, the cost to add new supply, particularly in iron ore has come off quite a lot. If conditions kind of stay stable and prices stay where they are at, we think there will be a supply response. And you can see with the more aggressive players, looking at Atlas Iron, like Hancock Prospecting, Fortescue and Mineral Resources, they are probably the three players in the (indiscernible) that make most sense that they would push ahead, and they have all got the funds to do it. So, if you are making your return, I mean, I think, there's a reason for them to – you can form a reason why they would want to add supply.