From spinster to supermodel is some makeover. But the once dowdy mining and metals sector has thrown away its safety specs and become sexy – fast. In March this year the Reuters CRB Commodity Index – one of the most respected bellwethers of commodity futures – came close to doubling since 2002. And natural commodity money has not just been shoveled into mining and gold stocks, but also into energy and agriculture. Commodities prices cooled recently, but many think mining and metals – after the current breather – will race forward again and keep going hard for several years.
However, even though the recent commodities ride has been exhilarating, can a continued lift in prices be sustained long term? Or could prices, particularly in base metals and mining, crash back to earth? And while fund managers try to build up their own factual resources from IROs, are IROs giving them the quality they expect?
Solid prospects
Mining analyst Jim Lennon from Australian investment bank Macquarie Group says that while the recent sell off in commodities has seen some commentators predict further cooling, he thinks prices will stick. ‘There’s no question lead indicators have turned negative,’ he concedes. ‘But what drives metals is supply and demand, and recently we’ve seen inventory levels reach their lowest levels for 40 years. That’s still the case. For example, the supply of iron ore is still extremely tight, as is the supply of coking coal. Nickel is now four times the price it was in 2001.’
In other words, although an economic slump or soft landing could cause prices to drift, metals still won’t suddenly get easier to pull out of the ground. And careful reading between the lines of mining company prospectuses won’t get easier, either. Since the end of 2001 the number of mining companies on London’s Alternative Investment Market (Aim) has almost quadrupled, from 32 to 111. The gap between fine words and delivery, however, is often considerable, says Matthew Vaight, an analyst from Vanguard’s $1.2 bn Precious Metals Fund, led by Graham French.
‘One of the bugbears in this industry is that the mining industry has a pretty poor record on producing projects on time and on budget,’ Vaight points out. ‘Many IROs ignore the capital investment side of the equation and how they allocate that capital. Some talk instead about cash costs of assessing performance, but ignore the initial outlay.’
Although careful number crunching is needed, Todd Warren, an analyst for First State’s £63.1 mn ($114.9 mn) Global Resources Fund, says more than any other sector, the mining industry demands that fund management companies physically get into the field and see the assets for themselves.
‘You’ve got to kick some rock,’ Warren comments. ‘Only by seeing the assets for yourself can you get a feel for whether getting 20,000 tons of copper is achievable. You also pick things up from body language, but fundamentally you need to look around: is the pit good looking? Is it in good condition? Are the ramps looking rough?’
Costly business
These assets also need very expensive equipment – tires for a 300-ton truck can cost $50,000 alone, which means analysts in the field have to have an eye for detail.
‘You just can’t get that sort of information by sitting in an office,’ Warren warns. ‘Often when you’re in remote locations you spend the night at the camp, and you get to have a meal in the mess, have a beer. So you look around: is it a happy place? Is the company keeping its staff? Many of the staff will be technical, engineers and geologists, but this industry has experienced a lack of capital investment, so you don’t have so many younger people to support it as people retire. We are seeing more exploration now, but it’s harder to do when you don’t have the people.’
The right sort of people extends to blue-collar truck and shovel drivers. Warren says First State reduced its position in one of its stocks after realizing truck and shovel drivers weren’t being paid enough. The drivers themselves weren’t worried; a rival was quick to poach them. But it means labor is fought over, right down the skills chain.
The market’s rush to natural commodities also means some companies are getting distracted from the real business of pulling the raw materials out of the ground, Vaight points out. He says gold companies may well talk about the future direction of the market, but he prefers to reclaim this subject for himself.
‘That’s our job,’ he emphasizes. ‘We take a view on the gold price, not the company. What we want to know is how the company is run, which is almost divorced from the price. Too many companies rely on the price to bail them out.’
Ignorance is not bliss
Andrew Ferguson, fund manager of the £66.9 mn City Natural Resources High Yield Trust, worries that fundamental ignorance about the mining sector, even from those who work inside it, is widespread. Too many white-collar employees – IROs and management – have never touched a mining shovel, he says. Ferguson’s an exception to this rule. After graduating he worked in the gold mines of Western Australia as an engineer in the mid-1990s. The experience taught him how to recognize a good mining firm from the inside.
‘Not enough people know what makes a good mining company,’ Ferguson explains. ‘At junior level, it’s management – and these people can make or break the business, or the potential of the deposit.’ What particularly horrifies him is the amount of shareholder cash spent on corporate shindigs. ‘There’s nothing wrong with the cocktail circuit, or the Prospectors & Developers Association of Canada (PDAC) hospitality,’ he says. ‘But spending vast amounts of shareholders’ money on booze is something else. You want to really understand the hypothetical dream, not entertain a whole lot of people. If I want to get drunk at these things, I’d rather pay for the pleasure myself.’
Corporate schmoozing at the expense of shareholders is hardly new. Justin Urquhart Stewart from Seven Investment Management points out that the mining industry has more than its share of people content to indulge themselves in booze at shareholders’ expense. ‘There are a fair few ‘thin’ companies based on ideas and geologists’ echo soundings,’ he says. ‘Many of the small Aim oil and mineral companies are about as good as their geologists’ reports, and often they say they don’t know, either.’ Urquhart Stewart singles out the Vancouver Stock Exchange a few years ago for hosting particularly suspect mining companies, though he says the situation has now improved.
Looking ahead
What might also have improved is corporate social responsibility (CSR) and safety credentials. For example, worker and permit processing or the pace of development of a project, all of which affect worker family welfare, are being taken more seriously by employers, says Vaight.
‘In Mozambique, for example, the biggest killer is not Aids but malaria, so some companies are investing in education and hospitals here,’ he explains. ‘If you are just seen as ripping off local communities then it can come back to bite you with higher taxes.’ BHP Billiton has a particularly strong record here, adds Vaight – which is one reason why Vanguard’s a long-term holder of the stock.
But while CSR issues are of concern, it may not always be possible to apply them across the board. ‘In western nations the permit process is quite well developed as we tend to be more conscientious about these issues,’ says Warren. ‘But in other nations where environmental concerns may not be as key, you still have to deal with a lot of bureaucracy.’
Whether the mining and metal sector’s fortunes will continue to build on the current boom is dependent, some predict, on continued demand from China, the driving force of the recent metals and mining boom. But one unresolved issue is when – or if – China will revalue its yuan, currently pegged to the US dollar. Because the dollar has fallen since 2003, so too has the yuan, making Chinese exports cheaper and bolstering its economy. The US Treasury, meanwhile, says the imbalance is feeding the US trade deficit, and has called on China to revalue its currency.
However, Lennon says the whole dollar-yuan issue is a complete red herring. ‘Because China has been through the hefty process of devaluation of the dollar since 2003, it means Chinese business has also been through the devaluation process,’ he explains. ‘So all this talk is just not relevant.’
Even if China does revalue the yuan, he adds, there are so many moving parts to China, that any revaluation impact on the sector – possibly meaning cheaper commodity prices – is likely to be diluted.
This moving parts theory also applies to China’s need for long-term commodity supply, says Warren. ‘A BHP Billiton presentation I saw recently made the point that usually when the US catches a cold, everyone sneezes,’ he notes. ‘But the presentation suggested this might not be the case for China – 80 percent of its GDP isn’t exported at all. It’s simply not reliant on an external economy.’
The big question, however, is: are natural commodities at the start of a huge super-cycle, or is the market already past its best? Warren believes demand is only just getting into its stride. ‘China isn’t going to go away,’ he says. ‘Huge numbers of people are moving from rural areas to the city every year, and they need houses, roads and bridges. They need power and light in their homes. Demand for air conditioners is higher there than in the West. You need aluminum in air conditioners, you need copper for wiring, and all the energy for turning it on every day.’
Andrew Ferguson agrees. ‘China won’t go in a straight line; there will be glitches,’ he says. ‘But they’re desperately short of infrastructure. If they can work only five hours a day now due to power problems, what will happen when they can run continuously?’
