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I found this interesting...also for AIM investors.

The State of Global Mining

By Jackie Steinitz
24 Nov 2007 at 12:52 AM GMT-05:00


LONDON (ResourceInvestor.com) -- The mood at this week’s biggest ever Mines and Money event organised by the Mining Journal in London was cautiously upbeat; more subdued than last year, but definitely underpinned by a view that the mining boom is alive, well and kicking.

With 28 conference presentations, 38 companies in the investor forum, 200+ exhibitors and 3,000 delegates walking the floors it is not possible to do justice to the range of opinions that were expressed.

But here is an attempt to summarise some of the more recurrent and/or interesting themes about mining which emerged from the presentations and conversations around the exhibition hall, drawing in particular on the comments of five of the presenters:

David Humphreys, keynote speaker and Chief Economist, Norilsk Nickel
Des Kilalea, Analyst, Royal Bank of Canada Capital Markets
Michael Lynch-Bell, Partner in Charge Global Mining & Metals, Ernst & Young
Frank Holmes, CEO and Chief Investment Officer, US Global Investors Inc
Judith Mosely, Managing Director, Société Générale

Long-Term Demand Prospects Are Strong!

First off there was a clear consensus that underlying demand prospects for commodities are strong and will continue to be so in the long term, though the business cycle and uncertainties associated with investment demand will result in increased volatility.

The supercycle theory has become more mainstream. Many commentators now agree that a prolonged rise in real commodity prices is underway.
The primary driver of the current supercycle to date has been China. Chinese demand still has a long period of catch-up ahead. Chinese demand for commodities has been “entirely conventional”, according to David Humphreys. It is based on a requirement to turn metal into “useful saleable products” and it is a demand “that can be both seen and measured”. As China industrialises it is essentially following the same consumption pattern as did the U.S., Japan and other developed markets. Its per capita consumption still lags way behind these markets.
Several charts were shown on this theme - this BHP [NYSE:BHP; LSE:BLT; ASX:BHP] chart was typical. It shows copper consumption growth against GDP per capita with Chinese consumption (demarcated by the red squares) only at the early stages of its journey.

As China continues to urbanise and industrialise so everyone will want a fridge, a car, a washing machine and so on. A typical family car can contain up to 20 kilograms of copper, 20 kilograms of nickel, 120 kilograms of aluminium and over 600 kilograms of steel.

India and other emerging markets will follow in the footsteps of China. India is perhaps some 10-15 years behind China, as suggested by BHP’s chart of GDP over the last 20 years.

Demand for commodities will also be supported by a massive infrastructure boom, not just in China and India but throughout the world, according to Frank Holmes, who argued that it would be driven by a combination of demographics, urbanisation, globalisation and wealth creation.

In the 1970s the world population was around 3.5 billion, and 40% of the world was not participating in the international economy. In a span of 30 years the participating population has increased to 6.5 billion with 3.5 billion living in cities which has led among other things to a massive deflation.

The increased population has led to a sea change in requirements for and attitudes towards infrastructure. Transportation infrastructure is now a huge bottleneck after 15 years of urbanisation.

Moreover governments are realising that investment in infrastructure can create jobs, have a multiplier effect and is a sustainable, essential element of culture, economic vitality and global competitiveness. The infrastructure boom in the U.S. and Europe in the 1950s and 1960s was an important prop in the prosperity of the era. Much of America’s infrastructure is now in urgent need of modernisation.

Net exporters of oil are awash with cash leading to an infrastructure boom in the Middle East, Russia and parts of Latin America.

The required infrastructure can take many forms. Many have a high requirement for commodities. Projections by Merrill Lynch suggest that the emerging markets alone will spend $1trillion of infrastructure investment over the next 3 years.

The new paradigm in the current supercycle is the scale of fund investment and this raises a number of real issues for the industry, according to Humphreys. Investors have been attracted in droves by the China story, the constrained supply and the price characteristics of metals and this has already increased volatility which has impacted directly on producers and customers. A key issue in the future will be reaction of the funds if and when markets begin to ease. How sticky will the money be and will the funds cut and run or will they have a sustained impact on prices of years to come?
Supply Side Has Failed to Catch Up With Demand

Supplies of many of the base and bulk metals remain tight, with inventories at or close to historically critical levels (as shown in for example in Des Kilalea’s chart of the zinc market).

A number of factors are underlying the tightness:

The strength of demand has taken everyone by surprise. Supply can only respond with a lag. It takes years to explore, prove resources, obtain permits and finance, and to construct new capacity.
Moreover supply side delays and disruptions increase when prices are high. Labour shortages are the main bottleneck because of the lost generation during the bear market in commodities. High prices lead to intense competition for equipment and labour, and increase the likelihood of strikes. Governments are also more likely to seek a share of the action. While the availability of drills now seems to be improving there is still an acute shortage of drillers to operate them. Tyres also are in acute shortage. The biggest shortage however is in the labour market.
There is a diminishing quantity of “low-hanging fruit” - i.e. resources which are high grade, low cost, in accessible and politically safe areas. Most has already been taken. Increasingly companies must travel further, dig deeper and increase either the political or technical risk that they face.
Projects are still being evaluated using conservative metals prices, often based on long run prices from the 1990s. This has deferred investment exacerbating the lack of supply capacity. Commodity price forecasts are often the most critical uncertainty when valuing a project, yet as Lynch-Bell showed in the chart below, an Ernst & Young analysis has demonstrated that for the last 4 years the average forecasts of the copper price a year ahead have consistently fallen below the outturn by anywhere between 20% and 200%.

As David Humphreys pointed out on a similar theme, “Attaching too little importance to recent conditions exposes risk us to the risk of underinvestment in capacity and the persistence of high prices will drive customers away.” But attaching too much importance to recent prices could create “a contrary risk of inflated expectations and a wave of investment which goes on long after demand has slowed and which submerges the industry under a mountain of unwanted capacity.”

Political risk if anything is increasing. According to Humphreys research by the Fraser Institute in Canada has indicated a general decline in the attractiveness of mining policy conditions over the last few years.
While there are exceptions, permitting and environmental requirements have tended to become tougher, expectations higher and there have been changes in some of the tax and royalty regimes. In a few instances there has been sabre rattling and talk of resource nationalisation.

Current Supply/Demand Fundamentals Are Impacting on Industry Structure and Finance

The combination of rising demand but constrained supply has led to bonanza profits for the producers, which in turn has had a number of effects.

There has been and will continue to be unprecedented cash generation. For example estimates by RBC Capital Markets suggest that the combined gross cash flow generation from just 3 companies (BHP, Anglo American [Nasdaq:AAUK; LSE:AAL] and Xstrata [LSE:XTA]) will rise from $25 billion in 2006 to $45 billion in 2009.
This has led to a tidal wave of Mergers and Acquisitions, culminating in Rio’s [NYSE:RTP; LSE:RIO; ASX:RIO] acquisition of Alcan and the possibility BHP takeover of Rio which Humphreys says would be the “Mother and Father of all mining M&A”.
Concentration in the markets is increasing. For example the top 10 producers for copper accounted for 41% global market share in 1975, 49% in 1995 and an estimated 61% in 2006. For zinc the equivalent trend has risen from 25% in 1975 to 44% by 2006.
There is a debate about whether more M&A will be necessary to meet world needs for resources on the basis, arguably, that only larger companies can provide or attract the necessary funding for exploration. Small companies may fall under the radar of funds who would inject capital to make exploration happen. However, as discussed in another article, David Hall, Chairman of Stratex [LSE:STI], has proposed that there is a need for a new paradigm in the relationship between exploration and development companies and mining companies in which mining companies are the customers for exploration success.
M&A activity appears to have rewarded the acquirers. Lynch-Bell reported that typically acquirers had paid significant premiums on the pre-bid prices. However hindsight has suggested that the recent big deals such as BHP’s acquisition of WMC, Xstrata’s of Falconbridge and CVRD’s [NYSE:RIO] of Inco were all ‘great’ deals. Indeed research by Ernst & Young has demonstrated that total shareholder returns by acquisitive mining companies have significantly outperformed companies that did not acquire. This could be in part because of the commodity price assumptions used to value potential acquisitions.


The number of IPOs has been falling since the peak in the London market in 2005 though the total money raised by IPOs has been increasing. The market is becoming more sophisticated, and there is a trend towards secondary fundraising.

There is an ongoing trend towards dual or even triple listings as companies seek to tap into the relative advantages of each financial centre.
The flow of funds in mining is changing. Chinese interest in Africa is the big story. As Humphreys pointed out the traditional direction of flow was from developed to developing countries, primarily from North to South. Now there is a ‘growing tide’ of flows from south-south or south-north and increasing investment by companies from emerging markets. Norilsk Nickel’s take over of Lion Ore was the largest ever foreign investment by a Russian company. The company now owns assets in the U.S., Finland, Botswana, South Africa and Australia.
Costs are rising. The weakening dollar will have a huge impact on margins. The factors which enabled industry to reduce costs in 1990s are reducing or have disappeared. These included technological advances, declining energy costs, improving Management Information Systems, exploration successes, the opening up of many previously closed countries, the destocking of the FSU, predictable steady demand profiles and increasing economies of scale. Now, by contrast, costs are rising sharply driven by rising energy costs, rationing of scarce equipment and escalating wage bills.
Since costs often have a significant local currency component while revenues are generally dollar-price driven the weakening dollar will have a huge impact. Kilalea sees the dollar weakness as one of the major issues facing the industry in 2008.
Recent Macroeconomic Developments Will Result in a Flight to Quality

The sub-prime crisis, fears about growth prospects in the U.S. and Europe and their impact on the rest of the world have had a number of effects on the mining sector.

The appetite for risk is diminishing. There has been a general de-rating of mining stocks and a preference for companies that are in or near to production. RBC Capital Market’s chart shows that there has been a significant reduction in the premium above net asset value.

The weakness of the dollar will have a major, though not a uniform, impact. Cost curves will become steeper.

Arguably some cooling of the markets is in the long run interests of the industry - otherwise high prices will accelerate the pace of substitution.
In debt finance mining has been hit relatively less than other sectors by the sub-prime crisis. Nonetheless projects in future will be subject to a much greater level of scrutiny, according to Judith Mosely. There will be more cherry picking in future. The banks will be selective and will not just lend to ‘anything that moves’. The rules have not changed. Companies seeking finance will still need strong projects and strong sponsors. However there will be less interest in plain vanilla opportunities and more focus on clients where ancillary business opportunities are available. Banks will look very carefully at whether project makes sense for all stakeholders as without any one of them the project would collapse.
Nonetheless there will be a flight to quality. Juniors and/or high risk marginal projects will find it more difficult to find finance. There will be a requirement to go back to the fundamentals.
The Bottom Line

Many bottom lines were expressed. David Humphreys for example argued that history may view 2007 as a year of transition with the “passing of the most overheated, over-hyped phase of the cycle into something more measured and sustainable.” However he argued that the timing of the transition would depend on the commodity.

Bulk commodities where China looms large and where logistical and infrastructure constraints are greatest could continue to have significant price momentum.
Precious metals could also be buoyant though for different reasons revolving around the dollar, inflation fears, general uncertainty and lack of alternatives.
Base metals could be looking at a general ‘fade in prices’ caught between the opposing forces of some slowdown in the rate of growth of demand but a supportive financial environment. Prices, however, would remain very sensitive to disruptions in supply particularly for copper.
Meanwhile Des Kilalea concluded that supply tightness remains the real story for the near-term outlook with metal inventories still critically low. He said that “stronger for longer” was the fundamental outlook for commodities but the key risk in the near term was the possibility U.S. recession.

Any market correction could be an attractive buying opportunity;
RBC Capital Markets’ preferred commodities are currently iron ore, copper, nickel, zinc and uranium;
Diversified mining companies will have lower risk and lower volatility than leveraged metal companies – but the flipside is that the latter offer greater upside potential.
Philip Richards, CEO of RAB Capital plc is looking for a boom in gold and silver for a number of reasons including the possibility of an increase in Chinese gold reserves.

Most of the presenters subscribed to variations of the ‘stronger for longer’/supercycle theory though all pointed out that the business cycle has not been suspended! Volatility will continue. But this, in combination with strong underlying demand, has to offer some excellent opportunities for the canny investor.