Good Prospects for Unloved Mining Shares
Good Prospects for Unloved Mining Shares
Commodity prices are surging and there’s the prospect of demand for some natural resources exceeding supplies for years to come. Some leading investment advisers now say that we’re in the early stages of another “super-cycle.”
Prices of copper – in some ways the most important industrial metal – have hit new record highs above $10,700 a ton. Lithium, used in electric vehicle batteries, has doubled in price this year. Cobalt, another key ingredient of those batteries, has gone up 50 per cent in six months.
Iron ore, the basic material in steel; palladium, the precious metal that goes into catalytic converters to curb harmful car emissions; and timber, widely used in construction; have all hit new highs. Key agricultural commodities, including grains, oilseeds, sugar and dairy products have also jumped, with corn prices above $7.50 a bushel for the first time in eight years, soyabeans more than $16.20,.
The buoyancy in commodities comes after ten years of weakness. Low prices have driven producers to cut back output and discouraged them from investing in expansion. Emerging imbalances between supply, stockpiles and demand eventually adjusted balances in favour of higher prices. Inventories are low. Covid has disrupted supply chains.
But now demand and prospects of future shortages are being lifted by accelerating economic growth as the world bounces back from the pandemic, supercharged by Biden’s mega-spending plans. The dollar, the principal global measure for commodity prices, is weakening, magnifying the scale of price rises.
A new factor is the prospect of huge demand for materials essential to delivery of the global electrification revolution. Electric vehicles, renewable energy suppliers, battery farms, are all going to require enormous quantities of minerals such as copper, lithium, aluminium, nickel, rare earths. To build and service a single large wind turbine, for example, requires about eight tonnes of copper.
The metal is a “cornerstone for all electricity-related technologies,” says a new report from the International Energy Agency, The Role of Critical Minerals in Clean Energy Transitions. But expected supply from existing mines and projects under construction is estimated to meet only about 80 per cent of the copper the world will need by 2030.
Resource quality is declining. In Chile, the largest copper producer, the average grade of copper being mined has contracted by 30 per cent over the past 15 years. Worldwide, mining company executives have been reluctant to invest in new supply. They have been scarred from the negative experience of the last bear market; it’s difficult to find rich new deposits, particularly in locations with stable, business-friendly political environments; greenfield developments require enormous amounts of capital and typically take ten years to bring into production. David Haynes of ANZ bank says the current pipeline of projects likely to start producing within the next few years will only add about 2 per cent more to forecast mine supply.
Rising prices and prospects of much greater and relatively stable demand are transforming the picture. Bank of America said in a research note earlier this month that copper prices could double, to $20,000 a ton, as early as 2025. “Copper is the new oil” says hedge fund Livermore Partners’ David Neuhauser. Goldman Sachs says green demand will match, and then quickly surpass, the additional demand for copper that China generated to bring the earlier commodities boom. But, says Kathleen Quirk of the mining giant Freeport McMoRan, copper isn’t like oil, where there was a major new source of supply – shale production.
Shares don’t yet fully reflect the fast-improving environment
Commodity prices have started to get a lift from demand from investors seeking “real” assets that tend to appreciate when inflation becomes, or is feared will become, a bigger risk to portfolios. Goldman Sachs predicts “an overheating economy and physical inflationary pressures” in the US. The bond market has started to reflect those inflation fears, climbing to its highest level in eight years.
Shares, however, are still a long way from adequately reflecting the fast-improving environment for mining companies. At current prices earlier this month the value including net debt of BHP, the world’s biggest, was just 3.5 times its forecast earnings before interest, tax, depreciation and amortization this year, according to estimates from the Swiss bank UBS. Similar comparisons were about 3 times for Rio Tinto, 3.6 for Anglo American, under 3 for Glencore.
Mining giants are set to record big earnings this year and should comfortably surpass the profits made during the last commodity bull market a decade ago. They will spew out cash, having cut back sharply on new projects. JP Morgan reckons Rio and BHP are likely to pay the largest dividends in corporate Europe this year, distributing almost $40 billion to shareholders.
So why are market ratings so low?
The problem seems to be caution fertilized by long memories. When commodities last traded in the highs of an exuberant super-cycle, that marked the top. The LME metals index, a gauge of metals trading in London, fell 50 per cent over the next five years. The market capitalization of London’s five largest listed mines fell 75 per cent.
“There are reasons for thinking things are different this time,” says the FT’s Neil Hume. When commodity markets tanked from 2011 the cycle was already mature, with industrialization of China, the main driving force behind high prices for natural resources, well-established.
“This cycle is still in its infancy. The global recovery programmes that governments are putting into plan today are more commodity-intensive than was the case after the [global] financial crisis. That makes commodity markets less dependent on China.”
Mining companies are also more disciplined and focused on shareholder returns than they were ten years ago. “After a near-death experience in 2014, when the sector was left struggling to service debts piled up in the boom years, balance sheets are in much better shape.”
Good Prospects for Unloved Mining Shares taken from our ‘On Target Newsletter’ issue no 267
