Trading one super-cycle for another

Good times follow bad, often sooner than people expect. So, unlikely as it might sound in mining, signs of a pending breakout are mostly there. Don’t expect China 2.0, but the deal making could get furious
By Ian McGugan

Cheer up, folks. Sure, Canadians enjoyed the good times more than most nations and, as a result, felt the crash of the super-cycle with particular intensity. But the recovery has been far quicker than many people expected.

A stronger global economy should translate into increased demand for raw materials

I’m referring, of course, to the dotcom bubble of the late 1990s. What? You thought the mining industry was the first sector to crash after flying too high for comfort?

As any historian can tell you, the commodity complex is just the latest in a long line of businesses to go through a down-and-out period. While the industry is now wrapped in gloom—an entirely accurate reflection of today’s depressing fundamentals—what many of the pessimists ignore is how quickly the fundamentals can change.

The doomsayers should note that Google, perhaps the single most dominant company of the current economy, went public a mere two years after tech stocks hit their lowest point of the post-dotcom era in 2002. Someone who prematurely wrote off the sector’s potential would have missed one of the greatest opportunities of the past generation.

In similar fashion, the people who are now writing obituaries for the mining sector are likely to find that the industry is more capable of change than they realize. Analysts took turns slapping bleak headlines on their 2014 outlooks for the industry. Credit Suisse, for example, chose, “The long and winding road,” while Bank of America went with the brusque, “No end in sight to downward commodity price pressures.” Check back in two years, though, and you may be surprised by a renewed outbreak of optimism.

The biggest reason to remain positive about the long-term outlook for commodities is the recent pick up in global growth, which has seen both the World Bank and the International Monetary Fund boost their outlooks for 2014. All else being equal, a stronger global economy should translate into increased demand for raw materials.

To be sure, the shape and source of that demand may change. The commodity super-cycle that began more than a decade ago was driven by China’s booming factories and frantic construction of infrastructure. Emphasizing that point, Credit Suisse analysts show that copper and other key commodity prices have closely tracked the growth of industrial production in emerging markets such as China over the past two decades. With China’s growth slowing, and other emerging markets facing problems of their own, some metal prices could stumble.

For the commodity sector to continue its run over the long haul, the developed nations will have to take the baton from the developing world. Fortunately, that is exactly what is happening as growth picks up in both the United States and Europe.

Some commodities will feel the benefits from the upswing in the world economy more than others. Lead and zinc, two unglamorous but vital metals, are both relatively cheap compared to their long-term averages and could feel the tug of an improving global economy. So could palladium, which is used in catalytic converters and will benefit from booming auto sales.

In contrast, iron ore will probably continue to swoon as the market struggles to accommodate the greatly expanded supply of the past few years. Credit Suisse (see accompanying chart) expects iron ore prices to fall by more than 30% over the course of this year.

Click to enlarge

Gold is also likely to feature among the biggest losers of 2014. Fears of hyperinflation after the financial crisis of 2008 drove many investors to seek out the metal as a refuge from currency debasement, but the continued absence of hyperinflation (or any inflation at all, for that matter) has sapped its appeal even among diehard doomsters. At the same time, rising real interest rates are increasing the opportunity cost of holding a non-yielding asset like bullion. The emerging market slowdown adds to the bad news for gold bugs. Consumers in India and China have been some of the most enthusiastic buyers of the precious metal in recent years and harder times in those nations could put a lid on demand.

Even in blighted areas like gold, however, the industry is making progress in dealing with its two biggest self-inflicted wounds: too much supply and too much debt. Both reflect the anything-goes mentality of the super-cycle years, when miners could easily raise money and investors pushed management to expand production at any price.

The world’s biggest miners, such as Barrick Gold, BHP Billiton, Rio Tinto and Anglo American, are now headed by new leaders who are focusing on capital discipline. One welcome effect of the renewed attention to cost discipline is going to be a slowdown in the growth of new supply. That will—eventually—set the stage for a rebound in commodity prices.

And in the short term? Expect more acquisitions, especially of the hostile variety. The glut of many metals has combined with a lack of investor interest in the sector to drive the share prices of many miners into bargain basement territory. Larger companies or firms with access to capital have the opportunity to snap up assets cheap, but are likely to be resisted by management at their target companies who would prefer to wait for a recovery in metal prices before selling out. Goldcorp’s recent bid for Osisko, a Quebec gold miner, is probably a harbinger of what is to come.

Like Osisko, firms with Canadian mines may discover they are particularly attractive to potential buyers. They now have a considerable currency advantage over many competitors, courtesy of the newly shrunken loonie. Unlike miners in Third World countries, they don’t have to worry about resource nationalists preying on their profits. And their location puts them next door to a U.S. economy that seems to be picking up its pace. All of that suggests that while the commodity super-cycle is over for now, the acquisition super-cycle could just be starting.

Ian McGugan is an award-winning business journalist in Toronto and the founding editor of MoneySense magazine. E-mail:

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