Ask most in the mining world and they would say 2016 was a pretty darned good year. News reports began by pointing to evidence of a market recovery or, if nothing else, an end to the doldrums of a market bottom. As the year progressed, analysts and investors were able to demonstrate positive returns, speculate on acquisitions and almost immediately begin criticizing some of the more robust miners for not taking advantage of cheap asset deals. And why wouldn’t they? According to CapIQ, in 2016 the TSX Global Mining Index increased 47%. Per Kitco Metals, gold prices had a good run to above US$1,300 per ounce and copper rose to the US$2.50 per pound mark at yearend, up from slightly over $2.00 as recently as late October. According to Platts.com, global sea-borne metallurgical coal prices surged, at one point peaking at just over a 300% gain. For those operating within these commodities, these were big changes.
The equity markets responded as one would expect. Gold producers in the S&P/TSX Global Gold Index rose 110% through last summer while gold developers, who typically attain a higher leverage to gold prices, moved accordingly—a basket of TSX-traded non-producing gold companies we follow gained 180%.
Financing activity also increased substantially in 2016 (see chart). If we dig into the data on TSX and TSX-V, CapIQ reveals there was a marked increase in smaller financings—with junior miners opportunistically getting some much needed working capital to keep projects afloat. Now we didn’t see a financing boom like the mid-2000s, and many juniors would argue capital remains very scarce for them, but there was a significant reaction by the capital markets on a selective basis.
But, and this is a significant “but,” there’s something that didn’t happen during this time—a meaningful shift in long-term price forecasts.
Take gold as an example. If you look at gold’s price performance over the course of 2016 (up from US$1,082 to US$1,159 at yearend), one might be led to believe not much happened. But you had to have spent the year in a soundproof box to have not heard the fabric fraying during Britain’s retreat from the EU (er, or not) or the banging of heads between Hillary Clinton and Donald Trump. Gold was clearly on a run during the Brexit decision with no signs of slowing down amidst increasing uncertainty surrounding the economic and political climate of the world’s top nations. Yet we now know that this price rise was essentially all for naught. After only a few hours of price spikes on overnight trading on U.S. election night, gold began moving back to levels witnessed at the start of the year, which was opposite to most forecasts.
But during the first half of that run spanning January to July we saw two things happen which are in stark contrast to the above.
First, long-term gold price curves didn’t move—sources such as Consensus Economics reveal they remained just over US$1,100 for 2019 (the “long-term” price) throughout that period. According to this same source, this price only moved modestly through the rest of 2016 despite gold’s spot activity, barely topping US$1,200 near yearend (see table). Mid-term prices didn’t really move either. Essentially the equity markets were telling a story of recovery based on spot price increases but analyst price forecasts didn’t seem to agree.
Secondly, many mining companies are still opting to focus on optimizing existing projects versus taking on new initiatives, and numerous private equity funds have kept their cash on the sidelines, or have even effectively wound down, such as the repositioning of Australia-based X2 Resources.
In short, despite very noisy runs for gold, metallurgical coal and, most recently, copper, when it comes to investment growth there has remained a notably silent response by many operators and fundamentalist investors. While rampant commodity price fluctuations are far from abnormal, short-term price movements for these metals have been drastically out of sync with forecast price curves. And this can be particularly challenging for investors. Sure, equity prices responded, but has any sustainable value been created?
Without a notable shift in mid- to long-term commodity prices, the answer is no. Sure, some turnkey uneconomic projects in “care & maintenance” mode could quickly return to a period of positive cash flow, but the startup costs and outlook for lower prices would be all for naught without an upward shifting price curve in the next two to five years. Furthermore—and more importantly for the vast majority of the development stage companies trading on the TSX and TSX-V—the net present value of their feasibility study stage projects remained essentially unchanged as only longer-term prices impact those assets. Yet we witnessed many of their market caps doubling, or even tripling in a short period of time in 2016.
So what causes the dynamic we’ve recently seen? While Chinese demand is likely to continue to drive long-term demand fundamentals of most commodity prices, it is also affecting spot prices for the bulk and base metals it consumes. Analysts have pointed to “near-term inventory shortfalls” in China for iron ore, coal and, more recently, copper as the primary drivers of spot-price appreciation. These short-term supply crunches are often due to government policy changes, with ripple effects that could well be part of China’s strategy to become the dominant trader of the metals it consumes. But with no clear basis to support long-term growth on the demand side, it would appear only a continued lack of sustainable exploration for and development of new projects can be the true test of long-term prices.
Robert Olsen is the national leader of Corporate Finance at Deloitte. E-mail: firstname.lastname@example.org. Kevin Becker is a managing director at Deloitte, specializing in mining opportunities. E-mail: email@example.com.