The End Of The Mining Supercycle

Published in Investing on 16 May 2012

Downturn in demand will affect us all.

I hate to write something negative while we're in the maelstrom of the euro crisis. Things look bleak enough without sounding the alarm over more threats on the horizon.

Whether the boom years are coming to an end is a hot topic in the industry. Sooner or later, it will hit the media and the wider community. So it's useful to be forewarned. It will affect not just investors in the mining sector, but in businesses that service the sector. And because miners make up such a big proportion of the FTSE 100, it will affect anyone with a bog-standard tracker.

China

The boom in mining in recent years has been driven in large part by voracious Chinese demand, which in turn boosted metal prices. But growth in China is softening. Whether you think the economy is in for a hard or a soft landing, sheer mathematics means that it can't continue to expand at recent growth rates.

As the economy matures, an increasing proportion of growth will come from domestic consumption, rather than investment in infrastructure such as roads, airports, railways and power plants. That is bound to affect demand for coal, iron ore, steel and other metals.

So, global metal prices are down 20% from last year's highs. At the same time, costs in the mining sector have been rising, as energy and manpower costs have risen faster than inflation. That's beginning to squeeze operating margins, which have been running at historic highs.

More significantly, the industry is cutting back on investment. That will bite sooner, as mining development projects can take many years. Citibank analysts forecast that global mining investment will peak this year, some 13% ahead of last year's total, and decline in 2013.

FTSE 100 members Rio Tinto (LSE: RIO) and BHP Billiton (LSE: BLT) indicated at an industry conference earlier in the month that they would scale down their investment plans. Both have also warned that reduced appetite in the banking sector could constrain their access to trade finance.

Retreat

These pressures have already caused a retreat in mining shares. The FTSE World Mining Index is down 36% since it peaked in April last year, a decline matched by the mining sector of the LSE. Indeed, the sector was the biggest faller yesterday, losing over 2% on the day.

What does it all mean for the future?

The mining sector is not about to fall off a cliff edge. China and other emerging markets are still growing strongly, and thoughts in the sector are already moving on to returning capital to shareholders through improved dividend payouts, which should help support share prices.

But the sector is perhaps unlikely to return to the giddy heights of last spring. Investment in miners might now need to be more selective, paying more attention to the mix of commodities that companies produce and the outlook for their end markets, and more attention to their cost bases and relative efficiency.

Suppliers

A slowdown in investment will have a magnified impact on equipment suppliers: the accelerator effect of economics. Stocks that have ridden the mining boom with great success, such as conveyor belt supplier Fenner (LSE: FENR), could be riding the down escalator if and when reduced investment is reflected in cut backs on equipment orders.

I'm not saying that Fenner isn't still a great share. Softening in demand for new mining equipment may be muted by supply of replacement parts and its non-mining markets. But shareholders in Fenner and similar companies will want to keep a close watch out for signs of a falling order book.

There's a good chance these developments will affect you even if you don't invest in the mining sector or companies that supply it. Miners represent about 12% of the FTSE 100, so what's bad for them is bad for the index.

Right now, these worries pale into insignificance compared to the turmoil in Europe, but it will pay to keep a close eye on the mining sector.

Investing is by no means easy in today's uncertain economy. That's why we've published "Top Sectors Of 2012" -- our guide to three favourable industries. This free report will be dispatched immediately to your inbox.

Further investment opportunities:

> Tony has shares in Rio Tinto but no other stocks mentioned in this article.

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Comments

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QuantumDealer 16 May 2012 , 2:19pm

Did you take a look at the presentation posted yesterday on the BHP Billiton website before writing this article?

Wuffle 16 May 2012 , 2:59pm

Plenty of people still going to work on a donkey, whilst very few people control a lot of the global mining industry. One wouldn't want to use the word 'cartel', but you get the idea. Under similar circumstances I would like to think that I could keep BHP quite profitable. Suppliers might find it more difficult.

Wuffle.

mcturra2000 16 May 2012 , 4:47pm

What will China do?

I think China is at least as bad as the EU: always looking to stimulate. China's economy is so rigged that it stimulates malinvestment everywhere. Look at the Chinese property bubble - it's soaking up demand for materials for stuff that shouldn't even be built.

It's my belief that the Chinese economic miracle is nothing but an illusion. Like the EU, we can be pretty sure that things will end badly. What we don't know is "when". Without knowing "when", it's very hard to predict the collapse of commodity prices. We need the benefit of hindsight - where everything is obvious in retrospect ;)

TRhere 17 May 2012 , 2:41pm

This was on Reuters today:

"(Reuters) - BHP Billiton (BHP.AX), the world's biggest miner, is likely to delay signing off on at least two mega projects after its chairman put the brakes on an $80 billion (50.4 billion pounds) plan to grow the company's iron ore, copper and energy operations, analysts say.

Slumping commodity prices and escalating costs have squeezed cash flows, pushing BHP to join rival Rio Tinto (RIO.AX)(RIO.L) in reconsidering the pace of their long-term expansion in countries such as Australia and Canada.

"The major message is: 'We can't approve anything right now. We don't have a spare cent to spend,'" UBS analyst Glyn Lawcock said.
In BHP's bleakest outlook yet, Chairman Jacques Nasser said on Wednesday the company expects commodity markets to deteriorate further and that investors have lost confidence in the longer-term health of the global economy.

Nasser stopped short of announcing a spending cut, but said BHP was re-thinking its expansion plans "everyday" and that the company won't spend $80 billion over five years as outlined by Chief Executive Marius Kloppers in 2011.”

Tony R

Benatar 17 May 2012 , 6:34pm

Fenner's Interim results, less than 1 month ago, said that both divisions were experiencing strong trading, and the growth drivers in their end markets reamined positive.

My feeling is that the recent drop in their share price is a great buying opportunity.

There may be a short term weakness in the mining industry (after all it is more prone to swings of fear & greed than any sector with the possible exception of the banks) but taking a long term view. The world's population is continuing to grow, and quality of life is continuing to increase. Both trends point to a long term increase in demand for reaw materials of all sorts. Of course if we had a major war to reduce the population that may change things, but weaponry has a great demand for metals; and wars always result in major rebuilding projects.

Either way I think there is a strong long term case for the mining sector.

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