Looking for a silver lining in the clouds
Many challenges ahead
Peter Koven, Financial Post Published: Tuesday, March 03, 2009
financialpost.com
Pouring gold at Agnico-Eagle's mine in QuebecDrew Hasselback/Financial PostPouring gold at Agnico-Eagle's mine in Quebec
It wasn't expected. It just wasn't. Not this. Yes, the warning signs were there for a long time. Even at last year's Prospectors and Developers Association of Canada convention, when the industry was enjoying what would turn out to be the very peak of the commodity cycle, problems were starting to creep into the U. S. financial sector. The credit crunch was already several months old, and Bear Stearns would fail within a few weeks.
But very few economists anticipated the complete and utter collapse of the global economy by the end of 2008, which brought an abrupt end to the commodity boom and left the mining industry in shambles.
The troubles of such high-profile companies as Rio Tinto Ltd., Teck Cominco Ltd., Lundin Mining Corp. are well documented. But to get a sense of just how this economic crisis has annihilated the sector, it is worth recalling the story of First Metals Inc.
The company was put together in 2006 by Richard Williams, 55, who hoped to capitalize on what seemed to be a very favourable outlook for base metals at the time. His team took control of copper deposits in Quebec that were discovered 30 years earlier by Noranda Inc., with a mandate to bring them into production as quickly as possible.
On that score, First Metals was a complete success -- it brought a mine into full production in less than 18 months, and was gearing up to do the same for a neighbouring deposit.
Quebecers were delighted. The up-and-coming company was named "Developer of the Year" by the Quebec Mineral Exploration Association.
That was on Oct. 16, 2008. Eight days later, the company halted work at the second deposit. Ten weeks later, it filed for bankruptcy protection.
Just like that, the party was over for a company that thought it had done almost everything right.
"I wasn't happy to go get the award in a sense, because things were precarious at the time," Mr. Williams said. "But it is a recognition of achievement. I'm pleased with what we did. We just got sideswiped here by the pricing."
First Metals is not alone. Countless other mining companies did phenomenal work, only to see their hopes and dreams evaporate in a matter of days during the Great Collapse of 2008.
It can all be traced back to the implosion of the biggest credit bubble in history, and subsequent Armageddon in the global banking sector.
The mining sector is merely one of countless victims from this economic crisis, but the fallout for this industry has been particularly awful no matter how you measure.
Under any circumstance, commodity prices are leveraged to the health of the global economy. Yet in this case, there was the added problem of over-leveraged hedge funds. They played a huge role in driving commodity prices and mining equity valuations to absurd highs, doing it mostly with borrowed money. Those bets are now being unwound through the biggest deleveraging in history, a process which has become all-too-familiar for investors.
It all adds up to a much grimmer picture for the 2009 PDAC conference compared with any of the past few years. Cash-strapped mining companies can only pray that the global economic picture improves relatively soon, but the truth is that no one really knows.
"The banking system did a bunch of things that weren't its job, and did them badly. You don't know how long it will be to clean that up," said Don Coxe, the famed market forecaster who called the commodity boom so accurately until it all fell apart.
That's the bad news. But experts say that there is some good news as well.
There is a growing feeling among investors that perhaps the mining industry is not in the awful straits that a peek at the balance sheets of Rio Tinto or Lundin Mining balance sheets might suggest.
For one thing, there is gold. For the past few months, gold has done exactly what it is supposed to do--it has been a reliable safe haven as the value of every other asset in the world collapses. As governments around the world now prepare to print trillions of dollars, they don't have to try to drag their economies out of recession; the likely result is inflation. That will be good for gold and it will be good for the gold companies, which are also benefiting from falling production costs. Given that gold is still worth roughly half of what it was worth in 1980 (in inflation-adjusted terms), it is not hard to believe that it still has plenty of upside.
That is little consolation for the companies that produce base metals and are tied more directly to the overall performance of the economy. They can only look on with envy at the PDAC conference as investors fawn over the gold miners and avoid eye contact with everyone else.
But even for the base metal companies, experts say it is worth remembering something important: The reason commodity prices ran up in the first place was the result of the growing middle classes in China, India and other developing countries. They want houses, cars, televisions, better food and many other things that need to be made out of basic commodities. Even though the growth in those countries has slowed considerably, it is still happening.
"The essential thesis is we're adding 50 to 75 million consumers a year to the metals and the grains and the energy. That's going to continue," Mr. Coxe said.
"What's happened here is that in the advanced world, we've subtracted the number of new consumers. We also slowed down growth in the Third World because they can't export. But the fact remains that we've added all these people to the list, and they're not going to stop consuming."
Like almost everyone, Mr. Coxe is anticipating a rough ride in the short term. But he is also of the view that a global recovery could come out of nowhere and could happen very fast.
The vast majority of economists are now predicting deep recessions, with many saying that the industrial economies are already in depression.
Mr. Coxe disagrees. "This is nothing like the Great Depression, where we had 25% unemployment. My tentative conclusion is we'll see recovery by late third quarter. The surprise will be how fast we can come back, because we went down so fast," he says.
Another point to remember, experts say, is that if this is the bottom of the cycle, it really isn't that awful: US$1.40 copper, US$5 nickel, and US50¢ zinc would have been cause for celebration in the industry in the 1990s. Of course, costs are much higher now than they were then, but top-tier assets that made money in the 1990s are still making money today.
Companies are shutting mines today on a regular basis, but the mines that are closing are either very old, or they are lower-quality assets that probably should not have been built in the first place.
The industry is also coming through a period where it made a lot of money, and it is better capitalized than it was in any other down cycle. So while some junior companies will struggle to survive, M&A will help many others. A state-owned Chinese company's proposed US$19.5-billion investment in Rio Tinto Ltd. is also evidence that if valuations get too low, state-owned entities and sovereign wealth funds are ready to act.
So despite all the bad news, experts say the industry is well equipped to get through this and emerge stronger on the other side. The more pertinent issue is whether this turns out to be a temporary break in a long-term bull market, or merely the early days of a long and devastating decline. |
