Dec '08/Jan '09

Supply Side

The market maelstrom and mining suppliers

By J. Baird

Rarely has the business world been convulsed as it has over the last couple of months. The mining industry started feeling the effects of diminishing commodity prices and the credit crunch earlier in 2008. It is now virtually impossible for junior companies to raise financing. Companies supplying exploration equipment and services are feeling the pinch as exploration programs decelerate or cease.

The TSX Venture Exchange, where many juniors are listed, is down more than 60 per cent since a year ago. Expecting risk capital shortages to last, juniors are striving to stay alive until better times return. In previous low periods in the mining cycle, many such companies hibernated, merged or went out of business, only to re-emerge when conditions improved, sometimes three to five years later.

Also hit, at least for the moment, are companies that have found good deposits and want to develop them. Currently, neither equity nor debt financing is available. This may affect suppliers with contracts or those expecting business for new developments.

On October 10, the Canadian Mining Journal reported that, in the previous week, five Canadian companies announced closures or suspensions at copper, nickel, zinc and palladium projects because of “low metal prices and the challenging financial environment.”

The low prices of mined commodities have affected the values of the currencies of commodity-exporting countries like ours. This has a mixed effect on Canadian mining companies and mining supply exporters, depending on their cost bases. The Canadian dollar revenues of companies mining gold in Canada have not declined, even though US dollar gold prices have fallen. At a lower Canadian dollar, our exporters are more competitive in the US market. On the other hand, many of our clients’ home currencies have also declined against the US dollar. Suppliers fulfilling contracts made over the last year in US dollars are big winners, just as they were big losers when our dollar reached US$1.10 in November 2007.

The big question is how long it will last. Those who confidently predicted that we were in a super-cycle of sustained highs in commodity prices assumed that the Indian and Chinese economies would continue growing at over 10 per cent per annum. They have now been proven wrong, at least in the short term.

Longer term industry observers discern a rather predictable decadal cycle. Commodity prices and activity, typically low in the early years of a decade, pick up about mid-decade and peak in the seventh or eighth year before falling again.

The last cycle peaked in 1997 when world exploration expenditures reached US$5 billion. They dropped to US$2 billion by 2002 before rising to US$10 billion or so in 2007 and 2008, which, I suggest, represents the peak of the current cycle. This 10-year cycle has recurred each decade, back to the 1960s.

Most industry forecasters focus on commodity prices. I do not think that this gives the whole story. One has to look at the major miners’ cash flows. Over the last three years or so, the costs of mining have risen substantially. If the prices of commodities like nickel drop much further, major operations will shut down, severely affecting global raw materials supply. Thus, I suspect that commodity prices will stay relatively high in historical terms. The recent rapid increase in costs, especially in energy, should now level off.

My prediction is that the usual cycle is taking over, exacerbated by financial market volatility. In 1997, it was a problem with the Thai currency that started the “Asian crisis” just as the mining cycle was taking its usual dive. On top of this, the Bre-X fraud frightened off the few remaining risk investors. This time around, I expect the downturn to be severe and short. Much will depend on what happens in China, India, Brazil and the rest of the developing world. I believe that these economies’ internal demand will support the global mining industry.

History repeats itself. Should we feel sorry for the high-rollers who bought Inco and Falconbridge at the top of the cycle? I prefer to feel good for the shareholders who sold out. I also feel good for mining suppliers who used this last boom to diversify their client base. They will be rewarded in the slow period that is starting now.

Jon Baird
Jon Baird, managing director of CAMESE and the immediate past president of PDAC, is interested in collective approaches to enhancing the Canadian brand in the world of mining.

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