February 2009

MAC Economic Commentary

The economic downturn – two unknowns

By P. Stothart

To mining company managers, an economic downturn is old hat. Typically, a few years of economic growth lead to a year or two of stagnation and low mineral demand and prices. Mining projects are put on hold until the price and availability of labour and materials return to a sound footing. Other variables, such as wars, strikes and technological shifts can exacerbate or mitigate this cyclical movement of mineral prices.

The current economic turmoil, however, is not a traditional business cycle. Yes, the real economy is slowing in a traditional manner. Manufacturing is in recession and overheated costs have dampened investment in natural resource development. Falling mineral and stock prices have made the raising of new equity capital and exploration financing difficult or unfeasible. In Canada and overseas, mine development has been postponed or cancelled and companies have entered a “batten down the hatches” mode. Credit Suisse estimates that $50 billion in capital spending in mining — two-thirds of announced global commitments — would be delayed in 2009.

Beyond this cyclical slowness, though, two new variables make the present downturn tougher to gauge and recovery time frames more difficult to predict.

The first new variable is the collapse of key elements of the U.S. financial system and its spill-over effects. Many factors in the United States, including weak governance and ethics in financial institutions, aggressive government housing policies and untenable fiscal and trade deficits, have led to near-trillion dollar liabilities in foreclosures and bailouts. Few analysts offer reliable predictions on the amount of time required to bring stability, good governance and optimism to the financial institutions. The restoration of healthy capital markets is a necessary precursor to enhanced investment in a capital-intensive sector like mining.

While the theme of global financial instability has dominated headlines, the impact of the second new variable — namely, the role of China — has received less attention. Until the most recent decade, the “global economy” essentially included Europe, the United States and, to a lesser extent, Japan. No other region had the consumer or industrial heft to drive mineral prices or shorten the duration of a global downturn. Now, after exhibiting 15 consecutive years of double-digit economic growth, China has become a part of the global economy. This is the first recession in modern history in which an economy outside Europe and the U.S. could play a significant catalytic role.

But how significant will its effect be?

On the bullish side, an estimated 13 million Chinese people are moving from rural to urban regions each year. Despite staggering expansion over the past 15 years, China exhibits relatively low metals intensity in comparison to Western countries. For example, China still has 76 times fewer cars per 1,000 people than the United States and 20 times fewer computers per capita than Canada. There is significant internal demand for metals and minerals for infrastructure and consumer/industrial products. Chinese capital controls are strong, the banks have healthy balance sheets, and the corporate and consumer sectors have low debt loads. The $586 billion U.S. economic stimulus plan announced by the Chinese government in November reinforces the notion of the country playing a significant global catalytic role as an investor in massive infrastructure projects. In railways alone, China plans to invest $300 billion in expanding its national network by 28 per cent by 2010.

On the negative side, some contend that Chinese growth has long been artificially stimulated through free business borrowing costs and that the country has built considerable manufacturing over-capacity and sells its products below true cost. Others point to widespread business corruption, the rewarding of communist party players and the risk of social unrest and disruption that could follow any significant rise in unemployment. China has also erected trade barriers in recent years to guard domestic inventories of key metals. Significant stockpiles of zinc, copper and nickel are reportedly accumulating in Chinese warehouses.

The trajectory of these two new variables — the stability of the financial system and the shape of future Chinese demand — will help determine the magnitude and lifespan of the downturn that the global mining industry is experiencing. These factors aside, most observers anticipate slow economic conditions and soft prices until 2010.


Paul Stothart
Paul Stothart is vice-president, economic affairs, at the Mining Association of Canada. He is responsible for advancing the industry’s interests regarding federal tax, trade, investment, transport and energy issues.

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