October 2013

Eye on Business

Miners reap what they sow with writedowns

By Phillip Crowson

Since the beginning of 2012, mining companies have collectively written off some US$73 billion, of which nearly $30 billion is related to gold mining assets. The rest is spread across a range of different commodities. Each case is no doubt unique, but there are some common themes that raise questions about the way in which companies are being managed.

Looking first at the non-gold assets, one major strand in 2013 has been new management teams wiping clean the perceived mistakes of their predecessors. With several leading companies replacing their chief executives, such spring cleaning has accounted for over one third of the writedowns. To the extent that major competitors are writing down assets, it becomes much easier for others to follow suit without attracting too many adverse comments. There is always safety in numbers.

As long as the senior management of a company remains in place it has a strong tendency to live with past errors, however costly. This is partly from an unwillingness to recognize that some acquisitions and investments may have been ill-judged or badly executed, but also from an expectation that things will improve in the near future and the investment will eventually come right. In many instances, favourable market conditions have performed that magic and turned ugly ducklings, if not into beautiful swans then at least into reasonably presentable ducks. In the past year though, economic and market conditions have not been as favourable, and poor investments have become increasingly exposed for what they are. Falling product prices and rising costs have exacerbated the weaknesses of some projects that might always have appeared marginal.

That takes us to the writedowns in the gold industry, which are variously attributed to rising costs, unexpected permitting and construction delays and, above all, weaker-than-expected gold prices. The last factor – weak prices – is an even more hollow excuse for gold miners than for other sectors, notwithstanding both the levels reached by prices and the widespread forecasts by banks and investment analysts of even higher future prices. The London price averaged $1,573 per ounce in 2011 and $1,669 per ounce in 2012, having briefly peaked at $1,896 per ounce in September 2011. Even into 2012, there were many forecasts of prices comfortably exceeding $2,000 per ounce in the near future. The managers of gold mining companies might well argue that they were in good company in misreading future conditions, that they were misled by the financial community, that the drop in prices was completely unexpected and that the widespread writedowns are merely the consequence. “It weren’t my fault, guv.”

This is where one has to question both the mining companies and the investing community. Yes, price forecasts were too optimistic, and companies were undoubtedly egged on by investors. In some cases, their share prices would have been marked down, and they might have fallen prey to unwelcomed takeovers had they not raised the carrying values of their assets or sought to expand. Yet to base decisions for the longer term on product prices achieved over a brief recent period is the height of irresponsibility. That applies not just to gold but to other products such as copper, iron ore and coal that have also suffered from asset writedowns. In gold, the 10-year moving average money-terms price only climbed to more than $1,000 per ounce in June this year, and the five-year moving average to $1,337 per ounce in August. There is no economic reason why either should persist into the future, but they do incorporate much more historical experience than just the somewhat atypical conditions of the recent past, when interest rates have been held artificially low.

Simply, it is a lack of historical perspective that underlies the reasons for many writedowns. Market conditions are continuously evolving, and history does not repeat itself exactly. But there is always a need to examine the experiences and lessons of the past rather than just look at recent trends or at the pronouncements of an increasingly narrow range of market analysts and commentators. The mining industry’s corporate memory has contracted dramatically in recent years, with cost-cutting and changes in personnel. There has been a growing tendency for the industry and financial institutions to rely on a common handful of sources for market analysis and price forecasts, rather than on their own internal expertise and judgement. Like all monocultures, that lays the industry open to a widening range of potential ills. This year’s writedowns are perhaps just one manifestation.

Phillip_CrowsonPhillip Crowson is a former chief economist of Rio Tinto, chairman of the European Copper Institute and president of the Mining Association of the United Kingdom. He has written several books and published many papers and articles on aspects of the minerals industry.

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