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The Trends and What They Really Mean

Mining industry news of late has been dominated by massive write-downs: $6.5 billion for Barrick; Kinross added $3.2 billion to the $2.5 billion written off last year on its West Africa operations; in total, the mining industry wrote off $50 billion last year.

The write-offs follow a shopping spree over the past few years that saw all of the top-tier majors making aggressive acquisition aimed at growing the size of their businesses. Higher operating expenses in the face of softening metal prices slashed operating margins, emphasizing that the companies had grossly overpaid for those acquisitions. Those deals were done by management teams who were committed to growing for the sake of growth.

Barrick has stated that it has no further mine development plans in the works and the other top-tier majors also assured their shareholders that they have shifted their focus from growth to maximizing return on capital.

This slowdown in growth for the largest of the majors has led to the superficial assessment that there will be no new mines built. According to that assessment, there is little value in the exploration and development companies which are proving up metal deposits. That view, adding to the generally negative mood toward resource companies, adds further downward pressure to the share prices of junior metal companies.

Billions of dollars of capital spending throughout the industry has been deferred or completely canceled. One does not have to look too far into the future to realize that a slowdown in new mine development will have important implications for the future. Demand for metals is continuing to rise. At the same time, mines are being continually depleted, meaning that new mine development is required just to maintain the production level. A slowdown in mine building by the largest companies will add upward pressure to metal prices over time.

A deferral of mega-projects by the mega-majors will create added impetus for the hundreds of mid-tier mining companies to develop mines on a more modest scale. While investors and analysts are focused on the large and established mining companies in the developed world, they are missing the emergence of powerful mining companies in the developing world. Late last year, two of the companies that we follow in Resource Opportunities were taken over for a combined $600 million in cash. One of the acquirers was a Chinese company and the other was a private Brazilian company. There are a large number of such companies which are looking to expand and will continue their hunt for metal deposits upon which to build mines.

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In addition to the emergence of a whole new set of mining companies, there is a great deal of capital beginning to come into the resource industry from other sources, including: state owned enterprises seeking to secure stable, long-term metal supplies; sovereign wealth funds looking for exposure to resources; metal trading companies, which are increasingly making equity investments to secure off-take agreements; private equity funds which can see the longer term picture in resources; as well as corporations that rely on metals as an input to their operations.

In summary:

  •  The current slowdown in new mine development by the large Western majors will further exacerbate supply shortages in the future, supporting higher metal prices.
  •  There are investors with a longer-term outlook who will continue to invest in and/or purchase metal deposits.
  •  As a result, those exploration and development companies which are advancing high quality metal deposits will appreciate in value over time.
  •  Investors stand to realize big gains by investing at this time in carefully selected metal companies.
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