Another BRIC in the wall?

Materials World magazine
1 May 2009

We all want to know what will happen in the future, for reassurance if not economic gain, and for this we turn to those in the know. Michael Forrest interviewed Paul Renken, Mining Analyst at corporate finance and broking service VSA Capital, based in London, UK.

What is your view of the current state of the industry, and how is it reflected in the commodity markets?

The world has changed. Since last year it has become apparent that the world economic crisis is farther reaching and more intense than anyone was prepared to model or willing to prepare for. I expect the cycle, in terms of commodity price, will hit bottom sometime during the first half of 2009, but instead of a sharp V-bounce in prices as previously predicted, there will be a gradual, but uneven, recovery.

This slow recovery will reflect the lack of concerted action by democratic governments. Command economies such as China are likely to weather the storm better, as they have direct Government stimulus spending to replace the dramatic decline in private sector output. Nevertheless, for most countries, the recession will feel uncomfortable, and unemployment and underemployment will rise significantly during 2009, well above levels earlier this year.

Metal prices, although at a low point are showing signs of recovery. Is this a universal trend or specific to certain commodities?

Looking across the board there are a number of indicators of the state of the market. February’s dry bulk shipping statistics showed that 80% of seaborne iron ore trade is now headed to China. This is bad news for the ferrous metals markets for the remainder of 2009 and indicates a surplus at all world destinations of ferrous metals, reflecting iron ore production in excess of demand. Stocks in Chinese ports are rising again, and, as a result, my price forecast for this year is now down 35% over 2008 prices. This will bring prices to a level not quite as low as 2007, which the Chinese would want, but lower than what the major world producers would like to agree to and lower than what they had hoped for three months ago.

The major ferrous metal mining companies (the large caps) will have diminished shipments and earnings going forward in the short term. Other metal concentrates used in ferroalloys, such as chrome and nickel, will remain weak as less costly and easier to melt scrap supplies will start building up again. Molybdenum should remain somewhat stronger as none of the major world pipeline projects are being deferred. The inability to finance porphyry deposits, including molybdenum, will continue the relative shortage of molybdenum concentrates as seen in the past few years. Supply and demand balance will be restored during 2010.

Will precious metals fare better?

Gold, and to a lesser extent silver, will be resilient in pricing during 2009. The price should break out to the upside sometime during the fourth quarter of 2009 and into 2010. Quantitative easing worldwide will restore some economic confidence while ballooning government deficits will start inflation, which will rise against all currencies in 2010.

Precious metal prices will be forced even higher as jewellery demand returns with greater employment confidence and improved consumer sentiment during 2010 and 2011, particularly in emerging markets and their currencies.
Platinum and palladium will remain subdued until automotive manufacturing stops contracting. We can expect a ‘short squeeze’ in platinum after that.

How about base metals, which led the past commodity boom?

Tin and lead, in my opinion, will be the first metals to show price strength as they appear to have the best demand profile in relation to existing inventories. Copper and zinc prices will recover more slowly. The duration of ‘modestly adequate’ prices for these metals will be longer than miners want, and will last until world manufacturing demand and output picks up. Evidence for this will be seen in increased factory utilisation and utility outputs.

Thermal coal contract volumes will also begin to increase, but aluminium will be slower than the other metals to recover in demand and price. In China, however, higher coal subsidies coupled with lower coal prices, hence lower energy costs, will limit gains.

Will Brazil, Russia, India and China (BRIC countries) come to the rescue?

The BRIC countries, particularly China and Brazil, will lead the metal commodity sector out of this ‘nuclear winter’ of demand and spot pricing in the fourth quarter of 2009. This will be accomplished by the drawdown of metal inventories in London Metals Exchange (LME) qualified warehouses worldwide to levels commensurate with around 2004. Even nickel peak stocks have levelled off in LME warehouses at 107,000t in April, due to production cuts that were first announced at the start of the fourth quarter last year.

The rate of decline in the various metal inventories is such that it will not be until the last quarter this year before actual manufacturing demand will balance with world mine production output at ‘normalised’ levels. The BRIC countries do not have the means to prop up world metal commodity demand and prices in the short term, even with government stimulus. The decline in private sector output in the rest of the world has overcome the BRIC countries’ appetite for metals and fuels, at least in 2009.

None of this is particularly encouraging for mining companies, especially juniors. What should they be doing?

For those companies with limited cash reserves, and little hope of raising more, a plan of cash conservation is necessary, including mothballing mine operations in the short term and/or extended shutdowns to save reserves and limit costs. This time should be used to renegotiate shipping, fuel, construction and labour contracts to reflect economic realities. Time should also be used to expand and de-risk known resources through drilling.

Further down the line concentrate treatment and refining charges at smelters will be difficult to justify for many mining companies over the next five calendar quarters (into 2010). Analysts, engineers and bankers will be recalculating new three and five-year average prices for commodities and projects, and tossing out feasibility forecasts made in 2007 and 2008. Pressure acid leach nickel projects will have no future in the coming five years.

What is bad for companies and markets may be good for investors. Is this your view?

The value of the shares of many junior mining companies has fallen to pre-initial stock exchange offerings (IPO) valuations, and in the same time they have reduced the project risk since listing. A number of them will stop trading. Many more will be forced to relinquish good properties, merge, or sell off ‘orphaned’ projects at bargain basement prices, as many now have market capitalisations lower than available cash in hand.

Prepare to ‘bottom fish’ these equities according to your investment tolerances and make your commitments by the fourth quarter of 2009. Now is a tremendous time to make pre-IPO level investments in the mining sector. It is a once-in-a-lifetime opportunity to gain control of excellent projects and companies at historically low valuations. It is likely that regulatory actions will steer money out of derivative instruments and investment strategies and into entrepreneurship initiatives over the coming five years, with the best returns on investment made in 2009 expected in three to five-year exit strategies.

Further information: VSA Capital