Major Industry Trends
The mining sector covers everything that companies extract by way of geological materials from the earth; from base and precious metals to coal, uranium, diamonds, rock salt, and potash. (Oil and Gas extraction is covered in a separate sector profile and will not be considered here). This profile will focus on the commodities aspect of mining rather than on extraction techniques, while the fortunes of particular companies in the sector will be touched on collectively, through an examination of merger and acquisition deals conducted during 2010–11.
The sector, along with agricultural products such as grain and coffee beans, constitutes the commodities sector, which is notorious for price volatility and boom-and-bust cycles. However, the latest boom-and-bust saga in the industry, associated with the global downturn, which really hit the sector in the last quarter of 2008, followed by a sharp and sustained rise in commodity prices up to July 2011, when markets stumbled badly, has been as sharp as anything witnessed in decades.
As PricewaterhouseCoopers (PwC), notes, an unparalleled period of soaring commodity prices and economic growth through to mid-2008 gave way to slowdown and recession in 2009. However, in the second half of the year, the commodities sector showed signs of recovery, driven by a pickup in demand in Asia, and the gathering global recovery in 2010 saw commodity prices for both agri-commodities and metals soar. It has been a strange boom, though, with demand for base metals like copper and iron ore soaring thanks to demand pressure from emerging economies, many of which are growing at a rate in excess of 7%, while precious metals prices have reached record levels driven by worries over the European sovereign debt crisis and burgeoning US debt.
In its survey of the sector, published in its annual “Mine” report, PwC points out that 2010 was characterized by growing optimism in the mining sector, with results that bore out this optimism. However, in 2011, even while emerging markets continued their high rates of growth and attendant demand for resources, the mining sector was finding itself increasingly supply-constrained. Extraction projects are becoming more complex and are typically in more remote, unfamiliar territory, and the cost base of the sector is pushing upwards on the back of lower grades of minerals and labor shortages. The world’s top 40 miners, PwC says, have announced more than US$300 billion of capital programs with over US$120 billion of this spend set to be completed by the end of 2011. PwC comments that “the sheer size and volume of the announced capital projects demonstrates an industry where fulfilling seemingly insatiable demand is the top priority.”
The results for the top 40 mining companies in the world were spectacular in 2010, with their total combined revenues breaking US$400 billion for the first time, according to PwC. Net profits rose by a staggering 156% to US$110 billion. Moreover, the sector is cash rich on the back of a great trading year, with the top 40 finishing 2010 with more than US$100 billion cash on hand. The one worrying note in all this, prior to the turmoil that hit the markets at the start of August 2011, is that despite sharp rises in commodity prices, the margins achieved by mining companies through 2010–11 are still down on the highs achieved in 2006 and 2007.
At the time of going to press, the world’s major stock markets, including Asian markets, had gone into virtual freefall on the back of two major concerns. The first involves worries over the possibility that two of the eurozone’s bigger economies, Italy and Spain, could move into default territory. The second concerned an unsettling lack of resolve by US politicians to raise the US debt ceiling. What should have been a technical legal point turned into a cliffhanging spectacular that seemed to demonstrate that the US political system was dysfunctional—a worrying thought for investors given the trillions of dollars of debt the United States has piled up. This was compounded on August 6 when the ratings agency Standard & Poor’s downgraded US debt from AAA to AA. The fear in the mining sector is that both these factors combined could tip the United States and Europe back into recession, which would make demand for emerging market exports contract, which in turn could harm emerging market growth, and thus reduce their demand for raw materials.
Mining companies across the globe lost a substantial chunk of their market capitalization through the 2008–09 downturn. However, 2010 saw a strong rebound, with many companies in the sector recovering most if not all the value they lost through the downturn, and some have even surpassed 2007’s valuations. By the end of 2010, according to PwC, the market capitalization of the top 30 miners had increased by 26%, with the largest gains being made by smaller companies. The market capitalization now required for a miner to make it into the top 40 list now stands at US$11 billion, a substantial hike upwards from the US$6 billion required just a year earlier.
PwC points out that some analysts feel that share prices in the sector grew at an unsustainable pace through 2010 and the early part of 2011. However, it argues that a comparison of net assets to the market capitalization of the top 40 shows that net assets have remained at 35% of market capitalization, demonstrating that market capitalization has only increased by the profits the industry has generated and retained in 2010.
During 2010 the world’s top three miners, BHP Billiton, Vale, and Rio Tinto, put clear blue water between themselves and the rest of the industry. Rio, the third-placed miner, has twice the market capitalization of the next biggest player, China Shenhua. According to PwC, price increases allied to production increases in iron ore were the major drivers of growth by the top three.
China’s appetite for acquiring access to the raw materials the country sees as essential to its growth plans seems undiminished, and this will continue to drive M&A activity and the price of commodities in 2011. China is the world’s largest consumer of commodities, and its rapid economic growth is fueling demand for all sorts of raw materials. The volume of imports to China of some commodities, such as iron ore, soybeans, and crude oil, reached record levels through 2010 and 2011, as the Chinese economy rebounded from its slowdown. China is also the largest global buyer of iron ore, scrap steel, metallurgical coal, refined copper, smelted aluminum, and refined nickel, and a major world buyer of lead, zinc, tin, and various ores. The steel required, for example, to enable China to build the 30,000 km of new railway line it is planning over the next five years is just one of a number of projects keeping demand for iron ore on the boil. However, demand for raw materials continued to be strong from emerging markets generally through to mid-2011 (which saw the potentially pivotal downgrading of US debt).
In 2010 four mining companies rejoined the top 40 and there were three new entrants, with Coal India being the largest new entrant following its IPO in October.
One of the new trends over the last few years has been the extent to which traditional sovereign wealth funds have invested heavily in the mining sector. In many instances this has been driven by the dual desire to diversify their portfolios and to secure access to resources for their owner nations.
PwC points out that gold has been on a constant upward trend since hitting a new record of US$1,421 at the end of 2010. By August 2011 the spot price of gold had passed US$1,670 and a number of commentators were forecasting US$2,000 as being achievable within months.