Resource World Magazine

EPILOGUE David D uva l Emphasis on cost control will benefit shareholders longer term W ith the recent weakness in commodity prices, mining companies are finally beginning to focus on controlling costs. In past decades, when margins were thin, cost control was almost an obsession with these companies, but that seemingly changed when demand from Asia for mineral commodities drove prices and corporate profits to record levels. Today, however, profit margins are thinning and the share prices of mining companies are falling because of it. Investors are understandably concerned about rising costs and lower profitability and are shying away from mining equities until there is some evidence that companies have them under control. In addition, companies are facing renewed pressure to pay dividends which is directly related to profitability. IntierraRMG, a resource sector intelligence firm, paints a sober picture of the current state of the minerals industry in its State of the Market Snapshot: Mining and Finance. (You can purchase the full report on its website at: http://intierrarmg.com/ Homepage.aspx). The report concludes that the industry is stuck between a rock and a hard place with metal prices falling and "little prospect of an immediate recovery because of increasing metals supply and lackluster demand." The hard place it surmises is "pressure on operating costs and a heightened threat of resource nationalism." Compounding matters further is "the restricted supply of finance, especially to the exploration sector," the report contends. Intierra points out that since 2008, operating costs for gold producers have soared, rising by over 60%, while copper mines have managed to keep costs under control and are reaping the benefits. In the case of gold, resource grades have plum46 www.resourceworld.com meted which, no doubt, coincides with higher production costs given the lower unit value per tonne of ore mined. Let's face it, in this business grade is everything and many people that should know better seem to lose sight of this basic fact. Shareholders of major companies can perhaps take some solace in the fact that mergers and acquisitions activity has fallen dramatically, with most companies now focusing on what they have rather than what they'd like to have. However, the global mining industry's market capitalization is back to where it was at the beginning of 2009 with interest in this segment still waning as the DOW and S&P indexes continue to breach new highs. Is it any wonder that shareholder sentiment for mining equities has become so negative and share prices are continuing to languish in the doldrums? While some analysts are arguing that the broader markets are in bubble territory, there's some understandable concern that when the bubble breaks it will take the mining stocks even lower, similar to the great sell-off in 2008-09. That's highly unlikely in my opinion given the massive amount of fiscal stimulation that virtually every Western economy has implemented or is in the process of implementing. The US remains the world's largest economy and if it turns around in traditional fashion, as the market anticipates, you would expect to see demand for mineral commodities rise significantly, especially copper. I did note recently that Canadian lumber producers are having difficulty supplying demand from the US housing industry, although some of that relates to bottlenecks in both nations rail transportation system. The housing and construction industry in general are major consumers of copper which might explain why prices have held up reasonably well. Exploration activity has also taken a tumble, the report notes, extending a downtrend that is now into its 17th month. With no news to report, exploration companies are trading at bargain basement prices and most are focused on preserving their working capital in order to remain compliant with their stock exchange listing requirements. You would think that exchange and securities regulators would attempt to relieve some of the onerous cost of meeting these requirements, considering the fact these companies are paying the salaries of their employees. But perhaps that's wishful thinking. It's not all gloom and doom mind you. The negative forces confronting the global minerals industry have generated some much needed market discipline. According to Intierra, production reports from mining companies indicate significantly lower gold output in the Americas, with copper and iron ore output also sharply down. That's a positive sign for base metal prices in particular which are driven by industrial demand – and perhaps gold which has different price drivers. The recent downturn in gold prices saw heavy demand from China and India which might have set a bottom for the precious metal. As I see it, the major problem for gold at the moment relates to the huge distortions in the marketplace from global monetary easing policies in the US, Japan and Europe. Momentum traders are pushing the DOW and S&P indexes to record levels, despite a tepid economic recovery in the US and ongoing weakness in the Chinese economy. Some day – perhaps sooner than most people think – the music will stop and all hell will break loose. Gold bugs in particular can take that to the bank, but it will take some patience. n JUNE 2013

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