All financial panics — as opposed to genuine crashes — have one thing in common: they throw the baby out with the bathwater. That certainly seems to be the case with global mining stocks as they have been hammered this summer by fears that problems in the subprime-lending market will derail global economic growth. As many investors are aware, one of the strongest themes of the last few years in global investing has been the global commodities supercycle. Prices of nearly every commodity, from corn to copper, have been on a tear, driven by a rise in global demand for metals, grains and livestock.
World-wide demand for copper alone is up 50% during the past 10 years and demand shows little sign of abating. Given the sharp moves in the prices of the stocks of global mining giants in recent weeks, it’s a good time to stand back and reassess the real dangers of investing in what have been some of the hottest stocks during the past few years.
THE COMMODITIES SUPERCYCLE REVISITED: A NOISY MARKET
Miners themselves remain convinced that the current market jitters are little more than noise — and that the strong demand from China and India means that the commodities supercycle remains intact. As BHP Billiton’s (BHP) retiring CEO Chip Goodyear put it during BHP’s earnings call last month: "We do find it curious that when subprime markets and private equity debt seem to go into a meltdown, our industry underperforms financial services stocks in the U.S. and Europe." He added, "There are a lot of strange things going on, the timeframe for investors has shrunk to nanoseconds."
Goodyear also reassured investors that the recent financial market turbulence would not hurt BHP’s growth — and reaffirmed his view that commodity prices would remain strong for some time. BHP recently conducted a survey of its major customers around the world to see if their demand for commodities would be dented by the fallout from the U.S. subprime mortgage crisis. The results? The United States was slowing down, "as it has been for the last year," but in developing economies such as China and India "it’s essentially business as usual." With more than 90% of China’s growth coming from its booming domestic economy, the impact of any slowing of exports to the United States would be limited. The bottom line? There was no "fundamental meltdown in our resources business."
Nor is BHP’s retiring CEO alone in his bullishness. The chief economist of rival commodity giant Rio Tinto (RTP) noted: "Nothing that’s happened in the last few weeks has shaken our confidence… If anything, it’s made me feel a little better about it, because even with the turmoil we’ve seen, [commodity] prices have held up." Most big investors agree. "If you’re looking at a three-to-five-year investment horizon, this is noise," noted the manager of BlackRock, Merrill Lynch’s world mining fund.
THE COMMODITIES SUPERCYCLE REVISITED: HAS ANYTHING CHANGED?
As Jim Rogers has noted, no one can repeal the law of supply and demand. On the supply side, commodities production continues to suffer from the same supply constraints caused by underinvestment earlier this decade which occurred before the subprime crisis. And with economic growth in China at 10%-plus, the nation’s seemingly insatiable demand for copper, nickel, and other metals seems set to continue. Indeed it would be a Chinese economic slowdown — not a collapse of house prices in Sarasota — that would spell bad news for the mining sector. Consider that China is BHP’s biggest customer and now accounts for 20% of BHP’s sales.
Merger rumors now sweeping the markets are also keeping the mining sector hot. According to Ernst & Young, global M&A deals in the mining industry have gone from $16 billion in 2005 to $68 billion in 2006. If London-based Rio Tinto’s $38.1 billion bid for Canadian mining company Alcan goes through, the newly renamed Rio Tinto Alcan would become by far the largest mining company in the world, controlling 11% of the world’s aluminum supply and 14% of global bauxite reserves. The one thing the subprime crisis has changed is that rumored plans by big private equity firms, such Blackstone and KKR, to make a run at one of the global mining giants have been put on the backburner.
COMMODITIES SUPERCYCLE REVISITED: THE STATE OF PLAY
The Cassandras of the world continue to worry that credit-market contagion spells the end of not only United States economic expansion, but also global economic expansion. If they are right, demand for commodities will evaporate, slamming the profits of all mining companies. Commodity prices have indeed slipped as speculative investors have unwound positions in oil, copper and other natural resources to cover losses in other sectors. Copper dropped about 10% from its peak and nickel is off about 15%. More bad news? Mining companies will see their borrowing costs climb significantly as lenders become more wary, putting a break on both expansion plans and merger activity.
How has the market voted thus far? Mining stocks fell the most after the market topped on July 19. Yet they are also among the stocks that have recovered the most. Brazilian mining group CVRD (RIO) — which had almost doubled this year — fell a vertigo-inducing 28%. By the middle of last week, the stock had bounced back almost to pre-crisis highs, supporting the "baby out with the bathwater" thesis. Indeed, the latest bout of turmoil could even turn positive for cash-rich mining giants. Tighter credit and softer commodity prices could help weed out marginal projects and competitors. And by reducing commodity supplies coming into global markets, commodity prices could stay high, giving more gas to the commodities boom. When the dust settles, there will be buying opportunities. Savvy investors will look beyond the headlines and realize that the fundamentals in the sector have not changed overnight. Time to go out and fetch the baby back.
Nicholas A. Vardy
Editor, The Global Guru