The ‘new world order’ of mining isn’t pretty
John Shmuel | 13/08/02 | Last Updated: 13/08/06 9:18 AM ET
If there was a stock market discount bin, it would be overflowing right now with mining stocks of all shapes and market caps.
The TSX materials sector is down more than 30% so far this year, with gold miners being particularly clobbered, having lost 38% of their value since January. It’s been the worst year for global mining stocks since the financial crisis.
The last bastion of safety for mining investors — potash stocks — collapsed this week to join their digging and drilling brethren in the basement. The break-up of a Belarusian-Russian cartel that was responsible for 43% of global potash exports is to blame. Its demise led to a potash price collapse, resulting in a sharp pullback for fertilizer stocks such as Potash Corp. of Saskatchewan Inc., Mosaic Co. and Agrium Inc.
The bad news didn’t stop there. A day later, Barrick Gold Corp. revealed the second-worst loss in Canadian corporate history. The miner announced it lost US$8.56-billion in the second quarter, after a massive US$9.3-billion writedown at its Pascua-Lama development in Chile.
All of that ensures Canadian mining stocks are well on their way to posting a third-straight annual decline. It’s no wonder many fund managers, despite seeing a lot of value in the sector, are proceeding cautiously.
“We’re staying away,” said Barry Schwartz, vice-president and portfolio manager at Baskin Financial Services Inc. in Toronto. “We’re done with our flirtations with commodity stocks, because we’ve been burned one too many times. That’s been the case for a lot of portfolio managers. One would have thought that with the world economy growing and with China growing, commodity stocks would have outperformed, but they haven’t. It’s mind boggling.”
Keep in mind mining stocks are cyclical, meaning their prices tend to move depending on whether the global economy or a specific domestic one is steadily growing. In the case of mining, one of the most important economies is China, the world’s largest commodity consumer and until recently on a torrid growth pace. But China’s economic growth has been slowing in the past few years and the slackening demand has hurt commodity prices.
Many miners are also suffering from rising cost inflation, as new projects, often being built in increasingly more remote locations, require more equipment and longer development time frames. Since the world’s most easily exploited resources have already been discovered, what’s left is simply harder and more expensive to get out of the ground.
“Until I see more of a rebound in risk appetite, I don’t think commodity prices will take off,” said Sadiq Adatia, chief investment officer at Sun Life Global Investments (Canada) Inc. in Toronto. He remains bearish on mining stocks, and says he’s staying away for now.
Another issue souring investors on mining stocks is the growing political risk that comes with companies mining in more remote locations. Barrick is one of the biggest poster children for how dangerous the politics of mining can be. At its annual general meeting in April, Barrick founder Peter Munk spent a great deal of time talking about the growing hostility to foreign miners in developing countries.
Mr. Munk said governments a decade ago were flocking to Barrick to try to get the company to sink money into the ground and create mines and jobs in their countries. Today, he said, “governments are more likely to ask questions like, ‘Who are these foreigners? Why would they take our gold away from us?’”
Many developing country governments are now demanding higher royalties from miners, with some even threatening to nationalize mines owned by foreign companies.
“The entire mining sphere has become really cutthroat,” Mr. Schwartz said. “You have a lot of political risk, and I think we’ll soon see companies mothballing more projects due to cost, due to political uncertainty. It’s the new world order.”
But while there is a lot of pessimism in the mining sector, there is also a sense among some fund managers that stocks have sold off so heavily that they’ve reached an inflection point. The collapse of potash stocks this week is key to that belief.
“People have to have some allocation to the materials sector, and the easy play for the last little while was to hide in the fertilizers,” said Gregory Taylor, vice-president and portfolio manager at Aurion Capital Management Inc. in Toronto. “The golds have been awful, the base metals have been declining because of the weakness of emerging markets, so a lot of people had been hiding in the fertilizer space.”
This could also signal a bottom for materials stocks as the last hiding spot just blew up
That changed this week. Fertilizer stocks across the board posted steep losses following the announcement that Russia’s OAO Uralkali was dismantling the world’s largest potash marketing group. Potash prices subsequently crashed, and fertilizer giants such as Potash Corp. and Mosaic saw their stocks pull back more than 20%.
“This could also signal a bottom for materials stocks as the last hiding spot just blew up,” Mr. Taylor said.
He thinks “value money” could start flowing into mining stocks as the collapse of fertilizers means there has been a “clean sweep” in the materials sector.
“We’re starting to hear some rumblings of private equity sniffing around these mines, and those are the real bastions of capital, which have five-year time horizons,” he said. “If you have five-year time horizons, now’s a good time to buy those companies that have good, strong balance sheets and healthy capital.”
Rob Edel, chief investment officer at Nicola Wealth Management Ltd. in Vancouver, said even gold miners, which face a lot of fundamental pressures, have become undeniably attractive investments. The only question is whether investors are too shell-shocked from the steep selloff this year to start buying again.
“What you’re seeing this week, with a lot of companies reducing their capex and their budgets, appears quite positive,” he said. “There’s obviously some near-term concerns with balance sheets, but I think at these levels it’s fairly attractive. If you look at the divergence between bullion and gold stocks, it’s more compelling.”
Mr. Edel adds that some of the political risks that have hurt the stock prices of companies such as Barrick could ease off in the coming years, saying much of it has been “political posturing.”
That may turn out to be especially true as emerging-market economies start to run out of steam and have to work harder to woo foreign capital. Emerging markets this year have experienced some of their slowest economic growth in a decade, hammered by a confluence of political, social and financial factors.
Economists are particularly worried about the effects tightening credit will have on the emerging world, given that the U.S. Federal Reserve is expected to begin scaling back its quantitative-easing program later this year. The current program, dubbed QE3, has been a boon for emerging-market investment, since it made borrowing cheap and led to more money flowing into developing economies.
But though the storm clouds may potentially be clearing in the mining sector, fund managers caution the selloff might not be over yet. Operating costs continue to rise for many miners, and China’s economy may slow even more over the next couple of years, further depressing demand for commodities.
“It’s impossible to tell where the bottom is with cyclical stocks,” Mr. Schwartz said. “We could have much lower to go.”
