For the mining industry and industry suppliers, the times are more than just interesting. Economic growth is utterly dependent on what the mining sector produces, and good times in the mining sector depend on economic growth.
The question on everybody’s mind as this column goes to press is whether the lunatics in the financial sector have actually pushed the world economy off the tracks. They have done it before.
The most common view out in the infosphere is that a world recession is almost inevitable. The majority of guesses say it could last six months to two years. There are a few who think the world will end, and a few who think that unprecedented co-operation among governments will have unprecedented results.
No one really believes that the long run story has changed. The BRIC nations – Brazil, Russia, India and China – still have the population, the potential and the momentum they had when Goldman Sachs identified them in 2001. They have been driving world growth, with help from the American consumer. Those BRIC consumers are just getting going.
Rio Tinto chief executive Tom Albanese reminded shareholders in October that China’s economy is driven far more by industrialization and urbanization than by exports to the USA. The company expects demand in China to strengthen across a range of Rio Tinto products.
In China, the government might not even survive if it can’t keep growth above 9 per cent. Faced with falling exports and layoffs in the export sector, Chinese leaders may be forced into a massive spending program. The targets will have to be infrastructure, housing and the environment. As projects roll out, orders for minerals and metals will rise.
And as you read this, a new president in the U.S. is probably talking about renewing his nation’s infrastructure. Since public spending does most to prevent a recession, when all the major countries do it at the same time, there will be unprecedented pressure for a co-ordinated fiscal policy. Governments normally prefer to let other countries do the spending, but, in the current crisis, finance departments and central banks aren’t encouraging their own governments to free-ride on the efforts of others. They are calling for co-ordinated liberal fiscal policies. Those expansionary policies would be very good for the mining supply and services sector.
But what about the astonishing declines in metal prices? Don’t metal prices tell us what will happen to the supply industry?
In fact, prices are not the key to the future of mining. For a variety of reasons, metal prices are the dog’s tail, exaggerating every little wiggle. It may be hard to figure out where the dog is going by watching its head. Watching its tail doesn’t work at all.
When demand is low, the price is determined by cost. When demand expands, capacity is the limiting factor. For much of the last five years, mines have been pushing capacity and prices have been whatever a wildly optimistic market would bear. A relatively small increase in world consumption drove prices through the roof.
Now, more than 20 new nickel mines are set to open in the next two years. Prices should drop back closer to the marginal cost of production. Expansion may slow. How much expansion slows depends on whether producers are maneuvering for the next round of growth.
Short-term prospects for the supply industry are mixed. Higher total output means more consumables and a higher steady-state exploration and development budget. Normalized prices means much more pressure on costs, and far more demand for innovation. The most innovative and the most experienced firms will have an advantage.
In the medium term, growth will pick up and capacity will have to grow. Interesting times are when the most ambitious and imaginative firms make the jump to the next level. Let the games begin.