The peaks of profit in the distance
The mining supply sector depends on tomorrow’s prices. Tomorrow’s metal prices decide how many mining machines are ordered today. Tomorrow’s prices decide whether development projects go ahead. Tomorrow’s prices decide how fast Canada’s junior miners are gobbled up by Chinese, American, or Brazilian buyers.
But the list of tomorrow’s prices doesn’t exist. We start with yesterdays’ prices and current conditions. Then, everybody from the Governor of the Bank of Canada to the trainer at Vale makes their own guess. For a small company, these guesses can mean life or death.
There is money to be made if prices are going up, but making money takes aggressive investments and good timing. Investing for future high prices only makes sense if you think demand will hold up well enough to keep you in business. You may see peaks of profit in the distance, but you have to worry about possible swamps just over the next hill. Prices that flap up and down can make investment very risky.
History tells us resource prices are going up. Oil is a good example. Back in 1869, oil cost about $70 a barrel in 2010 dollars. Today, oil hit $92. The U.S. Energy Information Administration is expecting the prices to bounce between $97.50 and $99.50 a barrel until the end of 2013. That looks pretty stable. It isn’t. After 1869, the price swooped down and stayed below $20 for almost 100 years. Technological change and exploration more than kept up to growing demand. Then, in the 1950s the price started to rise. Population was rising, incomes were rising, and, as Will Rogers said about land in California, “they wasn’t making any more” oil.
In the 1970s, oil jumped briefly to $70 for the first time in a century. Metal prices had been rising too, but it was OPEC that broke the back of the 60s boom. In the early 90s, the price of oil fell briefly to $20. Then it jumped past $90. Then it fell to $60, then it jumped past 90, and fell again. Oil prices weren’t just rising, they were flapping.
Each time growth in the world economy started to accelerate, the economy out-ran the supply of oil and metals. Prices shot up and growth crashed. The economy was like a hydroplane that flips over every time it tries to go fast.
Metal prices have behaved like oil, but a bit later and less dramatically. Through the 20th century, technology drove most metal prices down. Growth in developed countries was getting more oil-intensive and less metal intensive. The growth of demand slowed. Now, with world population headed for 8-10 billion, there has been an explosion of metal-intensive growth. Resources are getting harder to find and it looks like demand is set to push prices up much faster than technology can drag them down
Short-run demand could be a different story. In the U.S., Barack Obama and Mitt Romney agree the economy is in a bad way. Chinese growth has fallen, Europe is unstable and things don’t look good. Presidential pessimism is probably wrong, though. The editors of the Economist point to rising exports, a declining trade deficit, cheap housing, rising energy production, and banks that have ironed out many of their wrinkles. They are calling the American economy “The Comeback Kid.” And while China’s growth is expected to slow to a “mere” 7.5 per cent this year, it is 7.5 per cent of an economy that is 50 per cent bigger than it was five years ago because the Chinese middle-class has grown and incomes have risen.
One clear signal that resource prices will rise, and a clue about what it means for the supply sector is the surge in Chinese purchases of Canadian resource companies China’s third largest oil company is bidding $16-billion for Calgary-based Nexen Inc.
Canaccord Financial Inc. and the Import-Export Bank of China have put together a billion dollar fund to grab Canadian resource companies. They will be coming for supply firms next.
What do tomorrow’s prices mean for today’s mining supply firms? Should you go all out for growth? Should you wait and expect rich offers in the future? Should you look for international partners with money? All of these, and one more: don’t be rattled by panics in the stock market. There are good times coming.
Tagged Bank of Canada, Barack Obama, Calgary, California, Canaccord Financial Inc., Canada, China, economist, energy production, Europe, Governor, Import-Export Bank of China, metal, metal prices, Mitt Romney, Nexen Inc., Northern Ontario Business, oil, oil cost, oil prices, oil-intensive and less metal intensive, Ontario, Organization of Petroleum-Exporting Countries, Peak oil, Price of petroleum, Pricing, Sudbury, the Economist, U.S. Energy Information Administration, United States, USD