The world mining industry turnaround – its implications

The following article was written exclusively for The Northern Miner by Mr Anderson, former chairman, Cominco Ltd. and now a director of Gensler & Schwab Inc., New York, management consultants, and Mr Scheye, who is vice-chairman of the New York consulting company.

Based on figures from the Economist, the London weekly, metal prices increased over the last 12 months (June ’86 through June ’87) as follows:

*17.3% in dollar terms,

*7.2% in sterling terms, and

*5.6% in SDR money basket terms.

The worst of the deepest postwar recession in the mining industry appears to be over. In the same period, gold increased 29.9% in U.S. dollars, way ahead of other metals and minerals prices.

The “rush to gold” experienced in the last 12 months relates to the decline of the dollar, the fear of inflation, a potential Mid-East war escalation and the action of central banks either accumulating additional gold reserves or coining gold for nationalistic reasons.

To predict which of these factors accounts for what portion of price movement of gold is nearly impossible. Nevertheless, if the past is any indication, there may be a sharp peak and then a downturn in gold prices.

As with other commodities, one cannot predict when copper supply and demand will finally get into balance, an event that may be in part determined by the growth in world economies and the need for copper in rapidly growing third- world economies that are breaking through into the industrialized world. Nor do we know when to expect substitutes for the lead battery or the use of sheet steel in the automobile industry, for instance.

Least of all can we be certain what will happen to mineral production in the centralized economies and when some major-sized, world class mining ventures will emerge in these countries and lead to exports that can alter supply/ demand relationships.

The duration from trough to peak for the industry will probably vary between five to eight years provided we avoid a major war.

Such a time frame makes acquisitions desirable for companies that do not have orebodies available for development and eventual production to come on stream near the peak of the next business cycle, say, by 1992.

Acquisition of a going mining enterprise may take from nine to 12 months to complete whereby the acquirer will benefit from higher sales volumes at increasing, albeit probably paying a premium compared to early 1986.

While there will always be competition for good mining properties and sellers can be expected to know the value of their holdings, the poor experience with commodities in the 1980s and mining investments, in particular, probably has reduced competition for three reasons.

1. The recent mining industry recession, the worst in postwar time has removed many players from the acquisition field, for instance some formerly dominant copper companies.

2. Management of some mining companies are discouraged and are looking for diversification out of the mining business. 3. New companies that in the 1970 s hoped to profit by the inflationary forces are now disenchanted by price declines and the apparent collapse of the inflationary environment, forcing them to write down their assets and/or get out with heavy losses.

The disenchantment with the mining industry among the investment fraternity and on Wall Street has seemingly run its course and there appear to be pools of money available to re-enter the business without necessarily having the leadership to do so surefootedly.

One method to grow by acquisition would be for stronger companies to buy out smaller partners already co-venturing with them on an orebody or in a successful exploration play.

In such cases the reserves are reasonably well known and the parties have no difficulty agreeing on values.

The next logical candidates would be mining companies operating separately on the same orebody or in the same geological province where conditions are well understood by all parties. If processing/smelting facilities can be combined, economies of scale can become significant.

Companies that survived the last business cycle but were unable to introduce cost-saving technologies, new mining or exploration techniques, would be logical candidates for purchase by a group with money and know-how.

There are also successful mining companies, possibly family-held businesses, where management is getting old and welcomes the opportunity of an upturn in business to exit at a good price.

In addition, there are a number of unhappy owners of mining properties whose core business is not in mining. A good number of these operations are well known and some of these properties have been shopped for some time seeking higher prices.

At some point these owners will get out.

Investors should be aware that some major mining companies have been quite selective in what they will develop and what they will sell for development by others. In a good exploration program where a company has a whole pipeline of projects, it may wisely identify certain deposits that could be attractive for junior mining companies with lower corporate overheads.

Investors must also be aware that the mining industry is diversified both geographically and in their metals and minerals with activities on several continents. Occasionally, during the last 20 years nationalism and shortsightedness prevented international companies from entering certain areas or alternatively forced them out of certain countries.

Such restrictions have eased considerably in the last few years as governments realized that to maintain balance of trade it is desirable to encourage mining development, even by foreigners.

Both in Canada, Australia and certain Latin American countries barriers to investment are in the process of coming down or have been removed.

In addition to the metals, it is possible to develop a list of non- metallic minerals that can become an attractive investment for interested investors in the mining industry.

Florida has one of the best U.S. deposits of phosphate minerals widely used in the fertilizer industry. However, the green revolution created surplus food in areas of the world where 20 years ago imports were the rule (e.g., India, Thailand and China) and farm subsidies in North America and Europe created surpluses forcing acreage cutbacks to hold production in check. The result has been reduced phosphate fertilizer demand, massive mine shutdowns, and bankruptcies of a number of major phosphate producers in Florida. Such companies have taken huge write- downs on their assets. For those who see a comeback in this industry, this may be the ideal time to move in.

Similarly some coal companies continue to buy reserves to round out their holdings. The reserves have, in most cases, been picked up for a small fraction of what they were selling for three to four years ago.

Rare earth minerals are likely to become of great interest because of their high technology applications such as high powered magnets. While this represents a small segment of the mining industry it could become significant in the future.

Investors must understand, however, that there will always be cycles in the industry and that the metals and minerals industry is not homogenous. In the mining industry, there are segments where shutdown capacity is able to go back on stream once the price reaches a break-even level.

And, there are other segments where third-world countries for balance of trade reasons maintain production, despite the negative return. Zambia for instance is more than 90% dependent on copper exports for its currency earnings, Chile over 40%.

Thus, copper may still not be the one to re-enter at this time.

U.S. commercial and investment bankers indicate they have entire departments ready to look at feasibility studies and that they are in a position to make substantial investments.

Project financing is available for well-documented ventures supported by an adequate feasibility study and, where required, a country risk analysis.

Investors appear gun-shy to move
back into mining and are particularly reluctant to return to third world countries where they were expropriated with no or inadequate compensation and where loan defaults make daily headlines in the financial press.

However, European and Japanese interests have such cash surpluses that they are still willing to investigate investments in mining projects in third world countries.

Sellers of mining properties read price trends as well as potential buyers. However, seldom do the buyers and sellers hold exactly the same view as to the future of prices or product trends, thus leaving room for a deal between willing buyers and willing sellers.

Moreover, there are negotiating tools available to use in such transactions such as the use of kicker payments based on future profit, or future prices, which partially. protects both parties; the use of convertible preferred equity, or bonds with warrants that can serve the same purpose.

A high price at a given moment in time for one investor may be a low price for another, depending whether the buyer pays dividends in yen, dollars or other currencies.

A study of 1986 annual mining company reports supports the view that the mining industry is nearing the end of its rationalization/regrouping and is ready to move out once again.

For the more sophisticated investors in this industry, the future arrived in mid-1986.