Despite mining-sector volatility, investors can still reap rewards
• New Mining Charter will hurt the industry, but traders need to be patient and stay informed
Once the darling of the South African economy, the local mining sector seems to be digging itself deeper and deeper into a dark hole and the revised Mining Charter isn’t likely to do it any favours.
Already shedding jobs faster than you can say “monopoly capital” (70,000 in the past five years) and, with more employment cuts (up to 8,500 at Anglo Gold alone) and mine closures looming, the chances of the sector resurfacing anytime soon grow slimmer each day.
So, where to for the avid investor in mining stocks?
“Believe it or not, there are still options,” says Nilan Morar, head of trading at GT Private Broking who sent us his take on the situation, with some advice.
In 1980, mining was the second-largest contributor to SA’s GDP, bringing in 21% of the total. By 2016, it had dropped to 8% of GDP. The reasons for the industry’s decline are manifold, the most obvious being geology. You can’t change the fact that we have the deepest mines in the world. The cost of extraction at those depths is considerable.
Gold, for example, is becoming more expensive to mine. In some instances, the extraction cost is higher than the spot price of the metal. Either the gold price has to rise or extraction costs have to drop. We have large platinum reserves and there is fairly decent demand for the metal, but increased supply has put pressure on prices. Advances in technology have encouraged demand for palladium as a substitute for platinum, adding demand-side constraints.
Into this environment comes the new Mining Charter, which, among other things, calls for an increase in black economic empowerment shareholding in all mines, from 26% to 30%. In addition, 50% of all board members and executive management must be black, while 70% of all mining goods and 80% of all services in the mining industry must be procured from black economic empowerment (BEE) entities. New mining rights are subject to a 1% revenue payment to BEE shareholders prior to any shareholder distribution.
Also, it requires 1% of mining companies’ revenue, a total of R5.7bn, to be paid into development projects over two years. Given that dividends paid by miners in 2016 amounted to R6bn, there won’t be much left for shareholders in future.
Mining companies will have only 12 months to comply with the new charter’s objectives. Back in 2003, when the previous charter was introduced, the industry managed to reach the 26% black ownership required. However, since then many of the shareholders have liquidated their positions and taken the cash. This means there is probably less than 26% black ownership now, which means the firms have now further to go.
Traditionally, finance houses would provide the capital for these deals, as previously facilitated with other BEE restructures. But banks have announced that they are less eager to finance deals that involve the mining sector due to uncertainties around profitability. Plus the banks themselves, as suppliers to the mining sector, would have to conform with the charter’s requirements on suppliers.
So, where does that leave us? The mining sector has years and years of institutional knowledge, which will be impossible to retain under the new charter.
That is another reason why people are skittish. Mining stocks lost more than R50bn in value when the charter was announced. This affects many other parts of the economy. The Public Investment Corporation alone, through its investments in mining, lost R2.7bn on the day the charter was gazetted. This affects government employees.
The Royal Bafokeng, which among other things uses the proceeds from its mines to fund education, has already had to close down several of the schools it funds and retrench a number of teachers. This is just some of the collateral damage we have seen as a result of the mining industry’s woes.
Worst-case scenario is that investors sell up and leave, although we don’t see that happening to the extreme.
We shouldn’t forget that we are in a technical recession. Plus recent revisions from a ratings perspective have all been against us, which twists the screws in even further. Fitch has said that if the new Mining Charter gets passed, it will revise its opinion on our outlook.
In the meantime, GT Private Broking’s message to the trader is: “Look deeper than face value.” If something has come off 10% from its highs, it doesn’t mean it’s a buy yet. Traders need to be patient and wait for macro environmental factors to improve. Always justify and define your entry into the market. If you're a short-term trader, that’s fine, trade the volatility — because you’re going to be getting it! But understand that is what you are going to be doing. As a short-term trader, you should never start out looking for a 2% move and then still find yourself in the trade when it’s gone 3% against you. That’s behaving like a long-term trader, or an investor, which you didn't start out being.
Identify and justify your participation in the market and be rigid about it. Have a defined exit strategy with solid risk management associated with every trade. Keep abreast of what’s going on around you. As with the mines, there is so much that goes on below the surface that we need to be aware of. You can't be a good trader if you don't have good general knowledge.
Things will turn around. They always do. If the charter gets blocked, for instance, then some of the affected stocks would hold good value. Look at stocks such as Billiton and Glencore, which are not affected as severely by the charter as the local operations of Anglo American, AngloGold Ashanti, Gold Fields, Petra Diamonds, Sibanye Gold, South32 and Harmony.
LOOK DEEPER THAN FACE VALUE. IF SOMETHING HAS COME OFF 10% FROM ITS HIGHS, IT DOESN’T MEAN IT’S A BUY YET