GAM­BLING ON COM­MODI­TIES

A risky bet for in­vestors

Finweek English Edition - - FRONT PAGE -

The sad truth is that the com­mod­ity share mar­ket of­fers slim pickings. The in­vest­ment world has been steadily – and not so steadily – los­ing money on min­ing in­vest­ments for years. Why would you fore­see bet­ter re­sults? The fact is that the min­ing sec­tor is suf­fer­ing a hang­over of skull-crack­ing pro­por­tions. Ill dis­ci­pline, un­re­al­is­tic ex­pec­ta­tions, and com­pla­cency all have their place in an ex­am­i­na­tion of com­mod­ity mar­kets in the last 10 to 12 years.

The ‘su­per cy­cle’, as it was known, was a spec­tac­u­lar place to be, how­ever. Driven by un­stint­ing growth in China, the 30 to 40 years from 2002 were meant to re­sult in huge de­mand for steel and the stuff that goes into mak­ing steel, such as man­ganese and iron ore.

Since 2003, t he gold price gained 372%; iron ore be­came 302% more ex­pen­sive, the price of cop­per in­creased 384%, while ther­mal coal gained 273% in price. At first, share prices re­sponded pro­vid­ing in­vestors with good cap­i­tal gains.

Even now, the HSBC Global Min­ing In­dex is 235% higher t han in 2003, whereas the FTSE 100 and Dow Jones are 78% and 82% higher re­spec­tively. But share prices aren’t the whole pic­ture. Since 2010, mar­gins have been shrink­ing dras­ti­cally. Ac­cord­ing to a study of the world’s top 40 min­ing com­pa­nies by Price­wa­ter­house­C­oop­ers, the gross mar­gin of the world’s prin­ci­pal gold com­pa­nies fell 29% com­pared to the share price as a ra­tio com­pared to gross mar­gins of 49% in 2010.

The acid test, how­ever, has been the re­turn on cap­i­tal em­ployed (ROCE),

a ra­tio that digs deeper than just earn­ings, and pro­vides an in­sight into how ef­fec­tively man­age­ment has used cap­i­tal.

At the be­gin­ning of the su­per cy­cle, min­ing com­pa­nies used their money rel­a­tively well, with ROCE ris­ing to 23% in 2006, from 5% in 2002. There­after, how­ever, the trouble be­gins. As min­ing com­pa­nies be­came more en­thu­si­as­tic about the never-endi ng gift t hat was the su­per cy­cle, aided by talk

of I nd i a join­ing China as a world pow­er­house, the spend­ing on cap­i­tal projects in­creased, and with aban­don.

ROCE fell from 23% to 9% by 2009 amid the eco­nomic and fi­nan­cial cri­sis; it bounced back to 18% in 2010, but slipped again to 8% in 2012 – its low­est col­lec­tive level in 10 years.

In the last two years, the break­down of cap­i­tal dis­ci­pline in min­ing man­age­ment started to re­flect in the shares. The HSBC Global Min­ing In­dex de­clined 30% in 2011, whereas the Dow Jones In­dus­trial Av­er­age was 16% higher from 2012.

As a re­sult, in­vestors are ask­ing min­ing man­age­ment to deal more carefully with their dol­lars.

First, though, there’s been a wide-scale clean-out of those in man­age­ment, who have been re­placed with new lead­ers whom in­vestors have or­dered to fo­cus on cash re­turns, div­i­dends – or yield, as it’s termed.

“In­vestors are say­ing this is their cap­i­tal,” says Carel Smit, head of mar­kets, en­ergy and nat­u­ral re­sources at KPMG in Jo­han­nes­burg. “They are say­ing that they will in­vest in your iron ore mine, but don’t use the prof­its to buy a coal mine. Give it back to them in div­i­dends.”

The cat­a­lyst for the fail­ure of the world’s min­ing sec­tor has been a de­cline in the rate of China’s eco­nomic growth to ‘only’ 7% or 8%. This has led to an ad­just­ment in prices while in a sep­a­rate de­vel­op­ment, the 10-year bull run in the gold price has been stopped dead in its tracks by po­ten­tial changes to mone­tary pol­icy in the US.

In South Africa, the pic­ture is – some­what de­press­ingly – more com­plex. The pro­mul­ga­tion of em­pow­er­ment reg­u­la­tions in 2004, just as the su­per cy­cle was kick­ing off, mud­died the in­vest­ment wa­ters in the coun­try for po­ten­tial new in­vestors, who had more op­tions any­way thanks to ex­pan­sions in pro­duc­tion else­where in the world.

Never mind new in­vestors in SA. Ex­ist­ing in­vestors have be­come anx­ious about is­sues

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