Ernst & Young LLP
The latest report from ERNST & YOUNG says most mining analysts have missed the mark by repeatedly predicting a sharp decline in metal prices. Here's a summary of what the authors observed:
Contrary to the continued assertions of mining analysts, current metal prices are actually a return to sustainable price levels following an extended period of artificially depressed prices. While analysts are wary of straying too far from the comfort zone of historic averages, the mining companies by their actions are taking a far more realistic view.
There are three underlying reasons for the analysts' errors.
1) Research shows that analysts' short-term metal price forecasts since the beginning of 2005 have been significantly adrift of where prices have actually settled, by anywhere between 20% and 200%. The result? Most mines and mining companies have been materially undervalued.
2) More often than not, significant premiums have been paid over market prices. Over US$100 billion have been spent on the recent takeovers of Falconbridge, Inco, Phelps-Dodge and Alcan, as the key players fight it out for control of low-cost production across the globe.
3) Research shows mining companies that have pursued growth through acquisitions have consistently outperformed those that have chosen to grow organically.
The Ernst & Young team studied metal prices over more than a century, highlighting a number of periods that have been interpreted as cycles in the mining industry. The study shows that specific reasons were behind most of these cycles, which are unlikely to be repeated in the near future. For example, weak prices in the 1990s resulted from a collapse of the Soviet Union, triggering the release of 50 years of accumulated stockpiles of minerals alongside a sharp reduction in domestic demand in the CIS. Layered on top of traditionally recognized economic cycles are major developments such as the industrial revolution, the rise of the U.S. economy, the Cold War, the collapse of communism, and, now, the industrialization of China and other emerging markets.
SourceWhy the Commodities Supercycle Just Got Longer
By Andrew Mickey, Small-Cap Commodity Prospector
Saturday Dec 15, 2007
The term “supercycle” has been batted around the commodities world for a couple of years now. To be honest, the term just reminded me of the dot-com days when we invented new terms and valuation techniques like price-to-eyeballs that allowed us to justify valuations that we now realize were completely absurd.
As a result, I wasn’t willing to recommend going headlong into the commodities market. There were bound to be a few isolated opportunities in the sector as we neared the end of the commodities cycle.
One-hundred dollar oils and sky-high commodities prices would eventually prove to be a drag on the world economy and commodity prices would fall due to lowered demand from a world economy that isn’t growing quite as fast. It’s Adam Smith’s invisible hand at work.
But that all changed three weeks ago when a company in British Columbia, NovaGold (NG:AMEX) shocked the commodities world. NovaGold and its partner, Teck Cominko (TKC:NYSE), announced they would shutting down operations in Galore Creek copper-gold-silver project in northwestern British Columbia.
Galore Creek was supposed to be one of the largest new mines in the world. It was expected to be so profitable that building a new road, a new power plant and all the other infrastructure necessary for a mine would be more than offset by the value of the mine’s production.
It was so valuable that NovaGold was able to contract two of the world’s largest helicopters to transport large earthmoving and construction equipment into the remote Galore Creek region. That was how value the property was. Trucks and bulldozers were actually flown in while the road was being built.
The size and value of the project was more than offset the initial capital costs, which were slated to come in at about $2 billion. But it wasn’t long until the costs started getting really out of hand. As the Canadian dollar rose in value, costs of putting the mine into production soared to an expected $5 billion and the expected profit margins from the mine shrank.
With a $5 billion cost necessary to get the mine up and running, it just didn’t make sense economically. So it was shut down midstream.
On top of that, Teck Cominco, which was funding a large portion of the capital costs out of its own pocket, already saw the costs at its other projects soar. In fact, it was already spending more than 150% of what originally had budgeted in 2007. And that increase was just necessary to keep on line with its timelines and projections.
Over the past weeks, I’ve been crisscrossing Vancouver, visiting dozens of mining companies, and there is only one focus: capital costs. Since many advance-stage projects have to raise a few hundred million dollars to go into production or close down altogether, we’re at a major turning point in the current commodities up cycle.
There is one top consideration that has to be made when choosing mining stocks: capital costs. Early-stage exploration is still going to have some big winners, but anything that’s been around for a few years is going to have to go big or go home.
So what does all this mean? First, it confirms the commodities supercycle. The high capital costs are going to delay a lot of projects that were scheduled to go into production and bring more supply of copper, nickel, molybdenum, oil… pretty much every commodity.
However, a lot of exploration companies are going to experience what NovaGold has gone through in this commodities cycle, which is already going to be a long one -- and could even be longer than we ever expected. Sure, at Small-Cap Commodity Prospector we’ll have to be even more selective. We’ve got the wind at our backs with news like this.
The commodities bull market has even more years left in it now. As expenses continue to rise and reduce the number of economically viable projects, the commodities sector is going to be one of the top places to have your money.