Miners plug into new commodities supercycle

Analysts believe a new commodities supercycle is underway. The current crop of FTSE 100 mining executives should learn lessons from the mistakes made by their predecessors.

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  1. Garry White

Britain’s FTSE 100 index has lagged global peers since the Great Financial Crisis sparked an implosion in the banking sector more than a decade ago. This underperformance was exacerbated by a fall in oil prices, hitting some of the largest components of the index.

But things may be about to improve. Wall Street investment banks Goldman Sachs and JP Morgan claim a new commodities super-cycle is underway, driven by the rush to clean energy. This should help boost the shares in an underperforming sector, but also has implications for the FTSE 100 itself as basic materials has a 13.5pc weighting in the index. All of this is, of course, great news. The mining sector is very adept at digging itself into financial holes.

The driver of the latest uplift in the commodity complex will be the greening of the world through investments in green energy and carbon reduction. The multi-year transition to an electrified, clean-energy global economy is likely to result in a monumental draw on metals and minerals from the world’s mines, the banks argue.

Past value destruction

However, regular industry watchers will know that the history of the listed mining sector is littered with value destruction at times of sky-high metals prices.

When the last super-cycle died around a decade ago, many mining investors were left nursing heavy losses. When share prices soar, boards can easily get dizzy with their own success and go on acquisition sprees at inflated prices that leaves their businesses drowning in debt. One obvious example of the sector’s panache at value destruction was the near collapse of Rio Tinto as the financial crisis unfolded.

The breakneck rise of China in the early 2000s snapped miners out of a lull that had lasted for more than a decade. Dividends were not the number one priority for boards investing for super-cycle growth. Miners also competed for assets with rivals, bidding up prices even further. The boardrooms of the world’s major miners appeared to be hit by a serious case of FOMO – the fear of missing out.

In August 2007, when the “credit crunch” was already being discussed, Rio Tinto raised a record $40bn (£29bn) to fund its acquisition of Canadian aluminium group Alcan. It was the biggest loan ever raised by a UK-listed company at that time – and the fourth largest worldwide.

The hubris-filled Alcan acquisition brought with it a mountain of debt immediately before commodity prices slumped. The collapse in equity markets over the next year was more disastrous for Rio Tinto than many of its peers, who were simply lucky with timing.

Rio’s attempt to solve the issue angered its shareholders even more. The miner agreed a near $20bn cash injection from investor Chinalco, a move that would have resulted in the Chinese state-owned group doubling its stake in Rio to 19pc from 8pc. This was abandoned swiftly as it favoured one shareholder over another and angered much of Rio’s investor base. Chinalco trousered $200m in break fees and Mr Albanese launched a $15.2bn rights issue.

The big winners from the first mining mega-merger in 2001 were, as usual, the bankers. The combination of Australia’s Broken Hill Proprietary Company and Billiton was effectively reversed in 2015 when most of the remaining assets that can be traced back to Billiton were spun off into a new company, South32. BHP Billiton became BHP once more.

Translation in profits

Gains in commodity prices do not necessarily translate in booming profits either. In 2009, gold hit a new high just shy of $2,000 an ounce. Despite the surge in gold, gold miners underperformed significantly.

Mining is a difficult business with many political and operational challenges. The quality of ore mined can be poor, dams can break catastrophically – and these businesses are also run by flesh-and-blood employees who make mistakes and misjudgements.

Decision making in the sector is made much more difficult by the lead times involved in the projects. It is usually many, many years after the final investment decision being ratified by a company’s board until a mine is fully operational. The world will almost certainly change significantly over this period.

Of course, current management at the FTSE 100’s major miners understand this well. They have streamlined and focused their operations on quality, flagship mines in plumb sectors and have boosted returns to shareholders via dividends and buybacks.

However, no chief executive has a crystal ball. The two major market negative events of this century were largely unpredicted – the Great Financial Crisis and the Covid-19 pandemic. They were so-called Black Swan Events. The inability to predict the future is why Tom Albanese had to spend years rebuilding Rio Tinto after agreeing to an aquation that appeared to make complete sense at the time.

So, even if the rush to electrify family cars, remove gas boilers and install wind turbines boosts the price of metals, these gains – although positive - won’t necessarily translate into exploding share prices in the mining sector.

There is also the current dispute between Australia and China to consider, as the biggest UK-listed miners are Australian based. Reports suggest that the current political tensions have resulted in a push from Beijing to source more of their commodities from Africa. Investors need to watch how this plays out. Although these are undoubtedly positive developments for the bottom line of these businesses, super-cycle investors need to exercise caution before getting too excited about what it means for the prospects for the mining sector – and the FTSE 100 too. And they’ll probably need that caution in spades.

A version of this article first appeared in the Daily Telegraph.

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