Portfolio Manager: Supply Constraints, Not Demand Growth, Will Drive Next Mining Cycle

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Written by John Egan for Industrial Info Resources (Sugar Land, Texas)--The Metals & Minerals Industry may be nearing the end of a multi-year bear market, and the future boom cycle will be driven by supply shortfalls, not demand growth, Douglas Silver, portfolio manager at Orion Resource Partners, L.P. (Englewood, Colorado), told several thousand attendees this week in a keynote address to the Society for Mining, Metallurgy and Exploration's (SME) (Englewood, Colorado) annual conference.

Noting that it takes seven to nine years, on average, to build a new mine, Silver told attendees today was "a great time to build mines." The prices of oil, steel and labor are down now, reducing the cost to build a mine. "Based on historical trends, we are closer to (a) market bottom than (a market) top," he added.

"The next cycle will be driven by a supply shortfall," continued Silver, a portfolio manager at a mining private equity (MPE) firm. "This shortfall is not predicated on high rates of demand growth." Rather, declining supplies and depleting stockpiles of base and precious metals, largely the result of several years of low prices and low production, create the conditions for a supply-constrained bull cycle in the future, he predicted.

Silver delivered his keynote address February 20. The SME conference was held in Denver, Colorado. The event drew about 6,200 attendees, slightly below last year's attendance in Phoenix, Arizona, an SME official told Industrial Info.

The current mining commodity cycle, which Silver said dated from about 2008, has been characterized by mining companies over-investing to meet demand growth from the developing world, mainly China. As a result of this over-investment, 12 large mining companies took about $60 billion in write-downs in 2012 and 2013, causing investors to flee the industry. CEOs were cashiered and the value of global mining stocks fell by $1.4 trillion between 2011 and the start of 2016.

As their stock prices collapsed, mining companies sold assets, reduced staff and cut capital spending. They focused on profitability, not production. All of these actions create the foundation for a supply-constrained resurgence of the mining industry, he said.

Silver referenced several commodity prices to support his view that the industry is near the bottom of a multi-year bear cycle. Copper prices reached an all-time high of about $10,190 per metric ton (measured in 2015 dollars) in 2011, and since then its price has fallen to less than $4,500 per metric ton. Similarly, zinc and nickel have fallen by 30% to 50% from their 2011 highs, according to prices on the London Metals Exchange. "Metals prices are bouncing off the bottom," he said.

The current commodity bust cycle, Silver said, "is the result of generalized flattening of global demand growth due to macro instability and oversupply via new production and inventory. This cycle has been reinforced by a reduction in the availability of capital."

Silver said the current down-cycle, in place since about 2011, is expected to match the previous up cycles in duration and severity. In his technical analysis of mining stocks, he said the average up-cycle lasts 7.5 years and is characterized by stock prices increasing by a compound annual growth rate (CAGR) of about 11.7%. His analysis of the down cycles of mining stocks shows a bear-market trend lasts an average of 6.5 years, during which time stock prices fall by about 20.6% each year on a compounded basis.

Click on the image at right to see a chart of historic bull and bear markets in mining stocks, courtesy Orion Resource Partners.

According to Silver, factors driving the next up-cycle for the Metals & Minerals Industry are the likely closure of many marginal mines due to low prices, and the fact that developing new grassroot mines continues to be an uphill challenge owing to declining ore grades and the fact that many potential mines are located in areas of jurisdictions he termed "challenging." He told the SME attendees, "Under-investment in mine projects today will extend the next up-cycle."

He predicted global base metals demand will grow by 3.1 million metric tons by 2018 and that the existing inventory will be insufficient to supply the market beyond a limited timeframe. This year, he forecast, demand for zinc will outstrip supply, and in 2021, demand will outstrip supply of aluminum. "We'll need a lot more metals under almost any global growth scenario," he added.

Because banks and institutional investors have fled the sector, mining private equity (MPE) firms like Orion are poised to become a primary source of capital for mining companies, Silver said. He forecast mining companies would need to make about $120 billion of capital investments over the next five years. "Alternative finance providers are coming of age to fill the funding gap when risk aversion is high," he said.

"Mining private equity firms are the good guys," he continued. "We're the guys putting up most of the money and we're here to stay." Financing the supply growth will be mining's next great challenge, he forecast.

The portfolio manager acknowledged several potential risks to his predicted upswing. One could be a dramatic slowdown in Chinese economic growth coupled with currency devaluations. Another was continued strengthening of the U.S. dollar and rising oil prices. Other risks include a global economic slowdown, triggered either by Europe or emerging markets.

But Silver seemed to think those risks were less likely than a global resurgence. "Every day we wait, we get closer to the market improving," he told the SME audience.

Industrial Info Resources (IIR), with global headquarters in Sugar Land, Texas, five offices in North America and 10 international offices, is the leading provider of global market intelligence specializing in the industrial process, heavy manufacturing and energy markets. Industrial Info's quality-assurance philosophy, the Living Forward Reporting Principle™, provides up-to-the-minute intelligence on what's happening now, while constantly keeping track of future opportunities. Follow IIR on: Facebook - Twitter - LinkedIn. For more information on our coverage, send inquiries to info@industrialinfo.com or visit us online at http://www.industrialinfo.com.