The natural-resource sector is in trouble. After a new low last week, the UK mining sector is 27% below its 2013 peak, and exactly half the level reached in 2008. Suddenly all those theories of the commodity super-cycle are looking threadbare. And perhaps the best single measure of sentiment in the sector is the Australian dollar. Until recently it’s been riding high, reflecting insatiable demand from China for Australia’s metals and minerals.
So, Aussies have been flashing the cash overseas, enjoying the purchasing power of their mighty dollar. Just three months ago, one Australian dollar would buy $1.05 US dollars. But today it will buy just $0.92. That is a 12% decline a few weeks – a massive shift in currency markets.
So what has gone wrong? One penny share company summed it up in stark terms last week. Copper Development Corporation (CDC) has two copper projects in the Philippines. They are big and close to coastal ports. The project economics look great. At a $3.00 per lb copper price – below today’s price of $3.16 – CDC’s Hinoba-An project has an estimated value of $440m, using a 10% discount rate, and delivers a post-tax return on capital of 36%.
CDC has offered this proposition to several Chinese and Philippine mining companies and some 90 Canadian and Australian miners. None of them has been willing to stump up some of the $480m needed to bring the mine onstream.
The squabble between China and the Philippines over islands in the South China Sea is not helping. Any Chinese company investing in the Philippines would not win friends back home. But the problems for junior miners run much deeper than this one issue.
CDC’s experienced executive chairman, Mitchell Alland, talks of “distressed market conditions”. These have prevented CDC and potential partners from raising money. Unlike most mining executives, Alland pulls no punches. “In the second half of 2012,” he says, “quoted junior mining companies hit new lows and this slide has continued unabated. Share prices of the majority of junior to mid-sized mining companies have been decimated, and many now stand at one-tenth or less of their previous value. Copper Development Corporation has not been spared.”
With no immediate chance of getting Hinoba-An off the ground, CDC has mothballed the operation and cut its annual costs from $4.4m to $0.75m. With $14m in the bank, CDC can keep going for many years and wait for the upturn.
Finance is pulling the plug
CDC’s story is typical. Mining has always been a cyclical business… when the mood is positive, investors pump money into the sector, fund managers are flush with cash and can barely invest it quick enough. Today fund managers are facing redemptions, they are forced to sell shares even in those companies that they like, and they certainly do not have the funds to invest in new ventures.
Without cash, junior miners can’t move their projects forward. But the lack of cash is really just a symptom of a bigger disease. Prices of industrial metals have fallen, and the sudden reversal of those supposed safe havens, gold and silver, has further depressed the mood.
The real problem is China. For the last few years, natural resources have been a play on China’s growth. China uses 40% of the copper supply, so it’s no surprise that traders flinch at any sign of weakness over there.
China’s economy looks like it’s in trouble. Growth is slowing, and only last week rumours were circulating that the Bank of China was defaulting on its loans. China is facing a difficult transition from being a cheap manufacturing base to an economy with a bigger farming and service sector.
Value investors will note that the $8m stock-market value of Copper Development Corporation is well below its $14m cash pile. But patience is required – the chance of a quick bounce-back for natural-resource stocks is slim.