Metals explorers are undaunted by the uncertain global economy. According to a report from the SNL Metals Economics Group, spending reached $21.5bn on exploration for non-ferrous metals in 2012. That’s an increase of 19% over 2011, and a new record high. So where is this money going? And what are the implications for investors?
To put this into perspective the yearly global budget for non-ferrous exploration in the years 1993-2005 was in the range of $2-$5bn. Since then, and only interrupted by a dip post the 2008 banking crisis, the trend has been rising strongly. Some of this, of course, is due to rising industry costs, but still there has clearly been a big increase in project development. Miners are scouring the world for resources.
Exploration spending is gaining momentum
This boom is correlated to a rise in metal prices. There is a pretty direct mechanism. Although there is some financial speculation in metal markets, prices generally reflect the balance of supply and demand in the real world. Rising prices make financial projections look good, mining executives feel emboldened to launch new projects and above all, in an industry that depends upon up-front funding, makes the financiers loosen the purse strings.
This, though, makes the industry fitful. As SNL points out, spending was slashed by 42% in 2009. When sentiment turns, the reaction can be swift and savage. Most penny share miners avowedly need to raise money, and can only hope that it is on offer when they need it. That said, the industry has recovered much more quickly than many had predicted in 2009. As the report says, “despite a slowdown in China’s economy, the threat of economic collapse in Europe, and political and economic uncertainty in the United States”, exploration spending is now some 50% above the 2008 level. But where is the money going?
Latin America and Africa dominating
Exploration allocations for all regions increased to record highs in 2012, but the largest dollar increases were in Latin America and Africa. The former is the most popular exploration destination. Led by Mexico, Chile, Peru, Brazil, Argentina and Colombia, Latin America attracted one quarter of global spending in 2012, with the focus on gold.
The second largest increase both in percentage and dollar terms went to Africa. Despite the political strains in South Africa, the continent now accounts for 17% of global exploration spending. Within this, the top country for exploration spending is the Democratic Republic of the Congo, but there has been an increasing focus on West Africa, particularly in the hunt for gold and iron ore.
One commodity that has been overlooked is diamonds, where the amount devoted to the hunt for new discoveries fell for the sixth consecutive year. But while this may appear to indicate that diamonds are an unattractive product, the real reason is that diamonds are only found in certain identifiable geological formations, and these have mainly been exploited. Ironically, of course, the fact that miners are giving up on the hunt for diamonds is a good reason to be bullish about diamond prices over the long term.
Miners are playing the game
While investors have become increasingly anxious about political risk, miners seem to have no such misgivings. The smallest increase in exploration spending was seen in that political haven, Canada, allowing it to be overtaken by Africa. In Africa and central Asia, governments have repeatedly changed the rules of engagement, but miners see this as just part of the game. Eurasian countries have continued to attract their share of the exploration budget, with significant allocations for copper and nickel in China, Mongolia, Russia and Kazakhstan.
Australia, though, lost out – a fact attributed to the heavy hand of its own government. “Mining reforms at the national and state levels dominated the Australian minerals industry over the past several years”, says SNL, “and industry-watchers say this will reduce investment and make the country’s resource sector less competitive”.
One conclusion of the report, then, is that political risk may be overstated. Clearly, the miners are going to the places where they expect to find rich resources, without worrying too much about political risk. The extent to which this exploration effort will result in higher production is a moot point, as is the long-term balance of supply and demand which is so dependent upon China.
Certainly, the junior mining sector will continue to loom large in the penny share world. For my money, there is no point in taking on political risk if you do not have to, while I also like mines where production is close and not a distant promise. That is my strategy within Red Hot Penny Shares – if you are not already a subscriber you can sign up here.