Could we be sowing the seeds of the next boom cycle? Some observers think so, not willingly but as a result of the current bust investment cycle (investment has fallen off the edge of a cliff). This lack of investment and with it the identification of new reserves and in some cases even the maintenance of existing mining facilities could lead to supply shortages down the line.
As miners in general and junior miners in particular, are facing trouble raising new cash, servicing existing debt and funding losses on production at current prices, many junior miners are expected to go out of business in 2009 and 2010. For those that survive funds into new exploration will be severely cut back. The VM Group estimates a shortfall of up to $50bn will be lost in 2009 and again in 2010 meaning new reserves will not be identified and existing mines will be closed instead of being put on care and maintenance.
Meanwhile larger, better capitalized majors will use the opportunity to buy proven assets on the cheap rather than risk precious funds on new exploration. Likewise sovereign funds are already moving to buy into troubled established producers, witness Chinalco’s proposed purchase of Rio Tinto assets, Shenzhen Zhongjin Lingnan Nonfemet that recently took a 50.1% stake in Australian zinc and lead producer Perilya and China Investment Corps’ planned 16.5% stake in Fortescue Metals. Of all these investments, the only one that will likely result in new production is the investment in Fortescue where the funds may be used to develop identified lower grades reserves. In the meantime, the objective is to retire debt.
Where the majors do dare to make investment decisions they may be swayed by priorities such as the Fraser Institute policy potential index which measures the overall attractiveness of 71 potential investment jurisdictions around the world. Locations closer to home not surprisingly come out on top with 7 of the top 10 being in Canada. It reminds us of a quip from one mining executive that you don’t want to be investing anywhere you wouldn’t go on vacation! Of the bottom ten, five are in South America with Venezuela singled out for particularly stinging criticism along the lines of “In Venezuela, if you build it, Hugo Chavez will steal it. Ecuador is not much better. Although generally West Africa faired better, one or two locations were increasingly being shunned in the more risk averse climate such as the DRC where one executive commented “DR Congo has no rules; corruption has no limit; no justice in place; labor law is not favorable; skills are limited, re-negotiation of contract is regular.” In the new order, who would invest there? So risk aversion takes hold, miners seek sovereign funds to survive and capex is cut severely among large and small mining companies.
As time goes by, and less is invested the world’s available production base, supply shrinks. That is fine in terms of bringing the supply and demand back into balance, but in the long run, it sows the seeds for a tight supply market and forms the basis for the next boom cycle. When that may be varies widely depending on whether you are speaking to a producer, a market analyst or a casual observer. Take your pick from 1 to 10 years. Our take is probably 3-4 years before demand is sufficiently robust and the reduced supply base sufficiently limited to generate a sustainable growth in prices as we saw in 2002-2007.