Saturday, June 09, 2007

Commodity Prices - The 50-year low and 20-year average

In 2002 commodity prices were at a 50-year low, and with zinc, for example, the price was about half of the 20-year average price.

That 20-year average price was mostly in a bear cycle. Bear cycles lead to under investment. Existing mining companies are sustain operations without replacement investment. For example, the mines are already built; so only maintenance costs required. They already have drill results telling them where to mine, so exploration budgets can be cut, and that was happening. Individual mines depreciate in value as the minerals are mined and the life of the mine declines, so in real terms, without re-investment the value of mining companies was declining during the bear cycle.

Furthermore, if you look at what happened when prices hit that 50-year low in 2002, well, companies went into bankruptcy. Other companies sold off valuable assets at bargain basement prices. Look at how Roca (ROK-V), Northern Orion (NNO-T) and Eastern Platinum (ELR-T) all got started. The assets they control they got for probably 10c on the dollar.

Another example, Silver Wheaton purchased 37.5% of the Alumbrera mine in 2003 for $270.5 million, which was later acquired by Goldcorp. In 2006 that 37.5% interest accounted for $334 of the $455 million of operation earnings from the 15 mines listed with operations for Goldcorp. Alumbrera is in Argentina, where costs are relatively low and it was sold in a fire sale!

The mining industry in BC, where I live, practically died at those 20-year average prices, even where the mines were already built. And it was happening across Canada. Look at Teck Cominco’s (TCK.A-T) old Pine Point mine, the property now owned by Tamerlane (TAM-V). It was the site of one of Canada’s most profitable mines and it was shut down and practically given away with 70 million tonnes of historical, ie, not NI 43-101 compliant, resources with 1.59% lead and 4.19% zinc in 34 deposits. That is about 2.5 billion pounds of lead and 6.5 billion pounds of zinc.

Competition from countries with cheaper wages and costs played a significant roll in the demise of Canada’s mining industry. With those 20-year average prices gems were treated as pyrite. And that should be a wake up call for just how much relative value you should give to metals in the ground versus a company’s earnings in your own investment portfolio.

It seems to me that using that 20-year average price as a meter stick to come up with long term price projections is not reasonable given that it was a period of cannibalism of assets to maintain operations and I think that is partly why some analysts keep under estimating the strength of future commodity prices.

And, if you take a look around at what is happening in other countries that have developed a strong mining economy, the standard of living is rising, as are their wages. The proliferation of news releases about strikes is enormous, and wages are going up. The wage discrepancy is shrinking and the world is running out of countries where you can build a mine for slave labour wages.

And with increasing standards of living, when workers can actually participate in the economy rather than just exist in the economy, they stimulate the economy in a way that gives the enormous rates of economic growth that we are seeing in developing countries.

Those in the mining industry and those highly bullish on commodities insist that it will take years of new investment to meet current demand and that we are in a super cycle for commodities because of the gross level of under investment and because of the economic growth in developing countries. The bears of the market look at that 50-year low and the 20-year average price and use that as a meter.

There is no question that the high commodity prices we are seeing today are unsustainable in the long term, and the further out the prediction on where prices will be the more likely it will be wrong, but it makes far more sense to me that the next 20-year average price will be significantly higher than the previous 20-year average price.

3 comments :

Larry Nusbaum said...

I own GG, NTO and a few others

Jay Walker said...

Nice blog Deborah,

very cogent and succinct analysis.

Keep up the good work ...

Jay Walker
The Confused Capitalist

Deborah said...

Thanks Jay. I had a look at your blog and added it to my reader.