Having been fortunate enough to attend the Mines and Money conference in London recently it was amazing the sense of optimism that was permeating from the attendees at the conference, both investors and miners themselves. They’d survived the war of attrition which had pushed many to the brink, had learnt all the lessons of what went wrong and vowed never to repeat it again. Yes, miners had a new focus and that is on returns to shareholders.
Does this seem familiar?
To quote Einstein on the definition of insanity it is “doing the same thing over and over again and expecting different results”. Well, this certainly rang true by the end of the week.
A weird sense of deja vu had fallen over the conference. Here we had the mining industry, apparently having learnt its lesson as fund managers stood on stage proclaiming they would not to allow these miners to start the cycle again. I had to smirk. Had they looked at the evidence? The evidence suggested we were about to do it all again.
The conference started with a battery technology day, The Battery Metals Summit. This was not the traditional metals, no, this was the new SUPER METALS! Having been burnt by rare earths in the past surely this wouldn’t happen again with the likes of Tesla, Elon Musk, Samsung, Apple and the growing fleet of electric vehicles. No doubt this market is to be massive. Prices are only going one way, and that way is up.
I made the faux pas of asking whether the risk-reward might be better off in the more traditional metals of copper or even cobalt (I even asked about Sharpe ratio but drew blank stares). There was so little discussion about the direct customer. Every company got up and told you how big there deposit was and how big production could be as well as how large the market was going to be. Yet, there was not one question of direct customers for these miners. By this I don’t mean the Tesla’s of the world, rather the people manufacturing the battery. Tesla has invested zero dollars in mines to date – an often overlooked fact. Their cycle is that of a letter supporting a mine followed by no investment in the actual upstream supply.
Does this feel like something we’ve heard before? A supposedly fast growing market, currently limited producers and a spike in the commodity price. Yes, you have heard it before! Let’s think uranium, rare earths and lithium itself – back in 2008. Now everyone will say ‘but this time is different’. Wrong! The correct questions aren’t being asked to investigate the difference plus, investors need to be aware that the end customers may not have the capacity to soak up all this new supply.
Day 2 to 4 was more subdued from the rah rah of Monday. Meek mining executives presented gun shy investors whilst consultants stepped up to offer a tentative view. The consistent message was that we all don’t know where commodity prices are headed in the medium term but the focus on the industry will be return on capital through the cycle.
Let’s take a step back and consider this point. It is a point easily said by companies however perhaps more thought is required. (Not perhaps, more thought is definitely required if you are investing yours or someone else’s money). Companies have no control over the commodity prices which oscillate based on numerous macro-economic factors. Investing in the mining industry is exciting, stressful and difficult for these reasons as well as the company specific issues. It is astounding that the focus of the industry wasn’t on return on investment previously. I mean what was it on? Company Boards allowed management teams free rein on the shareholders and debtholders cash? Do what you want, as long as you build, or better yet, buy something we will all be rich!
It led to situations where we saw absolutely astounding investment decisions. For one large miner, they spent $3.7bn on a coal project in Africa only for it to be defeated by a river that floods in wet season and hippopotamuses. You read that correctly, they paid $3.7bn cash only then to realise hippopotamuses were going to stop their barges. What are the consequences for a Board that approves something like this? Well, there’s your $500k per year coupled with ‘unfortunately we no longer require your services but you’ll find another job quite easily so, no hard feelings.’ (Basically, a slapped wrist.)
We complain about the waste and proliferate spending that occurred in the 2000s by governments globally but this pales in comparison to the wastage of the mining industry during this boom alone. BHP Billiton and Rio Tinto wrote down ~US$60bn through acquisitions since 2009 and to shareholders, they report is as a “Non-cash impairment”. This is a great fallacy as it implies no cash is associated with the project. I can tell you when all is said and done over US$60bn was spent. We complain about government wastage which is far less than this amount and yet the Chairman of BHP who oversaw it is still Chair, re-elected by a margin in excess of 95%. For all Australians, you are likely shareholders via your superannuation.
Why do I raise the re-election margin? Well, a panel of fund managers at the conference suggested they were now working with companies to stop this wastage happening again. These are the same managers who allowed the re-election of the Chair who had wasted so much with not an ounce of a protest vote. These are also the managers who support Rio Tinto investing billions into copper in Mongolia rather than spending a few hundred million investing in their iron ore business that returns over 40% on capital.
That’s right, despite low iron ore prices, every dollar spent on Rio Tinto iron ore has returned $1.40 at least. The stupidity is their best asset is now funding a gamble. A gamble on capital, the government and the commodity price versus what they know and what has been the earner in the past. Then again, who would be surprised when the company sells coal assets at the very bottom of the market and the investors all stand around in admiration, applauding the decision? I was mocked for asking if it may better for Rio Tinto to spend a small amount of capital to fully utilise the already constructed infrastructure and add 30mtpa of production which has a margin of ~$40/t. $1.2bn of annual free cashflow versus cash outflow o 2019 in Mongolia.
So forgive me if I feel cynical about the revolutionary change that is coming to the fore in the mining industry. I love the sector but I don’t believe most of what I am told. Stick with the fundamentals and trust the management teams with a track record. Metals and mining investment isn’t for the faint hearted. At the end of the next downturn, don’t say I didn’t warn you.