Tuesday, March 5, 2013

Commodities Prices will only increase

At the moment there is a lot of hoo-ha about the difficulty the mining industry faces in terms of margin squeeze. This goes along with complaints that government is overtaxing mining companies. What we need to remember is it is the job of mining company executives to advocate for their company, but the long term sustainability of mining is nowhere near as dire as they say.   At least not in the way they think.

There is much more chance that the industry will be unable to meet demand than they will go broke trying.

I don't want to talk about the taxation side of this equation in this post, I'll do that separately. Here I want to talk about the probable trajectory of commodity prices over the medium to long term.

Supply is Constrained

Commodity prices are essentially driven by those old favorites, supply and demand. On the supply side we see that the industry is constrained by a number of things. Access to good quality ore is an issue because the easy to access, high grade ore gets mined first, so there is a trend now that orebodies are getting deeper and/or lower grade. They are also being found in areas distant from population centres and in difficult terrain as the close material has been mined out. This situation cries out for new ways of mining and that requires R&D and step changes. There are a lot of other factors: human, technological, political, but the availability and nature of the resource is the most important.

Demand is exponential

Demand for resources is driven by two things only. Population increase and societal development. The population of the earth is growing exponentially, and people everywhere are trying to improve their living standards. So even now, with commodity prices on the decline, we see a long term trend which is in exponential growth mode. Investment in China and India now, and probably in Africa in the next 20 years will continue to increase demand and put inflationary pressure on commodity prices.

Commodity Price Index

The commodity Price Index put out by the Reserve Bank of Australia (Link) (Graphic) shows clearly that industrial activity in China and India is driving unpecendted demand for resources. The increasing trend over the last 10 years includes a shorter cycle 'mini-boom and bust' but the overall trend is clear.

So What!

So what, you ask. Well, I've talked about myths in the mining industry that prevent investment in innovation, and here is another view. During times of increasing commodity prices, many mining companies will cease investment on anything that gets in the way of production, including innovation, vehicle maintenance and new equipment. Often they also take their eye of their operating costs. And in the bust cycle, they are too busy screwing down on costs to invest in anything. So it's a double whammy.

Over the next 30 years, resources demand will increase exponentially. Incremetnal change will not produce the productivty increases necessary, it by nature provides a diminishing return, so step change is critical. The mining companies that embrace it will be the success stories of the future, the question is - will your company be one of them?

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