A return to growth for Miners

The end of China’s property boom was once expected to lead to challenges for the producers of bulk commodities (e.g. iron ore, coal) and base metals (e.g. copper, aluminium). These miners benefited from two decades of strong demand as China’s industrialisation and urbanisation accelerated. Whilst that source of demand growth has now began to stagnate, intensive urbanisation continues globally and new demand drivers have emerged, notably decarbonisation and digitisation.  

Decarbonisation is driving the energy transition (favouring renewables to replace fossil fuels) and increasing electrification (notably electric vehicles). Increased demand for electricity has numerous impacts on materials demand, e.g. the amount of copper in a battery electric vehicle is estimated to be over three times the amount required by an internal combustion engine. The growth of renewable energy requires a broader transmission network that will increase consumption of aluminium and steel. 

Digitisation has further accelerated demand for materials. Data centres require significant volumes of aluminium and steel for the exterior building, with further consumption from cooling systems, electrical systems and backup power. Copper is also prevalent via network and storage equipment, and in the GPUs that satisfy the surging demand from the growing adoption of the Cloud and AI. 

What this means for investors

For investors, the attraction of this growing demand is matched by ongoing supply constraints. Mining is a capital-intensive business with high barriers to entry from challenging operating environments and significant initial costs in equipment and processing. Exploration has struggled to find new mines, with mine delivery times tripling over the past thirty years, and discoveries are often smaller and deeper than existing operations, increasing the industry cost curve.  

A steeper industry cost curve is good news for existing producers, especially those with long-life, low-cost mines. ASX listed diversified miners like BHP and Rio Tinto hold portfolios that contain such assets, notably Pilbara Iron Ore and the Escondida copper mine in Chile. But the growth in demand also generates a requirement for existing suppliers to grow their production, and this can generate risks for investors.  

Potential risks

Delays and cost overruns are not uncommon in new mining projects. Downside can be generated in the mines from unexpected variability in grades or impurities, or difficult ground conditions. High risks emerge in the processing capacity required to extract metals from the mined material, especially if high pressure, high temperature or the use of volatile materials like acids are required.  

Investing in mining companies can generate high returns but comes with high risks. Whilst the large, diversified mining companies are typically held by domestic investors given they are a large part of the S&P ASX 200 benchmark index, investors may be tempted to look at smaller mining companies involved in exploration and development. We are wary of the risks associated with the ‘juniors’, notably their high operating leverage and reliance on single operations. We believe the risk and return of these companies is best assessed by sector specialist fund managers with significant experience in geology and engineering. Please contact your adviser if you wish to understand how to best approach this investment theme.