It has been a tougher time for certain commodities in recent months as fears over the global economy mount. The longer-term outlook for the mining sector is still buoyant, argues Evy Hambro, co-manager of the BlackRock World Mining Trust.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
After gains since the start of the year, certain commodities have started to weaken over the summer. In particular, those commodities seen as dependent on global economic growth have seen prices fall. This includes metals such as iron ore, steel and copper.1 However, we believe the structural arguments for mining companies are still intact.
The short-term sell-off has been prompted by fears of global recession. These fears are well-founded, with rising interest rates and inflation weighing on economic growth. The immediate sell- off was sparked by weakness in China; in particular, the Chinese property sector, and ongoing, economically damaging restrictions as the government sticks to its zero-Covid policy.
Equally, earnings in the mining sector have been hurt by rising input costs, including higher oil prices, rising wages rates, higher raw material input costs and supply chain issues. These have dented share prices in the short term and could continue to impact results in the second half of the year.
Longer-term strength
However, we believe any price weakness for commodities is likely to be temporary. China is showing signs of recovery. Recent manufacturing data has shown the sector starting to grow once again.2It has loosened monetary policy and announced support for the property sector and on infrastructure spending.
While there are unquestionably strains elsewhere in the global economy, many commodities are subject to structural forces that are likely to support demand even if the economy weakens. The Ukraine crisis has put a greater focus on energy independence, for example, accelerating the plans of governments across the globe to increase energy supply from alternative sources. We expect the mining sector to play a critical role in the coming years in supplying materials required for lower-carbon technologies, including wind turbines, solar panels and electric vehicles.
Broader global infrastructure needs are also supporting demand for commodities. Infrastructure development is becoming a priority across the globe to promote more efficient use of resources. The US Inflation Reduction Act, passed in August, announced significant spending on green energy infrastructure, including charging infrastructure for electric cars, plus improvements in rail services and other transportation networks.3This shows how infrastructure is being prioritised by governments.
Supply constraints
Demand comes at a time when supply remains limited. The management teams of mining companies continue to maintain a focus on capital discipline, having learnt their lesson on expanding supply too quickly in previous commodities cycles.4Equally, for a number of commodities, notably copper, we see mines ageing, creating less supply each year, so mining companies need to run simply to stay still.
It is plausible that more supply comes through over the longer term, particularly given the visibility on demand. However, it will take time for any new expenditure to feed through into new supply, given the complexity of bringing new mining projects on stream. In the meantime, weak supply and strong demand is likely to keep prices elevated for many commodities and support the mining sector.
Mining companies
Mining companies are generally in robust financial shape today, with high levels of free cash flow. This is helping them weather cost pressures. Balance sheets for nearly all mining companies remain strong. This gives them flexibility at a difficult moment.5
Of course, there are risks. Mining companies often operate in difficult parts of the globe and geopolitical tensions are rising, not just with the war in Ukraine, but between China and the US. We strive not to invest in countries where there is uncertainty over the mining code and high political risk. Good governance is vital and we only invest in companies where we have faith in the management team.
There are two other reasons to consider mining in the current environment. We believe mining equities are an effective way to hedge portfolios against persistent inflationary pressures. There are relatively few sectors that can thrive in the current market environment, but mining has been an area of strength.
Also – and in spite of the relative strength of mining shares since the start of the year – shares remain, in our view, good value relative to other sectors and to their own history. This should hopefully support buybacks and future dividend payments.
While short-term concerns have held back mining shares over the past few months, the factors driving the sector are durable and will start to become increasingly important for the remainder of 2022 and beyond. The world is in transition and this is likely to support the mining sector even in the face of weaker growth.
1 FT – Industrial metal prices melt as global recession fears flare up – 6 Sept 2022
2 Statista – 30 Sept 2022
3 https://www.eesi.org/articles/view/how-the-inflation-reduction-act-and-bipartisan-infrastructure-law-work-together-to-advance-climate-action
4 World Trade Organisation
5 Blackrock – August 2022
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