Eenie, Meenie, Mining, Moe, Catch A Backhoe By The Toe

“Over against the prospective yield of the investment we have the supply price of the capital-asset, meaning by this, not the market-price at which an asset of the type in question can actually be purchased in the market, but the price which would just induce a manufacturer newly to produce an additional unit of such assets, i.e., what is sometimes called its replacement cost. The relation between the prospective yield of one more unit of that type of capital and the cost of producing that unit, furnishes us with the marginal efficiency of capital of that type. More precisely, I define the marginal efficiency of capital as being equal to that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital-asset during its life just equal to its supply price. This gives us the marginal efficiencies of particular types of capital-assets. The greatest of these marginal efficiencies can then be regarded as the marginal efficiency of capital in general.

 

The reader should note that the marginal efficiency of capital is here defined in terms of the expectation of yield and of the current supply price of the capital-asset. It depends on the rate of return expected to be obtainable on money if it were invested in a newly produced asset; not on the historical result of what an investment has yielded on its original cost if we look back on its record after its life is over.”

 Chapter 11: The Marginal Efficiency of Capital

 The General Theory of Employment, Interest, and Money

By John Maynard Keynes, 1935

 

The Global Mining Industry presents one of the most cyclical industries in the world. When times are good, money rains down upon companies as prices rise to levels well above those needed to justify building new mines. And when times are bad, companies struggle to pay their employees, suppliers, and creditors. Such is life for those companies whose existence depends on the next ore body and whether the costs to produce the ore make the mine globally competitive or not.

From 2011 to 2016, the industry endured one of its periodic swoons, which drove prices down to cash costs for a significant portion of the mining industry. Growth in demand slowed around the world, yet new mines under construction kept opening, making things worse and worse. Reflecting these difficulties, capital spending for the industry collapsed, dropping from ~$170 billion in 2012 to just $50 billion in 2016, the same level last seen during the 2001 – 2002 recession. But, the damage had already been done as a new mine can take 4 years from start to finish to bring online, and the numerous new mines under construction kept coming. Supply across multiple metals rose much faster than demand. However, in every economic disaster for the industry, there is a silver lining. No new mines entered the development stage, exploration spending collapsed, and expansions of existing mines were put on hold. This caused future new supply to take a steep dive, thus ensuring low supply additions through the early 2020s for copper, zinc, and many other base metals.

With the industrial economy recovering over the past two years, demand rose just as supply growth slowed, a not atypical scenario for a commodity industry. This enabled prices to recover, providing the mining industry a breather. However, for many base metals, despite the price recovery, they still remain below levels needed to justify building a new mine today. In addition, as existing mines age, miners face the necessity to move more rock to produce the same amount of metal, driving their costs upward. Average ore grades (the amount of ore in a given amount of rock) have been falling since 2007 for most base metals. Given this, even though prices recovered to levels that might justify evaluating new mines in the past, prices will need to rise even further to entice mining companies to sanction new mines and increase their exploration spending. In the meantime, they likely will need to increase spending to maintain their current operations, as several years of underspending have pushed their machinery to the limit.

Should the global economy remain strong over the next few years, the mining industry likely will see its fortunes rise as limited supply growth meets strong demand. Prices will soar once more, enabling cash to rain down on the industry. And this cash will lead the industry to expand existing mines, increase exploration for new ore bodies, and dust off new mine plans. With these actions, the roller coaster nature of the industry will be evident once more. As it has been for the past century and more, for the Global Mining Industry it is Eenie, Meenie, Mining, Moe, Catch A Backhoe By The Toe. (Data from Jefferies Group LLC, public sources, and the US Minerals Management Service coupled with Green Drake Advisors analysis.)

 

 

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