After a challenging start to the year, the past few weeks have seen strength in mined commodity prices and mining equity performance. Industrial metals prices have been supported by improvements in economic data from China and evidence that the underinvestment from producers in recent years is significantly constraining supply. Gold and the precious metals have slightly separate drivers but have also performed strongly, appearing to be supported by central bank demand and ‘safe-haven’ buying amidst heightened geopolitical risk.
We have also seen mining equities outperform broader equity markets in recent weeks. This follows a 12-month period of underperformance as equity markets appeared to primarily focus on artificial intelligence (AI)-related technology stocks. On top of rising commodity prices, stickier than expected inflation also appears to have been supportive for the mining sector more recently. Despite the recent uptick, mining companies continue to trade well below long-run averages compared to their historic figures and relative to broader equity markets. So, value opportunity or value trap?
The main driver for mining equities tends to be the performance of the underlying commodities, which are in turn dependent on market supply and demand. It is our view that the supply side of the equation is likely to remain constrained over the coming years, supporting commodity prices, while demand is evolving to support long-term demand growth.
Mining companies have largely focused on capital discipline in recent years opting to pay down debt, reduce costs and return capital to shareholders rather than investing in production growth. Capital expenditure for the European miners over the past eight years, for example, has averaged -35% lower than in the preceding eight years. This is limiting new supply, and there is unlikely to be a quick fix given the time lags involved in investing in new mining projects, especially at a time when inflation has pushed up build costs. At the same time, existing mines are ageing, and it is becoming more difficult to get products out of the ground.
The cost of new projects has also risen significantly. Recent M&A activity in the sector suggests that strategic buyers see an opportunity in existing assets in the listed market, currently trading well below the amount it would cost to build anew. Other issues restricting supply include cases of governments closing mines, permitting issues and a general lack of shovel-ready projects.
On the demand side, the commodity supercycle (2002 – 2011) was all about China’s extraordinary growth, and while China remains the most important individual economy for mining, we expect this importance to gradually decline through the end of the decade.
We expect global infrastructure spending to drive the next wave of demand, with low carbon transition-related infrastructure particularly meaningful, as mined commodities are essential for technologies like wind turbines, solar panels, and electric vehicles. For example, offshore wind requires 5.4x more steel and 2.9x more copper per megawatt of power capacity when compared with gas.
This is one reason that some investors who previously excluded the sector, are now reassessing their stances. Another reason is that some investors are considering investing in companies with plans to improve their emissions intensity as a new way to incorporate sustainability. We believe companies that are able to navigate the ‘brown to green’ transition (i.e., moving from fossil fuels to sustainable energy) effectively will be re-rated over time and perhaps see an additional premium on the materials they produce.
The other area gaining attention on the demand side is the implications for materials from the build out of AI-related data centres, both for the centres themselves but also for the increased power infrastructure required. There seems to be a relatively high degree of uncertainty around the exact impact on demand. However, this may be an additional oncoming tailwind for materials with already tight supply and demand fundamentals.
The main driver for mining equities tends to be the performance of the underlying commodities.
The BlackRock World Mining Trust aims to provide diversified exposure to mining assets such as: public equities (the majority of our portfolio), corporate debt and unquoted investments such as royalties. We have a bias to the copper subsector, the commodity for which we have the highest conviction in long-term prices exceeding current market estimates.
The supply and demand dynamics of mined commodities is such that there is the potential for higher-than-expected commodity prices and better-than-expected earnings for the companies producing them. The constraints caused by an extended period of underinvestment in production coupled with the structural demand growth that’s necessary for the energy transition present an attractive outlook for mined commodities – and subsequently mining equities. With the sector trading below long-run averages relative to history and relative to broader equity markets, we think it’s worth a look for investors without exposure.
Olivia Markham
Co-Portfolio Manager of BlackRock World Mining Trust
BlackRock World Mining Trust plc.
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