We have always sung the praises of speculative mining stocks. The truth is that the 'under-loved' speculative or emerging mining stock has never been more under-loved, and yet offered so much opportunity. This can be attributed to a number of developments.
Conventional wisdom was that the larger multinational miners were 'low risk' because they offered diverse exposure to different countries. I've always questioned this wisdom as a dogmatic truth, but its becoming ever so apparent in mining. In the 1990s I observed how power generations sponsoring big power plants were targeted for all manner of political reasons. Their attempts to commission plants were just thwarted at every turn. The same is true now for miners. Increasingly miners are confronting governments which are reneging on their taxation arrangements, whether its Australia, Ghana, Mongolia or China. The times are changing. The other problem is that the pricing powers of these major companies are being unwound, not simply by more competition (often sponsored by China, India, Korea, etc), but also pricing regulations in consumer nations. China, with out a doubt the most important consumer market, in August 2008 adopted an anti-monopoly law to prohibit price fixing.
The law prohibits 'abuse of a dominant market position; and the concentration of business operations that which may exclude or restrict competition' (Ref.1)
The iron ore and coal markets have witnessed a great deal of concentration in market share over the last 2 decades. There is good reason to think that market pricing power is over. But you could also argue that its simply just about to resume again. The Chinese government blames to be cutting down on corruption. Call me cynical, but I'd argue corruption just acquired a new rationalisation. Never believe the rhetoric. Having said that, markets are adjusting, and the outlook is for rapid expansion in traded volumes rather than prices. Will there be new pricing patterns? Expect price regulating agencies to get a kickback. How can you stop higher prices without breaking the high market concentration. Major companies can't be stopped from driving higher prices. All it takes is for a few major companies to decide that the biggest producer on a certain date sets the prices, and everyone asks for ridiculously high prices until the 'leader' settles, in which case, that price becomes the reference price. That will be the new tradition. There doesn't have to be any secret handshakes or encrypted message; simply a tradition. Matters for the major companies are far worse in Australia, where sovereign risk was once considered far less. Such conventions have been proven wrong again. The Australian Labor Party-led government has appointed a new Resources Minister Gary Gray, who has ruled out making any changes to the mining tax but has conceded it could have been handled better. Of course he is probably not going to repay lost earnings to shareholders. Gray said it will be “business as usual”. I guess that means taxpayer extortion 'as usual' (Ref 2). The Mineral Resource Rent Tax (MRRT) was originally adopted by former leader Kevin Rudd. He was dumped over his handling of the tax.
Thirdly, there is another huge problem for large miners and that is all-manner of objections to their projects, whether because they are large, because of their impact on alternative land uses, the environment. The liberals in the environmental movement seem to take special pleasure in targeting these large projects, and legislation often gives them powerful tools to obstruct them. The courts have proven particularly useful in blocking developments. Such objections can stop or slow smaller projects as well, but largely the focus is on the major. These conflicts can obstruct development or they can drive huge compensation pay-outs for contamination of aquatic (maritime, rivers or estuarine) environments. The most famous case is BP's oil spill in the Gulf of Mexico, however BHP's Ok Tedi gold-copper mine in PNG also comes to mind. Multinational companies today are less able to rely on the complicity of government officials, who receive a royalty from such mines, or who might even have equity.
The multinational miners have historically traded at large premiums or earnings multiples on the premise that they were low-risk propositions. This premise needs to be questioned, and its not just miners. Facebook has experienced a roller-coaster ride since listing. These companies are enormously liquid, so its easy for large funds to play 'trading games' with them, but given that these companies take large leveraged bets on these companies, investors need to trade wisely.
These risks bring me back to the benefits of small companies. Small companies, unless they have a highly profitable mine, will not be offering sustained earnings in this period of recession. Most commodity economies have high currencies and prices are softer, costs are high, so we can expect some to struggle. But these companies are also taking this recession to rebuild resource provisions so they will be better prepared moving forward. They can therefore be expected to be more competitive cost-wise when commodity prices do recover. If you are interested in the speculative stocks, we have a eBook 2-volume set dedicated to investing in 'Speculative stocks', as well as a blog for describing a number of the companies, as well as a blog where we discuss the commodity outlook.
References:
1. “CHINA IN TOUCH: A newsletter for Northern Territory”, Northern Territory Branch, Australia-China Business Council, website, 6th Aug 2008.
2. “Gray won’t change mining tax” by Alex Heber, Mining Australia, website, 26 March, 2013.
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