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Capturing upcycles in the next 25 years

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Reflecting on the last 25 years, BlackRock World Mining Trust managers Evy Hambro and Olivia Markham give their perspective on what to expect in the next 25.

We will always need the mining industry. So long as humans continue to produce things, mined commodities will be required to make them. But the way the sector looks and operates has evolved and will continue to do so.

Its evolution over the past 25 years – since the launch of the BlackRock World Mining Investment Trust, for example – has mainly been a function of a thriving global economy (most importantly in China) driving demand growth for commodities, technological breakthroughs in mining techniques, and the action of mining company management teams.

Looking ahead, the fundamentals of the sector should remain the same: Mining companies’ share prices should continue to be driven mainly by mined commodity prices and costs, as all equities are theoretically priced on expectations of future profits. Mined commodity prices, meanwhile, should ultimately be driven by supply and demand fundamentals over the long term.

But what could be different over the next 25 years compared with the last?

It is unlikely that we will see a country repeat China’s “economic miracle” between 2000 and 2011, given the unique circumstances of its fiercely competitive manufacturing labour costs and a government that allowed growth at any price. However, we are seeing exciting rates of growth in emerging economies, such as India, and these have the potential to accelerate.

Automating processes could make a big difference and has the potential to erode some of the competitive advantage emerging economies have by lowering manufacturing labour costs. In the mining sector, increased automation, such as wider use of autonomous trucks, will have mixed effects on the profitability of miners, as production costs will come down but overall supply is likely to increase.

What will also be different over the next 25 years is the sharper focus on sustainability. Regulation is stepping up as the world looks to crack down on pollution and carbon emissions – particularly notable in China, with the government rationalising inefficient capacity. This has been helpful in keeping supply and demand tight in commodity markets but, in terms of sustainability, it is thought we will see a step up in the recycling of mined commodities. This may mean we are already at or approaching peak demand for some commodities.

While we expect recycling to increase, we expect it to be outweighed by the world’s population being set to rise from 7.6billion people today to 9.8billion by 20501, which will increase demand for mined products.

Another key difference to look out for is accelerating technology innovation. The most prominent example today is the electric vehicle revolution, which is creating opportunities for battery materials including lithium and cobalt. More broadly, we are also seeing the world moving to more renewable forms of energy generation – mined materials will be required to produce products such as wind turbines and solar panels. Ultimately, where there is technology innovation, mined materials will be needed.

What is yet to be seen is whether mining company management behaviour will change. Will mistakes, in terms of poor capital discipline and pursuing growth over shareholder returns, be repeated? We expect there will be some element of the leopard not being able to change its spots but the extraordinary down-cycle of 2011 through to the end of 2015 has left lasting scars that will encourage restraint.

Today, for example, the rhetoric from management teams is giving us strong cause for optimism. Despite commodity prices being at much improved levels, capital expenditure increases last year have been modest versus 2017, and this looks likely to remain the case in 2019.

The mining sector is not going away any time soon but the industry will continue to evolve.

What will remain constant are the time lags involved in mined commodity supply, from discovery of assets to realising revenues. This will result in some periods of supply failing to keep up with demand growth and others where supply overshoots and overhangs on the market.

Therefore, in our view, the sector will continue to be cyclical, albeit not as extreme as we have seen through the last 25 years. Yet the potential to capture the upcycles will keep the mining sector an exciting area of the equity market for the opportunistic investor.

1Source: BlackRock, October 2018

 

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