Morgan: Base metals to rebound first

The legendary miner tells Eureka Report his hopes for a mining rebound rest with base metals and gold.

Summary: The Australian mining industry has a long history of fabulous booms and long periods of correction, according to senior statesman Hugh Morgan. The current environment has many parallels with the end of a previous boom in 1972 – back then, it was about satisfying the needs of Japan, while now the focus is on China. But as China switches to a focus on services, the iron ore and coal boom has run its course.

Key take-out: Look more closely at base metals, industrial metals and even gold. Iron ore and coal companies could be set for a long period of watching costs and ore grade as prospects of a recovery are uncertain.

Key beneficiaries: General investors. Category: Economics and investment strategy.

Investors should not expect a quick rebound in the iron ore and coal industries, but can expect a reasonable future performance from base metals such as copper and zinc, according to a senior statesman of the Australian mining industry, Hugh Morgan.

Gold is also a metal which earns a tick of approval from the man who worked for 26 years at Western Mining Corporation before it was acquired by BHP Billiton, including 13 years as WMC’s chief executive.

“I’m not so much gloomy about the outlook for mining as suggesting it’s time for a reality check,” Morgan said in an exclusive interview with Eureka Report.

“Just because we’ve come off a boom don’t imagine that it’s going to be fantastic tomorrow.

“You only have to look at the history of Australian mining to see that we have fabulous booms and then long periods of correction.”

Morgan’s view of the resources sector is based on a combination of historical performance and personal experience. While he has been criticised for some of his decisions when in charge of WMC, he was in the top job during one of the mining industry’s most severe downturns.

His starting point for explaining what’s happening in the resources sector today is 1972, the year when a previous boom ended and a long period of declining prices started – for commodities and the price of shares in mining companies.

“There are many parallels with what happened in the period leading up to 1972 and what’s happening today,” Morgan said.

“Back then it was a case of satisfying the needs of Japan. The latest boom has been about satisfying the needs of China.

“But, once the metal-intensive phase of a growing economy is hit there is a switch to the services sector.”

China, according to Morgan’s analysis of the current state of play in the resources sector, has started making the switch from metals intensity to a services-focussed phase.

Other factors have helped make the China-driven boom bigger than that enjoyed by the Australian resources sector during the 1960s and early 70s.

They included the first wave of China’s rapid expansion being fuelled by domestic metal and fuel production, the decline of skilled labour and professional services in Australia, and a wave of government regulations which slowed resource development.

“What we failed to see is that in the five to 10 years before Chinese demand caused a sharp increase in international metal prices China had already been growing rapidly using its own resources.

“As it started to run out domestic resources it had to go offshore for raw materials to satisfy its needs. But once it went offshore in 2002 the capacity of international miners to respond was limited, so up went prices.”

The China boom, according to Morgan, has run its course with abundant supply, especially of bulk commodities such as iron ore and coal, more than satisfying its demands with the Chinese economy changing from metal intensity to services focus.

Repeating history

China, Morgan says, has succeeded in exactly the same way Japan did 30 years ago in “engineering” an over-supply of important raw materials.

“Over-production is a perfectly sensible thing for China to do, but for suppliers it means they enter the era of cutting costs,” he said.

“The discussions we’re having now are exactly the same as we had in 1974.

“Why did you guys spend so much money? How efficient have you been? You won’t get a return on capital. It’s exactly the same.

“Which has brought us to the point where everyone is looking for an upturn, but that upturn some people are praying for leads to the question of why.

“Why does anyone think there will be a sudden upturn given the history of past booms and what comes after?”

To emphasise that point Morgan said that Australian mining booms had been effectively spaced out by 30-year periods of declining prices.

“If you analyse what’s happened there is a very interesting sequence. Gold in 1850. Broken Hill in 1880. Mt Isa in 1930. Japan in 1960, and China in 2000,” he said.

“There’s a gap of at least 30 years between these events, and while that doesn’t mean we’ve got a 30-year problem for the next driver, such as India, it does mean we need a reality check.”

Morgan said there had been brief periods of recovery in demand and price in the years after the nickel boom ended in 1972, but added that an analysis of long-term trend lines for metal prices from that year on show a straight line: down.

One of the key themes of Morgan’s analysis is that mining does not lend itself to minor adjustments. It is a big and cumbersome industry where it is difficult and expensive to develop mines, and almost as difficult to close them.

The outlook, just as it was in the period after earlier booms, is for a long period of mining companies watching two critical elements important for their survival and potential success – costs and ore grade.

“It always comes back to costs and grade,” he said. “Everyone says their mine is in the bottom quartile for costs, but the problem is that three-quarters of the world’s mines claim to be in the bottom quartile.”

“It’s not irrational to hope for a recovery, and there might be an upturn, but you’re at the races, you’re punting, because you don’t actually know.

“It can often be difficult to work out the difference between a prayer and a calculation.”

Staying optimistic

Despite his warning that history is being repeated Morgan said he was fundamentally optimistic about the outlook.

“There is a tendency to view the mining sector through the lens of coal and iron ore, particularly in Australia, because of the huge volumes and rapid expansion,” he said.

“But we shouldn’t forget the base metals (copper, zinc, nickel and aluminium), and even gold.

“It’s less than 20 years ago that the Reserve Bank sold its gold for less than $US300 an ounce. What’s it today, $US1200 an ounce, which is still a four-fold increase.

“With gold it is important to remember that we’re producing at twice the find rate and there are not many situations like that, and certainly not with iron ore or coal.”

Morgan’s advice is for investors to look more closely at the base metals, industrial metals and gold.

“There are a whole lot of situations where there is the potential for an upturn because the find rate (discovery) is a lot less than the consumption rate,” he said.

“I’m not without optimism, the issue is really one of passing through a perceptional readjustment, and one of the issues we will have to deal with is the inherited cost problem.

“Our cost problem is a caused in part by low productivity, high wages and a lack of freedom in the labour market.”

Morgan said the move by Australian mining companies, especially smaller companies, to seek opportunities overseas was a logical reaction to Australia’s high-cost environment. The destination he believes offers the greatest opportunity is Africa.

“Companies are not being disloyal by exploring overseas, it’s a case of following the money,” he said.

“Africa offers enormous potential. Not many people realise that by the year 2050 the continent will have a population of 3.5 billion people. It will be bigger than China and India combined.

“For all of its difficulties Africa is going to be a huge opportunity.”

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