Mining companies are beset with major investors who browbeat the CEOs and the boards into making major capital cutbacks when metal prices move against them.

mining cycle 1They just don’t seem to understand that the time to build major capital projects – and make what may seem like expensive and counter-intuitive investment decisions and acquisitions – is actually at times when metal prices are low. This will enable them to reap the rewards when the mining cycle picks up again as it inevitably will. That is the way the world’s mega miners built their real wealth.

I am probably being unfair in the title here – there are probably plenty of mining CEOs who understand this but they more often than not don’t have the clout to carry their boards and major institutional investors with them. The latter, in particular, tend to look only at the bottom line and the prevailing stock price with their ultra short-term investment outlook, thereby missing the huge upside potential that lies ahead.

As the Elliott Wave followers will point out, all economies move in quite pronounced cycles – there are boom and bust scenarios which repeat over and over again through time – and the mining cycle is more pronounced than most. Major investment decisions are made as the cycle picks up and tend to peak at or near the cyclic top thus bringing big increases in supply on line at around the same time, leading to big surpluses and thus contributing strongly to the succeeding downturn with too much production chasing too little demand.

mining cycle 1The smart company that looks to the long term, though, will make its big capital project decisions on the cycle downturns and low points (downturns are good given the length of time it can take to bring a new project on stream nowadays). That’s how the Rio Tinto’s and BHP Billiton’s of the world became the world’s mega miners.

All credit therefore to Rio Tinto’s CEO, Sam Walsh, for slamming the company’s critics who pontificate that it is mad for it to implement major increases in its iron ore and copper production at a time prices have been slipping dramatically given the apparent downturn in Chinese and global demand. BHP Billiton, the world’s biggest diversified miner, has made similar policy decisions as no doubt have a few others waiting in the wings – notably X2 Resources’ Mick Davis, former Xstrata CEO, who is building a massive investment war chest to build a new diversified mining company by acquisition when prices are depressed.

True, these companies do have the financial resources to build production when others are being forced to cut back. There is strong method in their financial madness as seen by some. Take iron ore for example. Companies like Rio Tinto, BHP Billiton and Vale have enormous iron ore resources which can be mined profitably even at much lower iron ore prices than those prevailing at the moment and, of course, what the expansion policy has done is stop in their tracks global new iron ore mine developments predicated on higher iron ore prices from less well financially supported companies.

Much of the world’s unmined high quality iron ore is located in remote areas requiring huge infrastructure commitments to bring them on stream. The longer iron ore prices remain depressed, the further back investment decisions on these new projects will be put. This will allow the mega miners not only to dominate the iron ore market for many years to come, reap huge profits when prices pick up again as much of the competition will have been eradicated, but also to acquire many of the best new projects from their financially distressed owners.

mining cycle 1But of course this doesn’t only apply to iron ore. It will apply to coal and copper too – the other two most significant mined minerals/metals. Indeed iron ore, coal and copper hugely dominate global mining. Gold only comes a far distant fourth yet generates most of the coverage. Again BHP Billiton and Rio Tinto are among the Western world’s largest producers of both coal and copper. Continuing investment during low cycle points is how they achieved their dominant positions. Sam Walsh is thus quite right to slam the critics from a company long-term corporate standpoint. The policy will mean that when economies, and the cycle, pick up again Rio and its peers will be even more dominant in the global mining sector.