Rising commodity prices – which miners could benefit most?

In the last week or so, we’ve seen some of the titans in the mining industry release their latest annual reports. There were records left right and centre, as cash flows blossomed, and investors were rewarded with hefty shareholder returns.

Strong results for the sector come off the back of higher commodity prices. Miners’ profits are directly tied to the price at which they can sell the metals they dig up. That’s not something they have direct control over, which means when prices are high, miners will try to ramp up production to take advantage.

Miners are cyclical businesses, meaning when economies run hot, demand for the commodities they produce rises. The reopening of economies following the pandemic provided the perfect catalyst for increased demand. Of course, that means the opposite is true when economic conditions get tougher.

With global inflation looking like it’s here to stay, miners could be worth some attention. They’re typically seen as a good inflation hedge given the prices of the goods they mine have tended to rise in an inflationary environment.

Here we’ll look at a few key metals and see who could benefit if prices stay high.

This article is not personal advice, if you’re unsure whether an investment is right for you, seek advice. All investments and any income they produce can fall as well as rise in value so you could make a loss.

Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

The need for steel

Steel is the most commonly used alloy in the world, with global consumption estimated to grow 1-2% a year over the next ten years. Humans have been using steel for thousands of years with a range of applications. With improved techniques, we can now make steel strong enough to build bridges and skyscrapers. Large industrial applications make steel particularly cyclical – governments tend to hold back on large infrastructure spends when times are tough.

The main raw material in making steel is iron ore, which saw its price balloon last year as economies round the world reopened.

Iron ore ($/Tonne)

Past performance isn’t a guide to the future. Source: Refinitiv, 28/02/22.

Despite prices falling back from the highs of 2021, the jump in demand meant Rio Tinto saw iron ore cash profits rise 46% to $27.6bn. Totalling 75% of overall cash profits, iron ore is the group’s main product.

Rio has 17 mines in the Pilbara region of Western Australia, which produce a particularly high-grade product including the world-renowned Pilbara Blend. Despite production costs at the flagship mines expected to rise to $19.5-21.0 a tonne, that’s still incredibly low compared to what they should be able to sell it for. Average market prices were $143.8 per a tonne during the last year.

Digging up some dirt and selling it for seven times what it costs is an attractive proposition. That allows the group to rake in the profits when prices are high and offers some reassurance should they drop back down.

If the price of iron ore can remain elevated, shareholders could be well rewarded, with the group’s policy of paying out around half of earnings as a dividend each year. A prospective dividend yield of 8.9% reflects the current positive environment. Though remember, both the dividend and broader performance of the business are tied to positive commodity prices, of which there are no guarantees. Yields are not a reliable indicator of future and dividend income is also variable and not guaranteed.

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Gold – the safe haven?

The price of gold has made a steady rise over the past couple of years.

Past performance isn’t a guide to the future. Source: Refinitiv, 28/02/22.

That comes as investors have been looking for safer places to park their cash amid all the uncertainty. Rising inflation across global economies puts assets with a limited supply, like gold, higher up on investors’ buy lists. The idea being, while the value of cash falls as inflation climbs, gold is able to hold its value.

Higher prices mean gold miner Barrick's been able to enjoy bumper profits over the last couple of years. With six top tier mines in the portfolio, the cost of production came in a touch over $1,000 per ounce last year. That offers plenty of room for profits with gold prices where they are.

With high prices and hot demand, the group can keep production high at existing mines. That can be a particularly powerful driver for the group, since costs rarely increase in line with output. Therefore, rising production helps boost margins, while lower production hits the bottom line hard.

A solid balance sheet and higher gold prices meant the group was able to deliver record shareholder returns last year, with $1.4bn being paid out. The group’s new dividend policy means any distributions on top of a base dividend will be linked to the net cash position – meaning cash flows really are king.

Consensus puts free cash flow coming in over $2bn a year over the next few years, which would leave plenty spare for extra returns, of course there are no guarantees.

We see Barrick’s diversified footprint, with mines in over 13 countries, as one of the better options in the sector. But remember, any future success is reliant on gold prices and there’s no guarantee they’ll stay where they are now.

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Metals for the future

As global economies shift focus on to transitioning to greener and lower-carbon economies, a host of growth opportunities have presented themselves to miners. Clean energy sources typically require more materials than their fossil-fuelled counterparts. Take an electric car for example, it needs six times the mineral input compared to a traditional internal combustion engine.

Anglo American’s diverse range of products includes the likes of iron ore and copper, but also significant exposure to platinum group metals, nickel, and manganese. That means the group isn’t reliant on any single commodity price for success, and already has exposure to assets that contribute to de-carbonisation efforts.

Chart showing breakdown of Anglo American revenue

Source: Anglo American Preliminary Results 2021.

Platinum group metals (PGMs) have a range of uses from cancer treatments to catalytic converters in cars and batteries that can be used in electric vehicles or new power grids. The division made up over a third of Anglo’s total cash profits last year, following an 82% jump in PGM sales.

Copper is another metal essential for the modern age. Around 60% of total global demand is used for electronics, from phones to electric vehicles. Anglo’s copper mines contributed just shy of 20% of total cash profits last year. The group’s new copper mine in Peru, due to start production this year, should boost overall production by around 50% when fully operational.

We like Anglo’s broad portfolio and the exposure to metals essential to the global de-carbonisation effort gives it a leg up over some rivals. But we shouldn’t look past the fact the near term remains uncertain.

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Unless otherwise stated, estimates are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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