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Mining – a look under the surface

We examine the drivers of the industry.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

The UK’s mining sector boasts two of the UK’s 10 most valuable companies, and as a whole, UK-listed miners have a combined value of £179bn. That means it’s likely a relevant factor in the average investor’s portfolio.

What moves share prices?

Mining is a very simple game. Profits are made if you can get something from the ground and sell it for more than it cost to extract it.

Like everything else, the price of what’s being dug up is dependent on the supply-demand balance. For lots of industrial and base metals, demand is a function of economic activity. New planes need aluminium, iron ore goes in the supporting beams in skyscrapers and almost everything electrical depends on copper.

Commodities trade in a global market, but China has the most influence. Its government is ploughing money into purpose built metropolises, and new car purchases outstripped the US by over 70% last year.

As we’ll see, other factors have a bearing on share price performance, not least the company’s balance sheet and political relationships. But for miners, the commodity price and operating efficiency are the foundations of performance.

All investments fall as well as rise in value, so you could get back less than you invest. This article is not personal advice. If you’re not sure if an investment is right for you, please ask for advice.

Big is best?

Miners fall into two camps. Big, diversified beasts and smaller sector specialists. Let’s look at the big players first – Rio Tinto and BHP Group.

Both are slightly less diverse than they used to be. Rio disposed of its last coal assets last year, while BHP sold its US onshore shale assets to BP. Both moves reinforce the focus on core industrial products.

As far as spending goes, both groups are investing heavily in their copper businesses, while Rio is also investing heavily in aluminium.

Aluminium has been a tough market for years as production, led by a surplus in China, outstripped demand. However, US group Alcoa reckons 30-40% of smelters are losing money at the current price. Logic would say that either the price recovers or it stays low until smelters start closing, which would change the supply-demand dynamic such that the price rises anyway. That’s the theory – the problem is commodity markets are anything but reliable.

Despite the push into aluminium and copper, iron ore remains the single most important contributor to cash profits for both groups.

As we’ve seen, the price of iron ore is heavily influenced by Chinese growth. Recently, we’ve seen indications China is starting to slow, and deteriorating diplomatic relations with the US have stoked fears the commodity cycle could be about to turn again.

However, we’d expect both groups to remain profitable through the cycle. Rio and BHP own some of the best assets in the world. Their average iron ore extraction costs in Western Australia are currently around $13-14 per tonne, some way below the current selling price of $74, and less than half of where the market bottomed out in 2015.

Fortunately, the pair have restored their balance sheets to good health. At BHP, debt is just 24% of total assets, and is expected to be a little under a third of next year’s cash profits. Rio looks even more robust.

While both are churning off excess cash at present, neither group is showing an inclination to overstretch itself with mega-mergers. That being said, both are going above and beyond their stated dividend policies to pay out around half of earnings – not exactly conservative. That means they’re set to offer attractive prospective yields next year, 6.5% at BHP and 7.6% with Rio. Please remember that yields are variable, not guaranteed nor a reliable indicator of future income.

Rio Tinto Share price and charts

BHP Group Share price and charts

Hunting for nuggets

With less diversification built in, smaller players with a narrower focus can often have a higher risk-reward profile.

And that’s not the only way they differ. With the notable exception of copper specialist Antofagasta, most of the specialist miners operate in the precious metals space.

Antofagasta share price and charts

Precious metals, like gold, are interesting because rather than being dependent on further industrialisation, gold can often move in a counter-cyclical manner. That’s because gold has a reputation as a good place to store wealth in a crisis.

As a result, the gold miners were among the only companies to see their share prices rise during the financial crisis of 2008/9. Counter-cyclicality could make them an interesting investment for those less optimistic about the global economy. Of course there’s no guarantee the gold price will rise when equity markets next take a tumble, especially since a rise in global interest rates could dampen demand for the shiny stuff.

In any case, there are other factors in play than just the gold price. For example, Centamin has run into production issues at its flagship Sukari deposit, which jolted the share price in 2018.

There’s also the fact gold miners often operate in volatile locations, which can be prone to sharp currency and political movements. Acacia Mining became embroiled in a bitter row with the Tanzanian government over tax obligations, with the resulting export ban bringing an $850m impairment charge.

With these risks in mind, we think there are benefits to extra diversification.

Barrick Gold, which recently acquired the UK’s largest gold miner Randgold Resources and is in the process of acquiring Acacia, is the world’s largest gold miner. It has assets dotted all over the world and the balance sheet looks in better condition than it did pre-merger. That could make it well-placed to weather the ups and downs in the sector, although the integration does bring risk.

Barrick Gold share price and charts

For more diversification still, investors could consider a specialist gold fund. While it hasn’t made it onto the Wealth 50 list, BlackRock Gold & General, managed by veteran Evy Hambro, would be our preferred pick of the options available.

Find out more about BlackRock Gold & General

BlackRock Gold & General Key Investor Information

View the Wealth 50

Unless otherwise stated estimates are a consensus of analyst forecasts provided by Thomson Reuters. 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.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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