Technology, healthcare, emerging markets, artificial intelligence, renewable energy. The list of exciting growth sectors in which to invest across multiple sectors and regions of the economy goes on. One sector few would include in this conversation, however, would be mining companies.
The companies who discover deposits of minerals in the ground, build mines, dig out the rock and then process it to produce steel, copper, nickel, etc., are widely considered today to be ‘old news’. These are ‘old economy’ businesses, reflecting the economy of the 20th century and far removed from the modern digital technology businesses of the 21st century.
This sentiment towards miners couldn’t be more wrong.
The modern lifestyles enjoyed by citizens of the developed world (US, Europe, Japan, Australia, Canada) owes more to innovation and productivity improvements in mining than any other single factor. One of the tightest correlations you will find anywhere in economic research is the correlation between the size of an economy and its installed base of capital (measured in tonnes of steel, copper, nickel, etc. accumulated in an economy).
Unlike many products, industrial metals like steel and copper are not consumed but are installed into an economy in the form of capital assets (buildings, roads, railways, ports, vehicles, etc.). This accumulated capital stock facilitates the improvement in lifestyles and rise in economic growth that personifies the state of the modern European or American economy. And it was built on the rapid accumulation and installation of capital in the form of metals mined by mining companies.
Given this tight correlation between accumulated metals (capital) in an economy and a country’s economic prosperity, the cost of those metals matters, and it matters a lot. The cheaper they are the more capital you can install in your economy and the faster you can raise living standards.
Between 1800 and today, the efficiency with which we can mine and refine a tonne of copper has improved by 99%. In other words, the labour time and input required to produce the same quantity of refined metal today is just 1% of what it was in 1800. This incredible improvement in labour productivity was facilitated by the introduction of larger and more powerful machines to replace labour as well as the adoption of new mining and refining technologies.
Over the same period the cost of labour and ore grades of deposits have moved in the wrong direction, they have supported a major rise in the costs of mining, however the improvements in labour productivity and introduction of new technologies more than offset this effect and brought about a 99% reduction in relative costs of mined materials. It was this massive improvement in labour productivity in mining which facilitated the rapid industrialization of Europe, America, and now China and East Asia.
Things are changing, however. Much of the innovation of the past two centuries is behind us and has little extra capacity to eek out more improvements in labour productivity. Without a new major technology to radically improve the economics of mining, we may currently be at the lows of costs to mine commodities, and from here, labour cost inflation and ore grade declines will steadily push costs up from current levels. This may sound like bad news, but for mining companies it is good news. Rising costs benefit companies who own the highest quality mining assets as it increases their profit margins (this is because of the shape of cost curves, where rising costs in a rising demand environment boosts margins of the lowest cost producers).
Meanwhile, much of the world’s population is still early in the industrialisation process. The installed capital base in India, Southeast Asia, Latin America, and Africa (+6 billion people) remains well below the industrialised world. If the poorer two-thirds of the world’s population are to be lifted out of poverty, it will be done on the back of continued growth in demand for industrial metals installed into their economies as capital.
What is more, the decarbonisation of the world economy to fight climate change adds another kicker to global demand for metals, especially copper. Copper is fundamental to any electrified system given its conductivity characteristics, and as the world’s economy shifts away from fossil fuels into electric vehicles, renewables, energy storage and more complex electricity grids, incremental demand for copper by 2050 could rise +300% from current levels.
So, we have somewhat of a perfect storm for industrial metals prices. A major wave of demand hitting a supply side with little room to improve productivity, this should mean higher prices. Higher prices are good for mining company margins. Owning them in a portfolio offers investors exposure to this long-term trend and acts as a hedge to inflation. Not bad!
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