The End of the Mining Supercycle


LONDON -- I hate to write something negative while we're in the maelstrom of the euro crisis. Things look bleak enough without sounding the alarm over more threats on the horizon.

Whether the boom years are coming to an end is a hot topic in the industry. Sooner or later, it will hit the media and the wider community. So it's useful to be forewarned. It will affect not just investors in the mining sector, but also businesses that service the sector. And because miners make up such a big proportion of the FTSE 100 (INDEX: ^FTSE) , it will affect anyone with a bog-standard tracker.

The boom in mining in recent years has been driven in large part by voracious Chinese demand, which in turn boosted metal prices. But growth in China is softening. Whether you think the economy is in for a hard or a soft landing, sheer mathematics means that it can't continue to expand at recent growth rates.

As the economy matures, an increasing proportion of growth will come from domestic consumption, rather than investment in infrastructure such as roads, airports, railways, and power plants. That is bound to affect demand for coal, iron ore, steel, and other metals.

So global metal prices are down 20% from last year's highs. At the same time, costs in the mining sector have been rising, as energy and manpower costs have risen faster than inflation. That's beginning to squeeze operating margins, which have been running at historic highs.

More significantly, the industry is cutting back on investment. That will bite sooner, as mining development projects can take many years. Citibank analysts forecast that global mining investment will peak this year, some 13% ahead of last year's total, and decline in 2013.

FTSE 100 members Rio Tinto (NYS: RIO) and BHP Billiton (NYS: BBL) indicated at an industry conference earlier in the month that they would scale down their investment plans. Both have also warned that reduced appetite in the banking sector could constrain their access to trade finance.

These pressures have already caused a retreat in mining shares. The FTSE World Mining Index is down 36% since it peaked in April last year, a decline matched by the mining sector of the LSE.

What does it all mean for the future?

The mining sector is not about to fall off a cliff edge. China and other emerging markets are still growing strongly, and thoughts in the sector are already moving on to returning capital to shareholders through improved dividend payouts, which should help support share prices.

But the sector is perhaps unlikely to return to the giddy heights of last spring. Investment in miners might now needs to be more selective, paying more attention to the mix of commodities that companies produce and the outlook for their end markets, and more attention to their cost bases and relative efficiency.

A slowdown in investment will have a magnified impact on equipment suppliers: the accelerator effect of economics. Stocks that have ridden the mining boom with great success, such as conveyor-belt supplier Fenner, could be riding the down escalator if reduced investment is reflected in cutbacks on equipment orders.

I'm not saying that Fenner isn't still a great share. Softening in demand for new mining equipment may be muted by supply of replacement parts and its non-mining markets. But shareholders in Fenner and similar companies will want to keep a close watch out for signs of a falling order book.

There's a good chance these developments will affect you even if you don't invest in the mining sector or companies that supply it. Miners represent about 12% of the FTSE 100, so what's bad for them is bad for the index.

Right now, these worries pale in insignificance compared with the turmoil in Europe, but it will pay to keep a close eye on the mining sector.

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At the time thisarticle was published Tony Reading has shares in Rio Tinto but no other stocks mentioned in this article. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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