Commodities are inherently cyclical, and I’d take it a step further and say they’re boom and bust, especially for the miners.
With any commodity (precious, industrial or agricultural), a sustained price increase will result in more supply being brought to market as the miners or farmers want to maximise their profits. This leads, in time, to an oversupply of the commodity, which pushes prices lower again. Producers then reduce supply, creating a shortfall that ultimately sends the price higher.
The challenge is how quickly the producers of the commodity can respond to price changes. For a farmer, it’s relatively quick — at the next planting season, they can increase the area under crop or even switch crops. But of course, not all crops can be grown anywhere, and not all farmers have the skills and equipment to switch.
With metals, adding supply is trickier. A miner may have a previously unprofitable mothballed mine they can fire up in a year or so, adding supply; otherwise, they’ll have to go the greenfield approach, and that will take more than a decade from discovery to production. We saw this with Gold Fields’s Salares Norte project in Chile, which took a full 13 years from discovery to the first gold being mined.
The larger problem with a commodity like gold is that the early mines have been mined out, and new deposits are in harder places to reach
So what will often happen is that miners will add production by acquisition, which certainly works for their profitability but not for overall supply.
On the downside, which is what we’re seeing now in platinum group metals (PGMs), miners need to reduce production, and this is happening. But the reality is that every miner is hoping the others will go first and take the pain of reduced production, revenue and ultimately profits. So everybody waits for as long as possible, and this can damage some of the miners’ balance sheets.
The larger problem with a commodity like gold is that the early mines have been mined out, and new deposits are harder to reach. Not only is it difficult from a geological perspective, but regulations in the host country and infrastructure problems in terms of power and water supply could hinder production. Logistics — the ability to get the commodity to market — is especially relevant for industrial commodities, and we’re seeing how Transnet's woes are hurting coal and iron ore miners.
The point is that every commodity boom has led to a bust and many will say it’s different this time, especially with green energy metals. But I remain unconvinced, having lived through many boom and bust cycles in the sector.
If nothing else, high prices will result in an increase in recycling, and users of the commodity will seek alternatives.
So, enjoy the booms while they last, avoid the temptation to short them until we see sustained weakness, and equally, with those in bust territory, wait until you see a real recovery in commodity prices before jumping in.
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