Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Why buy shares in mining companies? That's a question undoubtedly being asked by investors in Anglo American, which has fallen 69 percent this year and yesterday announced plans to sell more than half its assets and fire 63 percent of the workforce.

There used to be a simple answer: It was the only way for a non-professional investor to get exposure to the minerals they sell. As Bloomberg's Tracy Alloway demonstrated recently, purchasing physical commodities is really hard unless you're a fully fledged trader. Selling is even harder.

That's before you get into the complexities of derivatives markets, where it's perfectly possible to lose money investing in a commodity that's rising in value because of the way you have to sell futures as they expire and buy the next month's contract at the new, higher price.

Race to the Bottom
Mining companies have underperformed the commodities they sell
Source: Bloomberg data
Note: Dec. 10, 2010 = 100


Then exchange-traded funds came along, and changed all that. Most retail investors can now buy shares in ETFs that track the prices of all the industrial metals traded on the London Metal Exchange, plus gold, silver, platinum and palladium. There's even a product out there tracking physical prices of rhodium, a metal not traded on any exchange whose total annual production could be squeezed into a typical toilet cubicle.

Miners' response to fund managers' theft of their business model was to steal the fundies' business model right back. Once, they'd seen themselves as down-to-earth geologists and engineers competing over who could find the best copper lode, drive the cheapest dump truck or run the most efficient processing plant. Now, they were managers of portfolios of commodities, selling themselves on their long-term insights about the direction of the global economy and its demand for resources. The former BHP Billiton chief executive, Marius Kloppers, sang the praises of his company's diversified suite of assets in a 2012 speech: "Historically, oil and minerals have been inversely correlated."

Nothing in Common
Oil isn't a natural hedge against metals
Source: Bloomberg data

That forecast isn't looking so hot now. As a glance at current prices shows, you can't invest in petroleum as a hedge against weak metals. So major miners are now turning their backs on diversification. "Companies with less diversified portfolios right now, as long as they run tier one assets, are performing better," Jean-Sebastien Jacques, Rio Tinto's chief executive for copper and coal, told a Bloomberg event in Sydney last month. "All the commodities have dropped at the same time."

OK, so forget diversification. The thing about miners is they're steady, reliable investments. Buy shares in a commodities ETF and you lose all your money if prices fall. Buy a mining stock, and executives put their operational expertise on the line and promise that every year, rain or shine, they'll improve earnings and boost dividends.

Glencore's base dividend is "sacrosanct", chief financial officer Steven Kalmin told a investor call in 2014. It's "clearly pretty locked in against what your volume and what your views in commodity prices are. So that will continue to grow and rebase." He repeated the same point in an interview with Bloomberg's Jesse Riseborough and Javier Blas  this August, then turned round 17 days later and said the payout would be suspended until further notice. Now Anglo American is doing the same.

If mining companies can't offer exposure, diversification, or consistency, is there any point investing in them? There is one benefit a mining company has over an ETF: leverage.

If the price of copper rises 20 percent, the ETF Securities Copper fund should climb about 20 percent too. The earnings of a copper miner with fixed all-in costs at about 80 percent of the previous year's sales, on the other hand, could double. That means that when the current commodities downturn reverses, investments in mining companies will be a potent way to make the most of the recovery.

Another Day Older and Deeper in Debt
Debt levels at global miners have been rising
Source: Bloomberg data


Don't get too excited. As any margin trader knows, leverage works both ways. Net debt in the Bloomberg World Mining Index is at a record high of 2.57 times Ebitda, drifting in the direction of the 3.5-times-Ebitda levels where bank credit committees start to get jumpy. Executives and fund managers in the sector are arguing that a wave of bankruptcies may now be the best way out of the current morass. If you're investing in mining companies because you want to double down on a rebound in commodities, watch out for squalls.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net