2017: When the Commodity SuperCycle Returns

And meantime, you need strategies for success in this flat commodity market...

 

INVESTORS COULD be waiting until 2017 before the commodity supercycle is evident again, reckons John Kaiser, a mining analyst with more than 25 years of experience.

 

Now producing Kaiser Research Online, he speaks here to The Gold Report's new sister title, The Mining Report, about this lull in the commodity supercycle should encourage miners to develop new, innovative approaches to their business...

 

The Mining Report: John, you have characterized the current resource market as a bear market unlikely to have higher metal prices in the next year, with the possible exception of zinc. Why are you drawing a different conclusion than other analysts who believe we are in a resource supercycle?

 

John Kaiser: I believe the general supercycle is still intact as nations with very large populations are embracing capitalist methods. Because they are starting with much lower standards of living, they have a long way to grow. However, I do think we are in a bit of a pause. We are still dealing with the fallout from the 2008 financial crisis, a dysfunctional political system in the United States and Europe's issues.

 

Also, China's growth rate is slowing and the country is shifting from a capital-intensive development of infrastructure and production capacity to more domestic consumption spending. On top of this, the mining industry generated a lot of supply in response to the higher real prices of the past decade. So there is a supply glut coming as demand cycles downward, and we're going to see weak prices for a while. Unfortunately, or perhaps fortunately depending on what hat you are wearing, we have also seen rising costs, the response to which may curtail the supply glut sooner than expected.

 

I would say by 2017, however, the supercycle will be evident again, because this bear market is creating the same supply/demand imbalance conditions that existed 10 years ago, when the big bull market started.

 

TMR: What indicators will tell us we might see the supercycle in 2017?

 

John Kaiser: What we have to watch is the world's gross domestic product growth. The International Monetary Fund scaled back expectations in its October World Economic Outlook. We also have to see how the US deals with its debt ceiling problem, and the US won't get any traction until there is a political change where nothing blocks spending the money to get the economy ramping up again.

 

We also want to see which mines in the pipeline actually come onstream. This applies more to the raw materials that are used in the real world as opposed to gold, which is treated largely as an insurance policy hedging various future outcomes.

 

A lot of projects are being shelved right now because of escalating costs. All this misery that we're witnessing will actually underpin a future bull market in the commodity sector.

 

TMR: What gold price is required to make mines economic these days?

 

John Kaiser: The average all-in cost for gold production is about $1200 per ounce. Even though we're looking at a gold price that has increased three, four times since 1980's stabilized price, the costs have risen right along with it. We need something around $1500 per ounce-plus to justify putting a lot of these deposits into production.

 

TMR: Are the costs for getting copper out of the ground also higher than the selling price?

 

John Kaiser: In the past five years, we have seen above-average cost escalation in the mining sector. Both capital costs and operating costs have been increasing about 10% annually. In the case of copper, if your all-in cost was $2.49 per pound ($2.49 per pound) in 2007 and you apply 10% inflation each year, you're looking at a $4 per pound copper price just to break even, and we're currently at $3.20-3.30 per pound.

 

Now some of these costs are going to come down, but we're still looking at numbers that are at or higher than the current spot prices for gold and copper. It is not a wonderful situation for deposits where they have reduced the cutoff grade and started mining lower-grade deposits to meet the increase in demand. We're in a situation where we're going to have to just wait to see higher prices materialize to justify a fresh push of putting deposits into production.

 

TMR: If most of these commodities and the juniors that mine them are waiting for prices to go up, what does that mean for the juniors' common exit strategy – being taken over by a major?

 

John Kaiser: During the past seven to eight years, we've had a tremendous round of takeover bids, where 200-plus Canadian juniors were taken over at a value of over $128 billion. A lot of these deposits are waiting to be developed. The other companies out there own deposits that tend to be lower grade and have a more expensive cost structure. There is no appetite amongst the majors right now for that type of deposit, and the capital markets are not going to be interested in directly funding development because the profit margin just isn't there.

 

The one group that has not yet made a big move is Chinese sovereign wealth companies, which we know have been studying the landscape looking for opportunities. When these Chinese national companies start buying cheap gold assets, that will be a signal that the turnaround for gold is coming sooner rather than later.

 

TMR: While we're waiting for that to happen, what strategies should investors know about when looking for companies that will be successful?

 

John Kaiser: Look for a company that has a high enough deposit grade so that even at the current metal price there is still a decent profit margin. These companies are available at bargain prices. 

 

TMR: So look for a company with a higher-grade deposit. What's another strategy?

 

John Kaiser: I like the strategy of a discovery within a discovery that could completely eclipse the original low-grade resource. Looking for higher grade zones within the system is a way a gold junior can revitalize an existing deposit that doesn't work at current low metal prices. 

 

TMR: So look for a discovery within a discovery. Can you give us another approach?

 

John Kaiser: Look for companies that have an innovative target-generation strategy. All the easy gold that's at surface has been found and harvested. You now have to look deeper. 

 

TMR: Sounds like an interesting target-generating approach. Any other strategies you think could work between now and 2017?

 

TMR: Any thoughts on rare earths?

 

John Kaiser: Let's talk about nickel, an unpopular metal, currently around $6.25 per pound. Used in stainless steel, it was selling for $25 per pound in 2007. A seemingly unlimited supply of nickel pig iron is haunting the market right now. Nickel pig iron is made in Chinese blast furnaces from low-quality laterite ore direct shipped from Indonesia and the Philippines, which have in recent years emerged as the world's biggest nickel suppliers. Experts are pretty negative about the supply/demand surplus deficit in the next four years, but by 2018 they expect this to reverse.

 

By then we will start seeing that the Philippines' supply of laterite for nickel pig iron production is not infinite and that perhaps Indonesia has put a stop to exporting raw ore. Then once again we're caught off balance because the big guys during the interim have had to scale back their development plans because of this current glut of supply that's depressing the metal prices. It's a bit of a longer-term speculation, but it's based on a different processing style targeting a different type of mineral.

 

TMR: Can you give us one more idea that's completely different?

 

John Kaiser: Okay, how about diamonds?  We know that as long as the world doesn't go into a depression, demand for quality diamonds will continue to grow. Explorers have not found any giant diamond mines in a very long time, and no big new diamond mines are coming onstream.

 

TMR: Interesting. Can you leave us with advice for investors who are trying to survive 2013, or as Rick Rule says, thrive, because fortunes are made in bear markets rather than bull markets?

 

John Kaiser: Fortunes are made in resource sector bear markets by those with great patience, especially when you target juniors with deposits that are near worthless at prevailing metal prices. However, if higher real metal prices take a long time to arrive, such juniors run the risk of diluting away their upside to stay alive, or getting swallowed cheaply by predators with deep pockets and even greater patience. Most investors do not have Rick Rule's capacity to influence the destinies of the companies in which they make investments. The resource sector juniors that I generally target in the current bear market climate are ones with innovative stories that can flourish and create shareholder value whether or not higher metal prices materialize. If we do get into a stronger overall market, it's companies like these, which have well-articulated stories, that will accelerate out of the bottom faster than other companies with deposits that require a substantially higher metal price to be back in the money.

 

TMR: Thanks for giving us that wrap-up. We appreciate your time.

 

John Kaiser: You're welcome.