It’s not just assets now, but consumer goods too. Wednesdays’ Consumer Price Index reading showed general inflation in the US as running at over 4% currently, and although economists affiliated to the government machine continue to insist that this is just a re-opening blip, markets aren’t convinced.
And they’ve good reason not to be. Yes, straightforward supply and demand dynamics can account for the increase in certain staples like lumber. But the bigger picture is that the US is now accelerating an already rapid programme of money printing. And yes, modern monetary theorists think they’ve worked out a magical way in which money can be printed and inflation avoided. But right now, the statistics are showing otherwise, and analysts across the board are predicting that the Fed will have to raise rates sooner than it wants to.
In the meantime, what to do?
Well, it’s worth noting that as far as keeping up with and compensating for the declining value of fiat money goes, the mining sector has been doing a pretty good job. The industry may have a perennial public relations problem, but that doesn’t seem to stop the value rolling in. To put it in simple terms, the value of hard commodities is very difficult to debase. So, if the value of cash is relentlessly being diluted by central bankers, the same can never be true of copper or silver, or gold or iron ore. Yes, more commodities are put into circulation each year as mining continues, but the amount of new material remains strictly controlled by the limits of human endeavour. Apart from anything else, there’s the sheer difficulty of finding the stuff.
It’s in this context that the industrial metals and mining sector has been the top performer in the FTSE 350 this year, rising by 166%. And precious metals and mining, which has not been much in favour in recent months, comes in at ninth out of forty.
Industrial metals and mining is also the leading sector on a three and five year view.
Will this outperformance continue? Yes, if you believe the market. No, if you believe the Fed. Markets can be wrong, but market participants usually have more at stake than technocrats, so their views are at least worth taking seriously.
On a standard pattern, price rises start with commodities, then move to the factory gate. This is already happened in China, where the recent producer price inflation numbers came in far higher than anyone had expected. But with hindsight, with iron ore and copper both running at record highs, it makes perfect sense. Will the Chinese start to pass these input cost pressures onto the huge western consumer base they service? It’s a big question, not just for Western consumers, but also for the competitiveness of the Chinese economy. After all, the attraction of doing business in China to the west is almost entirely to with the production of goods at cheaper prices.
If it turns out that others can produce similar goods more cheaply, then China’s upward economic trajectory may stutter. Other Asian Tigers like Malaysia and Indonesia are waiting in the wings, as are places with less in the way of middle-class living standards to support, like Africa and the Middle East.
These trends have major implications for the balance of political and economic power in the coming decades, but for the miners themselves demand looks pretty well assured, wherever it comes from.
Mining sector yields remain markedly high, and projected earnings don’t yet look anything like the levels they reached in the bull markets of 2006 and 2007 or 2011 and 2012. Will they reach these levels again, and if so, how soon?
That’s hard to predict, because the mining industry as a whole carries some heavy baggage from the mistakes that were made in the run up to 2007. Back then major companies financed huge acquisitions with cash. The acquisitions were designed to support demand coming from the burgeoning bull market which, accordingly to then-prevalent “Supercycle” theories, was likely to run for decades. In fact, demand collapsed within a year or two, and those immense cash acquisitions ended up having to be paid for by emergency equity financings as projected cashflow dried up. The resultant dilution was a bitter blow, which no-one wants to repeat, albeit that the hurt was inflicted more than a decade ago.
With that in mind, there’s every chance that miners will prefer to run slightly behind the demand curve, rather than trying to anticipate it, and that that in turn will entail continued and ongoing shortages of supply, higher prices and bumper earnings. All things are cyclical, and the mining sector is especially so, but for now it looks like mining executives are faced with a win-win scenario.