Sunday, April 06, 2008

Philippine Mining: Supply Shortages Will Draw Investments

``You can observe a lot by watching.” Yogi Berra

Recently an article downplayed the sanguine picture of the Philippine mining industry. It attributed the drab outlook to emerging investor’s qualms over “Land ownership disputes, communist and Muslim insurgencies and bureaucratic red tape” as main reasons why resource based investors are having second thoughts on the Philippines.

The main fallacy with the argument is that the so called obstacles have been nothing new; they have long existed even long before the commodity boom. The fact that the present thrust by the government to reinvigorate the sector should signify as welcome news; even when confronted with some political resistance.

Next, the cited alternative venues to the Philippines have almost equal risks measures, be it in the context of political stability, red tape or cost of doing business. For instance going back to Figure 2 Vietnam is second to the Philippines in terms of price sensitivity to food. This implies of a marginal difference in the risk potential relative to political stability.

Third, figure 6 should validate the veracity of claims of meaningful alternatives.


Figure 6: US Global Investors: Copper Inventory with 3-4 days of global demand

With global reserves of copper at a hairline thin 3-4 days of demand, this posits that copper stocks have been in a chronic shortage and continues to deteriorate sharply which is reflected in current prices. In short, record sky high prices have yet to incite an equal response to supplies enough to stabilize or depress prices.

Yet, investments to increase reserves have been conspicuous see figure 7…

Figure 7: US Global Investors: Mining Deals Review

but mostly in deals which involves global mergers and acquisition.

According to US Global Investors (emphasis mine) ``PricewaterhouseCoopers International Ltd. released its latest Mining Deals 2007 publication. In it, PwC says that the merger-and-acquisition records set in 2007 are poised to continue in 2008 due to increased vertical integration in the industry, as well as Chinese, Russian and Indian companies assuming larger roles each year.” This means that global resource based companies have been doing less exploration which could imply limited access to areas for exploration.

Thus, we find it strange for an article to articulate on the availability of potential replacement sites as premise to the cynicism to the industry’s potential. Instead the major risk faced by the industry, in our view, is the rise of a populist leadership which may opt to retard the industry by prohibition edict or via nationalism. But that would be tantamount to shooting ourselves in the foot.

Of course, as we mentioned copper prices is just off from its recent peak, but is presently knocking at the doors of a fresh landmark high in prices.

Figure 8: Kitco.com: Base Metal Index

Nonetheless, it is not just an issue of copper; figure 8 shows the Kitco base metal index trading sideways following a huge bullmarket stretching from 2003 to mid 2007. Yet, like copper, stockpiles of lead and zinc are near historical lows.

Moreover, the economically recoverable reserves of lead, tin, and copper could be depleted within the next 25 years if their extraction expands at current rates, says Lester Brown of the Earth Policy. This means that unless a substitute for copper is found, the current pace of consumption would lead to severe shortages in the future. And severe shortage leads to high prices enough to cover the costs of undertaking a high risk project profitably.

So where there are real shortages, there isn’t much of an option.

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