GOWLING LAFLEUR HENDERSON (Gowlings) released its annual Trendwatch for the mining industry last month. In it the firm makes the case for continuing high prices in the mining industry. Here is what Gowlings had to say:
The mining industry has been hotter than molten gold over the past several years. Recent trends toward increased metal prices, increased costs, increased demand for services, personnel and equipment, increased merger and acquisition activity, and increased First Nations activism are expected to continue in 2008.
Metal prices have been rising steadily with gold leading the pack. Gold began 2007 in the US$600 range and rose to straddle US$800 throughout November and December 2007, reaching a high of US$838 and a year-end closing price of US$834, representing a 31% gain for the year. During January 2008, gold increased to a record US$942.20 and had its biggest monthly gain since April 2006. National Bank Financial has boosted its target on the price of gold to US$1,500 by the summer of 2009.
The expected continued upward trend in the gold price during the near-term can be attributed to the decline of the U.S. dollar, continued strong demand for the precious metal, in particular for gold jewellery and for store-of-wealth (this partly as a result of the U.S. dollar decline), and continued completion of forward sales contracts.
Increased prices drive the mining industry. As a result of the upward price trend, in 2008 junior exploration companies should continue to have access to equity capital for their exploration efforts. Producing companies are also expected to increase production to take advantage of the higher metal prices. For example, in early December of 2007, GOLDCORP announced plans to expand its Mexican Penasquito project by 30%.
However, non-producing companies with advanced stage properties are having difficulty raising debt capital to build their mines as a result of the credit crunch in the United States and the resultant loss of appetite of financial institutions to provide high-yield debt associated with junior mining projects.
In addition, project viability has come into question since increased metal prices may be offset by increased costs of exploration, development and production. Personnel and equipment shortages have plagued the mineral exploration industry for several years and this trend is expected to continue in 2008. With increased mineral exploration activity comes increased demand for experienced geologists and other industry personnel, and for equipment such as drill rigs and operators.
An analyst at HAYWOOD SECURITIES suggests that rising costs due to increased demand for fuel, labour, materials and equipment, create difficulties in accurately projecting capital costs several years into the future. Without firm contracts for construction, accurate forecasting becomes nearly impossible. Given this uncertain and changing economic climate, a number of existing projects may become unviable, potentially creating credit risks for mining companies and the associated harm to their financial and business profiles.
An example of this occurred in November 2007 when NOVAGOLD RESOURCES and TECK COMINCO halted their Galore Creek copper-gold joint venture project because a new study estimated capital costs as high as US$5 billion – more than doubling the original estimate of US$2 billion. The largest increase in the estimate was attributed to construction of the tailings dam and water diversion structures, which were originally grossly underestimated in terms of time and labour.
All is not bleak. Fewer mines mean fewer metals; and fewer metals means sustained higher prices. Although increased metal prices over the past several years have created a surge in exploration activity, new mineral discoveries have proven elusive. As a result, smaller companies with good existing projects have become attractive targets for the majors, which have accumulated cash for acquisitions from record profits. The steady flow of mergers and acquisitions in the mining sector in recent years is expected to continue through 2008.
There is also a global trend in increasing recognition of indigenous rights. On Sept. 13, 2007, the UNITED NATIONS GENERAL ASSEMBLY, after more than 20 years discussion, adopted the Declaration on the Rights of Indigenous Peoples by a majority of 143 in favour, four opposed and 11 abstentions. Canada was one of the four countries to vote against the adoption of the Declaration. In November 2007, Canada’s ASSEMBLY OF FIRST NATIONS and the MINING ASSOCIATION OF CANADA signed a letter of intent to enter into a partnership to jointly advocate on the Federal Consultation Policy and land claims, as well as to collaborate on public policy issues such as human resource development and land use planning.
Also in November 2007, in the TSILHQOT’IN NATION v. BRITISH COLUMBIA case, the British Columbia Supreme Court expressed its unprecedented, albeit non-binding, opinion that the Tsilhqot’in Nation has aboriginal title to approximately 2,000 km of land. Although it’s uncertain whether the Tsilhqot’in Nation will eventually be granted aboriginal title, this decision may have future ramifications for the Canadian mining sector.
Also of note is the recent rejection of NORTHGATE MINERALS’ Kemess North copper-gold project by a joint federal-provincial environmental assessment review panel because it was alleged to threaten a culturally significant lake, even though no evidence of likely material harm was presented. In November 2007, the B.C. mining industry wrote to all British Columbia mayors, MLAs, and MPs asking them to write letters in support of the Kemess North mine; however, First Nations have denounced this action and have called for recognition of aboriginal title and rights in the area. These events will likely have a significant effect on the mining industry in the future, as indigenous people increasingly assert their rights.
There are constant jitters in the mining industry that the current cycle is about to end, primarily based on the fact that the cycle has been up for such an extended period. However, the trends outlined above are likely to continue in 2008 so long as prices remain high and continue to drive the mining industry.
(Interested readers can subscribe to Gowlings Trendwatch from the company’s website at www.Gowlings.com/trendwatch.)