Johannesburg - The worldwide commodity boom might still be in full swing, but South African mining houses may see their earnings moving sideways from next year on the back of rising costs and production problems, says a mining analyst.

Gary Quinn, mining analyst and equity fund manager at Prudential Portfolio Managers (SA), says despite the incredible run that commodity stocks have experienced in recent months, this is probably not the time to put new money into commodities.

"We don't have a pessimistic view on commodities, but we are increasingly developing a muted view on earnings growth. The reality is that share prices tend to follow earnings cycles - ultimately it is difficult for share prices to move higher if earnings are moving sideways."

He says ironically the supply and infrastructure problems in the mining sector that have caused commodity prices to rocket, will eventually impact on the earnings growth potential of these stocks.

"The operational problems currently facing mining companies would normally lead them to perform poorly. But instead commodity prices shot up as a result of supply problems, rescuing a couple of companies from poor performance."

Quinn comments that without doubt, the biggest driver of commodity prices this year has been the disruption in supply of resources.

"The price of platinum is up 40% for the year to date. For now this incredible increase in the commodity price has bailed out Anglo Platinum, despite the company's production problems caused by Eskom's woes and safety issues."

Factors contributing to the declining supply of commodities include worldwide power shortages. South Africa is not the only producer of resources affected by a volatile power supply - North America, Australia and Chile are grappling with similar constraints.

Government interference in a number of countries has impacted negatively on supply. This includes the withdrawal of mining licences and the levying of ever-increasing royalties and taxes.

Heavy taxes imposed on oil companies, for example, have created a disincentive to open new oil fields. The average tax rate on oil companies is now 70%, compared to 30% some 10 years ago. Adverse weather conditions, like the heavy rains in Australia, have also contributed to supply problems.

Quinn says platinum production was down 15% in the first quarter this year, with Anglo Platinum alone coming in 400,000 ounces short of production targets. Gold was down 19%, diamonds 18%, copper 5% and coal 5.6%. Overall, mining production was down more than 11% in the first quarter this year.

Boom about 80% complete

Therefore, while supply constraints continue to push up commodity prices, mining houses are also increasingly feeling the pinch of rising production costs against lower output. If not curbed this will impact on the ability to grow earnings, says Quinn.

He points out that while retailers are able to pass on increasing costs to consumers, the same is not true for mining companies. "Because the price of commodities is not determined by individual companies, they cannot load it to make up for increased operating costs."

This means, says Quinn, that mining houses have no choice but to absorb the increase in costs and find ways to achieve more effective cost-cutting opportunities.

"If they don't and earnings start to move sideways and eventually drop, the boom cycle has to make way for the bust cycle.

"We have been in the commodities boom for so long, it has become hard to predict the ultimate top of the cycle. The last low was in 1999 - since the up cycle has been so drawn out, the downturn may be just as gradual."

Quinn has prepared his portfolios for a potential slowing, believing that the commodity boom cycle is about 80% complete. He adds, however, that as a value manager he is always on the lookout for the exceptions, and there are still some.

"There are still opportunities in paper and steel. Paper prices are lower now than they were in 1999 and margins are low as well. There is a lot of scope for earnings growth. And profitability in steel is up by 30%," he concludes.

- I-Net Bridge