Does the mining bull still have legs?

Exactly a decade ago, Don Coxe walked to the podium at the annual BMO Capital Markets mining conference and told dubious investors that a massive bull market in commodities was about to begin.

The reaction was predictable.

"Nobody would speak to me at that time, because they thought I was stark raving mad," Mr. Coxe, BMO's strategy advisor, says today with a laugh.

The skepticism was understandable at that point, as commodities were still in a 20-year bear market that annihilated portfolios. Mr. Coxe, however, saw that something significant was happening in the developing world, particularly China. He was also delighted to see that everyone disagreed with him.

"I did some interviews with mining people and couldn't find anyone who believed in the business. That was a requisite. Because it meant there would be no new capital spending for a few years [leading to supply shortages]," he says.

Ten years later, Mr. Coxe looks like a soothsayer. Miners have enjoyed a decade-long bull market of spectacular prices, beyond what almost any of them imagined back in 2002. There have certainly been some hiccups along the way (notably in 2008-09), but they were mere interruptions in a decade of prosperity.

So why doesn't it feel that way?

As miners gather in Toronto over the next few days for the Prospectors and Developers Association of Canada (PDAC) conference, the industry's largest event, there is a fair amount of negative energy in the air despite the recent rally in most metal prices.

Mining stocks continue to trade at extremely low multiples (particularly gold stocks), as investors seem to believe that the 10-year commodity rally is getting long in the tooth. The companies are struggling with out-of-control cost inflation, which has completely changed the economics of their projects. Operations have also become more challenging as miners work in more remote and risky locations. And junior companies are struggling to raise any cash for exploration, as investors have backed away from volatile stocks amid the global economic uncertainty.

The two companies that most embody the industry's challenges these days are a pair of gold miners: Kinross Gold Corp. and Agnico-Eagle Mines Ltd. Despite a gold price above US$1,700 an ounce, Kinross shares are down more than 35% since last September, while Agnico is down 50%.

Both have no one but themselves to blame. Kinross grew aggressively through acquisitions, and was then struck by soaring costs at the development projects it bought. Agnico encountered operating problems at its remote Meadowbank mine in Nunavut (a far tougher place to work than it has ever experienced), and had to shut a lucrative Quebec mine over safety concerns.

When investors see debacles like those, it is only natural for them to look elsewhere for their commodity investments (such as exchange-traded funds), or get out of the sector entirely.

"I think managements in general have proven that there are many things beyond their control, and they have conspired in the most unpleasant sort of way," says John Stephenson, portfolio manager at First Asset Investment Management and author of The Little Book of Commodity Investing.

While it may take a restructuring or two, one has to assume that the Kinross's and Agnico's of the world will figure out how to get their operations in order.

But even if they do, that won't eliminate the over-riding concern dragging down the sector right now: namely, whether the boom is sustainable. To many people, a decade seems like an awfully long time for a bull market in anything. And with the chaos in the eurozone and the concerns about slowing growth in China, slowing commodity demand does not exactly seem far-fetched.

The bulls, naturally, see it differently. They point out that the last commodity bull market ran for two decades in the 1960s and 1970s, and the economic activity back then does not compare to the exploding growth of emerging markets today. Plus, monetary policy is far more accommodative today than at any point in recent memory, and that is always bullish for commodities.

The other factor that could support the stronger-for-longer theory is the very issue that the Kinross's and Agnico's of the world are dealing with: the fact mining is an extremely difficult business, where things go wrong all too often. As industry costs soar and companies struggle to deliver on their production targets, huge supply gluts in the market seem unlikely, barring a major drop in demand.

"It's my own belief that this [capital cost] creep will ultimately result in boosted commodity prices, because a lot of assets that were scheduled to be in production by now are not even close," says Egizio Bianchini, co-head of metals and mining at BMO Capital Markets.

Companies are having enough trouble just replacing their own reserves and production. To take one example, about 440 tonnes of gold have been produced from new mines over the past decade, according to Mineral Economics Group. By comparison, production from existing mines has dropped by roughly 600 tonnes.

But even if one assumes the outlook for metals is positive, more volatility seems assured. The last couple of years have demonstrated that events that have nothing to do with mining (such as the Lehman Brothers Holdings Inc. collapse, the eurozone crisis or hedge-fund flows) can have outsized impacts on the sector.

"I think the bull market trend will continue, but you're going to have a cycle of minibooms and mini-busts that won't favour the buy-and-hold investor," Mr. Stephenson says. "You can't just buy this stuff and go away onto a desert island, because it will kill you."

Mr. Coxe, meanwhile, notes the disconnect between commodities and mining stocks is higher today than at any time during the past decade. To him, that is a screaming buying opportunity. "When I talk to the companies, I see the same gloom [as 2002], only for a different reason," he says.

"Before, they didn't think there was going to be any demand for their product. Now they've got demand for the product and there's no demand for their stock. So what we have is a requisite requirement, which is that there isn't too much optimism out there. Beautiful."

Ten years on, the contrarian call on commodities is still, quite often, the bullish one. And for investors, that might be for the best.

pkoven@nationalpost.com

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