Update No. 181 – 19/09/14

The primary reason I tend to almost never invest in mining businesses is the lack of pricing power they have for their commodity.

I made out very well investing in a number of mining businesses during the GFC, prior to the inception of EGP because a great number of them were priced as though another billet of steel would never be produced, or another tonne of coal would never be turned into electricity. A great many profitable miners were selling much more cheaply than the industrial type businesses that are my usual preference, so I went where the opportunity was.

Despite this, most of the time, I do not own miners because a business where the producer of a good has virtually no control over prices adds an unneeded layer of analytical complexity. If your product is a good or a service, you can innovate or improve to differentiate your product from that of your competitors, you have no such capacity in mining.

You may be able to use some innovation to improve your unit costs through more efficient logistics, but if a few very large producers do that, all that will tend to happen is that the unit price of your commodity will go down.

We are seeing these dynamics in Iron Ore at the moment. A massive supply reaction to extended periods where IO traded at over US$150 per tonne through most of 2010 and 2011 took place, but such reactions are slow to occur as the infrastructure needs to be built out. That supply has started to hit the market in large chunks and the natural consequence has been price falls. Gold supply reacted fairly swiftly to the very high bullion prices of a few years back to, causing it to decline in price also.

What makes me shake my head about the price changes in these commodities is people who claim to have ‘foreseen’ the price falls or to be able to tell where the prices will be in the future. Almost everyone projecting continued IO price falls were also doing the same last time there were substantial falls – over about 12 months from late 2011 to late 2012, prices fell from around US$180 tonne to under US$100 per tonne – many were predicting prices would go to US$75, but before long, prices were back above US$150…

Prices at any given point in time are just as likely to rise as fall, that’s how a dynamic market works; persons with a strong negative view about future pricing will sell, hoping to buy what they need cheaper later and vice-versa. IO trading around US$90 at the moment is every bit as likely to be trading at US$105 in 6 months as it is at US$75, distrust anyone who tells you with any certainty they think price will move one way or the other.

In just the same way that a period of very high prices can stimulate supply, periods of prices much lower than has been the recent case can stimulate demand – both factors are fluid. Furthermore, high-cost producers can only continue to produce at a loss for so long, one by one, their supply falls away. Too many unknowable factors are at play to reasonably be able to tell the future.

Unless you find yourself with an absolute no-brainer, it is simply much safer to steer clear of mining companies – Tony Hansen 19/09/2014

EGP Fund No. 1 Pty Ltd. Up by 2.0%, level with the benchmark since July 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 73.78%, leading the benchmark by % all-time (April 1^st 2011).

^{*1 after 31May 2013 dividend of 2.333 cents per share plus 1.000 cent per share Franking Credit & 31 May 2014 Dividend of 7.000 cents per share plus 3.000 cent per share Franking Credit}

^{*2 calculated based on dividends reinvested}