From commodities lull to… what will the next mining boom look like ?

2024 has been a weak year for mining. This was expectable – we are in a bust, the last mining boom ended in 2021/2022 when most mineral commodity prices peaked and began to weaken. For resources companies the experience of the bust has varied – large cap miners BHP and Rio Tinto are off 20.1% and 13.1% respectively from their peaks. Below the scale of the large caps, mid to small cap miner’s fortunes have depended on their commodity focus – gold miners in this group have largely had a strong year in 2024; but the worst performers are dominated by critical minerals focussed companies (lithium features prominently) and are down between 60% and 90% from their highs. It has been thoroughly miserable for micro-capitalisation resources companies, who have copped a double whammy of commodity price weaknesses and a broad lack of interest in micro-cap’s across the equity market. This has made for two-three years of grind, the micro-cap resources group down by 75%-90% from the peaks of 2021 / 2022.

Are there bargains ? Perhaps what you are really asking is “Are there bargains yet ?”. This is a question about timing – is there much mining lull / bust left ? (it’s been a lull for Rio Tinto, but it’s been a bust for IGO…) In a cyclical business like mining there is always a bottom, which will be followed by another boom – mining has experienced cyclical alternation from bust to boom and back again for centuries.

The far more interesting question is what will influence the magnitude of the next mining boom ? The most recent mining boom (2016-2021/22) was mild – it was overlain by a global market that was far more interested in seeking growth in tech, which has been an enormous phenomenon. But the market’s overall fascination also tends to be cyclical – one day the fascination of the market won't be tech equities. History shows a tidal shift that moves big money from an equities fascination to a commodities fascination and back again. This cycle is poised for a commodity thematic for big money to chase.

The energy transition will boost demand for commodities, and the global mining industry is under prepared to meet normal demand over the coming decade, let alone substantial added demand, after a decade of under investment in finding and developing new sources of supply. If this theme captures the interest of big money – like the China growth thematic did in the 2000’s – then the next boom will be a big one, and a lot of the share prices we see today across the resources sector are going to look like bargains.

Bottom picking is tricky but the best thing about cycles is their dependability.

The BIG cycle: Commodities or Equities (that is the question)

The market chases returns, and big themes that promise long term strong returns attract the biggest money.

• In the 2000’s, that big theme was the economic acceleration of China and the impact that had on commodity prices – mineral commodities and mining companies all made record highs well above anything they had ever seen before, and for years in a row this theme was the safest bet in town.
• Now, its big tech and artificial intelligence – nine of the ten largest companies in the S&P500 are tech companies all trading at capitalisations (and earnings multiples) that were undreamt of ten years ago.

Big money – on a global market scale – has washed in and out of similar themes that are either commodity focused or equity focussed for as long as there have been markets.

This behaviour can be charted over time via a ratio: dividing a big basket of commodities (Goldman Sachs Commodity Index) by a big basket of equities (S&P500 index) to create a commodities to equities ratio. This ratio provides a relative valuation which is an indication of how far toward equities or commodities the market has pushed.

• When the ratio is at high values commodities might be regarded as “expensive” – but not in an absolute sense, just in comparison to equities. Peaks in the ratio have occurred in periods when demand raced ahead of supply, such as the oil embargo of the mid 70’s and oil supply restrictions due to the Gulf War of the 90’s, or the Chinese commodity rush of the 2000’s. Peaks of inflation tend to align with peaks in the ratio
• When the ratio is at low values (as it is now) equities are regarded as “expensive” in comparison with commodities. Equity extremes include fads such as the Nifty Fifty of the late 60’s / early 70’s, the exuberance of the 80’s that led to the October 1987 crash and the dot com bubble of the late 90’s.

Charting the ratio over time exhibits the cyclical nature of the market’s interest between commodities and general equities. Right now this ratio is at the equity extreme, with the market valuing equities far above commodities. History may look back at this differently, but for now lets call this the “Magnificent Seven” in honour of the seven huge tech companies that have lead the charge in attracting big money to their monstrous market valuations.

Looking back at some of the extremes of the chart, the market has tended to push a long way beyond what hindsight might suggest was logical or safe. Joining in on investing themes that have already been successful and are providing strong returns can often transcend logic or valuation. It takes another big theme to divert big money – not logic.

If the market is a long way into its lean toward general equities led by big tech – what could catalyse the tide of big money toward commodities ? Its already being talked about so probably isn't all that far away.

Mineral Commodity outlook… supply at risk of lagging demand ?

Supply – restricted by lack of investment. The last decade has been a period of under-investment in exploration and development of new sources of supply. Additionally, a portion of future supply is held back by incentive prices that are above current market prices. This circumstance has been created by a mining industry that was gun shy to divert investment to growth, because of the uncertainty of returns. This is understandable, especially through a period that has been generally tepid for commodities. But it can't be sustained. The mining sector recognises this – recent M&A by large miners demonstrates a strong desire to acquire more sources of production, especially for metals like copper. But this form of investing won’t increase supply, it will just change the ownership of it.

Supply keeping up with demand is a constant consideration behind commodity pricing and something the market tends to pay for when imbalances occur, rather than speculate in advance. So this factor is more likely to be an amplifier than the catalyst to draw big money toward commodities.

New demand – energy transition. The last time big money started to move to favour commodities over general equities, China was growing rapidly and becoming the world’s largest consumer of mineral commodities. Future demand patterns under the energy transition are expected to reflect greater intensity of use for many critical / strategic materials, and overall this could present like a large new customer entering the market for some commodities. It is a factor that might be big enough to catalyse a shift in the interests of big money.  

The Mining Cycle: Booms and Busts

It is important to note, the “tidal” movement between commodities and general equities described above is not the mining cycle. Mining cycles operate independently of the big money swing between equities and commodities, on a much shorter time scale. The mining cycle is driven by liquidity – money coming into or leaving the mining space, and this follows absolute movements in commodity prices which rise and fall according to supply and demand.

Miners share prices track the mining cycle: up in booms, down in busts. Indices provide a great aggregate that eliminates stock specific issues, but indices mostly only go back to the 1990’s. The price of BHP tends to trace the performance of most mining equity indices (the largest component tends to dictate index performance), so is a proxy to go further back in time. There are clear limitations to using BHP as a proxy – but it enables a longer-term qualitative analysis. I wanted to look at this back to the 1970's so I consider the compromise is worth making, and given the primary interest is in rough magnitude differences - is reasonable enough.

Commodities to Equities Ratio compared with the Mining Cycle

Comparing mining cycles with trends in the commodity : equity ratio provides context for the difference between booms – some are large whilst others are quite mild (given the behaviours that are evident at the heady levels of the biggest booms, perhaps the superlative should be “outrageous” rather than just “large”).

The chart above compares the commodities to equities ratio with the share price of BHP which has been rebased to the start of each mining cycle, to compare the relative magnitude of each cycle. The chart spans 1970-present, encompassing five mining cycles.

The curiosity that led to comparing the two was – what happens when the commodities : equities ratio is increasing (when the market trend is to value commodities more than equities) and there is a mining boom building ?

Periods where the gradient on the commodity : equity ratio is positive, ie when the market is moving toward commodities, are shaded green.

Double whammy for miners: The mining boom that lasted from 1999 to a peak in 2008 was almost entirely overlain by a period of increasing commodity to equity ratio, as the market embraced commodities more and more. This was the period when China transitioned from developing economy to global major and re-rated every commodity along with it as it became the largest consumer of just about every raw material on offer and little native supply of most of them. This wasn't a short supply or demand shock, demand outpaced supply for over a decade. At the time, China and its effect on commodities was the equity market theme and mining equities were big business. From its low at the start of the boom to its peak, BHP shares went up 9.0x – a massive equity price performance for an ASX100 stock.

Double whammy against miners: The mining boom that lasted from 2016 to a peak in 2021/22 has been overlain entirely by a period of decreasing commodity to equity ratio, as the market embraced equities via the tech theme more and more. Through this boom BHP’s return has been 3.6x.

The ratio remains at an equity extreme, underpinned by technology enterprises trading on high earnings multiples. The capitalisation of the largest of these companies dwarfs the capitalisation of the entire global mining industry.

The full-cycle performance of BHP has tended to be stronger when the latter portion of the mining cycle overlaps a period where big money in the market is favouring commodities (periods shaded green), and the best performance through a cycle has been when there was full overlap of the mining boom.

Next Boom ?

The long term commodities : equities ratio is due a swing back toward commodities, and the mining cycle is also due to swing back into a boom. We don’t know when, and in both cases picking the bottom will be tricky and risky. But in both cases the weight of history provides confidence – it is a case of when, not if because these are cyclical phenomena. The two don’t usually overlap but we know when they do, they provide for outrageous returns through a mining boom.

If the two overlap, as it appears they may well do with the catalysing effect of the energy transition drawing broad market interest to commodities and amplified by a general shortness of supply, we would expect a mining boom with characteristics akin to the 1999-2008 boom: larger (and from an investing perspective, far more lucrative) than the boom we have just experienced from 2016-2021/22:

• High single digit multiple returns on the equities of the best of the global majors, especially the companies that dominate supply of whatever the biggest commodity beneficiaries of the energy transition are
• Huge liquidity to micro-cap resources companies / explorers, which is where the highest returns of all will be for successful companies.  This factor has been all but absent from the most recent boom

Notes:

This comparison of commodities and general equities via a ratio is not my original thought – the concept has been explored in detailed by the likes of Goehring & Rozencwajc: for example their commentary from Q1 2019: (VIEW LINK) and Q2 2024: (VIEW LINK)  

Lion Selection Group provide regular mining sector commentary via our quarterly reports and presentations.  They can be found via out website ((VIEW LINK) or our ASX ticker (ASX:LSX)