Glencore vs the mining boom

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No doubt everyone will have heard the reassuring story that the Australian mining boom has three phases. The first was a rise in prices. The second was the investment surge. The third is purported to be the volume surge that follows all of those new mines.

Phase 3 has always been questionable in my mind. The principle reason is that capitalist cycles are never quite so kind. They tend, rather, to boom and bust, and hence the investments made during the boom period end up being badly under-performing assets as price falls well and truly outstrip any volume growth.

There is support too for this reading of things in basic economic theory. Commodities are inelastic. That is, it takes time for supply to respond to new demand. In such markets, economics says, the supply and demand curve steepens:

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This is a model for price booms and price busts. Mining it seems is waking up to this fact. Overnight, Glencore CEO, Ivan Glasenberg, criticized his recently departed mining CEO peers for swamping the industry with mines and new production that crimped profits:

“The big guys really screwed up,” Glasenberg, 56, who runs the world’s largest publicly traded commodities supplier, told investors yesterday in a presentation.

Glencore International Plc Chief Executive Officer Ivan Glasenberg said he hoped mining CEOs “have learnt their lesson. They built, they didn’t get the returns for their shareholders. It’s time to stop building.” Photographer: Andrey Rudakov/Bloomberg

“We’ve always been wanting to keep building and keep putting the cash which we generate into new assets,” he said. “That’s what we’ve got to stop doing as a mining industry. We’ve got to learn about demand and supply.”

“Now we have a new generation of CEOs; I hope CEOs have learnt their lesson,” Glasenberg told the BMO Capital Markets conference in Hollywood, Florida. “They built, they didn’t get the returns for their shareholders. It’s time to stop building.”

“We will get better returns on our investments, we will be able to kick out more cash to our shareholders,” he said. “We will be late to invest. So, who cares? We’ll be late and we’ll have to invest in five years’ time. It’ll take us three years to build the mine but we could hopefully have an eight-year run.”

“What we’ve got to do, when the markets do get stronger, no need to keep building a new asset and let’s keep the market tight for a while,” Glasenberg said. “Not that we’re here to create an anti-competitive nature, but we’ve got to get returns. You the investors want to get returns on our assets and it’s easily done if we just use our brains.”

“I hope we are in a new paradigm in the mining industry,” Glasenberg said. “It’s really, I believe, catastrophic what we’ve done in this industry.”

These are serious words with very serious implications for Australia. The phase 3 volume story underpins Australian growth prospects for the next decade at least. To some extent it is defensible here than in other markets owing to the enormous growth in LNG supply, which is virtually an entirely new industry. But I fear the dynamics of falling prices hurting rising volumes will be the same, if diminished.

That is not to say that Glasenberg’s call to restrict supply is any better a solution. His take is a kind of privatised resource nationalism and next he’ll want a seat on the Security Council. What we are confronted with here are simply the pros and cons of capitalism since time immemorial.

The real culprit in all of this is not the companies, the bad ones of which will be punished in due course. Markets are no smarter than anyone else, but they are more ruthless at punishing mistakes.

Those that will probably end up hanging their heads are the policy-makers that ignored the lessons of history and basic economics in favour of an irrational embrace of the boom. It is they that will have failed to curb the excesses of the market, as they seem always do, by not saving the mining bounty for the rainy day that comes in place of hoped for new phases of boom.

Irrational exuberance is a given. What we need to address is irrational policy.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.