Managing Commodity Lifecycles, Mining

3. Impact of mineral commodity price cycles

Spending on exploration and investment

Although there are differences in the cyclical patterns of different mineral commodities, the impact of these cycles is common to all commodities and poses similar challenges for all mineral producers.Source: SNL, S&P Global Market Intelligence, The Economist

Most significantly, the cyclical nature of prices influence the industry’s attitude towards spending on exploration and investment. Companies invest pro-cyclically, meaning that investment takes place at higher levels when prices are high. There are good practical reasons for this.

Firstly, timing markets is difficult and rising prices provide a clear signal that the market is short of production. Secondly, when prices are rising, companies have the money to invest in new capacity. Higher prices boost their operating margins and increase their retained earnings, and provide confidence to investors and groups financing resource companies.

The graph shows the strong pro-cyclical pattern of spending on mineral exploration.  An inevitable consequence of this pattern of behaviour is that company investment gives momentum to cycles, contributing to a tendency for supply to overshoot on the upswing of the cycle and undershoot on the downswing.