‘Trimmed down’ should equal robust mining returns into the next cycle

Despite this, fund flows to emerging markets continued throughout the year as investors sought real returns, using the excess liquidity available to them through a combination of low interest rates and aggressive QE programmes from the US, UK and Japan. These flows were not, however, directed at the resource sector as global economic activity (demand) remained below trend, whilst capacity excesses (supply) persisted. The large diversified global mining companies fell over each other in the rush to cut costs and rationalise unprofitable operations. Short term, this is not confidence-inspiring behaviour but, longer term, investors will appreciate the leaner, meaner, trimmed-down businesses, which should deliver robust shareholder returns into the next cycle.

For the South African investor, lacklustre commodity prices in US dollar terms were more than offset by a significantly weaker rand (down 19% in the year). This came about against a backdrop of persistent political and labour instability throughout 2013. With South Africa’s current account and balance of payment deficits and weak economic outlook, international ratings agencies downgraded the country’s sovereign debt. Within this pernicious environment, the South African and finished the year as the second-worst performing currency, behind the Argentine Peso.

For domestic mining companies, the labour unrest, poor productivity and price inflation in utilities and stores all but eroded the profit margin benefit from the weaker and. Add to this security of tenure issues, moving black economic empowerment (BEE) targets and government interference in corporate decision making, and one can begin to understand why local mining companies were less attractive than their financial and industrial counterparts on the Johannesburg Stock Exchange (JSE) last year.

Should global growth continue its recovery trajectory into 2014, albeit tentatively, we would expect there to be greater support for mining/cyclicals this year given the current relative valuations that have resulted from such divergent returns in 2013 and the preceding years. The current investment sentiment towards the sector is universally bearish for the reasons outlined above, which often signals a great buying opportunity for a sector that is so reliably mean reverting (i.e. valuations are dependably cyclical).