It has been a mixed start to 2023 for the mining industry, one of the few remaining sectors where the London stock market still has many of the world’s biggest names.

A reopening of the Chinese economy helped drive a rally in miners of industrial metals in the first weeks of the new year before concerns about recession began to weigh more heavily. On the flipside the precious metals space has come to the fore as a banking crisis helped amplify the apparent safe haven credentials of gold.

SHORT TERM IS ABOUT CHINA, LONG TERM ABOUT TRANSITION

In the short term what happens in China, the world’s largest consumer of a broad spread of commodities, may dictate sentiment towards mining stocks. In the longer term investors need to consider the role of mining companies in the energy transition and whether now is a good entry opportunity into this theme.

Investment bank Morgan Stanley comments: ‘The initial excitement about the impact of China’s reopening on commodities has faded, as hard data points remain mixed and are hard to disentangle from the regular spring construction seasonality.

‘While there are some pockets of strength, such as infrastructure, vehicle sales started the year on weak footing. There are some green shoots in China’s property industry, but we are still far from a full reversal. It clearly takes time to turn around the oil tanker that is China’s economy.’

There have been some more encouraging signs of late, with Chinese GDP growth of 4.5% for the first three months of 2023 beating expectations. This represented the fastest pace in 12 months and has positive implications for commodities demand and therefore prices.

LOOKING BEYOND CHINA

A key thing for mining investors to watch is the extent to which Beijing looks to stoke growth by spending in areas like infrastructure and property which would make the reopening of the economy more metals-intensive.

But it is not all about China. Co-manager of BlackRock World Mining (BRWM), Olivia Markham says: ‘The previous super-cycle in mining was a China story but it is much more balanced this time and linked to energy transition in China but also in the US, Europe and other countries. It is about the impact that funding and legislation like the Inflation Reduction Act in the US can have and how it feeds through to the sector.’

As well as China, a surge in gold has been dominating a lot of the recent discussion around the mining sector. Berenberg analysts Richard Hatch and Charlie Rothbarth say: ‘In the near term, we believe that an overweight precious metals strategy is merited due to ongoing geopolitical concerns and risks in the banking sector. We believe this environment will result in a dovish stance from the Fed and a well-supported gold price – the gold/silver ratio has expanded, so our preference lies with gold names.’

In this article we focus on industrial metals but we will carry out a detailed examination of the UK-listed gold and silver miners in a future article.

Looking beyond the near future, other metals are likely to be draw focus away from gold and it was notable to see Azerbaijan-based miner Anglo Asian Mining (AAZ:AIM) announce a five-year strategy that involves a big shift in focus from gold to copper. Primarily a producer of the precious metal right now, by 2026 it expects copper to supplant gold as its main source of revenue.

Anglo Asian vice president Stephen Westhead told Shares, ‘Gold is obviously a powerful metal in global economics but copper was a specific target for the company. We have been cognisant of the global market and the demand for copper because of its role as a critical metal in the transition to net zero.’

While a lot of focus in the discussion of the role of the miners in moving the world away from fossil fuels is on battery metals and rare earths, copper could be just as important to the energy transition.

COPPER’S ROLE IN ELECTRIC VEHICLES AND RENEWABLE ENERGY

Copper is seen as a good barometer of the health of the global economy, earning it the nickname ‘Dr Copper’. The metal is a critical component in the manufacturing of electronics, homes and infrastructure.

Discussing the metals required for large-scale adoption of solar, wind and electric vehicles, the International Energy Agency says: ‘The types of mineral resources used vary by technology. Lithium, nickel, cobalt, manganese and graphite are crucial to battery performance, longevity and energy density.

‘Rare earth elements are essential for permanent magnets that are vital for wind turbines and electric vehicle motors. Electricity networks need a huge amount of copper and aluminium, with copper being a cornerstone for all electricity-related technologies.’

The IEA estimates renewable energy technologies are four to 10 times more copper intensive than conventional energy production.

Consultant McKinsey estimates annual copper demand will hit 36.6 million tonnes by 2031. Only 30.1 million tonnes are accounted for by current supply projections based on restarts, certain or probable projects and recycled production, leaving 6.5 million tonnes to be found elsewhere.

Their role in what is supposed to be a ‘green’ revolution means mining companies are having to consider how to get metals out of the ground with the lowest possible environmental impact. Renewable energy developers and electric vehicle firms are likely to consider these factors closely as they manage their supply chains.

BlackRock’s Markham notes: ‘This is something happening industry-wide, companies don’t want to miss out on opportunities because they can’t produce commodities in low carbon way. ESG (environmental, social and governance factors) is so important, it’s all about having a social licence to operate.’

However, she also acknowledges that ‘in terms of the timeframe we are relatively early on in this journey’.

One issue facing the big UK miners, several of which have significant exposure to iron ore used in steelmaking, is the need to move towards low carbon steel. This is likely to involve the application of innovations like the use of green hydrogen to remove oxygen from iron ore and create a product called ‘direct reduced green iron’. That can be fed into renewable-powered furnaces to make steel with negligible emissions. Moving in this direction will have implications for costs and output.

WILL MINERS REMAIN DISCIPLINED?

As companies react to the increased demand implied by the shift to renewables and electric vehicles by investing in new projects and technologies, there is a risk the capital discipline and accompanying generous dividends which have been a marked feature of the sector in the past decade or so will be abandoned.

Dividends have already started to retreat from the high-water mark seen in 2022 when significant inflation in commodity prices lifted earnings and cash flow.

However, BlackRock’s Markham believes miners will remain committed to managing their capital sensibly and rewarding shareholders. She says: ‘We’ve got management teams which are really committed to returning capital to shareholders and are compensated by the metric of pay-out ratios.

‘It is also difficult to see how it’s possible for companies to spend lots of capital at present. There isn’t a huge pipeline of projects they can invest in internally and while they may look at M&A, companies remain wary of large-scale deals.’

Different approaches to mining

There are three main methods of mining:

Underground mines: These are more expensive and are used to reach deeper deposits. The entry from the surface to an underground mine is typically through a horizontal or vertical shaft and explosives and machinery are used to blast and tunnel through rock.

Surface and open-pit mines: These are typically used for shallower and often less-valuable deposits and involve extracting metals and minerals from an open pit in the ground.

In-situ mining: This involves dissolving the mineral resource in place then processing it at the surface without moving rock from the ground.

INVESTMENT IDEAS: OUR PREFERRED MINING STOCKS AND FUNDS

The long-term direction of travel towards renewables and electric vehicles feels undeniable but in the short term the weaker economic outlook means sales of the latter are uncertain (unless prices come down a lot) and renewables investment could stall.

Battery metals like cobalt and lithium have already seen price declines, with cobalt also impacted by news Chinese mining company CMOC and its Congolese partner have struck a deal to resume sales from one of the world’s largest cobalt and copper mines. This will unlock a stockpile of the two metals worth a combined $2 billion. Typically, more supply means lower selling prices, unless demand is growing faster than supply.

This is a reason to avoid exposure to small producers and developers of battery metals which will find it more difficult to weather short-term fluctuations in prices. Miners with some level of diversification should be better placed.

Our favourite large cap miner is Rio Tinto (RIO). Jefferies analyst Christopher LaFemina says: ‘We believe that Rio is defensively positioned at this point, given its low production costs, strong balance sheet, and significant capital returns.’

Rio is trying to leave behind a chequered history in terms of ESG with current chief executive Jakob Stausholm at the forefront of these efforts. In 2022 Rio created the Juukan Gorge Legacy Foundation, as part of its efforts to make amends for destroying two ancient rock shelters at Juukan Gorge in Western Australia in 2020, as well as publishing an unsparing report into a dysfunctional and abusive working culture. In the short term Rio Tinto’s significant iron ore exposure makes it a good play on a recovering Chinese economy.

A small cap option with growth potential is Anglo Asian Mining. It has a target to produce 35,000 tonnes per year of copper by 2028 as it develops two new projects in Azerbaijan. This plan is underpinned by having a strong balance sheet with no bank debt, $20 million of cash and the cash flow generated by its current gold production.

The company, which has a track record of successfully operating in Azerbaijan, remains committed to dividend payments in the interim, with the shares yielding 6% based on consensus forecasts. Broker SP Angel’s estimated net asset value of $300 million (£241 million) is more than double the current value of the company on the stock market (£117 million). Risks include the single country focus and challenges in bringing its copper projects into production.

INVESTMENT TRUST AND FUND OPTIONS

Investors looking for diversified exposure to the mining sector have a few options. Our preferred name is investment trust BlackRock World Mining. Its 10-year annualised return is 8.5% and it has an ongoing charge of 0.95%, which compares well with the natural resources focused peer group.

A lower-cost alternative is tracker fund Van Eck Global Mining ETF (GIGB) which has ongoing charges of 0.5% and tracks a basket of global mining firms including BHP (BHP), US-listed Freeport-McMoRan (FCX:NYSE) and Brazil’s Vale (VALE:NYSE).

If you prefer a ‘picks and shovels’ approach, based on the idea the people selling these items during the 1848 California Gold Rush were the ones making the real money, then mining engineer and equipment specialist Weir (WEIR) could be a good option. The company became a more focused following the sale of its energy services arm in 2021 although the shares are not cheap on a 2023 price to earnings ratio of 18 times.

Shore Capital analyst Akhil Patel says: ‘Population growth, the convergence of living standards, urbanisation, ore grade decline (i.e., more materials need to be processed to extract the same amount of metals/minerals) and the demand for metals/battery metals to support the global clean energy transition/decarbonisation all point in Weir’s favour.

‘Especially given the need for mining to become more efficient and reduce its carbon emissions.’

Jargon busting – some key terms and metrics to understand

RESOURCES AND RESERVES 

The Joint Ore Reserves Committee code, also known as JORC, is one of several classifications of mineral deposits and is the most widely used by miners on the UK stock market.

An inferred mineral resource is where tonnage, grade and mineral content can be estimated with a low level of confidence.

Indicated resources are economic mineral occurrences that have been sampled to a point where an estimate has been made, at a reasonable level of confidence, of characteristics such as metal, grade and tonnage.

Measured resources are indicated resources that have undergone enough further sampling that a geologist has declared them to be an acceptable estimate, at a high degree of confidence, of the grade, tonnage and physical characteristics of the mineral occurrence.

A mineral reserve is the economically mineable part of a measured or indicated resource.

TAILINGS

This is the material left behind after the valuable minerals have been extracted from the ore. As mining methods have become more sophisticated, tailings have been reprocessed to recover any remaining minerals.

GRADE

This refers to the concentration of a valuable mineral or metal within an ore (i.e., the rock which contains the mineral or metal) and is typically measured as a percentage or sometimes per tonne. Ores are extracted from the earth through mining and then refined to extract the mineral.

There is a grade below which it is not profitable to mine a mineral even though it is still present in the ore. If the material has already been mined there is also a grade at which it does not make economic sense to refine or process it. The minimum grades vary on a project-by-project basis.

A good copper grade, for example, is anywhere around 1% but some mines are economic at grades of 0.5%.

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