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The world didn't stop turning when Lehman Brothers fell, but you could almost feel the wheels of global industry come to a grinding halt.
As we have since seen, of course, nations like China and India have effectively brushed off the dust of that financial fallout, and global demand for raw materials has recovered with noteworthy vigor.
For investors like us, still rightfully wary of undue risk as we countenance "the new normal", correctly assessing the landscape of global supply and demand is an absolute prerequisite to investing in the mining space with confidence.
On the supply side, investors are encouraged to follow the money. In the case of mined resources, this involves tracking trends in capital expenditures by the major producers, and carefully observing the operations of mining equipment manufacturers Joy Global (Nasdaq: JOYG ) and Bucyrus (Nasdaq: BUCY ) .
Recent earnings results from Bucyrus, for example, tell a story about supply that needs to be told.
You can't mine without equipment
It would be easy to presume that resurgent strength in commodity prices, combined with an outlook for long-term demand growth from emerging markets, has sparked an all-out blitz to invest in fresh mine supply. The truth is, however, that this response remains in its infancy. Shockwaves from the financial crisis (and the subsequent, short-lived collapse in commodity prices) continue to rattle the supply side of the mining industry. Bucyrus' tepid third-quarter results provide a snapshot of a mining industry that has scarcely begun to resume its adaptation to burgeoning long-term demand.
The equipment maker suffered a 16% decline in net earnings to $77.6 million, and without a handsome contribution from the product lines acquired from Terex (NYSE: TEX ) , the result would have been uglier still. Stripping out sales from that acquisition -- let's call it ex-Terex -- Bucyrus would have posted sales that were essentially flat with sales from the prior year (when miners were still reeling from the commodity collapse). Sales of original underground mining equipment fell by 3% for the quarter.
Order activity remains sluggish, although recent approval of loan guarantees by the U.S. Export-Import Bank -- corresponding to a major order from a coal project in India -- are set to improve bookings for the fourth quarter. New orders for underground equipment, meanwhile, fell 25%. Bucyrus' total backlog has increased nearly 35% to $2.5 billion this far in 2010, but here again the ex-Terex figures show an increase of only 6%.
The lost years
If this soft pace of equipment sales comes as a surprise, the lesson offered here is that mine development and construction is a time-intensive process even in the best of times. In the wake of a market shock like the one presented by the collapse in commodity prices from mid-2008 into late-2009, it can take a few years for the industry to hit its stride in responding to growth in demand.
With that said, we are finally beginning to see some very big numbers being thrown around in Capex forecasts by the world's largest miners. Rio Tinto (NYSE: RIO ) , ravaged by its disastrous Alcan acquisition, was forced to curtail capital expenditures drastically during the crisis. After a couple of relative lost years, the miner's investments in future supply are now set to surge some 50% next year (to $9 billion). Although BHP Billiton (NYSE: BHP ) and Rio Tinto have scrapped their planned joint venture for iron ore in Western Australia, both companies will nonetheless be moving forward with aggressive expansions in the region. A multi-billion-dollar financing deal is expected next year for construction of the Oyu Tolgoi copper and gold mine in Mongolia. All told, one analyst expects 2011 capital expenditures worldwide to surge 50% to $113 billion ... finally surpassing the 2008 peak of $110 billion.
It must be pointed out, as well, that the observable trend of consolidation within the mining industry -- whereby miners purchase their capacity expansion instead of building new supply -- only kicks the can further down the road with respect to meeting growing demand.
The coming surge
To be sure, the shares of most mining companies have enjoyed a pleasantly buoyant return from the worst levels of the commodity price collapse. In order to apply our analysis of these supply and-demand dynamics to the construction of an investment thesis, we must consider the relative position of mining shares to these underlying phenomena.
Although shares have recovered well, as a whole they have not yet surpassed their 2008 peaks ... and I believe this portends meaningful upside potential for miners with substantial production growth in the works. Beginning with the coal industry, we find that the Market Vectors Coal ETF (NYSE: KOL ) remains nearly 30% beneath its 2008 peak. Although the ETF includes the leading equipment makers in its holdings, the result remains indicative of the broader trend. The Global X Copper Miners ETF (NYSE: COPX ) is only a few months old, but its underlying index remains well off its pre-collapse peak. Even the shares of gold miners, as a group, have just begun to regrasp their 2008 peaks despite the obvious strength in gold prices.
By my estimation, the industrywide lag in responding to growing global commodity demand (not to mention ongoing currency impairment) portends further pricing strength going forward, and I believe the best-positioned miners are destined to profit handsomely as they finally grow their way toward meeting that demand.