August 24 2004

Base Metals Commentary:

===================================== Here are some interesting facts on the mining industry in Canada over recent years-

"Four centuries of Canadian history could be summed up as the beaver, the forests and the mines. Gold, copper and nickel not only built Northern Ontario and Northern Quebec, but much of the wealth dug from the Canadian Shield in Timmins, Rouyn-Noranda, Chibougamau, Porcupine and Sudbury flowed to Toronto and Montreal, helping to make these financial centres bloom. Long before natural gas became important to British Columbia, gold mining towns produced revenues second only to the forest industry. The Hudson Bay mine at Flin Flon was Manitoba's second most important commodity industry behind agriculture, decades before the nickel at Thompson was developed.

The industry has learned to suffer through disappointing commodity prices. Take gold. The Bretton Woods Agreement (1944) froze gold prices at the US$35-an-ounce level set in 1934. That price was a bonanza for gold mines during the Great Depression, and new gold mines opened across the land. But the price that launched a thousand tips on Bay Street in the Hungry Thirties was a starvation diet by 1950. When Second World War price controls ended, inflation hit Canada, and one gold mine after another became uneconomic as costs of wages and materials soared.

To save the gold mining towns, Ottawa introduced what was erroneously described as a short-term program called "cost aid." The mines were allowed to sell their output to Ottawa at a price adjusted for what gold would theoretically be in a free market. The nation's gold reserves, that the Bank of Canada has been selling so enthusiastically in recent decades, were accumulated back then by overpaying old gold mines for new production.

Canada's most memorable copper boom came in 1956, as copper prices soared to the unheard-of level of US60 cents a pound. That was great news for the Ontario nickel mines in Sudbury and Falconbridge, which also produced copper, but was fabulous news for the copper deposits in the Rouyn, Chibougamau and Gaspé areas of Quebec and in mainland B.C.

The inflationary 1970s were the last time of splendour for the Canadian mining industry. Double-digit inflation sent investors scurrying to sell bonds to invest in "hard assets;" i.e. metals, timberland and real estate. The international oil companies reacted to OPEC members' nationalization of foreign production by redeploying funds into the purchase of base metal mines, in the mistaken belief that metals were just another mineral, like oil. Storied company names like Anaconda disappeared from the stock market, bought by big oil at what proved to be ridiculously high prices. Investors who had owned these shares eagerly reinvested their winnings in the big Canadian mines such as Noranda, International Nickel (now Inco) and Rio Algom. Gold prices, freed of controls in 1968, ran from $35 to as high as $850, giving unbelievable returns to investors.

When Federal Reserve chairman Paul Volcker, Ronald Reagan and Margaret Thatcher demonstrated that strong leaders could not just control inflation, but smash it, gold entered a 20-year Triple Waterfall -- a three-stage price collapse which the Japanese market would experience a decade later and Nasdaq has just begun to suffer -- falling to US$250. Few established gold mines outside South Africa and Australia were able to remain profitable during that long depression. The only winners were a handful of new mines, of which the leader was Barrick Gold. These savvy operators used complex forward selling arrangements that delivered consistently higher prices for their output than was available through open market sales.

The Canadian base metal producers also suffered in the disinflation era, as their old ore bodies became decreasingly profitable, and major new production came on stream from Chile, Australia, Indonesia, Russia and China. Copper, nickel, zinc and lead became less important in the advanced industrial economies, yielding to plastics and electronics.

As the new millennium dawned, the total market capitalization of all the publicly traded mining companies in the world was about the same value as Cisco. Wall Street firms had virtually closed down their research coverage of mining stocks.

After a nearterm peak in 2003, a fairly deep correction set in for almost all the metal prices, but the long term fundamentals still make a very strong case for rising prices for some time to come.

The gold move was for obvious reasons: the U.S. dollar is in a bear market, which means higher gold prices. The move in the industrial metals could be dismissed as a fluke were it not for a huge leap in another price: rates for freight on container ships. When the cost for what's deep in the earth and what floats rise together, the world economy is strengthening, regardless of what dismal predictions you read.

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