The biggest thing I've observed in the commodities space is that out of all the industries there, the oil industry has done a fantastic job with emerging bigger after every downcycle. Returns in the oil industry far exceed that which is found in mining and farming.
Here's a look at Exxon Mobil
$XOMAnd here's a look at
$RIO, the Exxon Mobil of commodities
When adjusting the timeframe of the stock returns, Exxon's stock look like it took a more wild ride. However, since Exxon offers consistent and bigger dividends than Rio, Exxon still beats Rio in terms of returns by a wide margin. A question many have is, why does the energy sector have better capital allocators than the mining sector?
A few things come to mind:
- Returns are more predictable
Oil exploration often involves substantial upfront costs but can yield more predictable and higher returns compared to mining. The geological uncertainty in mining (variations in ore quality, accessibility, etc.) adds risk and reduces predictability in terms of returns on investment.
- Technology and Efficiency
The oil industry has been a pioneer in adopting advanced technologies for exploration, drilling, and extraction. These technological advancements have often resulted in increased efficiency, reduced costs, and improved returns on investment compared to mining operations that might not have undergone such transformative changes. Enhanced oil recovery, fracking, etc. are primary examples of this. For mining, most of the innovation is in the form of automation, which helps with reducing the labor intensity of the business.
- Market stability
The demand for oil is more stable than the demand for metals. In good and bad times, we need oil to go from Point A to Point B. As for metals, demand is dependent on whether factories are producing more cars, phones, etc. or not.
When looking at the mining industry, there are a few bright spots. Lithium is one of them where the increased usage of lithium-ion batteries for cars and electronics have pushed demand consistently higher.
$SQM has been a major beneficiary of this. To some, SQM is the Aramco of Lithium.
Then, there's
$SCCO, which acts as the Exxon of copper mining. Even if its rival,
$FCX, produces more copper, Southern Copper has lower production costs.
Conclusion
With the severe commodities downcycle that started around the timing of Brexit, I'm hopeful that the industry will be very wise with how it allocates capital. As the big shift towards EVs stresses the mining capacity for copper, lithium, etc. the eventual commodities supercycle will lift all commodities stocks higher. How these miners use their fortunes to improve their business is something I look forward to seeing. Those who use the great times to lower their cost of production will do far better during the downcycle than those who don't. And if I were Warren Buffett and I wanted to invest in a miner for the long run, I go for the lowest cost producer.
A concern I have with the mining industry is the scarce amount of capital flowing into the sector. Too much capital has been sent towards the EV and battery producers, and less of it has been sent to the miners. Until miners can find a way to attract more capital, I do see the mining industry relying more on metal prices spiking to boost their profits as they struggle to raise capital to expand production.
