Consolidation in Australia

The Australian resources sector has undergone tremendous change over the past three or four years, and global consolidation has focused heavily on Australian names.

The frenetic activity was due to several factors: an undervalued domestic market, high-quality and long-life operations, low operating risks, a sustained low Australian dollar (until early 2003), and a well-defined regulatory framework.

The major impact has been felt on equity markets. The mines have not disappeared, but the framework and ownership of the mining industry is now very different and dominated by large global diversified players, such as Rio Tinto, BHP Billiton and Xstrata.

The equity market is now polarized between these large global diversified players and small juniors with market caps under A$100 million. The demise of the mid-caps has seen investors focus on more exotic but successful plays, such as Oxiana in Laos. In addition, because of a lack of investment choice, ownership by Australian institutions of Australian Stock Exchange-listed foreign companies such as AngloGold has increased, though the transactions are often made on a foreign bourse. The flurry of mining IPOs in 2003 is dominated by small gold or nickel plays of a few million dollars.

Exploration spending in Australia has more than halved from the A$700 million reported for 1998. This trend is not unique but coincides with the void of new mining companies of size coming to the market in Australia. A proposal to introduce the Canadian-style flow-through share program to fund exploration in Australia has not met with success. The next wave of mining project discoveries, which over time would result in small caps turning into mid-tier miners, has not happened.

Having said this, metal prices are surging and the outlook for resource sector profitability is good indeed. Australia, like all resource-rich countries, is a major beneficiary of China’s enormous appetite for most commodities. It is only the strength of the Australian dollar that has capped stronger growth in profits. Australia currently supplies some 40% of Chinese iron-ore imports, and investment firm J.P. Morgan forecasts that US$2.4 billion will be spent to expand production over the next four years. Large sums are destined for coal and petroleum projects but not base metals or gold.

We may well be on the threshold of a long-term major shift in global economic power to Asia, and despite obvious issues and shortcomings, Australian mineral exporters are well-positioned to reap the rewards.

— With notes from a presentation of the recent annual convention of the Prospectors & Developers Association of Canada, held in Toronto. The author is a precious metals analyst with J.P. Morgan in Australia.