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How to invest in mining stocks

The global mining industry is massive. In 2018, the 40 largest listed mining companies raised $ 683 billion in revenue to dig, process and sell a variety of metals and minerals. Coal was the largest revenue-generating material mined that year, and it was used to generate about 38% of the electricity produced globally.

However, the coal's dominant share of the commodity market has been leveled out, and it is projected to plateau in 2023 due to the increasing use of renewable energy. As coal begins to disappear, another commodity will eventually take the top mining site, probably related to renewable energy sector growth. For example, copper is an important component of the solar, wind and electric vehicle (EV) industries. Lithium is also an essential metal for the sector ̵[ads1]1; it is used to make batteries for EVs, as well as to store electricity generated by wind and solar energy.

Other industrial metals such as iron ore and aluminum will remain in demand since they are essential to support the growth of the global economy. Similarly, precious metals such as gold and silver are likely to be in favor of investors who refer to them as a safe haven in times of economic uncertainty.

Because of the importance of metals and minerals for the future of the global economy, mining companies should find many opportunities to increase their production and profitability. This makes the sector exciting for investors to consider.

  An aerial view from an uranium mine.

Image Source: Getty Images.

What is the mining industry?

The mining industry consists of companies that search for, extract, process and sell metals, minerals and materials that are important for everyday life in our modern economy. The sector is grouped into the following categories:

  • Base metals : These commonly found and inexpensive metals serve many industrial purposes. We use them as building materials and electrical components. The primary base metals extracted are iron ore, nickel, lead, zinc, copper, aluminum, molybdenum and cobalt.
  • Precious Metals : These are rare, naturally occurring metals that have high economic value. Because of that, we often use them for jewelry and sometimes as a form of currency (such as silver coins and gold bars). The primary precious metals are gold, silver, platinum and palladium.
  • Energy Materials : Several materials are extracted from the earth and burned to create energy. The most common is coal. The mining industry also mines uranium (used for nuclear power) and bitumen (a tar-like substance, mainly found in Canada and refined into crude oil).
  • Minerals : These are solid chemical compounds found in their pure form in nature. Examples of mined minerals include potash, talc, gypsum, calcite, quartz, diamonds and salt.
  • Construction materials : These are rocks that have industrial use in the construction industry. Common construction aggregate materials are limestone, rock, sand and granite.

Basic metals are essential for building the infrastructure of the global economy. Iron ore is the most recovered metal because it is a critical component of steel making, as companies need to construct such things as bridges, buildings and pipeline systems. And aluminum is the second most recovered metal because of its importance to the aviation and automotive industries. Copper rounds out the top three because of its ability to conduct electricity.

Given the importance of base metals for the global economy, it is no surprise to see that most of the world's largest mining companies focus their efforts on at least one of these goods. Here are the top five players, ranked by their market value (a company's total available stock multiplied by the share price):

Global Mining Companies

Market Cap

Commodities Produced

1. BHP Group (NYSE: BHP)

$ 131.2 billion

Iron ore, copper, coal, oil and natural gas

2. Rio Tinto (NYSE: RIO)

$ 92.7 billion

Iron ore, aluminum, copper, diamonds and uranium

3. Vale (NYSE: VALE)

$ 62.3 billion

Iron ore, nickel and copper

4. Glencore (OTC: GLNCY)

$ 43.4 Billion

Coal, Copper, Zinc and Nickel

5. China Shenhua Energy Company (OTC: CSUAY)

$ 42.1 Billion


Data Source: PwC. Market value from September 15, 2019.

What are some important mining statistics?

Investors interested in the mining sector need to learn more industry-specific financial metrics that companies use to measure progress. These are the five most important things to know:

All-in-Maintenance Costs (AISC): Gold mining companies use this metric to show how much it costs them to produce an ounce of gold. It measures all the costs of maintaining a mine (for example, mining costs, royalties, production fees and refining costs), as well as company costs such as general and administrative and exploration costs. This calculation gives investors an accurate picture of what it costs a company to produce an ounce of gold.

By-product credit: By-product credit is cash payments received by mining companies to produce raw metals in connection with their primary objectives. Instead of incurring the costs of processing these raw metals into finished products, miners will sell them to others for further processing, and use the payments to offset the cost of mining their primary goals. For example, copper deposits often contain smaller amounts of zinc, silver, molybdenum and gold that miners will sell to offset the cost of producing finished copper.

Cash costs: Mining companies will also report the total cash costs, which are the actual costs of producing a metal such as copper or gold. This calculation differs from AISC or costs minus by-product credits because it only represents mining-related expenses. As such, it gives investors a glimpse of the performance of a company's mining operations by removing stripping expenses at the corporate level, as well as the credits received for the sale of by-products.

  A large mining truck

Image source: Getty Images.

EBITDA : This acronym stands for Earnings Before Interest, Taxes, Depreciation and Amortization. It is a non-GAAP metric that miners use to give investors a better picture of their underlying earnings. They use it because they often record large depreciation costs when clearing a mine's reserves, which reduces reported net income. Because of this, miners often seem to make less money than the mines actually generate.

Ore grades: Metal deposits usually contain more stone than valuable metal. For example, a commercial copper deposit often contains only between 0.5% and 1% of that metal. Miners use ore grades to measure how much metal is in a recent discovery or in a section that they are now mining. Often, miners will report fluctuating production figures from quarter to quarter due to variations in ore grades.

What are some headwinds facing rock stocks?

The nature of the business makes the mining industry susceptible to changes in the global economy. A slowdown in growth or even worse, a recession could significantly affect the demand for base metals such as iron ore, copper and aluminum. As a result, commodity prices may fall, which could cut the profitability of mining companies.

Another major headwind that many mining companies face is the diminishing use of coal as tools move to cleaner energy sources such as natural gas and renewable energy as part of efforts to combat climate change. According to a forecast from the International Energy Agency in 2018, coal will make up 25% of the world's total energy mix in 2023, down from 27% in 2017. That decline could accelerate if renewable energy costs continue to fall, which will add even more pressure on coal prices.

The decline in the coal market causes many mining companies to sell their coal mining assets. For example, Rio Tinto sold its remaining coal assets in 2018 to Glencore and a consortium of other investors. BHP Group concluded in 2019 that coal emissions would be in its best long-term interest. Given the decline of the sector and the exit of these large miners, investors should strongly consider avoiding mining stocks with significant exposure to the coal industry.

Growing concerns about climate change shine the spotlight on the impact of mining companies on the environment. Mining companies unfortunately have a poor track record in this regard. For example, many companies in the mining process use custom ponds to keep the mixture of water and waste left over from mining. These areas pose a significant environmental threat because toxic chemicals such as arsenic and mercury can be released into the wider environment if a dam that holds the landfill in place fails. Because of risks like this, communities are increasingly resistant to building new mines.

Mining companies are also facing an increasing shortage of fresh water. They use a lot of water to treat the ore they are digging out of the ground. Due to population growth and the increasing impact of climate change, mining companies are finding less available fresh water and must find ways to reduce the use of fresh water. Their options for addressing the problem often include construction for recycling water or desalination plants, which increases production costs.

What are some headwinds that can strengthen mining stocks?

Aside from an expanding global economy, one of the mining industry's largest growth drivers is renewable energy. This is because the industry uses many metals and materials. For example, production of a single 3-megawatt (MW) wind turbine requires 335 tonnes of steel, 4.7 tonnes of copper, 3 tonnes of aluminum and more than 700 kilos of rare earth minerals, as well as other metals and materials such as aggregates, zinc and molybdenum. In comparison, a conventional power plant uses about 1 ton of co-generation to produce 1 MW of renewable energy. Because renewable energy requires more metals, the sector's growth will lead to increased demand for these goods.

Manufacturing electric vehicles also uses a significant amount of recovered materials. For example, while gasoline-powered cars require between 18 and 49 pounds of copper, battery-powered EVs need 183 pounds of that metal. Given the accelerated adoption of EVs, the copper sector will need to produce an additional 1,700 kilotons of copper annually by 2027. For comparison, the world's largest copper mine – BHP's Escondida mine in Chile – produced 1270 kilotons in 2017, accounting for 5% of the world's supply.

Another major headwind for the mining sector is the effect that population growth has on food demand. As consumption increases, less arable land is available for agriculture due to climate change, land use change related to increased housing development and other issues. Because of this, farmers need to produce more food per acre. One way they do it is with extracted minerals such as potash, which is used as fertilizer to improve crops. Demand for these minerals should increase in the coming years.

  A miner who holds up a shiny piece of metal.

Image Source: Getty Images.

What are the opportunities for mining shares?

As mentioned earlier, copper is an important metal for the renewable energy sector. The world's largest copper miners should therefore have the opportunity to expand production to meet this growing demand.

However, copper is far from the only growth opportunity in the mining sector. Other important renewable energy metals are cobalt, nickel, lithium, platinum, silver and several rare earth elements. For example, lithium and cobalt are essential for making batteries. Miners focused on these metals should benefit from the faster use of EV and the construction of more wind and solar energy generating plants. This is because battery storage will become increasingly crucial to helping bridge the gap when the wind is not blowing and the sun is not shining.

Lithium demand is on pace to exceed the current production rate for mining companies by 2022. By 2050, analysts estimate that consumption could be as much as 170% above currently known lithium reserves, if they do not adopt any changes in technology. As a result, miners need to increase their exploration efforts to find new lithium resources. Similarly, mining companies must explore and develop new mines that supply the other metals and materials required by the renewable energy sector to meet future growth in demand.

What is the risk of mining stocks?

The mining sector may be risky to investors. One of the biggest problems is that metal prices can be quite unstable. Falling prices have a negative impact on the profitability of mining companies, which then weighs on stock prices.

Two factors cause commodity prices to fall: too much supply and not enough demand. The industry may have an abundance of supply if companies invest in building many new mines, which they tend to do in boom times. If the new mines all come online at the same time and increase supply significantly, commodity prices may fall. Demand for metals, on the other hand, tends to decline as the world economy or a metal-intensive sector like construction slows down. Because metal prices can fluctuate, investors should seek out mining companies that have low production costs. That way, they should still be able to make money even if prices fall.

Another major issue that has plagued the mining sector over the years is poor capital allocation. Mining companies often spend a lot during boom times to build second-level mines or make high-cost acquisitions because they have the financial flexibility to make these moves. However, these investments can do more harm than good. This is because lower quality mines have higher production costs, while costly procurements can burden a company's balance sheet. If commodity prices fall, which often happens, these investments will not pay off.

Governments also pose a risk to mining companies. They regulate industry to ensure that it does not harm the environment or communities next to the mines. These regulations can sometimes be too burdensome, which can make it harder for mining companies to operate and / or make money. Governments can also take steps to protect their national interests, which can also have a negative impact on miners. For example, Rio Tinto was a minority investor in the huge Grasberg copper-gold mine in Indonesia. However, that government wanted the mine under local control because it was such an important strategic resource. As a result, Rio Tinto had to sell its stake in Grasberg to Indonesia's state mining company. Given the important role of government in regulating the industry, investors should take the time to look at where companies operate. They should closely monitor whether the company's most important mines are in politically stable areas with a history of working with the mining sector.

What are some ways to invest in mining stocks?

The mining sector can be a challenging one for investors. Due to fluctuations in the world economy, metal prices can be quite volatile. Add to the industry's other risks and headwinds, and many investors may want to avoid mining altogether.

However, mining is important for the growth of not only the world economy, but also the renewable energy sector. Demand for recovered metals should grow at a healthy pace in the coming years. This should enable mining companies to increase their production and profitability, which has the potential to increase stock prices. This upside makes it an attractive sector for growth-focused investors.

Those who are interested in investing in the sector have three main options. First, they could buy an exchange-traded fund (ETF) or invest in a mutual fund that focuses on the mining industry. For example, iShares MSCI Global Metals & Mining Producers ETF has shares in approximately 200 mining companies. Thus, it offers investors wide exposure to the entire sector, which helps to reduce risk.

A similar way to invest in the industry is to buy shares in a diversified mining company such as BHP Group, Rio Tinto or Glencore. One of these options will give investors broad exposure to the sector. This diversification helps to offset some of the risk. However, investing in a single company opens investors up to company-specific problems, which can lead to underperformance. Glencore's biggest money maker, for example, is coal, which is in decline. Therefore, investors should carefully consider a company's portfolio, balance sheet and management team before purchasing shares.

Another way to invest in mining is through a company focused on a specific market segment. For example, many companies focus on gold mining, making them ideal alternatives for investors seeking the market's potential. Meanwhile, several others are focusing on important metals for renewable energy sectors such as copper and lithium. They would be alternatives for investors who want to focus on the growing segments of the mining industry. However, investors who choose a focused miner should pay close attention to the balance and cost structure, as weakness in both areas can cause a mining company to underperform its peers and miss out on sector gains.

Why Investors Should Consider Mining Shares

The mining sector is not for every investor. But because it is crucial to our modern economy, it looks set to continue to grow in the coming years. This growth will enable mining companies to reap great value for their investors as long as they operate wisely by focusing on the right goods while maintaining a strong diversified financial profile. This potential upside makes the sector worthy of further exploration.

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