Out of Africa: Prospects for the Future of Mining in the Continent

The dramatic and fairly sustained increase in US dollar-denominated commodity prices during 2003 renewed optimism for the development of new projects in the mining industry in general and Africa in particular. The extent to which the rally can be sustained throughout this year is dependent on a few key factors.

Fuelled by infrastructure development and rapidly increasing levels of personal consumption in the major cities, Chinese demand for raw materials was a key driver of the increase in commodity prices. At Barclays, we expect the marked upward trend in Chinese exports and imports to continue this year, again providing a major positive influence.

Another key driver was US dollar weakness, which encouraged speculative buying of precious and industrial metals. During the first half of this year, Barclays foresees further dollar weakness, but expects that trend to reverse during the second half.

Staying with the US, the relaxed monetary policy there has played a role in boosting metal-intensive manufacturing during the latter half of last year, and the combination of strong new orders and low consumer inventories continues to paint a strong picture for metal demand in 2004.We expect all base metals to register double-digit growth, with nickel and copper, driven by strong demand, performing the strongest.

Of central importance to commodity prices will be the investment community’s reaction when the Federal Reserve starts raising interest rates. We believe this could happen during the late second or early third quarter of this year, and that could well be a signal to liquidate long metal positions.

Influences on Gold

In the short term, gold has several positive factors:

• Continuing dollar weakness should benefit as it is one of the few real currency hedges available to investors
• The producer dehedging story is still making headlines
• The strong technical picture that encouraged trend followers to buy gold remains in place, although once investor interest in gold begins to wane, the metal is vulnerable to a significant sharp correction.

The evolution of producer hedging to dehedging has become one of my favourite topics. How many industries around the world would love to be able to lock in future prices at highly profitable levels? Unfortunately, highly vocal shareholders – so-called gold bugs – are forcing otherwise well managed global businesses to ignore one of their key responsibilities: risk management.

In a high-price environment, it is easy for shareholders to sanctimoniously declare that hedging is evil and demand that gold companies dehedge. But those same shareholders will be the first to hit the sell button when prices decline, leaving the long-term providers of capital – employees, management, lenders and local communities – struggling to manage a business in a lower-price environment.

I am not defending all hedge books. Historically the industry has not helped itself with poor transparency and communication. However, I firmly believe that companies should incorporate a vigorous risk management regime around metal prices in the same way they would around health and safety, environment, construction and business insurance.

Few of Gold Fields’ shareholders complained when the company protected its US$/A$ operating cost exposure when purchasing Western Mining’s western Australian gold assets. I am sure even less are complaining today about the fact that over 70% of the acquisition cost has been recouped from realising the value in those hedges. However, imagine the shareholder outcry if Gold Fields had decided to hedge its A$ gold exposure instead

Exploration

Has the increase in US$ gold and base metals prices done anything positive for the mining industry in Africa?

With robust metal prices, capital should be invested into new exploration and development programmes. However, historically the Mineral Economics Group (MEG) has reported that from a peak of US$5.2bn in 1997, non-ferrous exploration fell for five consecutive years to a ten-year low of only US$1.9bn in 2002.This decline resulted from substantial cutbacks by the majors, the negative effects of industry consolidation and the loss of funding for a large number of junior companies as equity disappeared from the sector. From an African perspective, this had a dramatic effect on the number of new discoveries in the last few years.

In 2003, MEG estimates that exploration budgets were on the rise and totalled around US$2. 4bn.This turnaround resulted from a combination of factors:

• Increased spending by the majors as they recognised the dearth of new projects moving through the pipeline and their own focus on reserve replacement
• Two significant reduction in the negative effects of industry consolidation on exploration
• Two consecutive years of increased spending by junior companies on the back of increased metal prices and rising investor interest.

How does Africa stack up against its competitors when bidding for investment dollars?

In terms of new gold mine development, Africa has led the way over the last seven years, with Australia second and North America third. But it is in terms of reserves and resources drilled up over the last seven years that Africa’s potential is truly revealed. Some 67moz have been defined in that period; almost double that of second-place Australia, with 37moz.

Led by a surge of spending in South Africa, Africa surpassed Australia for the first time in exploration spending, moving into third place by region in 2003.The large increase in allocations reflects Africa’s enormous geologic potential. Although no world-class deposits have been discovered there for the last couple of years, Africa’s geologic potential is still huge. With the recent increase in exploration investment, we anticipate that new discoveries will be forthcoming shortly.

Other Factors, Other Impacts

Now a look at factors within Africa that bear on the relevance of mining in the continent. Three key themes emerge.

HIV/AIDS is one of Africa’s most formidable obstacles, and the mining industry in Africa, and in South Africa in particular, has started to take action. Well reported programmes from Anglo American, AngloGold, Gold Fields, De Beers and Barrick show an appreciation of the damage that the disease can inflict on the sector. While most of these programmes are at a relatively early stage, spending is projected to increase significantly over the next few years. Failure to commit sufficient spending would have a devastating impact on the industry’s future.

Peace and stability go hand-in-hand with development in Africa. There has been recent progress towards resolving conflicts in Burundi, the DRC, Guinea-Bissau and Sudan. Although some of this progress is erratic and slow, under the auspices of organisations such as NEPAD, the continents’ leaders are playing an ever-growing role in strengthening their own capacities to prevent and resolve conflicts.

While I believe that a new generation of African leaders is emerging, until thorny issues such as Zimbabwe are dealt with, the rest of the world will remain sceptical.

Corruption, while by no means exclusively an African problem, thrives on potential imbalances of power and undeniably leads to poor decision-making and the breakdown of law and order. International investors in African mining have a huge responsibility to fight corruption at all costs, and the continent’s leaders must shed not just the image, but also the reality of despots and dictators. And South Africa must lead by example for the rest of the continent.