Commodities Supercycle: Why the cycle just got longer

Posted December 18, 2007

“Galore Creek was supposed to be one of the largest new mines in the world. It was expected to be so profitable that building a new road, a new power plant and all the other infrastructure necessary for a mine would be more than offset by the value of the mine’s production.” – Andrew Mickey

by Andrew Mickey, Editor, Small-Cap Commodity Prospector

Baltimore – (TFN): The term “supercycle” has been batted around the commodities world for a couple of years now. To be honest, supercycle just reminds me of the dot-com days when we invented new terms and valuation techniques like price-to-eyeballs that allowed us to justify valuations that we now realize were completely absurd.

As a result, I wasn’t willing to recommend going headlong into the commodities market these days. But there were bound to be a few isolated opportunities in the sector as we neared the end of the commodities cycle.

One-hundred dollar oils and sky-high commodities prices would eventually prove to be a drag on the world economy and commodity prices would fall due to lowered demand from a world economy that isn’t growing quite as fast. It’s Adam Smith’s invisible hand at work.

But that all changed three weeks ago when a company in British Columbia, NovaGold (NG:AMEX) shocked the commodities world. NovaGold and its partner, Teck Cominko (TKC:NYSE), announced they would be shutting down operations in the Galore Creek copper-gold-silver project in northwestern British Columbia.

Galore Creek was supposed to be one of the largest new mines in the world. It was expected to be so profitable that building a new road, a new power plant and all the other infrastructure necessary for a mine would be more than offset by the value of the mine’s production.

It was so valuable that NovaGold was able to contract two of the world’s largest helicopters to transport large earthmoving and construction equipment into the remote Galore Creek region. That was how valuable the property was. Trucks and bulldozers were actually flown in while the road was being built.

The size and value of the project more than offset the initial capital costs, which were slated to come in at about $2 billion. But it wasn’t long until the costs started getting really out of hand. As the Canadian dollar rose in value, costs of putting the mine into production soared to an expected $5 billion and at the same time future profit margins from the mine shrank.

With a $5 billion cost necessary to get the mine up and running, it just didn’t make sense economically. So it was shut down midstream.

On top of that, Teck Cominko, which was funding a large portion of the capital costs out of its own pocket, was already dealing with soaring expenses at its other projects. In fact, it was spending more than 150% of the company’s original 2007 budget. And that increase only kept Teck Cominko caught up with its timelines and projections.

Over the past few weeks, I’ve been crisscrossing Vancouver, visiting dozens of mining companies, and there is only one focus: capital costs. Since many advance-stage projects have the choice of raising a few hundred million dollars to go into production or close down altogether, we’re at a major turning point in the current commodities uptrend.

You should consider only one top factor when choosing mining stocks: capital costs. Early-stage exploration is still going to have some big winners, but anything that’s been around for a few years is going to have to go big or go home.

So what does all this mean? First, it confirms the commodities supercycle. The high capital costs are going to delay a lot of projects that were scheduled to go into production and limit the supply of copper, nickel, molybdenum, oil… pretty much every commodity.

A lot of exploration companies are going to experience what NovaGold has gone through in this commodities supercycle, which is already going to be a long one — and could even be longer than we ever expected. Sure, at Small-Cap Commodity Prospector we’ll have to be even more selective. We’ve got the wind at our backs with news like this.

The commodities bull market has even more years left in it now. As expenses continue to rise and reduce the number of economically viable projects, the commodities sector is going to be one of the top places to pull in gains.

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