How Low Can Mining Stocks Go? (Part II)

 |  Includes: ACH, FCX, FDG, HL, OXY, PTR, RIO, SCCO, TCK
by: Andrew Mickey

By now it’s clear a global recession at hand. China announced its plans to stay the course, the Obama rally has passed, and the U.S. consumer has decided to cut back. We’re in a bear market and the highly cyclical commodity stocks have led the way down.

Is there more downside to come in commodities? Have we finally hit rock bottom? These are a few questions I posted a few weeks ago in “How Low Can Mining Stocks Go?

The answer at the time was pretty much summed up with:

I realize most of these mining stocks are at the lowest prices they’ve been in a couple of years. But considering the overcapacity in the automotive industry, sharp fall-off of industrial production and the unknown impact of a global slowdown on base metal prices, there could be even more downside to come.

Since then, the slide has continued. Even the worst case scenario (reversion to 2002 prices) has hit a few mining industry leaders. For instance, Teck Cominco (NYSE:TCK) shares have gotten absolutely pummeled thanks in large part to the economics of its leveraged buyout of Fording Canadian Coal. Currently shares of the embattled mining company are below 2002 price levels.

Teck Cominco isn’t the only mining company that has paid a big price, Southern Copper (PCU) has hit the “worst case scenario” price levels. As copper prices continue to slide (yesterday down below $1.60 per pound), Southern Copper shares are sliding right down with it. Wednesday, shares fell another 12% down to just over $10 per share. This new low is actually lower than you could have bought shares for in 2002.

Considering it happened to these two major mining companies, there’s nothing stopping it from happening to others. For any investor that decided to just wait it out through commodities’ cyclical downturn, the risk of a lot more pain coming is very real as you can see in the chart below:

Historical Mining Share Price Snapshot

Recent Share Price
104-Week High
% Decline So Far
Jan. 2002 Share Price
How Low Can They Go?
Rio Tinto (RTP)
Freeport-McMoRan (NYSE:FCX)
Hecla Mining (NYSE:HL)
Teck Cominco (TCK)
(below 2002 price)
Southern Copper (PCU)
(below 2002 price)
PetroChina (NYSE:PTR)
Occidental Petro. (NYSE:OXY)
Aluminum Corp. of China (NYSE:ACH)
Click to enlarge

As you can see, many of the base metal mining companies’ shares have fared the worst. As aside from the two that have already fallen below 2002 prices, there are plenty that appear to be on their way.

Of course, it makes a lot more sense now. If the stock market can return to its 2002 lows, unemployment could go back to 2002 lows, and it’s looking like world GDP has a shot at falling back to its 2002 total, then everything else could too.

Oil and gold have managed to avoid a big part of the reversion. However, as the table points out, if the whole world is flashing back to 2002 price levels, there could be a lot more danger in holding stocks in the oil and gold sectors.

Mining companies are continuing to get prepared for 2002 base metal prices by closing up even more mines.

Preparing for the Worst

In the past two weeks, the flood of mines which will be closed for “care and maintenance” continued to increase.

Consolidated Minerals in Australia announced it will be closing its nickel mine and downsizing its chromite mine “due to deteriorating market conditions and the uncertain outlook for our product.” Chromite and nickel are primarily used in the manufacturing of stainless steel.

Also in Australia, CBH Resources ((ASX:CBH)) cited an “extremely difficult” 2008 as the primary reason for announcing it is one step away from putting its substantial zinc mine, Endeavour, on care and maintenance.

The problems aren’t just in Australian mines which were leading exporters to China and other quickly growing Asian countries. There are plenty of mines in North America headed for care and maintenance. First Nickel ((TSX:FNI)) announced it will be shutting down its nickel mine in Sudbury, Ontario. 

All these announcements came in just the past two weeks. And given the state of the commodity markets with high risk of more downside and limited near-term upside potential, we’re almost certain to see more mine shutdowns in the weeks and months ahead. The impact of mine closings can be disastrous to many of the smaller companies. Many of the share values of the companies mentioned about have fallen more than 90% from their highs.

The Risk/Reward of Mining Stocks Now

It still blows my mind how many people are expecting ongoing demand from China to keep base metals prices propped up. Yes, China is going to continue to build new infrastructure, buildings, sewage systems, etc. and will need a lot of base metals. China, however, is not going to be doing it fast enough to offset the decline in demand for base metals in other parts of the world.

With each passing day, it seems like we’re headed for a very long economic downturn. There is still a lot of oversupply and low-grade mining operations are going to be the first ones to get shut down. Mining companies are forced to survive and the major mining companies, although not in a great spot, are in a much better position to weather the storm. 

It’s a deflationary environment and there’s no reason to buy anything today…especially many of the base metal mining stocks. Even contrarians looking to buy at or near the bottom should buy using an extremely conservative investment strategy. But for me, it’s still too early. The risk/reward situation is getting better, but it’s still not that great considering we’re still in the down part of an economic cycle.

Disclosure: I have no interest in any of the shares mentioned.