The global mining industry is softening, as evidenced by Caterpillar's (NYSE:CAT) recent announcements of layoffs in its Wisconsin mining equipment factories. Various mining companies have announced layoffs in recent weeks.
Mining has been a strong industry for quite a while. The growth of emerging countries, especially China, sparked a global boom in metals and energy prices. That price boom sowed the seeds of the current challenges.
High prices attract investments. Companies spend millions of dollars to open new mines, expand old mines and upgrade equipment to increase production. When all of the different companies' production hits the market, it often overshoots demand. Prices start to fall, and by more than one might expect.
Mining is an industry with high capital costs. Like airlines, once they have the equipment, the operating costs are relatively low. When prices fall, the companies don't ask whether the price covers their entire average cost of production. Instead, companies ignore their capital costs-they are bygones. Companies focus on the marginal costs, or the cash outlay associated with each ton of product. If they can recover just a little more than their cash outlay, they will continue producing. They may be taking a loss when overhead and interest expense is counted, but they will be making some contribution to those expenses. Shutting down the mines means that no contribution to overhead and debt service is made.
What does the future hold? The global economy is likely to continue expanding at a moderate pace, pushing demand for metals and energy up to new highs. Unfortunately, it looks like we have more capacity mining than we need right now. The world will have to grow into the capacity we have. At that point, prices can head up again.
How long that will be depends on the specific materials being mined. The longer the time lag to increase production and the more capital-intensive the sector, the longer it will take before prices recover. On average, look for more price declines for metals and other minerals.