I’ve been looking more and more into mining companies,
the below site was helpful to me…it brings me back to chemistry class + conversion factors!
Might be useful for others that want a quick overview of commodity prices as well:
http://www.undervaluedequity.com/Break-Even-Analysis-How-to-Calculate-the-Cut-Off-Grade.html
This isn’t really that useful. The calcuations are extremely simplistic compared to what an industry mining team would use and the assumptions are basically pulled out of thin air. 1) You never really know the true size of the ore deposit up front. They may do expansions or the experience may change with mining. 2) Estimating that mine’s position on the cost curve over its life is going to be very difficult (cost curves are highly variable, see current downcycle), particularly as an outsider. 3) You’re just pulling a random number out for the commodity price over the life of the mine. The guy completely ignores the location of the mine which is probably among the biggest factors. Location impacts shipping costs (huge), geopolitical risks (high taxes and investment requirments in Indonesia or war and tax hikes in Africa).
At the end of the day you really need to focus on 1) what is global supply going to do over the near, mid and long term 2) what is global demand going to do over the near, mid and long term 3) what does this mean for market balance and pricing and 4) what is the firm’s relative position on the cost curve, life of their mines and potential looming CAPEX requirements and opportunities.
Because of their need to be overly precise, SS analysts are famous for their extravagant models that lack any useful predictive value because rather than focusing broadly getting supply and particularly DEMAND right, they lose sight of the forest for the trees. If you try to approach FCX and model it out and invest in the industry like it’s Coca Cola you’re not going to get the best results.
Commodities seem impossible to forecast.
I am not quite sure how anyone can invest in most of these companies, without calling it gambling—
You have to calculate world known reserves, then figure reserves not yet confirmed, then compare that against all of the buy orders. Plus decide if demand will increase or decrease, based on future material (will the next iphone use copper instead of gold, etc) across all industries.
Then you have to decide each mine’s cost, using estimated figures of what type of metal is in the mine : 1% copper, 2% molybdenum, etc. then compare that against the current cost / forward price. Plus shipping to refinery, trucking, etc. Not to mention the fact, you are assuming the estimate is a fair estimate. It could very well be the mine paid a geologist to provide higher numbers than actual so you have to discount to some degree.
Not to mention the risks you mention, like tax rebates and anti-dumping laws all around the world. Or labor strikes.
This leads me to believe only a few companies have a solid idea of supply/demand/price - the mine companies themselves+trading companies. And in some cases, government
not to mention, the use of derivatives contracts to potentially hedge commodity price / currency risks
It’s tricky, so I cover commodities on the buyside and my approach has been to focus on supply, demand and cost curve assumptions and compare my views against SS assumptions on a high level. Based on that and some broader sort of theoretical heuristics used to guide or discipline the investment process we make decisions. Essentially, the process I use is very macro / economics driven.
BS you still holding onto JOY? Havent done anything with my FCX, have been keeping my eye on JOY for a pull back but after that last quarter it seems I missed out on any of that happening.
can you elaborate pleae
“4) what is the firm’s relative position on the cost curve,”
i believe he’s referring to the average cost of mining metal - if copper is at $3, and one mine extracts at a cost of $2.50 vs another at $3.50, the $3.50 mine will likely be mothballed very quickly
There may not be a major pullback on JOY at this point (although a minor pullback is always possible in second half). I’m holding that particular company long term.
Basically what the other guy said. If you built a curve out of each firm’s cost per unit of mined output, the lower cost high quality guys (geography, geology and execution are primary drivers) will outperform on a downturn while the higher cost lower quality guys will have more upside in terms of operational leverage to an upturn. So which you would want to buy would depend on your outlook.
In a downturn, prices will fall to a marginal cost point at which X% of production will close, this will come from the higher cost guys. For some of them, it may mean the entire firm going under while for others it may just mean closing unprofitable mines. In an upturn, all of these high risk assets will leap in value as they become cash generative.
There are two caveats to this. 1) The most important is that cost curves shift and are very difficult to predict. Pretty much every SS analyst was WAY off and failed to predict just how much firms were able to cut costs this time around. Some of this came from high grading in which firms cherrypick high quality ore areas for short term benefit while diminishing long term mine economics and mine life. It’s something of a desparation measure. But much of it came from aggressive cost control. As a result, the cost curve flattened with the spreads between the high cost and low cost producers narrowing. This was similar to the manner in which the US frackers aggressively and unexpectedly lowered their position on the cost curve relative to the Saudi’s beyond initial forecasts, this prolongs the period of time until supply exits, puts downward pressure on prices and inflicts greater pain on the low cost producers. A major factor that plays a role here is dollar strength and production location. If you have US assets and the dollar is rising like it did in December and January on rate hike expectations, your international competition is benefiting from cheaper local currency costs vs USD denominated production. 2) The second caveat is analysts try to predict where the bottom may be for pricing in a trough. So they may look at the cost curve and say prices will drop to the 85th percentile or some other estimate, at which point supply will exit and prices will recover. So ideally you’d want to be below that. But you need to be aware of how much of supply comes from say, China and may be state supported. In this case if 10% of production is in China and they seem determined to protect their own, then you may go to the 75th percentile or “85th percentil ex-China”.
Other major drivers are determining how much of demand is tied to a region (like China) and segregating CAPEX (infrastructure) commodities like steel and iron ore from OPEX commodities (production) like oil which is a common Goldman theme as they see China in a structural shift towards production while CAPEX commodities struggle as the emerging market feedback loop reverses. Some commodities like copper sit in the middle with uses in both production and infrastructure.
What’s the difference between investing and gambling?
I know my odds of winning when I gamble.
sorry i didn’t find that to be super helpful at all
EVERY choice made is on the spectrum of “gambling”. Investing is on that spectrum too. It is a function of the quality information known and implied. Investing is just not at the same extreme end as scratchies and lottery tickets. 
True, but mining moves from risk to uncertainty - some commodities are seem much simpler than others (amount of smelters around the world,etc)
the complex ones, i have no idea how anyone can confidently invest in companies without physically seeing some of the sites/being a geologist. Investing in a utility company or retailer is easier.
in addition, you’re valuing the miner like an option - i assume you take the expected cash flow from a certain output using market prices (and forward prices/expected prices) then account for volatility on the commodity price. If cost higher than market price, dont mine, if even, continue for x amount of days/weeks, if below, possibly increase mining ops.
I guess there isnt much difference between investing and gambling…
You can’t really put all commodities under the same umbrella. Unless you want to move gold (and silver) to currency status. Gold and frozen concentrated orange juice have nothing in common.
And then there are other commodities, like frozen orange juice… and GOLD. Though, of course, gold doesn’t grow on trees like oranges.
I would define the difference by expected return. Gambling: negative. Investing: positive.
To be honest, we had a killer year investing and I don’t see it as all that difficult or more like “gambling” than any other style of investing. You have more volatility, but the returns are there too and sometimes the volatility makes your job easier by bringing subtle differences to the forefront. You simply have to approach commodity investing much differently than typical corporates. Some people lack the mental hardware to do it correctly. I already explained that worrying about exactness (ore deposit grade, etc) is getting it ass backwards and missing the forest for the trees. Better off sticking to standard corproates with that mindset, where you can fool yourself into a false sense of preciseness and focus on linear beta estimates.
It primarily takes a high level approach. You need to have your macro economics down to gauge demand, not just some undergrad level ability to regurgitate. You also need to have a broad, high level view of the pipeline of new projects (incoming supply). Lastly, you need a loose feel for the firm’s overall asset and balance sheet quality (cost curve position) and available levers to pull. I spend nearly all of my time looking at those three factors (particularly the first two) and the remainder thinking about how I think about things (trading discipline, gauging robustness, convexity and fat tails). It’s not particularly hard but takes a certain stylistic approach or mindset.