Invest Like A Billionaire: Mining Metals

(photo: Nic’s events)

Mining is a risky business for practitioners. Though 33 Chilean miners were recently rescued after surviving more than two months underground, in the past week alone a mine collapse in Ecuador and a mine blast in China have led to fatalities.

Yet, the minerals under the earth’s surface – from coal to copper – are in high demand and the pace of mining is heating up.

So what does that mean for investors? While the mining sector is definitely one to consider if you’re seeking to diversify your portfolio — and its recent performance is definitely appealing — it may not be the right investment for everyone, not to mention your exposure should be limited.

Here is a guide to the sector, its major players and trends, and how investors can benefit from its recent success.

Uptick in mining

Over 1,300 global mining deals worth more than $100 billion have been announced so far in 2010 according to a recent report from consultancy PricewaterhouseCoopers. The 150 companies that control 85% of global industrial mine production are looking for smaller exploration companies in which to invest. A resource-hungry China is driving demand for new projects, from Australia to Africa.

“There is infinite insatiable demand for finite resources,” says Chris Berry, founder of commodity research firm House Mountain Partners.

Over the past year, the S&P/TSX Global Mining Index, which comprises 123 companies, has appreciated 16.89%. It represents one of the strongest sector performances compared to the broader S&P 500 index, up only 5.48% in the same period.

“Overall, the performance of the mining industry is heavily tied to global economic cycles,” says Morningstar ETF analyst Abraham Bailin.

The Price is Right

According to the PricewaterhouseCoopers report, despite short-term volatility, particularly after the global financial crisis in 2008, most resources have experienced ten years of appreciation. Long-term prices of zinc, lead and copper, considered key base metals, have more than doubled over the past decade and are nearing record levels set in 2007.

The report compares the price escalation to two previous historical periods – the 40-year industrialization of the US in the late 1800s and the 30-year post-war reconstruction of Europe and industrialization of Japan beginning in the 1940s.

Such mining booms have minted billionaires across the globe. Australia’s richest man, Andrew Forrest, who has an estimated next worth of $4.1 billion, founded Fortescue Metals in 2003 – now Australia’s third biggest iron ore exporter. The company’s stock price is up 22% over the past year on the back of iron ore prices doubling.

Demand from China is heating up the market. Chinese firms are also aggressively making moves in Africa. South Africa’s first black billionaire, Patrice Motsepe, with a net worth of $2.3 billion, built mining conglomerate African Rainbow Minerals with interests in a diverse array of minerals: platinum, nickel, chrome, iron, manganese, coal and gold.

India’s population boom is also driving mining demand. Anil Agarwal made his $6.4 billion fortune from India’s largest non-ferrous metals and mining Vedanta Resources, which is now also expanding into resource-rich Zambia.

What’s Hot: Fertilizers and Rare Earth Metals

Today miners and investors are particularly captivated by two new moneymaking opportunities.

The first is fertilizers, in high demand because they help farmers feed a growing world population. Canada’s Potash Corporation (POT) was the object of mining giant BHP Billiton’s (BHP) $38.6 billion hostile takeover bid in August – the bidding continues with a controversial counter-offer from Chinese state-owned Sinochem. (More than 95% of potash is used as a fertilizer applied to fruit and vegetables, corn and rice)

The second is rare earth elements such as terbium, lanthanum and neodymium and lithium. These are used in everyday electronic devices such as cell phones, as well as green technologies like hybrid vehicles, electric cars and wind turbines – a seemingly insatiable demand with uncertain supply.

Over 97% of the world’s rare earth elements production is controlled by China, which recently blocked shipments of these minerals to Japan, Europe and the United States because of trade disputes. Governments around the globe are trying to promote new discoveries: the US has already committed $1.2 billion to REE exploration; Japan recently started ‘urban mining’, recycling the metals from stockpiles of used electronics. A small mining outfit, Stans Energy, last year won the auction to restart rare earth mineral mining in Kyrgyzstan in a former Soviet-era mine.

Mining ETFs

To circumvent the volatility of owning individual stocks like those listed above, retail investors’ best bet to get in on the mining action is to consider investing in a commodity-based exchange traded funds (ETFs).

“ETFs do allow retail investors convenient miner exposure and can be used to make a bet on the space overall rather than a single mining firm, “says Morningstar’s Bailin. “Miner ETFs will exhibit significantly greater leverage to commodity prices than direct physical ownership or, in many cases, futures based commodity exposure.”

ETFs are also preferable to mining mutual funds because the investment is easily liquidated, adds Gary Gordon, financial advisor with Pacific Park Financial.

SPDR S&P Metals & Mining (XME) is a fund that provides exposure to the broad U.S. mining space including steel producers, coal miners, and zinc and palladium extractors. It aims to mimic the performance of the S&P Metals and Mining Select Industry Index, comprising 25 companies in the material/energy-acquisition business.

Words of Caution

However, one consideration for investors, says Morningstar’s Bailin, is that the largest metal mining firms in the world are located outside the U.S., and will not be included in the SPDRs US-focused offering.

Options for more aggressive investors: Dow Jones Emerging Markets Metals and Mining Titans ETF (EMT), which has about 60% of its exposure to Brazil, China and Russia. iShares MSCI South Africa Index (EZA) provides an opportunity to tap into the country’s rich resource base. Or for those interested in a riskier country bet, iShares MSCI Chile Index Fund (ECH) offers exposure to Chile’s copper mining business. Chile mines about one-third of the world’s copper.

Investors should also note that miners within the materials category account for up to 3.5% of the S&P 500 index based on market cap. In other words, if you own an S&P 500 index fund or ETF, you already have a stake in the sector.

“It’s just important, as with any other investment, to thoroughly understand both the investment vehicle and the space in which it operates,” says Morningstar’s Bailin.

Both Bailan and Gordon agree that 5% of an investor’s total portfolio is the upper limit for investing in a sector as volatile as mining.

Be sure to consult with your financial planner or adviser (if you have one) before making any radical portfolio moves.

Tatiana Serafin, a former staff writer at Forbes, now heads Global Markets and Ideas.