Will exploration businesses diversify to hedge their bets in volatile metal market

David Hough, associate director at RSM

Metal prices had been recovering slightly to March 2017 and, though a far cry from the boom of 2011 and 2012, helped create a sense of renewed optimism amongst investors, and CEOs, in the extractive industry that the worst is behind them.

The Commodities Metal Price Index had been at its highest point since late 2014 and had been trending steadily upwards for north of twelve months. Appetite amongst extractive businesses to explore new deposits had risen and then prices took a nosedive, but why?

China remains the key force when it comes to metal prices and commitment in key infrastructure and development is a catalyst for upward movement. On this occasion, concerns that the Chinese industrial demand that rose during 2016 may have spiked had seen the price of iron ore plummet once again by 33 per cent since March to June 2017. However, the Chinese influence on the market has led to a recent price uplift as concerns over pollution have led producers to source their iron ore from overseas. In such a volatile market, this may go back down.

AIM market investors know all too well the importance of effective portfolio diversification but what of the exploration businesses themselves – African Minerals and London Mining were high profile casualties, among others, of the collapse in iron ore prices. However, can effective commodity diversification be achieved by Board’s themselves to reduce shareholder risk at the investment rather than portfolio level.

The recent past has seen a number of AIM companies expand their license portfolios increasing the potential to capitalise on significant upside price movement when, and if, they occur. However, retaining the benefits of effective diversification becomes a challenge when market shifts require management teams to direct sometimes limited financial resource into a single booming commodity. Directors face a Catch 22 situation. Do they risk investor return in the short term by deflecting capital investment into other projects but in doing so reducing commodity price risk; or do they capitalise quickly on short term gains retaining dependence on a single resource.

With optimism slightly skewed by wider economic uncertainty, and a marketplace still bearing some of the scars of lost capital, we may see a gradual shift towards diversification which may suit the investor looking to hedge their bets.

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