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A turning point for South African mining?

With both labour relations and the rand appearing to settle, we ask whether investors should once again look at South Africa's mining industry
November 4, 2016

The slow re-setting of commodity prices since Chinese demand peaked at the start of the decade has been painful for most economies that rely on metal exports. But even against that backdrop, the South African mining industry has had a torrid few years. The darkest pall may have been cast by the 2012 killings at Lonmin 's (LON) Marikana mine, but the sector can count a litany of issues - from job losses, economic strife and power shortages to regulatory uncertainty and political interference - that have discouraged investment, precipitated corporate collapse and prompted asset sales.

But now, as the country inches torwards a new mining charter, and following this week's news of wage settlement at the largest platinum mines, we ask whether investors can expect anything approaching stability from the most volatile of industries in an, at times, unpredictable nation.

 

 

South Africa's mining industry currently accounts for around 7 per cent of the country's gross domestic product. Not only did this figure used to be much higher, but because much of the industry's output is exported, the long fall in demand in recent years has resulted in a disproportionate effect on the country's economy. Worse still, collapsing demand has often correlated with the rand. For example, the decision by the People's Bank of China in June 2015 to devalue the yuan by 2 per cent - which international markets took as a sign that Chinese growth and resource consumption were both slowing - led to a 26 per cent drop in the value of the rand against the dollar in just six months. And the fall only accelerated last December when South Africa's president, Jacob Zuma, fired his finance minister Nhlanhla Nene, in a decision that shocked markets and rocked confidence in the government's management of the economy.

 

Currency falls and wage inflation

The rand's devaluation - which in recent months has softened - has had a mixed impact on miners' costs. Pan African Resources (PAF), which operates in the historic gold mining region of Mpumalanga, has certainly benefited. Financial results for the year to June show that all-in sustaining costs - the most comprehensive measure of a miner's outgoings - were essentially flat in rand terms at ZAR405,847 per kilogramme. However, those costs were a fifth lower when priced in dollars, which for a gold producer is probably a fairer yardstick. That's all the more impressive given that rand-denominated labour and energy costs edged up 12.5 per cent and 16.8 per cent during the year, neither of which was solely down to increased production.

Others less buffeted by 2016's ballooning gold price have found the rand's depreciation a more complicated factor. Desperate to avoid a repeat of a 2014 strike that crippled production, yet hamstrung by domestic inflation, the country's three dominant platinum miners - Lonmin, Impala Platinum (SA:IMP) and the Anglo American (AAL)-owned Amplats (SA:AMS) - have been under considerable pressure to settle a wage negotiation with the Association of Mineworkers and Construction Union (AMCU) this year. That's despite next to no support from platinum prices, which remain subdued thanks to surplus production and tepid demand for catalytic converters.

This week, the AMCU and Lonmin reached a three-year wage settlement at an average annual salary increase of 7.6 per cent. Impala and Amplats are both in the process of striking similar deals. But while the rhetoric from both sides of the negotiating table suggests peace has broken out, the possibility of a downgrade to South Africa's credit rating remains. Were that to occur, the inflationary challenges would be likely to test any agreement in its current form, and could yet haunt a key chuck of the country's mining industry.

To add to the concern, few platinum watchers are predicting a strong rebound in prices in the next three years.

 

Legal shifts and human rights

Despite this, platinum group metals remain a central component of Anglo American's rationalised strategy which, alongside the cash-generating power of diamond miner De Beers, represents something of a retrenchment to the Johannesburg-headquartered group's roots. However, the company's commitment to platinum may soon face a significant test, in the shape of a long-overdue revision to the mining charter. At present, any mining operation must be at least 26 per cent owned by a black economic empowerment partner, as part of legislation to address historic disadvantages faced by black South Africans. That 12-year-old law and its implementation have faced criticism, particularly over the interpretation of mining company equity, and whether an operation can divest its empowerment stake.

In the case of Amplats, empowerment deals involving some of its older divisions were based on units of production rather than equity, which some analysts think may be challenged under a new charter. And following Amplats' sale of its Rustenburg mines - which completed this week - there could be complications if courts rule that mining companies must be empowered in perpetuity. While these questions appear to be a matter of legal debate, South Africa's department of mineral resources will be aware of the trade-offs in asking any company to relinquish equity, given the need for desperately-sought investment.

 

 

The government is also facing repeated calls to address the environmental and social impact of parts of the industry. A recent report by Harvard Law School found that toxic waste dumps from mines around Johannesburg - a region dominated by gold production - has led to a human rights crisis for locals suffering the effects of contaminated water. Investors should always consider the ethical trade-offs involved in mining, which in South Africa have sometimes proved enormous.

 

 

Favourites

The pains of South Africa's platinum industry are well-known, but for one recent debutante to London's market weak prices have been made much more comfortable thanks to low costs and chrome by-products. Tharisa (THS), which completed its secondary listing in June and is on track to issue a maiden dividend in 2017, is currently benefiting from a surge in chrome prices. That jump represents a clear vindication of the group's decision to more than double speciality chrome concentrate production during the 12 months to September 2016. Throw in excellent recent platinum group metals recovery rates in excess of 80 per cent, and the rally in Tharisa's share price since the company made its shares available to UK investors looks set to continue.

 

Outsiders

Less than a year after a heavily dilutive rights issue, platinum miner Lonmin remains in a pickle. Despite boasting some of the highest recovery rates in the industry, the company has laid off swathes of its workforce in efforts to bring down unit costs, which in the three months to June stood at ZAR10,596 an ounce, just 11 per cent below the average selling price. Unsurprisingly, such a tightrope walk is eating into the funds raised in the re-capitalisation; indeed cash had fallen to $91m by the middle of 2016. Consequently, Lonmin is somewhat reliant on - and operationally leveraged to – a recovery in platinum prices, which few in the industry are expecting any time soon.