Australian mining giant BHP trying to buy London-listed Anglo American (LSE: AAL) suggests that the people at BHP – who know a lot about mining — find BHP’s valuation attractive.
On the other hand, consolidation can sometimes indicate a sector that is going through difficult times and so players look for economies of scale. At the moment, I do not own Anglo American shares. In fact, I have no miners in my SIPP.
But mining is a sizeable business sector and looks set to stay that way. Man has been pulling thing out of the ground for thousands of years and I do not see that changing any time soon.
Demand for minerals looks set to keep growing as the global economy develops. So am I missing a trick by not having any mining shares?
Highly cyclical industry
A quick look at the economics of Anglo American (or indeed, any of its large rivals) quickly reveals some key points about the mining industry.
It has huge costs – buying the rights to mine and setting up operations is costly. Once that is done, if a project does poorly, the miner typically has to bear the losses. But if it does well, the local government may try to squeeze more tax revenue than anticipated out of the profits. Everyone knows you cannot move a mine.
Demand comes and goes, in line with the ups and downs of the global economy. There will always be some need for copper or iron. But how much depends on the state of the wider economy. If carmaking slumps, for example, demand for iron will be hurt.
As miners have those huge fixed costs to cover, they walk a perpetual tightrope of not wanting to slash production volumes while also wanting to maintain pricing.
The result is that mining can be highly lucrative, but also financially volatile.
In the past five years, for example, Anglo American’s annual revenues have ranged between $25bn and $42bn.
Even more dramatically, annual post-tax profits in the period have been anywhere from $1.2bn to $11.7bn.
Investing for the long term
That sort of financial volatility does not necessarily mean that mining is a bad industry to invest in. If I had bought Anglo American shares for my SIPP five years ago, for example, my investment would now be worth 39% more than I paid.
At one point in 2022, that same investment five years ago would already have more than doubled in value, but Anglo American shares have fallen back since then.
On top of that, I would be earning a 3.8% dividend yield on my investment (the share price rise means the yield if I buy the FTSE 100 miner today is 2.7%).
If I wanted to aim for stable income, mining shares would not be on my shopping list. Just like earnings, Anglo American’s ordinary dividend has moved round dramatically. Last year, it more than halved.
But a SIPP by its very nature is a vehicle for long-term investment. The key to success of investing is buying at the right price – and that is certainly true of cyclical industries like mining. For now, I do not think shares like Anglo American look particularly cheap.
The next time metal prices crash, if mining shares follow, I may consider buying some for my SIPP.
