Constructive On Mining Sector, Despite Major Challenges
BMI View: Recently released data on foreign direct investment (FDI) into Mexico's mining industry confirm our constructive view towards the industry, reaffirming our belief that the country will be a relative outperformer within the Americas mining sector. We expect positive macroeconomic trends, domestic advantages, and large mineral reserves to lead to continued investment into Mexican mining over the coming years.
We see recently released foreign direct investment data into Mexico's mining sector as indicative of the country's appeal as a mining destination and expect inflows to increase over a multi-year time horizon. Data released on February 25 from the country's economic ministry showed FDI hitting a five-year high in 2013, totalling nearly US$2.8bn. Given the country's significant, though underexplored, mineral resources, particularly of copper, gold, and silver, as well as its open investment climate, FDI into the sector will rise in the years ahead. Canada, which is home to many of the world's junior mining and exploration firms, is likely to remain the largest contributor to investment inflows.
We further note several domestic factors that will work in Mexico's favour. First, we maintain a positive outlook on Mexico's economy in the coming years. We currently forecast real GDP growth of 3.3% and 3.7% in 2014 and 2015, respectively, as the manufacturing and construction sectors regain momentum. This should support domestic demand for refined base metals, including copper, lead, and zinc. Second, Mexico has several advantages that keep costs relatively low for mining firms. These include low-wage, skilled labour, relatively good infrastructure, and lack of widespread social opposition to mining investment that continues to affect the regulatory environment in Chile and Peru. That said, ongoing security concerns will likely raise related costs for smaller miners operating in remote locations.
|Long-Term Gains Likely|
|Mexico - Mining Sector FDI, US$mn (LHS) & Percent Change Y-o-Y (RHS)|
Price And Tax Headwinds Ahead
Despite our overall positive view towards the Mexican mining sector and expectations that FDI will see more growth in the long term, we believe moderating metal prices and recently imposed royalty rates present shorter-term downside risks to both FDI and mined output. We expect the former to be of greater salience as lower metal prices are likely to have a greater impact on the economics of the mining sector. We currently forecast copper prices will average US$6,800/tonne and for gold to average US$1,150/oz in 2014, declines from 2013. Lower prices may lead more firms to revise downward their reserve estimates as higher quantities of ore become uneconomical to extract, a trend we have seen in recent months. Rather than hitting the industry across the board in equal measure, we believe royalty rates are likely to have a greater impact on smaller producers with thinner operating and profit margins.
|Rates Elevated, But Not Necessarily Game-Changing|
|Latin America - Current Royalty Rates (%)|
As Mexico did not previously have a royalty regime, and given that the country's rates, while relatively high, are not significantly out of line with others in the region, we believe such royalties are likely to lead to delays or suspensions on projects primarily affected by lower metal prices and rising operational costs. Thus, royalties will likely increase the hurdle rate for mine projects, but not be the primary driver behind investment decisions. We note that while firms such as Goldcorp and Grupo México threatened in late-2013 to rethink long-term investment plans in the country, no such announcements have been made. Pan American Silver, for example, took a deferred charge in 2013 in anticipation of the new royalties, though is still investing in new mine capacity in the country.
|Industry Set To Grow|
|Mexico - Mining Industry Value & Growth|