Wall of Worry Becomes Wall of Panic

16 August 2007

Today's stock market sell-off hit the resource and precious metal sectors disproportionately hard, particularly mining and exploration companies.

It is true that miners are facing rapidly escalating costs due to inflating raw material and energy prices - which is of course what they are in the business of producing. Therefore, the market is punishing them for the pressure on their profit margins, rather than rewarding them for the increasing value of the products they produce - which are in fact the very types of materials that are driving up their costs (though labour shortages, increasingly complex regulatory procedures and other factors also impact the cost of the business of mining).

At some point, the paradox has to be played out one way or the other.

Given that long-term supply deficits have accumulated during the two-decade commodities bear market, my long-term prediction remains that miners will be rewarded for producing increasingly valued raw materials, and that improved selling prices will ultimately counterbalance the drag caused by rising costs.

But the market, being a psychological mechanism, always plays both sides of the equation before making up its mind. Further, the current "liquidity crunch" forces leveraged investors to sell their highest quality holdings, as well as provoking mainstream investors to panic and "sell everything."

Right now, the focus in the raw materials production sector is on the drag of high costs, and on possibly slowing global demand, should a recession come about (this is in fact a very likely scenario).

These are valid concerns, but I think that in the long run, the supply deficit for raw materials remains the primary factor that will drive the value of mining company shares - and this means that the long-term direction remains up, rather than down - though on a day like today, with the TSX down 585 points at one juncture, it is very easy to forget that the prospects for miners and explorers remain quite bright.

It is no secret that bull markets climb a wall of worry. On days like today, that wall of worry becomes a wall of panic - but it does not shift the fundamentals, which have taken 2-1/2 decades to accumulate.

Two weeks or even two months of selling does not undo the over-arching fundamental factors that are driving the value of mineral exploration and mining companies inexorably higher.