Make money from the metals mining boom in Latin America

Latin America has suffered more from Covid-19 than any other region. The Financial Times points out that Peru and Ecuador have the world’s highest number of excess deaths per capita, while Brazil has the second-largest total of coronavirus deaths. The botched public-health response has also exacerbated the economic impact. According to the International Monetary Fund, a combination of a 9.4% drop in 2020 GDP followed by an estimated weak recovery of 3.7% in 2021 means Latin America will have incurred greater economic damage than any other region in the world.

But there is one bright spot among the carnage: Latin American metals mining looks set to benefit from the pandemic. The economic crisis has pushed investors towards gold, helping the yellow metal reach a new record high. Meanwhile, copper prices have eclipsed pre-pandemic levels, supported by stimulus packages in the EU and China.

I suggested MoneyWeek readers invest in Latin American mining in June 2019, and in October 2019 I looked at Ecuador's mining sector – nearly all the shares I tipped then have risen strongly, with some doubling. The long-term fundamentals I highlighted back then still apply, but the pandemic looks set to give the sector a further fillip, so this is a good time to revisit it.

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Profitability is on the rise

The immediate impact of coronavirus was disastrous for Latin American mines. Despite being categorised as a strategic industry by governments conscious of the need to maintain export earnings as other sources of revenue dried up, many mines, particularly in Peru, were forced to close. When they did reopen, it was with elaborate coronavirus measures – such as keeping workers in a seven-day quarantine before they were allowed to start work – that added to costs.

Analysis of 15 gold majors by S&P Global Market Intelligence found that costs increased by 2.5% in the second quarter of 2020. However, the shutdowns cut supply, which eventually led to higher metals prices that outweighed the extra costs. Other elements of the coronavirus fallout, such as lower oil prices and declining local currencies, have provided a further boost. As a result, profit margins have increased for gold and copper miners across Latin America.

Metals were also given a boost by the unprecedented stimulus unleashed by governments in response to coronavirus. In the first few months following the World Health Organisation’s declaration of a pandemic in March, more than $13trn of stimulus measures were announced around the world. For the first time, emerging markets such as Chile and Colombia engaged in quantitative easing (money printing), while developed countries tried everything from wage compensation to boosting infrastructure programmes.

The first direct impact of this splurge of money printing and borrowing was that gold’s value against paper currencies began to rise. In addition to gold’s typical function as a safe haven during crisis, this was also a case of simple arithmetic. The yellow metal is priced in dollars, so if there is a finite amount of gold and a sudden increase in the amount of dollars then it makes sense for the paper money value of gold to increase. Indeed, analysis from the World Gold Council reveals a massive increase in demand for gold from financial products, such as gold-backed exchange-traded funds (ETFs).

That helped gold climb by 34% from the start of the year to August and reach a record nominal price of $2,061. It has since cooled off to around $1,921. Buying an asset when it’s near a record high is never normally a good idea, yet if you take inflation into account then gold is still well below levels it reached in 1980 and 2011. And with stimulus packages set to be extended in the UK, EU and the US, gold should receive more support in the years to come, especially as all this printed money raises the spectre of a nasty jump in inflation. That’s good news for Latin America, which produces 12% of the world’s gold.

Accelerating the shift towards electric cars

The region is even stronger in copper, where it produces 44% of global output. Indeed, just two countries, Peru and Chile, account for 40% of global copper production, a similar level of market domination that 13-member cartel Opec boasts with oil. Here prices will be supported by the green nature of Covid-19 stimulus packages in the EU and China. Improving infrastructure, including telecoms upgrades through 5G networks, will underpin demand for copper – as will incentives to encourage the spread of electric vehicles (EVs).

Covid-19 is therefore accelerating the shift towards EVs that was going to happen anyway. That’s why US electric carmaker Tesla has been the standout stock this year, overtaking Toyota to become the world’s most valuable car firm despite making a fraction of the cars. Analysts debate whether Tesla’s early lead in EVs will be overhauled when the established car producers switch to electric.

But either scenario will be good for the raw materials that go into EVs. A battery-powered EV uses about 83kg of copper, compared with 23kg in an internal combustion-engine car, with hybrids such as the Prius somewhere in the middle. But it’s not just copper that should benefit. Cobalt, nickel and lithium are also heavily used in different parts of the electric car and battery.

To give us some idea of the impact EVs will have on demand for metal let’s run through the numbers for nickel. Today there are between four to five million EVs on the road. By 2030 that figure is expected to have risen to between 40 and 50 million. At present the world consumes 2.34 million tonnes of nickel per year, with just 5% being used in EVs. By 2030 the growth in EVs will have added one million extra tonnes of annual demand.

Latin American mining’s competitive edge

The coronavirus factors I mentioned above apply to miners around the world – so why am I so bullish on those in Latin America? The first is that Latin America, which accounts for roughly 10% of the world’s GDP and a similar share of the planet’s population, produces a disproportionately large quantity of metals. In addition to its strong position in gold and copper, it currently accounts for 20% of zinc output, 51% of silver and 20% of iron ore. As for lithium, set to be another beneficiary of green stimulus, the lithium triangle of Chile, Argentina and Bolivia holds more than 50% of global reserves. The mismatch between the region’s output and domestic demand makes it a natural exporter.

It is also a low-cost producer. A renewable-energy revolution in Chile means miners in the country can now access cheap, green solar power. Peruvian, Ecuadorian and Brazilian operations can access low-cost hydroelectric power. Being powered by renewable energy is especially important for miners producing metals such as copper, zinc or lithium for EVs. As EVs become more common, their environmental benefits will come under more scrutiny and manufacturers will pay a premium for metals with a low carbon footprint. The same applies with social responsibility. Mining investors sometimes complain that Latin America’s myriad rules and regulations hold up new projects.

But at least that ensures that legal mining complies with global best practices. For example, much of the cobalt that Tesla or Apple currently use in their products is mined in the Democratic Republic of Congo, where child labour is rife. That doesn’t happen in legal Latin American mines, giving cobalt from the region an advantage in the market place.

Latin American taxes are also surprisingly competitive. For example, Chile has a lower fiscal burden for mining companies than Australia, while Peru and Ecuador have cut taxes in recent years. Indeed, Latin American countries have climbed up the rankings of the influential Fraser Institute’s Annual Survey of Mining Companies. Chile and Peru are the top-ranked in Latin America, while Brazil and Ecuador have made the most dramatic improvements in recent years. The region has steadily increased its “investment attractiveness” score in consecutive surveys, which is impressive when you consider that it has basket cases such as Venezuela and Guatemala weighing it down.

Huge potential in mega-deposits...

In mature mining jurisdictions – say, Canada, Australia or even Chile – you tend to have older deposits that have been mined for many years or even decades. Over time the grade of these deposits falls, meaning miners have to dig and process more ore to get the same amount of metal, which leads to rising costs. What’s exciting about Latin America is that it is home to some of the world’s latest discoveries of mega-deposits. These newly-found ore bodies have much higher grades, ensuring low-cost production when the mine comes online.

And more discoveries are on the way. The Andes copper belt has given Chile and Peru the world’s first and second-largest reserves respectively. Yet political and social factors have prevented the exploitation of large stretches of the Andes in Argentina and Ecuador. Now Ecuador has rewritten its mining code and enticed more than a dozen mining majors to set up offices there, while smaller explorers are searching for copper and gold. London-listed copper and gold developer SolGold’s recent Ecuadorian discovery, Alpala, due to begin production in 2025, could become the world’s largest underground silver mine, the third-largest in gold and sixth-largest in copper.

...implies vast scope for growth

And that’s just one discovery. To give some idea of the potential, mining accounts for 15% of GDP in Peru and Chile, but just 1% in Argentina and Ecuador. Given that they all share the same metal-rich Andes (indeed Argentina’s stretch is the largest of the lot), it seems fair to assume that there are plenty more discoveries waiting to be made in Argentina and Ecuador. Even in Peru, which has a well-established mining industry, there are $57bn-worth of stalled mega-projects – defined as deposits awaiting the green light for construction or held up by social protests or bureaucracy.

In recent years Peru has doubled its copper production to 2.5 million tonnes per year, making it the world’s second-largest producer. However, if it were to exploit all of its discovered deposits it would be able to double output again to five million tonnes and keep that rate of production going for 40 years without any new discoveries. That matters because analysts predict a crunch in both copper and gold supply in the next few years – perhaps as early as 2023. According to S&P Global Market Intelligence, 2010 to 2019 was the worst decade for copper discoveries since 1990, contributing only 16 major discoveries to a total of 224 over the last 30 years. The commodity-price crunch at the start of the decade forced majors to impose financial discipline and stay away from risky greenfield projects. As a result, “the sector faces a drop-off in mine supply in a decade or so, with few major copper developments entering the project pipeline”. Something similar happened in gold, where majors’ gold reserves fell by 26% between 2012 and 2017. Given that it takes between 15 to 20 years to take a gold or copper deposit from discovery to production, mining companies will focus on jurisdictions such as Ecuador and Peru, which already have plentiful resources waiting to be developed.

The prevalence of abundant deposits, high ore grades and low energy costs mean that Latin America will make the most of the coming metals boom. EVs may take decades to become a significant demand driver for metals such as cobalt, zinc, nickel, lithium or copper, while the inflation likely to boost gold could take time to materialise. And in the intervening years the prices of these metals is sure to fall as well as rise. But Latin America’s competitive advantages means that its miners will be best able to ride out the lows and benefit from the highs. We look at some of region’s best miners below.

What to buy now

All of the companies I tipped in my Ecuadorian mining story in October 2019 have risen by between 50% and 100%. I will now focus on just two. The first is Canada-listed Lundin Gold (Toronto: LUG), which since I wrote my piece has put its flagship Ecuadorian gold deposit into production – the country’s first large-scale gold mine. Now that Lundin has an operating mine it is a less risky prospect. One remaining risk is community protests, but here the firm has gone out of its way to keep neighbours onside. It even shut down its mine during the crisis – despite the government imploring it to remain open – out of respect for local concerns that its trucks would bring the virus to their remote communities.

Up by 84% since I tipped it, Lundin has more to offer as there is plenty of exploration potential around its gigantic Fruta del Norte deposit. And as Ecuador establishes itself as a mining jurisdiction, the shares will be perceived as less risky.

SolGold (LSE: SOLG) is the only UK-listed Ecuadorian pure play. The firm’s main target is 85%-owned Alpala, which will become the country’s largest mine when it begins production in 2025. Despite its name, SolGold is more of a play on copper than gold. Not possessing an operating mine makes SolGold riskier than Lundin, but it also has more upside. It is the largest exploration concession-holder in Ecuador. The share price has increased by 60% since the end of September on the back of recent discoveries at other targets. The big risk is getting the financing together to build its multi-billion dollar mine. But given the shortage of quality gold and copper projects it seems likely that majors or the market will support it. Indeed, Australian majors BHP and Newcrest have already bought big stakes in the firm. Even though it has doubled since I tipped it in October 2019, at the current price of 42p you will still be getting a discount on the 45p per share that BHP paid in 2018. Elsewhere in Latin America I would advise taking stakes in a handful of miners to diversify your risk. On the safe end of the spectrum is Fresnillo (LSE: FRES), the world’s largest silver producer and Mexico’s second-largest gold producer. It is up by 51% since I tipped it on 27 June last year. It’s a well-run major with lower debt and production costs than its peers and remains a solid way to play Latin American precious metals.

A new tip is Yamana Gold (LSE: AUY), which has mines in Chile, Brazil, Argentina and Canada. It has just floated in London. CEO Peter Marrone founded Yamana in 2003 and sees it as his baby. As a major shareholder he has “skin in the game” and has done an incredible job of building up an Americas-focused gold major.

At the other end of the precious-metal scale is tiny penny stock Rio 2 (Calgary: RIO), which is developing a gold mine in Chile. Its CEO and major shareholder is Alex Black, a man well respected in Latin American mining for turning one of his previous tiny explorers into a billion-dollar goldminer. The stock has jumped by 107% since I tipped it. But if Black repeats his successes it will go much higher. A similar small base-metals play is Brazilian nickel and cobalt developer Horizonte Minerals (LSE: HZM).

Antofagasta (LSE: ANTO), the copper giant, is up by just 9% since I tipped it. Yet the long-term rationale for owning this low-cost copper producer remains. Half of its output comes from its Los Pelambres mine, which is in the bottom quartile of production costs of copper mines globally. Peruvian miner Buenaventura (NYSE: BVN) was my only disappointing pick, down 24%. Being based in the world’s most severe coronavirus hotspot wasn’t good for a firm with nine mines dotted around the country. Now is a great buying opportunity.