Currency fluctuations present risks for recovering mining sector

After several years of reductions in investment, the global mining industry seems to have turned a corner. Many analysts are now suggesting that the outlook for the industry looks positive for the year ahead. Standard & Poor Global Ratings suggest the projected rise in house, roads and railways building will bring an increased demand for metals. Meanwhile Credit Suisse has pointed to China’s house-building boom continues, which has continued for longer than many in the market expected, to further drive demand for raw commodities.

While this is promising, there are also a number of factors which could harm many within the industry in the year ahead. This includes the on-going rise in resource nationalism, where some nations, especially emerging markets, are demanding a greater share of the profits that come from mining their resources. There are also ever-present geopolitical complexities in developing resource rich nations like Venezuela, Vietnam and Indonesia as well as relatively established countries like Brazil and even the US.

Another threat, and one on which that we advise a number of mining clients, is the potential for currency fluctuations to impact profitability.

Here in the UK, the Pound has failed to make a significant recovery since falling by 20 per cent after the Brexit referendum result in June 2016. Last summer’s snap general election didn’t help matters as the value of Sterling dropped by two per cent against the US dollar after the result was confirmed. It also continued its slump against the Euro, falling to an eight year low in August before making a modest recovery to €1.13 at the time of writing this article.  

With London currently positioned as the heart of the global metals trade, any further fluctuations in the Pound could be a major concern. While there has been recent progress on Brexit negotiations, the UK Government is still a long ways away from a final deal. Any major disagreements in the next round of talks with the EU could therefore have a detrimental impact on the Pound over the course of 2018. Given that £7.8 trillion of notional trades in metals such as copper, aluminium and zinc passed through the London Metals Exchange last year, a significant fluctuation in Sterling – upwards, as well as downwards - could present a significant financial set-back to many companies.

In the global mining industry, companies should consider the potential for dramatic movements in any form of currency where they conduct their operations. Those which transact in Euros might expect to see stability in the value of that currency as the EU appears to be slowly getting its credit crisis under control and European Central Bank has slowed down the pace of bond buying. There are, however, a number of additional factors which could see a reversal of this expectation, including uncertainty over Angela Merkel’s leadership in Germany as she struggles to form a coalition government and the impact this could have on her intentions to reform the Euro.

Meanwhile in the US, there are also a number of sensitive issues which could have a significant impact on the Dollar going forward this year. President Trump’s tax cuts package has the potential to fuel inflation while the current escalation of the war of words with North Korea’s leadership could also threaten currency stability. Progress in the investigation over the Trump campaign and its ties to Russia is, however, likely to present the biggest risk in the short term. If evidence emerges that directly implicates the President in this saga, it would very likely have a negative impact on the value of the Dollar.

The potential for fluctuations in currency values is, of course, not always detrimental to a mining business. It can present a threat as well as an opportunity, depending where it conducts its operations and how well-prepared it is to capitalise on a rise or drop in currency value.

In this climate of uncertainty, it is vital that companies implement a robust and comprehensive risk-management strategy to minimise their exposure to foreign currency movements which often result from political uncertainty. The starting point for this is to clearly understand the company’s level of exposure in terms of currency movement. From there an appropriate budget rate can be set and a suitable hedging plan put in place. Using a combination of forward contracts, spot deals and orders according to such a strategy can provide certainty and protection, shielding their bottom line and maximising the funds they receive. 

The optimistic outlook for the mining industry after so many years of stagnation is welcomed. It is now important for companies to ensure they insulate themselves from other factors, including the potential for currency movements, to ensure a positive year is not tarnished.

Daniel Stanley is an Option Trader at London-based foreign exchange specialists Global Reach Partners