ECONOMIC OVERVIEW
Tailings Dams, Trade Wars & Trump
March 2019
The recent tailings dam failure at Córrego do Feijão, Vale’s iron ore mine in Brazil has greatly affected both the iron ore commodity and Brazil—however, the consequences haven’t ended there as global commodity markets begin to feel the pressure of increased scrutiny.

Vale’s disaster in January follows 70 major incidents of tailings dam failures since 1970. Recent large-scale disasters include the Brazilian Samarco tailings dam failure in 2015, the Canadian Mount Polley failure in 2014, the Romanian failures of 2000 and the Philippines Marcopper tailings breach of 1996.

Prior to Vale’s incident, one might have argued that if any dam was to fail iron-ore tailings might be the least devastating, given the benign content. Indeed, it was the sight of dead fish floating in the Danube after the Romanian spills that rang the death knell for the use of cyanide in Europe and has all but put a stop to new open pit mines being approved.

However, the apparently benign tailings of Samarco and Minas Gerais cannot offset simple physics. The Samarco failure of 55 million cubic metres of tailings had a much lower death toll (19) than Minas Gerais, but saw the deluge travel some 400 miles to the Atlantic Ocean, destroying villages in its path. As ore grades decline, tailings dams necessarily get larger. It is estimated that the average ore grade in copper mines has decreased by some 25% in the last 10 years.

Some of the copper mine dams in the Peruvian Andes are now as high as the Hoover Dam with permits in place to go higher. However, it is believed that they are 10 times more likely to fail than water retention dams.

There is general agreement that downstream dams are far safer than upstream dams and indeed upstream dams are now prohibited for new mines in Chile, as well as in most developed economies. The addition to capital cost of a downstream vs upstream dam is highly significant, and can result in more than double the capex in many cases. Additional measures, such as the filtration and dry-stacking of tailings add significantly to operating costs. It is not surprising therefore, that a study conducted in 2009   covering 42 years of accident data showed a high correlation between the frequency of tailings spills and falling commodity prices.

What is the medium-term impact for global commodities going forward?

  • Where there isn’t an outright veto on new open-pit mines (as in the Philippines), there will inevitably be a highly restrictive and rigorous permitting regime. This will add significantly to capital and operating expenses, rendering marginal projects uneconomic and even the more robust projects less profitable.
  • Financing for mining companies is also likely to become increasingly difficult. The risk departments of many Banks will be increasingly concerned about the “lender liability” consequences of tailings dam failures.
  • The Institutional equity market will also come under significant pressure from activist investors, concerned that the funds in which they invest have holdings in mining companies, whether directly, or indirectly, through index tracking.
  • Notably, in response to the Vale incident there has been a call for a global independent public classification system that monitors the safety risk of mining company tailings dams. The funds that have jointly proposed the new system include the Church of England funds, Swedish Public Pension funds, Dutch funds APG and Robeco, New Zealand Super, UK’s LGPS Central and Canadian fund BMO Global Asset Management (together representing combined assets of US$1.3 trillion).
  • As demand continues to grow and supply is constrained by economics, permitting and finance—prices will inevitably rise. The rise in prices, however, may not necessarily translate into more profitable mining companies

Global tensions, trade wars and Trump’s unpredictability are all factors that would ordinarily point to higher gold prices—however, gold has failed to make the gains one would have expected as it competes against the US Dollar for safe haven status.

The liquidity in the gold market afforded by the Physical Gold Exchange Traded Funds (“ETFs”) has been a very welcome enhancement to the gold sector and is undoubtedly the principal driver behind an additional US$1,000/oz in value over the last 30 years. With liquidity comes volatility and the key measure to watch is the inflow/outflow of the ETFs. In 2018, European ETFs had net inflows, while a trend of heavy US outflows for most of 2018 was reversed in Q4. This would normally be expected to be the start of a positive trend, although battling against a strong US dollar, significant net outflows were again seen in the first few months of 2019.

The US dollar is maintaining its strength due to a buoyant (if not overvalued) stock market, tax cuts, creeping inflation and the prospect of interest rate rises. Thus, the lid has been kept on the USD denominated gold price. However, a more recent signaling of a neutral stance by the Fed should limit the expectations of interest rate rises going forward and, as such, go some way to offset preference for the USD over gold.

Furthermore, Trump’s economic policy relies upon a lower US dollar redressing a perceived competitive disadvantage. All the historically systemic drivers for Gold are in alignment, these include:

  • Inflated market valuations and higher market volatility.
  • Global political tensions.
  • Political and economic instability in Europe.
  • Protectionism, leading to higher inflation.

The key to unlocking the full impact of these drivers will be a weakening in the strength of the US dollar.