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Global shortage of metals looming

Section: Daily Dispatches

By Peter Hodson
National Post / Financial Post, Toronto
Monday, February 25, 2008

Our peak oil thesis gained some new respect last week as oil prices hit yet another record, the first close over US$100 per barrel. Demand fluctuates, but it is all about supply, and supply concerns this week showed how tight the market really is.

Peak oil has lots of press, but what about peak copper? Peak zinc? Peak gold? Sounds preposterous, but maybe it's not so far-fetched. Nearly every commodity is experiencing some supply issues, for a host of reasons. Add it all up, and it means potential supply shortages in the future. Demand may slacken this year, but in the next 10 years today's high commodity prices may actually look like a bargain.

Let's take a look at some of the issues facing commodity projects today, and give some examples of companies that have already been impacted by them.

Cost overruns: Inflation, equipment shortages, and labour issues have combined to wreak havoc on so many new commodity projects that long-term supply issues may result.

Simply put, because of inflation, a commodity project that appeared economical two years ago may no longer be viable. Case in point: Novagold's (NG/TSX) Galore Creek project in British Columbia.

Costs estimated at $2.5-billion a year or so ago escalated to more than $4-billion. The cost overruns have put the project on hold despite high copper and gold prices. That means an expected 432 million pounds of copper production a year is not going to hit the market anytime soon.

Newmont this month said its Boddington gold mine in Australia was experiencing 77% cost overruns.

Petaquilla's copper project in Panama is in a similar situation, with costs soaring to $3.5-billion.

Political issues: Too many examples to list here, but ask any mining company based in Ecuador, Venezuela, Mongolia or the Democratic Republic of Congo how easy it is to get a project started. It's practically impossible. For commodity supplies, that's too bad, because some of the best remaining projects in the world are in some of the most politically unfriendly jurisdictions. Once again, future world supply will not be helped.

Power shortages: If you were the president of a country, and your people had no electricity, what would be the first thing you would do? How about shutting down a gold mine? Gold is not actually used for anything, yet gold mines suck out massive amounts of power. Would you rather provide energy for your constituents or produce a bar of gold?

The answer is obvious, and so we see countries such as South Africa institute rolling blackouts for mines -- resulting in record high platinum and gold prices. We expect ongoing power issues to becoming even more prevalent in the future, with serious implications to future supplies of many commodities.

Financing: We all know credit is much harder to come by these days. For large-scale projects, it's even harder for banks to part with cash. Look at Skye Resources. It has an attractive nickel project in Guatemala, but in early February the company said credit market turmoil has delayed its financing plans for the project. This is a theme being reflected worldwide, and it means that many of the best commodity projects in the world will be delayed, resulting in more supply issues years from now.

Environmental issues: Rightly so, countries are getting more stringent about the projects they approve, with a view to protecting the environment. Environmental permits are not quite as easy to obtain any more, and governments have shifted their priorities away from the jobs projects create to a focus on environmental factors.

Australia recently rejected Rio Tinto's proposed iron mine because the environmental protection agency there determined five species of troglobitic animals would be killed by the project. For those who skipped biology, a troglobitic animal is one that lives in total darkness.

Mother Nature: Coal prices and agricultural product prices have soared this year. One reason? The weather. The worst snow storms in China in decades have impacted rail lines and production. The result: China had to import huge amounts of commodities that it used to export.

The rest of the world has to pay the price. Just ask Cameco Corp. how nature can impact production, with its Cigar Lake mine beset by flooding problems. Weather issues world wide only highlight how tight supply is in numerous commodities.

All being said, it seems like there is a potential perfect storm brewing on the commodity front over the next five to 10 years. If the world keeps up its insatiable demand for commodities, watch out -- there won't be much left of anything.


Peter Hodson is a senior portfolio manager at Sprott Asset Management in Toronto.

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