The ex-head of JP Morgan’s influential resources fund, Ian Henderson, talks to Critical Resource about the current state of resource markets and the importance of political intelligence
We are in for an ‘L-shaped recovery’
“The resource sector is clearly going through a period of much reduced demand, particularly with Chinese growth slowing down. Most base metals have seen reductions in inventories on the London and Shanghai exchanges this year. This would normally be an encouraging sign, but inventories are still more than adequate. While the sort of pain the industry has been going through is clearly unsustainable and there are signs of recovery, the economy will not turn around to become a bull market any time soon. With no real shortage in supply – and in the absence of the motor of Chinese demand – we are in for an ‘L-shaped recovery’.
Individual commodities may do very well. Diamond demand has been strong and zinc looks to be recovering. Demand for potash and phosphate is also likely to increase. But I do not, for example, see the iron ore price shooting up. It is also interesting that instability in the Middle East, as well as Russia’s sabre rattling against Europe, has had a very little impact on the gold price. Ultimately, investors should look at individual projects rather than particular commodities when making investment decisions.
Given the availability of assets at well below replacement value, it is a good time to get involved for those with a long-term outlook. It is likely that we will see a number of substantial deals over the next 18 months or so. For private equity however the problem is that returns are not promising at current commodity prices. As a result, it is unsurprising that there have been few major private equity deals recently. The money is there but the obvious targets are not.”
Political risk often catches investors off-guard
“One of the hardest things to evaluate is political risk – I often got it wrong. Companies may feel they have engaged all relevant stakeholders, only to be caught off-guard and finding themselves lacking relations with precisely those groups pulling the strings. That is why in-country knowledge is crucial. In the past, a lot of value has been wiped out by insufficient understanding of local contexts.”
Personal biases on politics often determine investment decisions
“Investors tend to approach investment decisions through the lens of personal bias. Investors will usually have formulated an opinion by the time a project is put in front of them. An investor may decide that certain countries are simply beyond the pale and refuse to invest. It is quite hard to imagine a company persuading an investor to enter a country, which the investor instinctively has a bias against. Ultimately it is also a question of the size of the prize and risk appetite. Investors running diversified portfolios will be more willing to take risks.”
Bad politics can delay development of good deposits for decades
“Meeting expectations – particularly around job creation – is difficult. In wanting to appeal to the electorate, politicians will often make increasingly punitive demands on companies. At times this reaches the point of being irrational and driving investment away. I used to be of the view that good deposits will ultimately be developed. Today I am more cautious. Some jurisdictions may simply be too hard to operate in. For example, the attitudes of the governments of Ecuador and Indonesia towards the extractives sector appear to be more motivated by political calculation than economic rationale. Other countries like Zambia or Cote d’Ivoire have taken more pragmatic approaches, proving that it is possible for companies and governments to reach mutually acceptable agreements on the distribution of benefits.”
Engage government and communities in tandem
“The importance of government and community relations is highly context specific and will be determined by each country’s particular relationship to the resource industry. The capacity of companies to manage these issues varies greatly.
Community and government engagement needs to occur in tandem. It is crucial to engage local communities from an early stage to build support. Although politicians are stakeholders for the people, there is no substitute for direct engagement, particularly as politicians will often have little understanding of how local people feel towards a project. At the same time, companies need to be careful not to neglect government engagement so as not to jeopardise the granting of permits or the security of a contract.”