How will mining cuts hurt our miners?

Billions in exploration budgets are being cut but it might take a toll on future earnings.

Miners right around the world are making cuts to exploration budgets in a bid to save costs heading into a period that is forecasted to hold much lower prices across a number of commodities.

In the past six months, gold stocks have been hit hard by increased global confidence levels, contrary to what is taking place in iron ore and coal stocks. Confidence amongst markets has risen since the US and European crises, meaning both gold and the miners themselves have become less attractive to investors.

According to mining researcher SNL Metals Economics Group, exploration budgets for miners of nonferrous metals — those that don’t relate to steel or iron ore — have fallen by up to 35% this year from 2012. Due to the nature of commodities, the turnaround time for production rates is long and if the market experiences an increased demand for the metals, miners will likely be scrambling to increase production.

Exploration budgets can rebound quickly and SNL said the commodities downturn of 2008 and 2009 caused a cut of 40% in exploration budgets, but was quickly boosted another 40% when prices began to pick up.

The cyclical nature of commodities means that it is likely we will experience a turnaround in prices at some point. The difficultly is predicting when it will occur. However, a miner is only as good as its ability to find new resources and tap into the value of the commodity. As such, bullish investors focusing on the next cycle in commodity prices must be prepared that there may be chance that productivity drops off.

Major Drilling Group International, a Canadian supplier of exploration drills around the world, said its revenue has fallen in the range of 41% to 47% across all regions including Australia, Asia and Africa. In addition, the Australian Bureau of Statistics forecast that exploration for new deposits had declined 25% in the first quarter of this from a year earlier.

BHP (ASX: BHP) also said earlier this year that it is cutting its exploration spending by 39% to $671 million. Likewise, Rio Tinto (ASX: RIO) is responding to investors’ expectations to reduce debt and said it would cut $750 million from its $1.97 billion exploration and project-evaluation budget.

Foolish takeaway

The slowdowns do make miners more efficient and condition them to keep costs low. This is why investors who are able to find the lowest point in commodity prices are usually well rewarded if they buy stocks at the right price. However picking the trough in prices is very difficult and with a market consensus that is forecasting iron ore and precious metal prices to drop significantly, a little patience might save investors money.

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Motley Fool contributor Owen Raszkiewicz does not have a financial interest in any of the mentioned companies.

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