During the famous War of the Pacific in 1879, Peru and Chile exchanged cannon fire both on land and sea. Among other issues, the war involved control over nitrates, guano and other minerals. Now Chile and Peru are once again confronting each other, this time behind closed doors, to maintain regional leadership in the mining sector and come away unscathed by the financial crisis.
When the global economic crisis erupted in September, it put an end to the bullish cycle in the metals sector. The mining sector reacted with caution in Peru, which is the world’s largest producer of silver, the third-largest for copper and zinc, and the fifth-largest for gold. The impact was also felt in Chile, the world’s largest producer of copper.
Copper has lost more than 50% of its value, if you compare its current price of $1.81 per pound with its price of $4.07 on July 3, its all-time peak. Likewise, zinc was selling at $1.08 per pound at the beginning of 2008, but it now sells at about $0.50 a pound.
“Prices of metal commodities tend to move along with economic cycles,” notes John Tilton, a professor in the mining department of the Catholic University of Chile. “When the global economy expands, it increases demand for metals as well as their prices. And if the economy is undergoing a recession, prices drop.” He adds, “Since Peru is an important producer of gold, silver, copper and zinc, it is very likely that it will be less affected by the global economic slowdown than Chile, which produces mainly copper and, to a lesser extent, molybdenum.”
Analysts’ forecasts agree that the Peruvian mining sector could withstand the volatility of international markets better than Chile’s. Another factor is that Peruvian mines exploit various kinds of minerals in the same mining deposit. That doesn’t happen in Chile.
The Sheen of Gold
Jorge Oyarzún, a member of the mining engineering department at the University of la Serena in Chile, agrees with Tilton. “Without doubt, Peru’s greater variety of metallic resources gives it an advantage, especially the fact that the country [Peru] has huge deposits of gold,” he says. Peru has 40% of the world’s deposits of gold. The country’s Yanacocha mine is the largest mine in Latin America, followed by Alto Chicama and Pierina, both of which are also in Peru.
For his part, Juan Carlos Guajardo, director of CESCO, Chile’s center for research on copper and mining, agrees. “Having mining deposits with more than one kind of metal product effectively helps Peruvian operators take better control over their production costs.” (CESCO is the organization that draws up public policies for developing the Chilean mining sector.)
However, Aldo Casali, professor of mining engineering at the University of Chile, rejects that argument. “In addition to copper and molybdenum, Chile also produces other minerals such as gold, silver, zinc, manganese, iron, and lead,” he notes. According to a report by Chile’s National Institute of Statistics, those metals contribute a relatively small share compared with copper, which provides 85% of the country’s total mineral production. Chile has 40% of the world’s copper reserves.
Another factor favoring the Peruvian industry is the potential for gold prices to rise, says Raúl Castro, professor of engineering at the University of Chile. “When faced with events of great uncertainty, investors tend to buy gold to protect themselves from damage in the international economy. This could lead to an increase in the price of the ‘yellow metal’ and for gold-mining companies, which would help Peru soften the impact of the financial crisis more effectively.”
Tilton adds, “Gold and silver, to a lesser extent, are the big exceptions whenever key mineral resources are battered by negative economic cycles.”
Although the price of gold fell on the London Metal Exchange after the crisis broke out, Barclays Capital noted in a recent report that “investors view gold as a refuge because it is a hard and secure asset, which reduces risk in times of crisis.” Analysts at that bank believe that the price of gold could jump from its current level of $727 an ounce to more than $1,000 in coming months.
In contrast, notes Castro, “The price of copper has experienced an abrupt drop, which has made Chilean mine operators very nervous.”
Analysts say that Chilean industry has come to terms with the end of the cycle of sky-high copper prices. There is uncertainty now about the future of the ‘red metal’ because of declining demand in China, the key destination for Chile’s copper exports.
Other Variables Affecting Competitiveness
Nevertheless, it’s a very complex task to compare Peru’s mining sector with Chile’s, the professors warn. There are other factors that also determine competitiveness, such as transportation costs, energy, labor costs, country risk, the level of financing, and the level of investment.
According to Castro, labor costs in Peru are cheaper than in Chile. Guajardo agrees, adding that in terms of energy resources, Peru’s mining sector is more competitive. “When it comes to transportation, infrastructure and logistics, Chile has additional advantages,” he says.
As for financing, Castro emphasizes, “The Chilean government owns Codelco, the largest state-owned copper producer in the world, which generates surpluses for the country. The cash Codelco brings in plays a critical role in the national economy, providing a firm cushion during times of financial crisis.”
Recently, President Michelle Bachelet asserted that Chile’s central bank has reserves of $22 billion to ride out the crisis, thanks mostly to the contribution of Codelco, which pays mining royalties, as well as taxes that the state collects from mining firms on their output.
Peru’s Higher Country Risk
Nevertheless, notes Oyarzún, “One of the strengths of the Peruvians is that they are excellent miners, in terms of both exploration and development of minerals. Their industry is used to working under very difficult conditions, such as those that were imposed by the Shining Path during its apogee.”
The Communist Party of Peru, known as the Shining Path, was a terrorist organization that between 1980 and 1990 unleashed an armed conflict against the government and all of Peruvian society. The Shining Path operated in several regions that have mining potential, blocking access to those regions as well as to other territories through a series of crimes until its leader, Abimael Guzman, was ultimately arrested and convicted.
According to Casali, Peru’s characteristic instability weakens its mining sector. “One of the main weaknesses of Peru is that it still runs a higher risk because of political realities and the potential for social conflict to break out.”
Guajardo says that local Peruvian communities play a much larger role in mining projects than in Chile, attracting the attention of regional political authorities and paralyzing investment in those mines. “This leads to additional tension in local mining activities. One emblematic example is the Rio Blanco project – an important copper deposit located deep in the rain forest of northern Peru – which could not be carried out because of opposition from the local population.”
Another reason the sector has proven to be valuable for Peru, notes Casali, is that the country’s macroeconomic policy has focused on pursuing the correct course in recent times. Guajardo agrees, saying, “The great volume of foreign investment that Peru has accumulated is something that has attracted a lot of attention.”
The Domino Effect
The mining sectors of Peru and Chile aren’t the only sectors that are bravely competing to stay on their feet during the global slowdown. The overall decline in demand for primary metals has had a domino effect on other competitive countries in the region, such as Brazil.
Brazil’s iron deposits are the best in the world, especially in the district of Carajás, in the south of Pará State, notes Christian Moscoso of the mining engineering department of the University of Chile. “As an important exporter of iron to China, Brazil should move away from Asian markets and try to do exploration and development projects in Western Africa. The goal would be to achieve greater proximity to the European market as well as to counter the geographical advantage of Australia, its main competitor in global markets.”
Nevertheless, Casali takes issue with Moscoso’s proposed strategy. “Without doubt, Brazil’s iron industry is going to face major problems in the short run. However, China still has some basic infrastructural needs that have yet to be addressed. So demand for iron used in civil construction and public works, as well as demand for copper, is going to recover and lead to higher prices for metal prices. Copper is a basic input in Asian automobile production, as well as in ‘white goods’ [appliances], computers, and electronics.”
In contrast, Tilton emphasizes the opportunities presented by the current state of the global economy. “For the moment, the crisis will help Brazil and other regional producers of metals to alleviate various bottlenecks, such as the shortage of adequate infrastructure and equipment, and the scarcity of engineers in their mines. These problems have impeded new investment in the mining industry of the region.”