Rio marks the re-emergence of the miners

Two forces have set the scene for a big boost to the bottom line of mining companies but investors need to remain alert.

Rio Tinto chief executive Jean-Sebastien Jacques speaking at the Melbourne Mining Club.

In the next two years we are going to have a mining profits boom of considerable magnitude.

Don’t be surprised to see the profits of some mining companies rise 50 to 100 per cent above their lows. Sometimes the rise will be even more.

I reached that conclusion as I was listening to the address by the chief executive of Rio Tinto Jean-Sébastien Jacques to some 700 mining, accounting, investment, legal and other executives at the Melbourne Mining Club last week.

Jean-Sébastien Jacques did not actually mention profit trends, so, to get the message, you had to listen very closely to what he was saying and combine that with the mood of the people at the function.

I think Rio Tinto understands what is happening in China better than any other large mining company. Its major shareholder is a big China state-owned enterprise and, of course, China is Rio Tinto’s main customer.

Jacques has spent a large part of his first year as CEO in China.

He told the Melbourne Mining Club that, given the politics of the country, it was virtually certain that it would meet its projected growth over the next two years. Assuming that is right, and there is no better source than Jacques, then commodity prices are going to remain strong unless China unleashes a tirade of local coal and iron ore production to flood the market.

But there is a second and perhaps even greater driver of profits.

Australian mining companies have slashed their costs by monumental amounts. That means profits are boosted two ways — better prices and lower costs.

Here Jacques gave a not too subtle warning to those in the audience. He underlined that important to longer term mining profits was not so much the fall in costs but the rise in productivity.

As I moved around the room, I discovered that a number of mining companies had cut costs in an unsustainable way, which means that the profit boosts in the next two years will fall away unless there is a price boom.

For example, in some mining companies, production workers were doing cleaning and other tasks that they will not do when profits rise.

Similarly, at the bottom of the market many suppliers cut their prices to unsustainable levels just to keep things going and hold onto market share.

But they are now bleeding and you could feel the under current in the room. Once it’s clear that profits are going through the roof, those prices will rise.

But where companies have looked hard at changing the way they conduct their mining and/or invested in better equipment, then the cost reductions will be sustained — or in the words of Jacques, productivity has been improved.

And when the big profits start rolling in, working out who has improved their productivity and who has simply reduced costs in an unsustainable way, will be the key to determining share prices.

Meanwhile, the rise in mining share prices is an indication that the market sniffs what is ahead but, to date, few analysts have fundamentally changed their predictions.

My guess is that after Jacques address, they will all be pondering whether to make a move. When one major analyst ups his or her profit forecast, the others will follow.