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David ThurtellMetals Research

Binnacle Capital Group+203 742 1455

dthurtell@binncap.com

ETFs: Helping or Hurting? ETFs’ impact on the availability of

long-term capital for mining companies

August 2012

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Overview

Investors have increased their allocations to pure commodity plays over the past decade.

The form of investment has varied: some has been short term (read ‘speculative’) while some has been longer term.

ETFs have enjoyed a significant share of this fund inflow. However, precious metals and energy have dominated these inflows. Base metal ETF holdings tiny.

(Gold) ETF investors appear to be much stronger ‘longs’ than futures investors, and hence seem closer to equity investors on the investor spectrum.

It appears that ETFs have acted to deprive gold miners of a modest amount of investor funds.

Miners have no choice but to take the good (the beneficial impact on commodity prices of investors’ money and a more stable shareholder base) with the bad (a slightly lower availability of long term capital).

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Investors Have Pushed In To The Pure Commodity Space

Investors have entered the pure commodity space in the past decade. Index investment (such as the GSCI and DJUBS Indices) and ETFs have enjoyed the bulk of the allocation. Most of the new investment has been in gold, oil, PGMs and copper. Investors have been attracted by:

Increased accessability (ETFs and Commodity Indices) and potentially higher returns (with interest rates at multi-decade lows);

the ‘China’ factor, portfolio-diversification considerations.

INVESTMENT FUND FLOWS

Source: Bloomberg, CFTC, ETF Securities, Citi Investment Research and Analysis

050

100150200250300350400450500

Dec-9

7De

c-98

Dec-9

9De

c-00

Dec-0

1De

c-02

Dec-0

3De

c-04

Dec-0

5De

c-06

Dec-0

7Ma

r-08

Jun-0

8Se

p-08

Dec-0

8Ma

r-09

Jun-0

9Se

p-09

Dec-0

9Ma

r-10

Jun-1

0Jul

-10

Aug-

10Se

p-10

Oct-1

0No

v-10

Dec-1

0Jan

-11

Feb-1

1Ma

r-11

Apr-1

1Ma

y-Jun

-11

Jul-1

1Au

g-11

Sep-

11

US$b

nInvestment Index Non-commercial Futures Metal ETFs

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Investors Have Helped Raise Metal Prices

The ‘China’ factor, rising costs and rising investor participation have boosted the price-stocks trade off. LME financing (using cheap bank funding) and warehouse plays have also raised prices across the base metal complex.

Miners’ profitability has benefited from higher prices, induced partly by increased investor participation. These higher profits have been used to finance new investment, reducing the call on investors for new funds.

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Gold ETFs Have Helped Push The Gold Price Higher

Along with USD weakness, de-hedging, petro-dollar recycling, emerging market demand and a reversal in central bank behaviour, gold ETFs have made a major contribution to the rise in the gold price that has occurred since 2000.

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ETF Holders Are Much Stronger Longs

(Gold) ETF investors appear to be longer term investors – commodity futures ‘investment’ is much more speculative and hence much less stable.

In this sense, they more closely resemble mining equity investors.

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Have ETFs ‘Stolen’ Equity Investors?

Deflating the market cap of gold miners for the move in the gold price – using the existing price as an imperfect proxy for the long term price – shows that, since 2007, the total market capitalization of gold miners has declined in trend terms.

But the variation in market cap is much larger than can be accounted for by ETFs. So ETFs have deprived miners of long-term capital, but one suspects the direct ETF impact has been small, and indirect benefits have been a significant offset.

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Conclusions

ETFs have enjoyed a significant inflow of money into the pure commodity space, though it has been mainly in energy and precious metals, rather than base metals.

(Gold) ETF investors appear to be much stronger longs than futures investors, and hence seem closer to equity investors.

It appears that ETFs have acted to deprive gold miners of a modest amount of investor funds.

Miners have to take the good (the impact on prices of increased investor funds and a more stable investor base) with the bad (slightly lower availability of long term capital).

Mining companies need to improve their marketing story and not fret too much about ETFs. Miners need to remind investors that ETFs are a very passive investment: they can’t make fresh mineral discoveries nor use their expertise and balance sheet to takeover cheap, good prospects.