They close mines, don't they?

The closure of the Lennard Shelf Pillara zinc and lead mine, owned by two big mining companies, clangs out warning bells for investors across the world.

JOHANNESBURG - 

Beneath the headline-grabbing surges in individual commodities, with crude oil the most persistent variable, there are commodities that continue to deliver rotten individual performances. By the same token, there are individual mines and mining companies that are under delivering beneath now-gloomy sky high promises rattled out over the past few years.

The latest casualty is the Lennard Shelf Pillara mine in Western Australia, a 50-50 joint venture between established miner Teck Cominco and mining major Xstrata. Companies with this kind of track record do not easily give the green light for mines to start up. While the operation is small beer for both owners, the underlying story may well clang alarm bells in investment circles, given the "bullet proof" reputation that increasingly clings to the commodities complex.

The main factor behind the decision to close Lennard Shelf Pillara is probably the near-halving over the past year of USD prices for lead and zinc. Production commenced in early 2007, and to 31 December 2007, the operation produced 42,100 tons of zinc metal and 12,400 tons of lead metal.

The reopening of the Pillara mine and milling operations was announced in April 2006, with a projected mine life at that time of three to four years. The operations are due to cease next month, at a time when lead and zinc prices are back around the level when the mine was given the green light. Ahead of closure, support will be provided for some 300 employees and contractors currently employed at the Pillara mine and mill and Derby port facilities.

While the Lennard Shelf Pillara mine had been designed to operate for a short term life, the full reasons given for its closure may be regarded as benchmark in the heave-and-shove of the current global investment climate. According to the official announcement, "The Pillara mine has become uneconomic, primarily due to the sharp decline in zinc and lead prices compounded by the appreciation in the Australian dollar. Higher energy and labour costs and lower than planned production have also contributed to rendering the project uneconomic".

Another lesson from the short, unhappy life of Lennard Shelf Pillara is that the "bullet proof" nature of the commodities supercycle, as described in some circles, is more appropriate when attached to physical commodities, rather than investments in listed stocks producing physical output. Even then, the label may not be fully appropriate, given the idiosyncrasies pertaining to individual commodities.

Lead, zinc and nickel have been heavily sold down over the past 12 months, on basic fundamental factors, while the same underlying supply-demand dynamics have seen the other three base metals - copper, aluminium and tin - recently trading up to record highs. Small wonder that investors have shown an increasing preference for switching portfolio flows from listed stocks to broad (and also energy) commodity indices and commodity exchange traded funds (ETFs).

BHP Billiton, the world's biggest diversified resources stock, exposed to choice mining output such as iron ore and coal but also oil and gas, is now 24% off its price highs. At the same time, commodity indices such as the Reuters/Jefferies CRB and S&P GSCI GFI-Futures are trading just off record highs.

The preference of investing in the physical commodity rather than producers has been increasingly visible in empirical performance numbers. Over the past 12 months, for instance, a well-timed investment in silver bullion ETFs would have rendered a return of close to 61%, compared to a return of roughly zero for a fully-weighted investment in 50 listed silver miners.

Investments in physical commodities, or their proxies, are not only a hedge against inflation, but also eliminate potential exposure to negative factors that can impact individual resources operations, such as Lennard Shelf Pillara.

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