Understanding the Commodity Cycle Using M and A Activity

In investing, a prevalent belief suggests that a surge in M&A (mergers and acquisitions) activity can signal an impending market peak. This notion stems from the psychological phenomenon known as FOMO, or the "fear of missing out," which affects not only individual investors but also high-ranking corporate executives. This condition is particularly notable in the mining industry, where the rush to secure lucrative deals can be a barometer for market sentiment. Essentially, the volume and value of M&A deals can reflect the broader commodity cycle, highlighting periods of market optimism or caution.

Historically, a single high-profile acquisition should not be viewed as an immediate cause for alarm. For instance, BHP’s recent bid for Anglo American is reminiscent of its 2005 acquisition of Western Mining Corporation (WMC). At that time, BHP paid a substantial A$9.5 billion, now worth approximately A$15.4 billion, for WMC and its assets. Despite the considerable expense, this move did not signal a market peak; rather, it was the precursor to a significant rally in commodity prices that extended for another six years. This example underscores that while individual deals are noteworthy, the broader trend in M&A activity provides a more accurate gauge of market conditions.

The number and value of M&A deals can offer critical insights into the commodity market's cycle. For example, the 2007 peak in M&A activity accurately predicted a top in commodity markets before the 2008 financial crisis, leading to a sharp decline in prices and a cooling off in M&A deals. Similarly, the period from 2010 to 2012 saw a frenzy of acquisitions, culminating in historically high commodity prices. This era, marked by intense competition and lofty valuations, eventually resulted in significant financial setbacks for companies like Barrick, which had to write down $4.2 billion following an ill-timed acquisition of Equinox Minerals' copper assets.

The lessons from past cycles are clear: elevated M&A activity often precedes market corrections. However, despite high commodity prices, does not mirror the euphoric peaks of previous cycles. Junior mining stocks, for example, are still trading at multi-year lows, indicating a lack of speculative fervor. Therefore, BHP's recent move on Anglo American likely represents a strategic acquisition rather than an indicator of an overheated market. Investors should view the current environment as an opportunity to identify value, recognizing that while M&A activity can signal market extremes, it is the broader context that ultimately determines the trajectory of the commodity cycle.