Much of Canada’s mining industry faces a short-term donnybrook but bright prospects in the long-term. However, the industry’s short-term difficulties may have consequences for the economy as a whole when economic recovery begins.

The world may shift from a credit crunch to a commodity crunch.

The most endangered mining companies are in exploration. These are the often small companies that find the resources and then typically hand them off to larger production companies for development. Canadian exploration companies dominate the sector worldwide.

The Fraser Institute’s Annual Survey of Mining Companies, released on February 26, was sent to approximately 3,000 exploration, development, and other mining-related companies around the world; 658 companies responded, representing US$14.4 in mining investment worldwide.

The survey asks miners about key policy issues for 71 jurisdictions on every continent except Antarctica. This year, it contained new questions about the impact of the current credit crunch and economic crisis on the mining sector.

The results were stunning. Four out of five miners believe at least 30 per cent of exploration companies will be forced to close due to the crisis. Two out of five say 50 per cent or more will close.

The damage is reflected in other responses. More than 90 per cent of respondents believe that the exploration and development activities of exploration companies will be curtailed, with 57 per cent saying that activity will decline “a great deal.” Nearly 85 per cent of respondents believe that the activities of production companies will be curtailed, though only 31 per cent believe that the activity of production companies will decline “a great deal”.

Looking down the road, miners believe the outlook is much brighter; 70 percent say commodity prices will climb upward over the long-term. This is actually a break from history. For the past 100 years, commodity prices have declined by about half in real terms. This is due to a number of factors such as new finds, recycling, increased efficiency (in extraction, processing, product manufacturing, and the use of materials in the final product), and the shift to a service economy.

Globalization and the move to market oriented economies around the world powered the increases in commodity prices prior to the recent downturn. Despite the fact-free anti-globalization movement, all the research shows that the move to market economies and freer trade resulted in dramatic prosperity growth and poverty reduction in reforming nations, including very large nations like China, India, and Brazil. That hugely boosted demand for raw materials, pushing up commodity prices.

Here’s the catch for the recovery. As economies begin to move out of the current recession, weakened exploration and development will limit the new supply of minerals. Normally, it takes sometime into a recovery for commodity prices to increase into as existing spare capacity is available, but the pattern might be different this time.

The central question is: How long will it take for the current spare capacity to be used up before the lack of new supply begins to bite. The huge new demands generated by countries like China and India could turn the credit crunch into a commodity crunch depending on the speed and vigor of the recovery.

This is because markets cannot immediately respond to demands for additional raw material. It takes many years from exploration through to development before new supplies are created. The current downturn in exploration will affect supply several years down the road, just when demand may be taking off.

And this raises the troubling prospect of inflation. Rising commodity prices typically represent a change in relative prices rather than overall inflation if the policy response is appropriate.

But, to battle the recession and credit crunch, monetary authorities are dropping interest rates and injecting trillions of dollars into the system while governments worldwide are spending more trillions on “recovery” programs, all of which in normal times would spur inflation.

This could create a real challenge for authorities when the economy begins to turn around. Tighten too soon and the recovery could be choked off; tighten too late and inflation emerges. Rising commodity prices could complicate the challenge by creating more price pressure.

So despite, short-term problems, the world mining sector is likely to come roaring back during a recovery – good news for Canada, a big global player – but in a way which could give policymakers more problems in the good times; like finding a lump of coal in the Christmas stocking.