Pick mining giants for commodity exposure

CHINA’S restrictive export practices in rare earth metals have intensified fears among traders and market analysts that a bubble is forming in junior mining stocks such as Canada’s Rare Element Resources, Quest Rare Minerals and Avalon Rare Metals. These companies have seen their share prices surge in recent months despite the fact that they are not yet extracting any rare earths.

These frothy junior stocks are difficult for contracts for difference (CFD) traders to buy and sell and provide a timely warning of getting involved in niche sectors where one player controls much of the market. In the rare earths market, China mines over 90 per cent of the global supply of the 17 rare earth oxides, which are used in nuclear batteries, lasers, and x-ray machines. It has also cut its second half export quotas for rare earths by 70 per cent and has stopped all exports of them to Japan following a political row.

CFD traders do not need to look to niche markets such as rare earths to make the most of the Chinese commodity story. China’s voracious appetite for metals has given it enormous power over all the commodity markets, which have seen rapid price increases as traders bet on its future economic growth. For example, investment flows into commodities rebounded strongly in September, to $8.5bn despite growing pessimism. (See chart.)

Mining giants such as Rio Tinto, Anglo American, BHP Billiton, Vale and Xstrata all offer plenty of exposure to commodities and Chinese growth without the problems of liquidity and security posed by the small cap stocks. These are easily tradable and have lower margin requirements than some of the Aim-listed mining tiddlers.

RBS’s head of commodity strategy Nick Moore says confidence in the sustainability of a commodity price recovery is growing among some of the major mining firms, which are increasing their capital expenditure and reactivating idle capacity.

Evolution Securities’ Charles Kernot is positive on the outlook for both Anglo American and BHP Billiton, rating them as a buy and an add respectively. He believes the market has not yet recognised the full potential of Anglo’s ongoing restructuring and has a target price of 3,220p; the stock closed yesterday at 2,980p, up 2 per cent after an upgrade by Goldman Sachs. But Kernot feels Rio Tinto has neared a top and advises investors to start cutting positions.

Big cap miners are not without their problems but they offer diversified exposure to the commodity story. In contrast, small cap miners appear attractive but they are fraught with problems for a trader with anything other than a very long-term horizon.