Weaker dollar is behind the mining sector rally

IT IS a sign of the optimism flooding the mining sector at the moment that Rio Tinto’s share price was able to rise yesterday even as a Chinese court jailed four of its staff for between seven and 14 years for taking bribes and stealing commercial secrets. The heavyweight miner was able to shrug off the news and gain 1.2 per cent on the day to hit 3,910p, its highest level since before the crisis.

It’s not just Rio Tinto that has been making gains lately. The sector, as measured by the FTSE 350 Mining index, has jumped 25.5 per cent since the start of February – its highest level in nearly 20 months and double that of the FTSE 350 index.

In some ways, this is not surprising – mining firms like BHP Billiton, Antofagasta and Kazakhmys are cyclical and tend to do well when the economic outlook is improving. Resurgent emerging markets have regained their voracious appetite for natural resources and traders are generally happier to take on risk.

But the key driver behind the recent improvement in the mining sector is rising metals prices. Copper is trading near its 6 January high of $7,660 per tonne – giving copper miner Rio Tinto a boost – and gold is back above $1,100 an ounce. While fundamentals have been supportive, the recent rally has been given an extra boost by the decline in the dollar as currencies such as the euro and sterling have staged a relief bounce.

Michael Hewson, market analyst at CMC Markets, says that all of the latest buoyancy in commodity markets has been driven by the weakening in the US dollar – a result of traders taking profits: “The rise in the copper price is due to dollar weakness more than copper strength.”

But unfortunately for the mining stocks, Hewson says that any weakness in the greenback against the euro is likely to be short-lived. “In the short-term, we will see $1.35 and a move back down towards the $1.3380 level,” he adds.

Renewed dollar strength will have a negative impact on metals prices because it will become more expensive in domestic currency terms for emerging market countries to buy metals, which are usually priced in US dollars. Lower demand will mean a less rosy outlook for mining firms.
Demand from emerging markets and China has played a crucial role in taking the mining sector index to its current levels of over 24,000. Therefore, the uncertainty surrounding Chinese monetary policy tightening is adding to the bearish sentiment because any policies that serve to cool growth in the region will have a negative impact on miners operating there.

Joshua Raymond, market strategist at City Index, says we are nearing resistance at 24,400 in the mining index and we have seen profit taking at this level before.

The sector, which is tradable as a CFD, has been very sensitive to previous tightening measures introduced by emerging markets. A stronger dollar combined with potential Asian tightening should cap gains in the mining sector index over the coming months.