Depressed mining stocks are finally starting to look attractively valued
IT WAS a tough second quarter for London-listed miners, which were dealt a severe blow by a toxic combination of general risk aversion, a planned tax on miners’ profits in Australia and a government-orchestrated slowdown in China. After reaching 25,356.51 on 6 April – its best level since July 2008 – the FTSE 350 mining sector took a nosedive in the three months that followed and ended the quarter some 7,000 points lower at 18,412.96. And despite a strong start to July, which saw the mining sector rise back above the 20,000 level, the sector is still trading at a 25 per cent discount to the wider market, according to Citigroup.
The diversified mining stocks – Anglo American, BHP Billiton, ENRC, Rio Tinto, Vedanta Resources and Xstrata – are currently trading on a base price-to-earnings (p/e) multiple of 6.2 times. Multiples have recently been ranging within a band of 8-10 times, suggesting that the market may have oversold.
Consequently, contracts for difference (CFDs) traders looking for another opportunity to get exposure to emerging markets’ appetite for natural resources may well be rubbing their hands at the thought of such cheap valuations. But do current levels represent an attractive entry point, or are we likely to see lower levels?
Citi analyst Heath Jansen falls into the former camp: “This presents an attractive entry point in our view for those who are sceptical of the extent of the recent sell-off in commodity markets. We believe the market has overshot the recent uncertainty emanating from the Chinese government-led slowdown and the Eurozone sovereign debt crisis.” He adds: “The market could be placing too much emphasis on the movement in spot prices in the wake of recent global uncertainties, thus ignoring the medium- to long-term fundamentals, which appear much more stable.”
However, there is currently a strong positive relationship between FTSE 350 mining stocks and spot prices – see chart. In contrast, earnings momentum is a much less reliable indicator of stock performance during periods of market volatility. This is more relevant during the mid-cycle – still some way off – when moderate movements are the norm and the future is fairly certain.
Another relationship that CFD traders should be looking at is the correlation between
Chinese monetary expansion and net copper imports. With money growth beginning to moderate, market fears of a slowdown in copper demand from the Chinese construction sector appear valid, says Jansen although he adds that these fears may turn out to be exaggerated. Indeed, figures out yesterday showed that China’s copper imports fell for the third straight month, by 17.3 per cent to 328,231 tonnes. This would appear to support the view of WorldSpreads’ Alastair McCaig, who says that we may well get a bit more downside over the next few weeks and that we might get some cheaper levels at which to pick up mining stocks.
CFD traders can either choose to take a punt on the UK?mining sector or on specific stocks. Individual stocks may well be attractive since traders with long CFD positions receive dividend payments.
JP Morgan’s David Butler says: “We should also almost certainly see the restart of interim dividends at Rio Tinto and Xstrata, while BHP Billiton never stopped paying out. Only Anglo American appears unlikely to take the plunge just yet.” In his view, investors should make the most of the uncertainty and dip a toe into a sector. JP Morgan’s preferred plays are Rio Tinto, Xstrata and Vedanta. They could well prove to be a profitable seam for the second half.
CALENDAR | EARNINGS SEASON
Tuesday 13 July
Burberry – Q1
Intel – Q2
Wednesday 14 July
Richemont – full-year
Barratt Developments – full year trading update
Rio Tinto – Q2
Wetherspoon – trading update
Thursday 15 July
Carrefour – Q2
Experian ?– Q1
Mothercare – Q1
JP Morgan – Q2
Google – Q2
Friday 16 July
General Electric – Q2
Citigroup – Q2
Bank of America-Merrill Lynch – Q2
LVMH – Q2
Mattel – Q2