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Are unloved miners heading for a turnaround?

Underperformance has led some investors to ask whether valuations have fallen to such a level that miners now look attractive.

Strong gains in developed world stockmarkets over the last year left many investors looking harder than ever for pockets of remaining value. Could unloved miners be one area where value can still be found?

The FTSE All-Share Mining sub-sector has trailed the wider FTSE All-Share for a number of years as investor confidence was hit by concerns such as slowing demand from China, the world’s second-biggest economy and its largest commodity consumer.

FE Analytics shows FTSE All-Share Mining has lost 36.24 per cent over three years to 4 February, massively underperforming the 23.66 per cent gain seen in the FTSE All-Share. In 2013 alone, FTSE All-Share Mining dropped 13.74 per cent while the FTSE All-Share jumped 20.81 per cent.

But this underperformance has led some investors to ask whether valuations have fallen to such a level that miners now look attractive.

F&C multi-manager co-head Gary Potter notes investors have essentially written off commodities stocks and the funds that invest in them because of the “disastrous” 2013 but cautions against being bearish on nothing more than past performance.

He says: “That is rear-view mirror investing and I would lay a pound or penny that commodities do not have as bad a year this year. It might not be the best year for them but I suspect it will be a stabilising year.”

Over six months to 4 February, the FTSE All-Mining index has outperformed the wider market despite the sell-off prompted by emerging market concerns and signs of weakening global growth, rising by 1.22 per cent. The FSTE All-Share, on the other hand, dipped by 0.45 per cent over the same period.

Against this backdrop, some analysts have started to turn positive on miners with Citi recently moving its 12-month view on the sector to bullish for the first time in three years. The firm’s top picks here are BHP Billiton, Rio Tinto and Glencore-Xstrata.

In an analysts note, Citi lead analyst Heath Jansen says: “Investor sentiment has hit rock bottom. The mining sector has moved through five stages of grief, namely denial, anger, bargaining, depression, and now we think we are in acceptance that the sector has moved into a new norm.”

Jansen argues expected improvements in US and European economic growth will act as supports for commodities while weakening currencies in exporting nations such as Australia, New Zealand and South Africa will help. New management teams, cost-cutting exercises and greater alignment with shareholders’ interests are also seen as positives.

JP Morgan Natural Resources client portfolio manager James Sutton points to improvements in miners’ free cash flow estimates – or how much money they are expected to return to shareholders – as adding to their investment case.

Sutton says: “When you consider where we still stand in terms of depressed valuations in the sector and you compare that to the free cash flow yield and the multiples, it’s an exciting opportunity.

“Fund manager surveys have been underweight in the large-cap miners for something like two years and this sector has been all but abandoned by investors, so if we do get a material re-rating across the sector, we could see potentially powerful flows as money returns.”

January’s Bank of America Merrill Lynch Fund Manager Survey showed asset allocators’ biggest concern is an economic hard landing in China followed by a commodity collapse but Sutton maintains long-term demand from China will continue.

He says: “China continues to shift away from fixed asset investment towards greater domestic consumption, so that is a tailwind, particularly for commodities like copper that are needed for urbanisation. Platinum and palladium are used in the automotive sector where demand for new cars is strong.”

Whitechurch Securities is running a tactical position in commodities to capitalise on the short-term opportunities created by depressed valuations. This has been implemented through a holding in Evy Hambro’s £820m BlackRock World Mining investment trust.

Head of research Ben Willis says: “We were too early going in but it is beginning to look a bit more interesting. We have seen some UK managers seeing some value there.”

One of these managers is Richard Buxton, who has been building up exposure to miners such as Rio Tinto and Glencore-Xstrata in his £1bn Old Mutual UK Alpha fund. He says: “Sentiment is very against these things, partly becuase of this view on China that there is a huge collapse in the demand side just as supply is picking up. I don’t think the demand side will fall away as sharply as people think.”

Hargreaves Lansdown head of VCT research Richard Troue says the good news surrounding mining is starting to be recognised after the sector’s recent “torrid time”. He tips Hambro’s £966.7m BlackRock Gold & General fund for gold equities and Joanne Warner’s £488m First State Global Resources fund for its broader exposure to mining stocks.

Troue says: “With much of the bad news factored into prices the sector is starting to look interesting again and the key thing for this year and next will be if companies can deliver earnings and profits growth. If they can we could see the beginning of a sustained turnaround.

“There are still uncertainties around shorter-term volatility in commodity prices which cannot be ruled out and the sector could still get cheaper. The sector is a good contrarian bet but, given the difficulty of timing the market, phasing money in could be the best choice rather than investing a lump sum.”

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