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Can you dig it?

Improving investor sentiment since the start of the year has sparked a rally in stockmarkets worldwide and has prompted investors to look at previously unloved sectors such as mining.

From 1 January to 17 April, the FTSE All Share index was up by 7.6 per cent, led by more defensive sectors such as pharmaceuticals and biotechnology, which were up by 18.7 per cent. The FTSE All Share Mining index, on the other hand, was down by 17.1 per cent.

With miners trading at lows, driven by the slowdown in China and falling metal prices, and hopes of global growth starting to solidify, investors might be considering increasing their exposure to the cyclical sector.

Stockbroking firm Charles Stanley recently upgraded mining to “attractive”. Analyst Tom Gidley-Kitchin says: “There is a general agreement that given shares are cheap at spot prices, current valuations build in a fair degree of protection against metal price falls over the next few years.”

In addition, some of the world’s biggest publicly-owned oil and gas companies, or ‘supermajors’, have announced senior management changes, with new chief executives at Rio Tinto and Anglo American, while BHP Billiton head Marius Kloppers will step down in May to be replaced by head of base metals and coal Andrew Mackenzie.

The new management at these companies are expected to rein in costs and improve shareholder relations with a greater focus on returns and cash retention. For instance, Mackenzie recently announced he will receive a base salary of $1.7m (£1.12m), which is a 25 per cent reduction on that of his predecessor Kloppers, who received a base salary of $2.2m.

F&C head of European equities Peter Lees, who manages the £228.8m UK Alpha fund, says attractive valuations in the mining sector compete with negative sentiment over its health. 

He says: “On the maths, you are tempted to put your money into Rio Tinto or BHP, but there is emotion attached to miners. You need proof statements from the new management that show they really mean capital discipline and are thinking of the shareholder rather than their empire.”

The “emotion” Lees refers to is the negative perception that the mining industry has had to deal with in recent years. As well as having an uphill struggle to overcome in terms of disappointed shareholders, mining is associated with operating risks. Aside from high-profile gas blasts and pit collapses, last year’s South African Marikana massacre put mining unfavourably in the headlines.

Hargreaves Lansdown investment analyst Richard Troue is concerned the damage has already been done for retail investors put off by the falling share prices that have hit miners in the past five years.

Troue says: “Their fingers have been burnt. This might be the time retail investors start to look at bailing out of the sector. That is a little bit worrying.”

Demand for mining supplies has also been impacted by slowing economic growth. GDP growth in China, the second-biggest economy in the world, stuttered in Q1 2013 with a rate of 7.7 per cent.

The global economy has a significant bearing on the opportunities in mining, and Equilibrium Asset Management investment manager Mike Deverell says: “I would be wary of mining because it is quite cyclical. Unless the economy picks up strongly I do not see how it could perform strongly.”

However, BlackRock Commodities Income investment trust manager Richard Davis is confident China will continue to be a boon to mining. He says: “I think 7.7 per cent is a pretty good number in terms of GDP growth from China. That will be good news in terms of commodity demand. It has generated quite a bit of bear sentiment.”

Psigma Investment Management head of global equities Tim Gregory also believes demand for mining will be renewed in time, despite some setbacks from Chinese growth and other struggling economies.

He says: “The supercycle of the mining industry is largely over but China will still make substantial investments in targeted infrastructure projects and a sustained recovering in the US housing market will absorb plenty of copper.

“Low-cost producers increasingly focused on shareholder value could ultimately do well in an environment where new-found capital discipline and previously planned expansion projects are mothballed or scrapped.”

Davis says the renewed efforts of the supermajors to repair shareholder relations will also have benefits. “Dividends have gone up from a low base compared with other parts of the stockmarket and there is scope for it to go further.”

With so much negative sentiment attached to mining and with the success of the sector precariously dependent on a few select economies, many could be forgiven for being reluctant to upgrade. But the supermajors’ focus on cost cutting has garnered some attention from fund managers.

Troue is cautiously optimistic that conditions may soon be ready for more investment. He says: “The valuations are starting to look reasonably attractive. It could be time to start dipping a toe into the water again and drip feed some money into the sector.”

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