Here be dragons. The mediaeval map-making shorthand is particularly apposite for FTSE 350 mining investment in 2008 because, while we are indeed moving into uncharted territories, China – where dragons were mythical guardians of subterranean metal – remains centre-stage.
What's new, though, is that following several years of burgeoning Far Eastern demand being just part, albeit an important one, of a generally strong global environment for commodities, the US is now technically in a manufacturing recession. So we will finally get to see if the grand theme of the mining bull run to date - the mooted 'commodity supercycle' predicated on Chinese and Indian industrial development - really has legs. Have these emerging markets decoupled sufficiently from US-dependent export-led growth to withstand a contraction in the consuming nation of last resort and, if they have, will their own requirements sustain industrial metals prices, and by extension mining earnings and share prices, at current levels?
For many commentators, even if emerging market demand does remain strong, a US recession will make a noticeable difference. Metals experts such as John Reade of UBS and Martin Hayes of Basemetals.com expect base metals prices to be volatile and wide-ranging throughout 2008, but caution that we are currently around the top of that range, and expect most metals to finish the year lower. They do have favourites, however – for example, Mr Reade thinks this year might see aluminium strengthen if China finally moves to curtail swathes of highly-polluting production that also diverts scarce electricity from worthier uses.
So, given the outlook above, our first instincts would be to temper the generally bullish stance we have maintained on base metal miners throughout 2007. It was indeed well-justified – compared with flat or negative returns across the FTSE All-Share and FTSE 350 indices, mining shares in general offered chunky returns last year, averaging some 40 per cent across the sector. While we remain fairly confident that an investment in a well-run miner, particularly one still relatively cheap in forward price-earnings (PE) ratio terms such as Xstrata or Antofagasta, still offers good value for investors with a long-term buy-and-hold mentality, in the short to medium term there is downside risk given the metals pricing outlook outlined above and the way these shares move in step with bellwether metals such as copper.
But there is at least one, very considerable complication, and that is the merger and acquisition (M&A) speculation kicked off by BHP Billiton's unsolicited and still informal offer for fellow diversified behemoth Rio Tinto. By the early February put-up-or-shut-up deadline mandated by the Takeover Panel, BHP will either have walked away from an intransigent Rio or it will have improved its current three-for-one all-paper share proposal - and, if the latter, we can expect a whole new bout of bid speculation driving up the key players again. In a post-BHP Tinto world, will Xstrata be taken out by Brazilian iron ore player CVRD, or will Xstrata in turn feel it needs to swallow Anglo American, or vice versa? Will Chinese state-backed bidders with deep pockets feel they finally need to purchase a seat at the table of the iron ore suppliers - which in the FTSE 350 includes BHP, Rio, Anglo American and, to a far lesser extent, Vedanta and Ferrexpo - selling into China? The latter commodity is at least one that can be counted on to surge in price again this year - making Ferrexpo, the one FTSE 350 iron ore pure play with significant current production, particularly attractive.
Precious metals are a different proposition altogether. Gold, silver and platinum are all at sky-high levels, but here the thinking from analysts is that this trend could well continue with fresh highs coming through 2008. The erosion of the dollar's status as the global reserve currency par excellence will continue to fuel this appetite for gold and to a lesser extent silver, while industrial demand versus production shortfalls is also an important driver for platinum. Randgold Resources and Hochschild Mining should benefit from gold and silver strengthening further, Lonmin and Aquarius from platinum. That said, we are less enthusiastic about the latter two companies, given their exposure to European autocatalyst production - a major industrial market for platinum, which will suffer if the US recession and/or credit crunch spills over into the real economy in the eurozone.
FTSE350 Mining Sector:
Company name | Price (p) | Mkt val. (£m) | P/E ratio | Div. yld (%) | 12M price chng.(%) | Last IC view |
---|---|---|---|---|---|---|
ANGLO AMERICAN | 2591 | 34256.37 | 11.8 | 2.18 | 7.51 | Good value, 2,754p, 7 Aug 2007 |
ANTOFAGASTA | 602.5 | 5939.79 | 8.4 | 0.42 | 34.34 | Good value, 678p, 29 Aug 2007 |
AQUARIUS PLATINUM | 558.5 | 1432.74 | 45.8 | 0.41 | 32.66 | Sell, 1,526p (509p post share-split), 30 Nov 2007 |
ARICOM | 70 | 783.35 | 0 | 31.46 | Buy, 67.5p, 14 Nov 2007 | |
BHP BILLITON | 1378 | 30412.54 | 11.6 | 1.71 | 53.11 | Fairly priced, 1,670p, 12 Dec |
FERREXPO | 251 | 1541.06 | 0 | Buy, 234p, 4 Jan 2008 | ||
GEM DIAMONDS (DI) | 935.5 | 583.74 | 0 | Good value, 1,075p, 13 Apr 2007 | ||
HOCHSCHILD MINING | 397.25 | 1220.95 | 46.7 | 0.35 | 0.44 | Buy, 349p, 8 Jan 2008 |
KAZAKHMYS | 1155 | 5282.31 | 6.7 | 1.69 | 12.57 | Fairly priced, 1,508p, 10 Oct 2007 |
LONMIN | 3254 | 5083.52 | 22.6 | 1.73 | 14.38 | High enough, 3,200p, 21 Nov 2007 |
RANDGOLD RESOURCES | 2118 | 1612.65 | 77.1 | 0.23 | 92.37 | Buy, 1,409p, 18 Sep 2007 |
RIO TINTO | 4700 | 46874.03 | 17.6 | 1.24 | 83.88 | Fairly priced, 5,657p, 12 Dec 2007 |
TALVIVAARA MNG.CO.(CDI) | 300 | 669 | NA | 0.0 | NA | Buy, 214p, 14 Sep 2007 |
VEDANTA RESOURCES | 1732 | 4986.69 | 11.3 | 1.02 | 56.32 | Good value, 1,990p, 15 Nov 2007 |
XSTRATA | 3363 | 32677.14 | 12.3 | 0.68 | 46.92 | Good value, 3,700p, 12 Dec 2007 |