The statistics aren't pretty. For the third year running, metals and mining equities delivered double-digit losses, on average, making the sector the worst performer in the FTSE 350 by some distance. Of the five worst-performing FTSE 350 shares in 2013, four were miners. The price of gold fell by a quarter; silver by over a third; nickel by a fifth; copper and aluminium by a tenth.
All in all, the broad sector decline that has dominated any company-specific news since the end of 2010 shows few signs of abating. This time last year we suggested investors reduce their exposure to mining equities in 2013. And as we look forward into 2014, we're tempted to repeat ourselves.
Commodity prices appear likely to remain soft in the near term, driven by subdued credit conditions and lower economic growth in China. This will pile more pressure on already strained industry margins. With shareholders and fund managers demanding better capital allocation from mining companies, earnings growth will need to be driven by cost-cutting and asset optimisation - hardly a recipe for a dramatic sector re-rating.
"[Investor] focus will be on projects already financed, or with access to financing, with undeveloped projects facing intense competition for scarce capital," surmises Investec mining analyst Hunter Hillcoat. "While there is value in the sector, and opportunities that should encourage M&A activity, focus is likely to be directed more towards maximising existing assets than pursuing growth."
Mr Hillcoat says mining investors need to start paying more attention to what really matters across all sectors: deliverable earnings growth, strong balance sheets, healthy dividend payments and value. We agree, but find it difficult to locate all the desirable qualities under a single miner's roof. Silver miner Fresnillo (FRES) and diamond miner Petra Diamonds (PDL) are two that possibly come close.
Still, our house view is that the commodity supercycle has peaked and that caution should be the priority again this year. Those tempted to call the bottom of the cycle should bear in mind that mining downturns have historically tended to play out over five to 10 years, mainly because the supply curve tends to overshoot demand in times of growth and undershoot in leaner times.
| Diminishing returns from FTSE 350 Industrial Metals & Mining Companies | |
| Year | Average sector performance (%) |
| 2011 | -54.0 |
| 2012 | -30.1 |
| 2013 | -49.7 |
Instead, we recommend investors look at short-term trading ideas as a way to play the sector, if at all. For example, Canaccord Genuity's Dmitry Kalachev says "operational delivery" can often be the key for a temporary re-rating. "Despite a flat gold price since June 2013, discounted producers that delivered operationally in second-half 2013 have substantially outperformed high-quality companies, perceived as defensive plays within the gold universe. African Barrick Gold (ABG) and Centamin (CEY) have risen by 98 per cent and 47 per cent respectively, while best-in-class Randgold Resources (RRS) has slid 13 per cent since June 2013."
Mr Kalachev reckons shares in African Barrick now appear fully valued, but says other under-appreciated producers, such as Pan African Resources (PAF) or indeed Centamin, should turn in robust operational performances in the months ahead. They could even outperform in the short term amid the ongoing 'risk-on' environment, which looks "likely to remain in place over 2014, as the announced QE tapering in the US will likely be a slow process".
Nevertheless, it is a worthwhile exercise to recall the reasons oversold miners are oversold in the first case. Often, they face higher than average political and company-specific risks that could send the shares tumbling at any time. In Pan African's case, the company's mining operations in South Africa could be affected by union trouble, lower than expected ore grades, currency debasement, electricity issues or regulatory changes.
That's why we wouldn't be afraid to short sell selective mining shares in 2014. It should come as no surprise that the four best IC sell tips in 2013 were all mining shares. Nimble investors who are willing to take on extra risk could profit from the broad sector decline in this way.
| Metals & mining | ||||||
| Company Name | Share price (p) | Market value (£m) | PE ratio | Dividend yield (%) | Share price change in 2013 (%) | Last IC view |
| African Barrick Gold | 200 | 818 | 12 | 4.3 | -57.8 | Sell, 155p, 13 Dec 2013 |
| Anglo American | 1,367 | 19,051 | 12 | 4.5 | -30.3 | Buy, 1,275p, 2 Jan 2014 |
| Antofagasta | 820 | 8,079 | 16 | 1.6 | -37.8 | Hold, 885p, 28 Aug 2013 |
| BHP Billiton | 1,834 | 38,735 | 14 | 4.2 | -12.2 | Hold, 1,883p, 23 Aug 2013 |
| Centamin | 47 | 518 | 4 | 0.0 | 13.5 | Hold, 54p, 28 Mar 2013 |
| Evraz | 103 | 1,509 | na | 0.0 | -56.8 | Sell, 141p, 19 Sep 2013 |
| Ferrexpo | 169 | 994 | 8 | 2.5 | -24.0 | Sell, 187p, 14 Nov 2013 |
| Fresnillo | 755 | 5,560 | 16 | 6.0 | -59.6 | Buy, 672p, 16 Jan 2014 |
| Glencore Xstrata | 335 | 44,483 | 40 | 3.1 | -11.0 | Hold, 308p, 27 Nov 2013 |
| Kazakhmys | 180 | 803 | 5 | 2.9 | -71.9 | Sell, 305p, 22 Aug 2013 |
| Kenmare Resources | 18 | 504 | na | 0.0 | -33.1 | Hold, 27.6p, 28 Aug 2013 |
| Lonmin | 321 | 1,828 | 25 | 0.0 | 8.6 | Hold, 351p, 11 Nov 2013 |
| Petra Diamonds | 135 | 691 | 21 | 0.0 | 5.1 | Buy, 120p, 17 Sep 2013 |
| Polymetal International | 559 | 2,175 | na | 3.7 | -51.1 | Sell, 691p, 28 Aug 2013 |
| Randgold Resources | 4,121 | 3,801 | 20 | 0.6 | -36.3 | Hold, 4,276p, 08 Aug 2013 |
| Rio Tinto | 3,246 | 45,856 | 7 | 3.5 | -2.9 | Buy, 3,263p, 2 Dec 2013 |
| Vedanta Resources | 910 | 2,427 | 14 | 4.2 | -19.3 | Hold, 974p, 20 Nov 2013 |
FAVOURITES
If you wish to remain invested in commodities through the cycles, then BHP Billiton (BLT), the world's largest and most diversified mining group, is a decent bet. The new management team is slashing costs and improving operational cash flow while the dividend yield is nearly 4 per cent. Petra Diamonds, which plans to double diamond production over the next five years, also offers steady, stable growth.
OUTSIDER
We picked copper miner Antofagasta (ANTO) as our outsider last year and the share price duly halved as metals prices fell and costs continued to climb. Yet its shares, on 16 times forward earnings estimates, are still pricey, considering near-term growth is minimal. According to Investec, the company is likely to spend over $7bn by 2020, but between now and 2016 this will only support flat production.
