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Hold on to the mining giants

Created:
20 November 2008
Written by:
Richard Hemming

What are we to do about mining stocks? They rose sharply in October and have been sold down this month. It seems investors can't make up their minds. On the one hand, China is slowing down. The world is slipping into recession. Metals prices have fallen and 2007 earnings are almost certainly the peak. But on the other hand, the long-term supply/demand picture just keeps getting better.

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Evolution Securities' Charles Kernot and Charles Cooper, are unambiguously telling investors to sell the majors. One of their key reasons is the deterioration in the Chinese economy. "The Chinese market has continued deteriorating rapidly. Talk that the economy is insulated from the global economic downturn is plainly wishful thinking. A realistic appreciation of the issues points to ongoing weakness, which means that domestic demand for international commodities will slow," they write in a report. They conclude that investors should sell Antofogasta, BHP Billiton, Kazakhmys and Rio Tinto.

Commodity bulls point to the longer-term story. A prolonged period of weak prices in the 1990s led to woeful under-investment in new capacity. Investment picked up again during the recent price boom, but as prices slide, expansion projects have once again been deferred and capital expenditure curtailed. Much more of the world's productive capacity is now in private, rather than state, ownership, so output is much more likely to be cut the moment it becomes unprofitable, rather than kept open to preserve jobs. This, bulls say, is just creating the next supply squeeze (see The buying opportunity in commodities for more on this thesis).

Also, the slowdown in China is, in our opinion, being rather over-played - just as its contribution on the upside was. We have yet to see any forecasters predicting gross domestic product growth of less than 8 per cent in China for next year - slower than last year, but still way in excess of western economies. Furthermore, while the US government throws trillions of dollars at failed banks, the Chinese are investing in infrastructure - the government said earlier this month that it would invest $586bn over the next ten years.

For the longer-term investor, our advice would be to stick with big, well-run miners. If you sell now, it's not as if you're going to buy them back in six months' time at half the price. Particular favourites include Vedanta and Antofagasta, both of which are buy recommendations. BHPBilliton and Rio Tinto are also well placed courtesy of their near-monopoly positions in iron ore, although the ongoing bid saga between the two is distorting prices. We're a lot less keen on Lonmin (operationally disastrous, as its recent results testify) and Kazakhmys (ongoing nationalist agenda and corporate governance issues).

Or, you could use the UK's rapidly expanding range of exchange-traded funds (ETFs) to buy the underlying commodity at minimal expense.

Mining's ups and downs

Company Bounce Oct-Nov (%) Fall since then (%)
Xstrata 83.9 40.8
Kazakhmys 70.5 45.7
Antofagasta 51.9 20.8
Anglo American 46.1 29.7
BHP Billiton 40.7 27.1
Rio Tinto 40.0 24.5
Lonmin 25.8 41.8

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