Barron's Vito J. Racanelli suggests (Barron's subscription required) that mining stocks may be headed for a fall. Too much optimism, and growing signs of diminishing Chinese demand are the most significant factors. Here are the key points:
- Due to China demand, commodity prices and related stocks have soared over the past two years.
- Stoxx sector of European basic resources stocks, has jumped 73% over the past 25 months.
- 66% of the sector is weighted in miners like Anglo-American (ticker: AAUK), BHP Billiton (ticker: BBL) and Rio Tinto (ticker: RTP).
- Analysts continue to increase earnings estimates for the sector.
- There's talk of a "supercycle" of commodities demand (thanks mainly to China).
- Goldman Sachs (ticker: GS) warned recently of a potential "super spike" in oil to as high as $105 a barrel.
Will the mining rally continue?
- Assuming China growth continues, so should growth of basic resource companies.
- BUT, Barron's suggests that a correction may be on the way.
Jacob de Tusch-Lec, a London-based Merrill Lynch strategist:
- Points to parallels between basic resources stocks, and the tech stock bubble.
- "....this is a sector which you can't allow yourself to be underweight."
- But, the rise has been too strong and the sector now so big, that "it is hard to find sellers".
- The idea that "China will consume anything that the U.S. doesn't" and that its GDP can grow at 8% all the way out to 2050 has firmly taken hold of the market's imagination.
- The euphoria about China is so thick that investors aren't pricing in any risk.
- Sounds like the 1999-2000 herd mentality.
- It's rare for a capital-expenditure and credit boom to have a soft landing, for capex growth isn't a function of the level of final demand growth but is highly sensitive to the changes in growth.
- If Chinese exports slow, it could have a disproportionate effect on the country's capex spending.
- If there is a second-half US economic slowdown, "then it might have a much larger impact on China and Asia than the market expects".
Alastair Duffy, a fund manager at Aegon Asset Management:
- When Chinese demand slows, the resource sector stock prices will fall quickly.
Standard & Poor's equity strategist Charles Dautresme:
- Steel data suggest a slowdown in production is beginning.
- The value of January imports of iron and steel declined by 2% from a year earlier.
- Since steel prices have skyrocketed, that means the imports dropped even more.
- Chinese monthly steel production is now growing at 26%, down from 31% late in 2004.
- Further signs of weakening from China could hurt the stretched valuations of mining shares.
- Resource and mining stocks are trading at about 12X 2005 consensus EPS estimates.
- While not rich, the valuations are at the top end of the most recent two-year valuation range, according to S&P's Dautresme.
- Any bad news will cause investors to exit.
- Basic resources stocks are down 3% over the last 30 days. Of course, this could just be profit-taking.
- Even during a lengthy growth spurt, slowdowns are inevitable.
- A China slowdown may be on the way.
Relative stock market performances of select mining companies:
BHP Billiton (ticker: BBL) in ORANGE.
Rio Tinto (ticker: RTP) in BLUE.
Anglo-American (ticker: AAUK) in GREEN.