Goldman joins the stampede away from banks and into miners today:
Mining valuations at 10-yr lows vs Banks: Having underperformed Banks by 90% from late 2010 (third largest gap in 50 years), momentum has started to reverse. If sector earnings fall to 10-year averages (i.e. 30% fall in Mining EPS, 10% in Banks), Banks would still be 40% more expensive.
Falling A$, rising bond yields and global growth support Miners vs. Banks: Our global forecasts call for a return to above 4% global growth and above 8% China growth in 2014. Early indicators of global and China industrial cycles have turned more supportive. Meanwhile, Australian banks have been a key beneficiary of the search for yield, which is now becoming exhausted in the Australian market. Our forecast rise in bond yields as the Fed tapers and rising risk of a domestic recession in 1H14 suggest that Australian banks will underperform. Miners are also highly leveraged to our forecast of A$/US$0.90 in 12 months’ time, while the impact to the banks is more lagged.
Both face structural risks, but Banks are near highs while Miners languish: While structural factors will lower growth rates (Banks: weak mortgage growth, Miners: falling China demand), we think the valuation gap is excessive. Both have healthy balance sheets, but we view the banks as more constrained. Miners can do more on cost-out and would benefit more from a change in government, in our view.
We prefer Miners with diverse commodity portfolios and low-cost operations. Moving Overweight Miners (Buy BHP), Underweight Banks (Sell WBC): Miners: We expect BHP’s diverse asset base and low-cost operation to continue to deliver strong returns as Chinese commodity demand weakens. Banks: Sell WBC, our least preferred bank, driven by valuation and its larger exposure to a structural decline in mortgage credit growth. ‘Best of’ Bank Puts lower the cost of downside exposure by 40% and should outperform in the event of a broad-based fall across the four majors.
Sigh. It’s not easy fending this off, I gotta admit. Obviously I agree on the banks but the miners are a big risk. Look at the assumptions: 4% global growth. Meh. Above 8% Chinese growth. Meh.
Moreover, I can only repeat that for BHP every 1 cent fall in the Australian dollar is completely cancelled out by every $1 fall in iron ore. Goldman sees an average ore price next year of $115 and $80 the year after. But the big supply expansion is in the next nine months, not the nine months after that:
If anything, Goldman has it back to front. $80 iron next year and above $100 the year after as capacity is cut.
The risk/reward of miners versus banks definitely favours miners but, FFS, there are other, better options.
