They just don’t learn. After last week’s ill-timed recommendation by Goldman to buy BHP the day before iron ore crashed, Nomura is now joining the chorus of fundamental sell-side analysts declaring mining is a buy:
Resources link to commodity prices not that strong
The historical relationship between commodity prices and resources performance is surprisingly not that strong. In three of the five periods of outperformance prior to 1999, commodity prices were flat or down, as resource stocks outperformed the market by ~10%. In most of these periods, resources valuations were very attractive.
Strong parallels with earlier periods of outperformance
There are parallels between these earlier periods and now, suggesting that resources could outperform even if fundamentals do not improve:
Commodity prices have already fallen by a large magnitude. Two of the three episodes where resources outperformed without commodity prices rising were also preceded by a sharp fall in commodity prices;
Valuations are at levels seen during earlier periods of outperformance. On a PB basis relative to banks, valuations are at 30-year extremes.
Large caps still preferred in the resources space
For those investors who are willing to move into resources, we think that the large caps still present the best risk reward proposition given their low cost of production. Of the smaller companies, we would prefer stocks with
the best balance sheets, as measured by net debt to market cap:
In the iron ore space, we prefer MGX and AGO over FMG;
In the copper space, OZL and PNA are preferred to SFR;
There are several gold companies which are net cash and are trading on cheap valuations (AQG, OGC, RSG, MML). However, we still prefer NCM, as it is the cheapest on a PB basis and has the highest margins.
Value analysis really fails sometimes without a macro overlay. Just because miners are cheap does not mean that they can’t get cheaper. Those exposed to gas are worth a look but not those exposed to bulk commodities. As China changes, iron ore and coking coal are going to fall much further. Further than the dollar. The time to buy miners will be when blood flows in the gullies of the Pilbara.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific's leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
