Is the tide beginning to turn for the UK Index miners?

It’s always been a question of balance, and after years of massive investment in commodities, culminating in three or four of massive overinvestment  the world is now oversupplied and not growing like many hoped it would. But this has been the case for at least a year now. Analysts and investors now expect to see profits hit and the miners’ earnings reports are largely in line with those expectations. Lower profits are no longer surprising the market which means they’re probably pricing themselves in.

What may be surprising to many market watchers though is twofold. First, the extent to which the UK 100 miners have already recovered from the lows of the last 12-months, and second, a recent breakout above May 2015 falling highs on the Mining Sector index (MINING). Fundamentally, we’re seeing little change in terms of Chinese growth and the strength of the US Dollar, so what’s driving the recent broad based mining sector rally?

Past performance no indication of future success.

Never has the focus on a company’s 12-month outlook been so important. Sure, 2015 profits are down. Everyone knows what to expect there because things have been this way for a long time. But investors care about the future. For example, given the recovery (or re-growth) potential of mining stocks, the fact that hitherto generous dividend policies have been abandoned may be seen by growth seekers as a welcome cost-cutting measure. In the case of Glencore (GLEN), +100% from last autumn’s lows 66p, a debt reduction plan that’s ahead of schedule has reinforced renewed confidence in emerging markets.

Furthermore, Anglo American (AAL) pleased investors with its decision to streamline its operations, reducing its portfolio from 9 products to just 3 – copper, diamonds and platinum. This sort of action is welcomed by the markets because it addresses the supply/demand imbalance that’s keeping commodity prices low. Cut back on supply and the price should find support. In Anglo American’s case, its abandonment of iron ore and coal (demand for which is slowing) will have implications for the supply of both, while a concentration on rarer, more valuable elements like diamonds and platinum stand to benefit from growing demand (diamonds in the luxury goods market and platinum in the car industry) from a growing EM middle class.

Source: Alpha Terminal, 2 March

The miners are well off their lows

The table above details all the UK 100 miners’ performances over the past year. You can easily see that they are all trading well off their 12-month lows. While a return to the highs would be an unrealistic expectation, the miners are still showing an attractive amount of upside. On the other hand, precious metals miners Randgold Resources (RRS) and Fresnillo (FRES) are trading relatively close to their 12-month highs, evidence of a bygone year of heightened uncertainty that’s boosted safe haven demand for gold and silver. Will this trend now start to correct itself, given renewed confidence in the equity markets? Quite simply, no other UK 100 sector offers this kind of recovery/growth potential. That’s why mining remains one of the most followed sectors on the UK Index .

A sector breakout

Yet more encouraging is the mining sector index (below), which has staged a breakout above May 2015 falling highs and its 100-day moving average, together with both a recent and potentially imminent bullish cross. With an initial pullback – on ‘buyers’ remorse’ – itself bouncing back up off what now appears to be support, could the worst really now be behind the miners?

mining index, 12-month chart

Source: Bloomberg, 1 March

Where do emerging markets sit within all this?

Growth in the emerging markets like China is not accelerating as fast as some would like, in the way they would like. Firstly, as mentioned above, China is transitioning, which is actually a good thing for some commodities – your diamonds, platinum and copper. But let’s address industrial materials too – coal, iron ore, nickel, oil etc.

What’s growth of 6.9% compared to growth of 7%? In absolute terms (as opposed to percentage terms), 6.9% growth last year is more than 7% growth in 2014. That means demand for commodities was higher last year than it was the year before, in absolute terms. That’s why mining giants like Glencore have always maintained that demand for basic materials remains strong.

The only issue is that the mining companies prepared themselves for constant growth in percentage terms and massively overinvested in commodities, but the market is already re-adjusting. Virtually no one believes that the commodities downturn will continue indefinitely, while virtually everyone believes that the time will come to buy back in to commodities. But whether you see mining stocks primed for a rebound or on the edge of a cliff, it’s our duty to make you aware when we see things changing.

The brokers’ point of view

You’ve seen our take on the situation. But what position are the other institutions taking in all this? The table below details the current consensus on the UK 100 miners, which is neutral-to-bullish (but not too bullish!) with Rio Tinto (RIO) and BHP Billiton (BLT) the only stocks trading below their current average target prices.

Source: Alpha Terminal, 2 March

The reason Anglo American gets the most bearish recommendation consensus is that analysts are worried it won’t be able to sell off the things it needs to (things for for which demand is low) to achieve its goal of streamlining the business.

The reason Rio Tinto gets the most bullish consensus number is that its approach is simply to cut jobs in its iron ore business rather than embark on a long and difficult sales pitch, which will immediately save cash.

Likewise, Glencore has already demonstrated that it’s able to reduce its debt pile with applomb.

Randgold Resources and Fresnillo look to be the subjects of some form of mania, given the strength of the gold price rebound in 2016. Such large moves are seldom maintained in the long term.

So, which miners are set to embark on a serious recovery and which could be primed to head south? Read on to find out!

Glencore (GLEN)

Where next for GLEN shares?

• Historical broker target price action suggests that they’re consistently behind the curve with Glencore, meaning there’s the potential for upward revisions after the price broke above the most recent average at 126p.
• FY2015 results were in-line with expectations while debt reduction remains ahead of schedule.

Will Glencore (GLEN) fall back towards the lows of 66p or rally on towards the highs of 260p?

Broker Consensus: 62% Buy, 24% Hold, 14% Sell

Average 12-month broker target price: 126p

Rio Tinto (RIO)

Where next for RIO shares?

• Most upside potential of all the UK 100 miners according to broker consensus with simple job cuts seen to immediately reduce capital outflows.
• While iron ore has shown recent relative strength, overinvestment has seen income fall, so it makes sense to reduce investment in that product to re-balance things.
• 75% of brokers have targets above the current price (see table on right).
• A move towards the average target price would require a break above the 100-day moving average.

Will Rio Tinto (RIO) fall back towards the lows of 1558p or break above the 100-day MA 2025p?

Broker Consensus: 62% Buy, 23% Hold, 17% Sell

Average 12-month broker target price: 2182p

Randgold Resources (RRS)

Where next for RRS shares?

• The gold miner has benefitted from a strong rebound in the gold price through January and February and a positive earnings report for FY2015
• Shares will have benefitted from healthy safe haven demand, but while miners like RRS should be negatively correlated with more basic materials-focused peers, both have seen shares recover in 2016
• A more risk-on market sentiment into March could put pressure on the gold price and shares in gold miners may now be overbought

Will Randgold Resources (RRS) continue to make fresh 2016 highs or fall back towards the average broker target of 5357p?

Broker Consensus: 28% Buy, 56% Hold, 16% Sell

Average 12-month broker target price: 5357p

BHP Billiton (BLT)

Where next for BLT shares?

• The miner has benefitted from recent strength in iron ore and oil prices, both of which have posted good gains in the past week, as have a host of other commodities whose prices are linked to the Chinese economy after the PBoC hinted at more stimulus.
• The company has had its credit rating maintained by S&P at “A” and Fitch at “A+” after it cut its dividend.
• A break above the current average target price potentially puts the 200-day moving average within reach.

Will BHP Billiton (BLT) fall back towards the lows of 575p or rally on towards the 200-day MA 1000p?

Broker Consensus: 38% Buy, 41% Hold, 21% Sell

Average 12-month broker target price: 778p