Global trade tensions among the causes of some volatility in the mining sector.
Sector in focus: Mining
The recent escalation in trade tensions between the US and China has caused some volatility in the market, and especially the mining sector. That has in turn raised the question about whether now is a good time to get in, or perhaps remain wary.
Good economic growth across many parts of the world in recent years has increased demand for commodities and led to a rise in prices. That helped many of the big mining groups who were still recovering from the sharp drop in prices in 2015/16. Demand for metal commodities in China has remained strong and some analysts believe that the authorities there could increase spending on infrastructure if the trade dispute with the US continues, as a way to support economic growth.
The mining sector generally has seen a lot of restructuring over the past few years as many companies addressed large debt levels and attempted to improve their efficiency and profitability.
Those efforts are now beginning to pay off as was made clear in the latest edition of our quarterly Profit Watch publication recently, which showed that growing revenues in the mining sector were a large part of the overall 13.6% rise for UK plc in the year to June.
Thanks to their lower operating costs the recovery in the top line for the mining groups is feeding through more swiftly to profits and leading to a noticeable increase in dividends to shareholders. In August one of the largest, BHP Billiton, announced a record final dividend thanks to a 33% rise in underlying profits due to a combination of generally higher commodity prices and record production levels across several operations, notably copper production which was higher by 8%.
The company has also sold its US shale oil assets to BP for $10.5bn this year, and some of that may be returned to shareholders, but the picture is not entirely rosy. There are signs that some costs are on the rise and demand for steel, produced using iron ore from groups including BHP, has flattened out in China, but we still think BHP is heading back in the right direction and retain our buy recommendation for investors seeking a balanced return and willing to accept a medium to higher level of risk.
BHP’s peer Rio Tinto has also been streamlining its operations and cutting costs. With a stronger balance sheet than many of its rivals the company did not suffer quite as much when commodity prices plunged a few years ago. It was able to return $10bn to shareholders last year and with profits rising again this year it has recently announced a further $7bn will be distributed.
Having sold out of coal some investors are concerned that it is now heavily weighted towards demand for steel as profits on its key constituent, iron ore, accounted for 70% of the total in the first six months of the year.
Despite some short term uncertainties the company remains convinced of the strength of the long term demand outlook and expects global steel demand to rise by 2.5% a year until 2030.
They are therefore keen on progressing with current major investment projects, especially in Australia, along with cost cutting measures and believe that being one of the lowest cost producers of iron ore should give them an advantage over their peers. We continue with our buy recommendation for investors looking for a balanced return and willing to accept a medium to higher level of risk.
While many commodities wax and wane over time one that deserves a long term place in a well-diversified portfolio is gold. The reason is simply that it tends to respond positively to events that cause the value of fixed income and shares to fall.
Gold has maintained its purchasing power despite short-term volatility and moves independently of stocks and bonds so it should, over the longer term, protect your purchasing power.
The price has been falling this year mostly due to the strength of the dollar and expectations for rising US interest rates. But looking ahead higher levels of inflation could provide a boost with a number of factors present that could push it up including tax reform, trade wars, low employment rates and rising wages.
At the same time global production of the shiny stuff has been declining due to higher costs and lower investment. The latter is unlikely to change any time soon as it takes time to appraise, develop and bring mines into production.
One company that has managed to increase its gold production consistently over the years is Randgold Resources, the African miner whose principal operations are in Mali.
The trend towards restructuring and achieving greater efficiency in the mining sector was reflected at Randgold recently with the news that it will be merging with its Canadian peer Barrick Gold to form the world’s largest gold mining group.
The merged group will be the owner of some of the world’s top gold mines in terms of production and reserves, and will have established partnerships with leading Chinese mining companies.
The merger is effectively a takeover without a premium and investors will now need to decide whether they want to end up holding Barrick Gold which trades on the Toronto exchange. We take the view that Randgold investors should cut their losses and sell.
Those looking for an alternative UK-listed gold miner may want to consider Fresnillo which is another FTSE 100 member. Based in Mexico it is one of the world’s largest producers of silver and also owns a number of gold mines.
The half year results in July were mildly positive as production of both gold and silver were higher partly helped by improved grades of ore mined. Management raised the production guidance for the full year for gold but reduced that of silver. We see the stock as suitable for investors seeking longer term capital growth and willing to accept a medium to higher risk exposure.
So overall, the fall in mining stocks may provide a better entry point for investors looking for growth, but with the strength of the dollar and ongoing concerns about economic growth in emerging countries as US interest rates rise, there may be further volatility to come.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.