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Base metals clobbered

Fear dominates as investors continue heavy sell off of mining stocks; world’s eight leading mining stocks have lost a combined $246bn in just months.

The excitement created by a potential bid by BHP Billiton (BLT.L, £15.10 a share) for Rio Tinto (RPT.L, £51.51), announced November 8, has done little to halt the flow of smart money from mining stocks, on the back of generally falling commodity and metal prices. In the past seven weeks, the price of copper, the leading base metal, has plummeted by nearly 25%.

Stock prices for the world's eight biggest mining stocks are now down by an average of 22% from 12-month highs (in practice, all time highs), representing a collective contraction of $246bn. The outlook appears to be tipped toward further downside. The Bank Credit Analyst, noting a "growth scare unfolding in financial markets", points out that base metal prices, commodity currencies and materials stocks are under pressure. 

Notably, the LME (London Metal Exchange) index of traded metals has broken down both in dollar and euro terms. This is an important point, given that commodity and metal prices are typically quoted in dollars, a currency now in its fifth consecutive year of a severe bear market. A falling dollar tends to support higher commodity and metal prices than would be the case if the dollar was stable.

Broader markets also remain unhelpful. Beyond ongoing fears over the near-contagion triggered by the US sub prime market crisis, analysts are also warning over risks of a serious global economic downturn on the scale of the early 1980s recession. Here, the culprit is a commodity, crude oil, which has recently traded close to $100 a barrel. 

Experts at Cambridge Energy Research Associates note that while analysts' predictions of economic disaster as oil prices have shattered records in recent years have proven premature, crude oil prices above $90 a barrel are more likely to have an impact.  Prices in the $90s have negative impacts on the global economy and consumer spending, according to CERA.

The full effects are yet to be seen, given that the year-to-date annual price for oil this year has been around $70 a barrel. CERA reckons that if oil prices were to average $110 for six months or more, it would increase the world economy's vulnerability to a serious downturn of the early 1980s type.

This gloomy, but specific, analysis may assume more serious proportions as risk aversion mounts amid mounting concerns over a severe year-end liquidity squeeze.

Recent trading data has shown a continued unwinding of the Japanese yen-funded carry-trade on credit woes and recession fears; the yield on the 10-year US Treasury note recently plunged to a two-year low as investors increasingly look for park offs in safe assets. But just as all base metals have slid in the past few weeks, there are the inevitable strong individual performances within the overall commodities and metals universe.

Gold bullion continues to play a dual role as metal and a safe haven asset, with its recent strength further underpinned by a weak dollar. Also in the precious metals complex, platinum continues to benefit from rising supply worries; the metal hit a record high of $1 486 an ounce on Monday.

Investors, however, continue to adopt a cautious stance towards precious metal stocks. Barrick (ABX, $41.40), the world's leading gold stock, is 13% off its highs. Most platinum stocks remain in the doldrums, despite record metal prices.

Changes remain afoot in China, epicenter of global economic growth. There are more signs that China's governmental lending restrictions - arising from the 17th Party Congress - indicate that a significant and controlled change is now taking place in the implementation of policy and the structure of future economic growth. Far greater emphasis will be given to rectifying the imbalances in the economy, in paying attention to social needs (education, health care, etc.), to energy conservation (and what that means for industry), and to the environment. Growth should continue but at a slower pace, as evidenced by China's most recent economic data.

The overall recommendation from BCA Research is for a more cautious stance to commodities and metals in the near term, given increasing risks in and around cycle-sensitive assets.  Beyond the warning signs on both fundamental and market factors, BCA Research further cautions that further downside cannot be ruled out "as speculative positioning remains elevated". 

There are also special and specific risks attached to the value of the dollar. A renewed vigor in the dollar could also spur a wave of capitulation out of commodities (especially precious metals, according to BCA Research) as investors who sought safe havens from a falling dollar unwind positions.

"Nevertheless" states BCA Research, "we advise against taking an outright bearish stance as we believe that reflation will eventually work". The Federal Reserve, the US central bank, is expected to lead a fresh round of interest rate cuts.

World's biggest mining stocks

 

Stock priceFrom high*Value US$bn
BHP Billiton£15.10-20.4%192.0
CVRD$31.00-19.1%152.5
ShenhuaHKD 42.70-26.3%145.1
Rio Tinto£51.51-13.1%143.4
Anglo American£28.24-26.1%86.6
ChalcoHKD 16.24-38.4%64.1
Xstrata£30.25-17.8%58.6
Norilsk$301.10-10.4%57.4
Average/total-21.5%899.7

* 12-month

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