Mining Sector recovery gathers pace this week

As we have been postulating in our recent blog postings over the last few weeks, and also in the last magazine issue, we believe the mining sector to be widely undervalued.

While global equity markets, led by the US are well off the lows seen at the start of the Great Financial Crisis in 2008, many mining stocks are noticeably depressed with some back at their March 2009 levels.

In looking at the best performers amongst the FTSE 350 sector indices, we have to scroll the mouse down to find the mining sector, so bad has its performance been this year. With underlying commodity prices recovering in recent months from their sell offs during the first half of this year, and additionally benefitting from the QE3 implementation, there seems no real reason to us as to why the mining sector is still lagging behind. It is time to go fishing!

While the FTSE 100 is currently up 6.19% for the year, the FTSE 350 Mining Sector index is down 1.52%. This hides a myriad of underperformers however with the usual suspects Lonmin, Bumi, ENRC topping the fallers list. Since the QE3 announcement the mining sector has actually risen 4.80%, outperforming the FTSE 100 and other sectors but it is still materially undervalued on a PE relative basis. Valuations are in fact back to where they were at the bear market trough of 2009, sentiment is poor and technical’s, notwithstanding the recent rally, are still oversold – in short, this rally is at ground floor in our opinion.

If we look at the table below, we see that the mining sector has in fact been underperforming for the last three years. It is flat in one year, down 21% in two years and flat in three years. But, there is some good news: the sector is the fourth best performer so far this quarter, outpaced only by Personal Goods, General Retailers and Banks. This is a good signal that the reversal in sentiment is underway, particularly considering that many fund managers are presently underweight the sector.

The importance of China for the mining sector also cannot be underestimated as China is a heavy importer of iron ore, gold, oil and many other commodities. As long as the Chinese economy continues its nascent recovery, there is no doubt the benefits will spread to commodities in general, and indirectly enlarge mining companies’ revenues and thus profits.

The current Federal Reserve policy is also in favour of commodities. During the last quantitative easing programs, the mining sector materially outpaced the broader market and there is no reason to expect that this will not happen with QE3. This will additionally create a favourable environment for the mining sector.