Each week, a professional investor tells MoneyWeek where he'd put his money now. This week: Bradley Mitchell, manager of Royal London UK Growth Trust, Royal London Asset Management.
It's been tough being a mining bull in recent weeks. Suggest that the sector is oversold and you are drowned out by a chorus of bears telling you "it's over"; "metal prices will crash"; "the sector's lost its momentum" and "look at the charts!" I feel like a panellist on the radio programme Just a Minute; every time I try to argue my case using fundamentals, facts and valuation, the buzzer goes. This is a market driven by sentiment and momentum and it is very hard to swim against this particular tide. But here goes.
Miners have been sold off for several reasons. Firstly, the banks have started to rally (for now, at least) and investors are probably funding these purchases by selling miners. Secondly, we are seeing downgrades in forecasts for global economic growth. Many commentators believe this pulls the rug from under miners' feet as the news flow is now seen as poor. Finally, certain metals have had sharp price corrections, which is considered proof that prices overall are falling.
Much of this is noise. It's important that we get back to the fundamentals of supply and demand. Some commodity prices have held up and even continued to rise. These tend to be those where the price is set by contract negotiations, meaning they more accurately reflect what's happening in the real world. As these prices aren't set on a daily basis, they are not influenced by speculation. Examples include iron ore and coal, where prices have risen and we have price visibility for up to a year ahead. No speculation here – just a straightforward assessment of intrinsic worth.
Then there's copper. Copper demand remains very healthy – hardly surprising, given that China accounts for 25% of world demand, compared to just 10% for America. Yet despite record prices, we are likely to see flat, or even falling, production growth during 2008, and last year wasn't much better. This is the key reason why commodity prices will stay high. To paraphrase Bill Clinton, "It's the supply side, stupid!". There is very little spare copper around and no reason to expect a surge in supply anytime soon. We could, therefore, see a surge in the copper price later this year.
Given these drivers, there is little real evidence to support a universal collapse in commodity prices. The supply response has been pitiful for major commodities such as iron ore, platinum, ferrochrome, coal and copper. As for the demand side, do we really think that China or India are going to stop building coal power stations? On this basis, mining stocks are cheap, spectacularly so in terms of their p/e ratios and cash flows. They are still being valued as deep cyclical stocks, reflecting investor prejudice built up over decades. These low valuations are already driving mergers and acquisition activity and the Chinese remain keen to acquire long-term supplies of strategically vital mineral supplies.
Two stocks in particular look set to benefit from this backdrop. Xstrata's (LSE:XTA) strong positions in a range of under-supplied commodities will help it boost profits in years to come. International Ferro Metals (LSE:IFL) is one of very few specialist producers of ferrochrome, an essential ingredient in producing stainless steel. Strong demand from the developing world should ensure a steady pipeline of orders and a resilient share price.
Published in Tips & advice
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Bradley Mitchell
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