Commodity Markets, Where To Invest

This story features MOUNT GIBSON IRON LIMITED, and other companies. For more info SHARE ANALYSIS: MGX

The company is included in ALL-ORDS

By Chris Shaw

For some time the dominant theme in markets generally and commodity markets in particular has been uncertainty, but in the view of Barclays Capital, recent sessions have showed some signs investors are now becoming more prepared to again take positions in certain commodities, with oil and gold the first to benefit.

The group points out some of the move in oil is really a catch-up with respect to its underlying fundamentals, but given the lack of any clear picture as to the outlook and condition of global financial markets, there will likely continue to be outside factors that mean markets don’t trade strictly in line with what should be expected based simply on supply and demand fundamentals.

This helps explain why the precious metal sector has also enjoyed renewed buying, with Barclays noting investors have again returned given the “safe haven” status enjoyed by gold in particular. Any boost in oil prices should also flow through into gold and the precious metals given the inflation implications of higher oil prices. Here the group sees risk to the upside given non-OPEC production expectations appear to be overly optimistic at present.

In contrast, the base metals sector is suffering from a combination of poor sentiment and concerns over the health of the global economy as investors look to reduce risk via reducing exposure to the metals. While a relatively soft supply side picture in a number of metals is a positive, Barclays points out this is currently being offset by softer consumption, so a pick-up in activity levels globally will be required to really turn sentiment.

Fundamentally the group sees lead and tin as best placed, though even here there are few obvious positive catalysts, while copper, nickel and zinc could all track lower in coming months in the group’s view. Macquarie is also cautious on the outlook for commodities and agrees with Barclays there are few if any catalysts at present to quickly push prices higher, with the bulk metals being one possible exception.

Given its cautious view on commodity prices, the broker suggests the safest and best way to play the market at present is via quality and liquid stocks, which means most attention should be paid to the global diversified miners. The advantage of investing in these stocks, in its view, is they generate strong cash flow and have solid balance sheets, both of which reduce the investment risks involved.

Moving down the stock list a little further and Macquarie likes Mt Gibson ((MGX)), as it offers exposure only to iron ore and here contract prices are expected to roll over, which means a continuation of good margins for the company. In coal, the broker likes Felix Resources ((FLX)) and Centennial Coal ((CEY)), as coal markets globally are still strong, while Energy Resources of Australia ((ERA)) offers a solid uranium play and OneSteel ((OST)) has an attractive integrated model.

With gold’s role as a hedge against the current market uncertainty, the broker prefers Lihir ((LGL)) and Sino Gold ((SGX)), viewing these as the most attractive among the gold stocks under its coverage.

UBS also sees some value in the diversified miners at present, with the broker pointing out that while it is restricted from making a recommendation with respect to Rio Tinto ((RIO)), the stock is presently trading below its estimated net present value even assuming a bear market outlook for commodities generally.

As the broker notes, if it were to use spot metal prices and foreign exchange rates, flat thermal coal prices, a 30% decline in coking coal and a 10% fall in iron ore prices, its earnings estimates would fall by around 27% in 2009 and 40% in 2010.

But even then the stock would be on a P/E (price to earnings) multiple of only 9x in 2009 and 2010, which would equate to a price to net present value (P/NPV) multiple of just 0.7. This compares with its historical average P/NPV ratio of 1.1x, with a range over the past 28 years of 0.57x to 1.6x.

To give an indication of the market’s view of the stock’s mentioned, the FNArena database Sentiment Indicator shows Mt Gibson scoring a 0.8 rating, Felix a 0.4, Centennial 0.9, ERA 0.6, OneSteel 0.7, Lihir 0.6 and Sino 0.5. The majority of brokers are restricted on both BHP and Rio Tinto given the proposed merger, so the Sentiment Indicator has little meaning at present for both stocks. 

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