FYI | Oct 04 2006
Investors would be forgiven for thinking it’s all over with the great big commodities boom. Share prices for most resources stocks peaked in April-May this year. Since then these shares have been going through one period of volatility morphing into the next one. The end result is huge losses for those who bought too late and didn’t get out.
Meanwhile all of the securities analysts have simply raised their recommendations for individual stocks. BHP Billiton (BHP) and Rio Tinto (RIO) currently enjoy ten positive recommendations which is the maximum achievable given that FN Arena only covers ten leading experts in the local market. But share prices keep on going down, with the odd rebound in between the slides.
There’s something not right here.
Ever had the feeling that something’s not quite what it should be, or what people tell you it is; when something, somewhere tells you there’s more to the story, something you haven’t been able to lay your finger on?
I had a Eureka experience when I read a recent ABN Amro report on the global mining industry today. The report was published last week already but I only picked it up this morning.
I thought it would probably be a good idea to share some of the suggestions and conclusions drawn in the report as I am sure many readers are questioning their conviction regarding the Commodities Super Cycle these days. Especially with the likes of GaveKal stating it is time to say goodbye to commodities and resources stocks.
Share prices will start rebounding soon, suggests ABN Amro. History is providing us with the evidence for this thesis. ABN Amro analysts have trailed through the past few decades and found that share prices tend to bounce back and appreciate further once base metals prices have hit their peaks.
The analysts would argue that “further substantial declines in equity prices this time would be a significant deviation from the historical behaviour of the markets”.
You probably heard this theme over and over and over again over the past few weeks (and admittedly FN Arena as well as myself have delivered our contributions as well) but there are simply too many compelling value reasons why resources stocks cannot remain out of favour for too long. ABN Amro has repeated the same mantra throughout their report.
There will be additional growth, and a big chunk of it will come from the excess cash flows that have been generated during the price rallies. We all know most prices will likely come down but they are to remain at historically elevated levels. ABN Amro believes major support will come from the traditional laggards in the sector, the bulk commodities.
On Monday I wrote that iron ore is likely to surprise over the next half year or so (negotiations for new contract year 2007). ABN analysts agree. They recently increased their iron ore price forecasts to unchanged for next year, from a fall previously, but they expect prices to remain at their current levels for another two years (first price decline in 2009).
Also, don’t forget the healthy balance sheets and cash flows throughout the mining sector are widely expected to drive further consolidation in the sector.
So why are share prices down? Why is BHP closer to $24 than to $30 and Rio equally at 40%+ below its average twelve month price target?
ABN analysts think the market is confused. Well, that’s not exactly what they’re saying, but I think that is a fair summary of their thesis. The analysts suggest the sharp share price declines, after the sector appeared to have recovered from the May slaughter-fest, have now separated the true believers in the Super Cycle from the rest.
But now the market is confused as there are, as one might expect, simply less people with a true conviction in the market than there are “others”. In the absence of a genuine catalyst for the sector, investors turn to macro-economic data, says ABN, and this translates into big sell-offs one day (because some GDP data disappointed, for instance) followed by a sharp rebound the next one (because inventories have fallen to critically low levels).
What the sector needs is a major catalyst, but the analysts suggest between the lines of the report that such a catalyst may well remain absent for the next year or so and investors are therefore likely to take guidance from smaller events and indicators. The result will be ongoing volatility, because one day GDP data will disappoint (or not) and the other day… I am sure you all get the picture.
Bottom line is that the big diversified resources stocks are still trading at or near their Net Present Values (depending on whose calculations we use) and ABN analysts would not think twice and simply buy at current price levels. History shows this is usually a wise investment decision (a point brought forward by quite some other experts recently as well).
Diversifieds are favoured above single commodity plays, for obvious risk reasons. ABN Amro is not a big fan of uranium, but I would add that uranium appears to have all the ingredients in place to positively surprise over the next few years as well. (without the prospects of a protracted negotiation process with the Chinese steel mills).
For those who may have missed it, Paladin Resources (PDN) is currently rated Buy three times out of three while Energy Resources of Australia (ERA) enjoys three Buys out of four.
Till next week!
Your patient as always editor,
Rudi Filapek-Vandyck
(Supported by the Fabulous Three Chris, Greg and Terry)