Weak Pound May Be The Only Thing Digging Big Miners Out of Their Funk
Mining has been one of the few bright spots in London's post-Brexit stock market with names like BHP Billiton (BHP) - Get Report , Rio Tinto (RIO) - Get Report and even perennial loser Anglo American all posting strong gains.
Rio was up again on Thursday, climbing 2.53% to 2,389 pence, taking its gain since the referendum on June 23 to 14%, BHP gained 4% to 969.7, up 11.7% since the vote, while Anglo American jumped 5.9% to 772.9 pence, up 11% since the referendum.
Those gains give hope that the mining sector has finally caught some favorable tail winds after years of battling commodity price headwinds. Yet there is much to suggest that the rally is more a case of any port in a storm and will be short lived.
"The recent rally in the mining space post Brexit has been due in our view to investors rotating out of U.K.-exposed names to other names, a move from which mining stocks have benefited," noted Goldman Sachs analysts earlier this week.
The London-listed mining stocks at first glance appear a good defense against a Brexit-induced decline in U.K. economic activity. Minerals and ores are priced in dollars, protecting earnings from the falling pound, while Britain's often lamented lack of manufacturing means pound-denominated earnings account for a vanishingly small percentage of sales.
Currency movements, however, also play a key role in exaggerating the gains made by UK-listed mining stocks. The pound's 11.6% fall since June 23 means investors in London-listed mining stocks have seen little gain in dollar terms. Tellingly, BHP's NYSE-listed American Depository Receipts are down 2.8% over the period since the vote, Rio Tinto's ADRs are marginally lower over the same period.
Worse could be to come.
Mining is not a traditional safe-haven sector. It may have provided a quick escape from the immediate carnage of Brexit, but investors are unlikely to continue to support the sector if the contagion hits European and U.S. growth. Or as Goldman puts it, "As [the] market moves to a more risk-off environment mining stocks are likely to be affected."
If that happens the falls could be sharp. There is little in the fundamentals for miners to suggest they warrant a positive re-rating. China's trend to slower growth remains unchanged, despite state intervention in the form of lower interest rates and an easing of restrictions on bank and home lending.
Worryingly, Chinese stocks of iron ore, a key commodity for both BHP and Rio, increased sharply over the start of the year as buyers took advantage of low prices. Imports rose about 9% in the period from January to May, year on year, even as crude steel production slipped 1.4% over the same period, according to a July 6 note from Australia-based Commonwealth Bank mining and energy analyst Vivek Dhar.
That increase in stock is likely to weigh heavily on prices as Chinese building activity slows toward the end of summer and could be compounded by new supply coming online from Australia and Brazil, where miners have ramped up production following the recent price rises.
"We see prices returning to $40-$45/tonne...in 2H16 as surplus risks mount," noted Dhar.
Similar pressures are emerging elsewhere too, as recent price increases have leaned on the supply side of the scale.
"Coal supply [trade] is now lifting again from marginal suppliers," UBS analysts including Daniel Morgan and Lachlan Shaw noted on Thursday. "Copper mine supply shuts have stalled. Restarts are also a big theme in China for aluminium and alumina."