An ill wind is blowing across UK mining stocks, which are trading at around a five-year low. Stocks, however, are offering tempting dividend yields and some momentum-driven traders are predicting the cycle is about to turn. Volatile mining stocks have long been popular with individual investors with a more aggressive approach to risk. But is now the time to buy in, or does the sector remain too unpredictable for even the very brave?
The first thing private investors should be aware of is what is happening in China. The fall in mining shares can be blamed on slowing growth in the world’s second-largest economy, which has historically been the major global consumer of most commodities, from copper to cotton.
The China slowdown is not miners’ only problem. For several years until around 2012, the industry invested heavily in new mines, then greatly increased their production of commodities such as the steelmaking material iron ore.
So metals prices have been falling.
To fund their investments, many mining companies loaded up with debt. Lower commodity prices have made it harder to service such borrowings. FTSE 100 miner Glencore, for example, is selling mines to repay loans and shore up its balance sheet.
Amid all this pain, some analysts are exhorting brave investors to buy into the mining sector now, claiming the market has reached a nadir and is set to bounce back.
One thing that is exciting mining bulls is the US Federal Reserve, which has backtracked on hints it is going to raise interest rates, which in turn creates a better outlook for investment into the emerging markets that miners depend on for commodities demand. Futures markets imply just a 10 per cent chance of a rate increase this month, according to Bloomberg, down from almost 50 per cent in mid-July.
Private investors, however, should remain cautious, advises Russ Mould, AJ Bell investment director. He sees little point in including this high-risk asset class within a balanced retirement portfolio.
Miners have “high operational gearing and high financial gearing”, he says, meaning that the high cost of running mines and the large loans they must take on to build them leave them vulnerable to economic downturns.
This leverage, Mr Mould says, means mining shares “often outperform when global economic growth is strong, though they can underperform in tougher times and they also do not have much pricing power [over customers] as commodities prices are what they are”.
Mining stocks, he says, are “a play on global economic growth, and if you just want that, you can buy a global equities fund and wait for time to increase the value of your money”.
For short-term traders, there are reasons to go against the selling trend in the mining sector.
Investment banks have been almost uniformly reducing their price forecasts for commodities, while betting against mining stocks by short sellers, according to figures from JPMorgan, is close to a historical high of just under 5 per cent. If everyone is selling, it could be the end of that trade, and this idea has already caught the imagination of some private investors.
“Clients within our more momentum-driven customer base are trying to catch the bottom in these more volatile mining names,” says Mr Mould.
FTSE 350 mining shares are currently offering high dividend yields on average.
But the level of dividend cover these companies offer is only around 1.1 times, which is not a high enough earnings-to-payout ratio for investors to be comfortable the dividends can be maintained, Mr Mould advises.
China offers another kind of bear signal. When the nation’s property market and industrial base was firing on all cylinders, the country was gobbling up iron ore and copper. Now, however, capacity in its idling steel mills means China is exporting ever more steel to the rest of the world instead of using it at home.
The investment outlook for mining stocks could not be more uncertain, and even at current low valuations, the sector appears risky. Five years ago, mining bulls talked about a “commodities supercycle”. It now appears to have suffered a puncture.
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